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Executives

Bill McComb - CEO

Andy Warren - CFO

Dave DeMattei - CEO of Lucky Brand Jeans

Analysts

Edward Yruma - KeyBanc

Omar Saad - Credit Suisse

Bob Drbul - Barclays Capital

Kate McShane - Citi Investment Research

Mary Gilbert - Imperial Capital

Chi Lee - Morgan Stanley

Jennifer Black - Jennifer Black & Associates

Jim Chartier - Monness, Crespi, Hardt & Co.

Liz Claiborne Inc. (LIZ) Q1 2010 Earnings Call May 6, 2010 10:00 AM ET

Operator

Good morning, everyone, and welcome to the Liz Claiborne first quarter 2010 conference call, hosted by Chief Executive Officer Bill McComb. After the opening remarks we will be taking questions. This call is being recorded and is copyrighted material. Therefore, please note that it cannot be recorded, transcribed, or re-broadcasted without Liz Claiborne’s permission.

Your participation implies compliance with these requirements. If you do not agree, simply drop off the line. Please note that there will be a slide presentation accompanying the prepared remarks. The slides and earnings release can be accessed at www.lizclaiborneinc.com in the Investor Relations section. There are separate links to the slides for webcast and phone participants.

Please note that statements made during this call that relate to the companies future performance and future events are forward-looking statements within the Private Securities Litigation Reform Act. These forward-looking statements are based on current expectations and are subject to the qualifications set out in this morning’s press release, as well as in the company’s first quarter 2010 quarterly report on Form 10-Q under the captions Item 1A Risk Factors and Statement Regarding Forward-looking Statements being filed today with the SEC.

Also, please note that during this call, and in the accompanying slides and press release, net sales, gross profit, gross margin, SG&A, SG&A as a percentage of sales, operating income or loss, operating margins, income or loss from continuing operations and EPS, are presented on both a GAAP and a non-GAAP basis. Reconciliations of adjusted results to the actual results are available in the tables attached to the earnings release and slides captioned Reconciliation of Non-GAAP Financial Information. The Company believes that the adjusted results represent a more meaningful representation of its historical operations and financial performance since they provide period-to-period comparisons that are consistent and more easily understood.

Now, I would like to turn the call over to your host, Mr. McComb. Please go ahead, sir.

Bill McComb

Good morning. Welcome to our first quarter 2010 earnings call. Today, we’ll report on the results posted in this morning’s earnings release. As you just heard, we are broadcasting today with speaker support slides, which are available via the Liz Claiborne corporate website, from the Investor Relations section. These slides will then be available after the call on that site as well.

With me today here are Andy Warren, our CFO, and Dave DeMattei, our new CEO of Lucky Brand Jeans. I’ll start by providing an overall perspective on the quarter and the year ahead, including our view of second quarter. Andy will take you through an in-depth review of the first quarter. I’ll then walk you through the segment results, and finally, prior to Q&A, we’ll introduce Dave DeMattei, who will share his perspective on his first 100 days at Lucky Brand, in the same way that Thomas Grote, of Mexx, did back in February.

Before we dive into the results and our commentary, I want to reiterate our key themes for 2010, in the context of our longer-range plans to achieve, by the end of 2012, the minimum threshold goals that we presented on her last earnings call. You should recall that those goals included realizing an EBITDA margin of 10% or greater, generating cumulative operating cash flow over the next three years of at least $600 million, and 2012 adjusted earnings per share of $1 or more.

To remind you, we said previously that 2010 would be marked by continuing losses throughout the first half, largely driven by next year of troughing prior to relaunch this fall, and sales of the department store Liz Claiborne brand being suspended during our major transition from traditional department store customers, to JCPenney and QVC this August.

In addition, some remaining operational challenges including returning our licensed DKNY Jeans business to profitability, reversing the long declining Liz Outlet business, and addressing the Liz International franchise, will contribute to operating losses in the first half. But, importantly, our plan for 2010 calls for sequential improvement in virtually all of the metrics in the back half of this year, as we make progress with each of those callouts, Mexx beginning its long awaited product and brand relaunch under new management, high profile launches of the Liz brand with committed and outstanding partners, and improvements on each of the moving parts inside partner brands.

Moreover, we expect to see continued momentum at Kate Spade and Juicy Couture, continued success at Mexx Canada, and a relaunch of Lucky Brand Jeans, which you’ll hear more about today. We expect to improve margins throughout the businesses in the second half, and although we’re not forecasting robust increases in traffic, we do expect positive comps in the direct brands.

So, against that backdrop, I’d say that I’m happy with the progress we’ve made in the first quarter. We realized improvement on gross margin in total. We achieved positive retail comps at Juicy and Kate Spade. We initiated significant changes at Lucky Brand, implemented an inventory clearance strategy which brought down AURs significantly, and drove negative comps, but achieved our goal of cleaning out the system very effectively.

At Mexx Europe, we’re executing the plan that Thomas outlined on the year end call, focusing on product development efforts for the fall relaunch, to address higher quality levels, and much more productive assortment strategies. I’m pleased with the product and merchandising initiatives that I’ve seen for the second half across the businesses, and thrilled with the transition taking place for the Liz Claiborne brand franchise at both JCPenney and QVC, where our aggressive launch plans are only getting stronger since we last talked. We’ve made the improvements to the licensed DKNY Jeans business that should help us get back to profitability during the fourth quarter, and we remained focused on fixing the Liz International and outlet businesses as well.

So, looking forward at second quarter, here, in the meantime, adjusted results for second quarter will be slightly worse than first quarter, although the assumptions are generally unchanged. The themes will be consistent with the first quarter, a strong concentration of sales from our own retail network, overall gross margin improvement, sales expansion at both Juicy and Kate Spade, and additional inventory clearing of aged product at Lucky Brand, driving negative comps and compressing gross margins there, again.

Additional pressure adding to the second quarter earnings decrease includes declining wholesale shipments at Lucky and continued trough earnings at Mexx Europe. Healthy and consistent results at Mexx Canada are expected to continue, and a final hiatus quarter on the Liz Claiborne wholesale business. In essence, we see a repeat of first quarter with an adjusted EPS loss of $0.45 to $0.55. So, even with the still tough first half, we said in February that all of this nets to a plan that would stretch to break even. That remains our management mantra and clearly the ultimate goal.

While it is still a possibility, a breakeven adjusted operating profit for the total year is not the most likely scenario. We still lack the visibility to be able to actually provide an adjusted earnings guidance range for the year. But, we continue to expect meaningful operating profit improvements in both the third and fourth quarters, with important momentum drivers taking us in to 2011, with Mexx Europe on a turn-around trajectory, Lucky Brand Jeans showing positive comps and margin expansion, single digit comp growth at Juicy and double digit comp growth at Kate Spade, earnings expansion in both, and profit and expense momentum in partner brands.

With that, we believe that we’re still on the path to achieving or exceeding the EBITDA, operating cash flow, and EPS threshold goals by the end of 2012. I continue to have faith in our strategy, our brands, and our people. We are in the midst of building a world class company on the strength of a handful of magnificent brands, brands that we believe have significant and sustainable earnings power as our product retailing and marketing capabilities take better shape, and our distribution strategies get in sync with available profit pools.

We’re doing this with a healthy mix of new and legacy people, absolutely determined leaders. I believe the thesis supporting an investment in our corporation remains very strong. We believe that the prospects for sales and margin expansions at Juicy, Lucky Brand, Kate Spade, and Mexx, over time, around the world, across product categories and demographics, all remain very solid. Now that liquidity is officially off the table as a looming short-term threat, we hunker down in execution mode. The payoff is within sight for our patient and supportive investor base.

So, now that I’ve given you my perspective on the quarter in the context of the total year ahead, let’s proceed with a thorough review of first quarter results. Andy, take it away.

Andy Warren

Thank you, Bill, and good morning everyone. I’ll start today by walking your through the first quarter adjusted results and our key financial metrics. Slide seven lays out our first quarter operating results against operating assumptions that we previewed with you back in February on our fourth quarter conference call.

Overall, our financial results were generally in line with our expectations. Our sales are down 22% year-over-year, compared to our guidance of down 20% to 25%. We have a sales bridge laying out these top line trends later in the presentation. Adjusted gross profit fell short of our operating assumptions, improving by 150 basis points versus the 200 to 300 point improvement we guided. I will walk you through a more granular view of our gross margin trends by segment in a few slides.

But, in summary, this lower margin was driven by the strategic operating decisions we made at Lucky Brand and Mexx Europe to accelerate liquidation of prior season product, and earn a more significantly improved margins for the second half of the year. We continued to over deliver in our cost productivity commitments, with total adjusted SG&A down year-over-year $56 million, beating guidance by $11 million. We have now reduced our full year adjusted SG&A assumption, based upon this positive first quarter cost trend, as well as the forecasted weaker Euro.

Adjusted operating loss and EPS were also favorable compared to our expectations. We posted results better than guidance with an adjusted operating loss of $52 million and adjusted EPS of negative $0.38. This adjusted EPS falls in line with our expectations to exclude the non-cash FX translation gain related to the de-designated portion of the Euro bond hedge, and the associated change to our effective tax rate due to variances in the mix of adjusted pretax results, which net to $0.09 per share.

Balance sheet progress was impressive for the quarter. Total inventories are down 28%, accounts receivable down 34%, and very importantly, our asset based bank facility borrowings were down $233 million year-over-year, while total debt was reduced by $163 million. Lastly, we ended the quarter with significant borrowing availability of $248 million. Needless to say, we remain highly focused and have been very successful in managing cash and deleveraging the company.

Moving now to slide eight. I’ll let the slide speak for itself. You can see the quick snapshot of our first quarter adjusted P&L, versus our 1Q 2009 performance. On slide nine, we bridged a 22% year-over-year adjusted net sales decrease. The partner brand segment drove approximately 75% of the first quarter sales decline, primarily due to the Liz Claiborne brand’s hiatus in department stores.

As we outlined when we provided the first quarter guidance, the Liz Claiborne brand was planned with no first-quarter shipments to department stores, as we transition the business model for our launch at JCPenney and QVC in August. Our license DKNY Jeans business, which we believe will perform significantly better in the second half, as well as the Liz Outlet traffic issues that Bill highlighted, also contributed to the drop in sales at partner brands.

International-based direct brands declined $27 million year-over-year. This decline was mainly driven by Mexx Europe, wholesale rationalization, fewer doors, and reduced open-to-buys, slightly offset by increased retail sales at Mexx Canada. Domestic based direct brands net sales declined $17 million. This decrease was mostly attributable to reduced wholesale shipments for Juicy, as well as Lucky specialty comp store declines. These decreases were partially offset by strong increases across all channels of Kate Spade.

On the next slide, we have broken out our first quarter adjusted gross margin trend by segment. Overall, adjusted gross margin increased 150 basis points year-over-year. Domestic based direct brands, Juicy, Lucky, and Kate Spade combined had a healthy adjusted gross margin of over 54%, up 218 basis points versus last year. Excluding Lucky results, which are negatively impacted by the heavy inventory liquidation strategy, this segment would have realized an adjusted gross margin increase of over 500 basis points.

I’ll let Dave DeMattei walk you through the compelling strategic and financial rationale for this Lucky liquidation later in the call. Partner brands adjusted gross margin was essentially flat year-over-year.

In the second half of the year, the JCPenney and QVC deals will have a positive impact on gross margins as we align with JCPenney via net sales licensing fee and gross profit sharing model, as well as QVC via net sales licensing fee model. International based direct brands, our Mexx business, had gross margin declines of 362 basis points versus last year, while Mexx Canada maintained healthy gross margins of 58%, growing by 629 basis points.

Our Mexx Europe business was down 613 basis points in gross margin. Mexx Europe was also liquidating old inventories in order to maximize the impact and value of the new team’s fall product arriving in stores this August. Gross margin betterment across all of our segments continues to be a key imperative for 2010. Although our first quarter was slightly below our expectations, we believe that our merchandising strategies, retail execution, and approved sourcing initiatives will deliver the 500 basis point total year gross margin improvement we are guiding to today.

On slide 11, our year-over-year first quarter adjusted SG&A trend reflects our continued, highly successful cost productivity efforts, with adjusted SG&A down 14%. Down 17% when you exclude the impact of foreign currency exchange rates. We have dramatically reduced costs in partner brands and corporate overhead, which contributed to approximately 75% of this total cost reduction. We have also significantly decreased expenses in international based direct brands, mainly driven by Mexx Europe.

We are benefiting now from the annualization of the many cost reduction efforts we have rigorously executed upon last year. As you may recall from the fourth quarter call, we also looked at cost efficiencies at Lucky, Juicy, and Kate in order to reduce expenses without taking away from the consumer experience these brands offer. Therefore, we also posted a $10 million year-over-year reduction in domestic-based direct brand adjusted SG&A.

Now on slide 12, let me take a deeper look at the operating goals and assumption page that Bill discussed earlier. First, we are now forecasting sales to be down 10% to 15% for the year versus our year end conference call view of down approximately 10%. This lower sales expectation is driven by reduced sales at Mexx Europe, Liz Outlet, and Lucky, coupled with the FX impact from the weaker Euro. Second, while we are seeing a robust 500 base point gross margin improvement year-over-year, this is 100 points lower than our previous view.

Two factors are driving this reduced expectation. First, inventory liquidation at Lucky and Mexx Europe are depressing total company margins. Second, we are beginning to see real second half sourcing inflation. Cotton prices are higher, the reduced Asian factory base is experiencing increase of utilization, and freight costs are significantly higher than previously thought. Our global sourcing initiatives are focused on offsetting as much inflationary pressure as possible.

Third, we have re-baselined our full-year cost outlook, and now plan adjusted SG&A to be no more than $1.41 billion in 2010, versus our previous $1.46 billion view. This $50 million improvement in total cost assumption is driven by our continuing efforts to drive and realize better cost productivity across all of our global platforms, as well as the benefit of the weaker Euro.

As Bill stated, while our stretching to break even operating assumption is a viable scenario, it is not our most likely outcome for the year. We are forecasting sequential improvement throughout 2010. In the third quarter we expect positive adjusted operating income with a breakeven adjusted EPS. In the fourth quarter, we expect significantly improved adjusted operating income with a positive adjusted EPS.

Slide 13 speaks for itself. Let me highlight a few important metrics. First, total debt was reduced significantly by $163 million, a 22% decline year-over-year. We ended the quarter with $591 million versus $754 million in total debt, a huge accomplishment. Secondly, cash flow from continued operations over the last 12 months was $216 million, including the receipt of $165 million in net income tax refunds. Lastly, capital expenditures were $63 million for the last 12 months. This year we have planned our capital expenditures to be approximately $90 million, compared to $73 million in 2009, as we expect to open approximately 25 additional retail and outlet stores globally.

On to the next slide, we continue to thoughtfully reduce inventory levels with international and domestic based direct brand inventories down 20% and 21% respectively, compared to 1Q of 2009. This reflects conservative and focused inventory management. Partner brand inventories were down 46% in the quarter, as they manage inflows and properly adjusted inventory levels to sales.

As a Company, we are focused on key metrics that measure the efficiency of our inventory management now more than ever. Although we have successfully reduced inventories year-over-year for ten consecutive quarters, including this quarter, we are now mindful that the remaining quarters of 2010 will be a different story, in order to support our back half sales and gross margin plans, especially in our domestic-based direct brand retail and outlet stores.

Now, let’s review our total company debt. We remain highly focused and committed to deleveraging the company throughout 2010. We will continue to utilize 100% of our free cash flow to reduce debt, and plan no share repurchases or acquisitions in the near or medium term.

I have walked you through our availability calculation on prior conference calls, so, today on slide 16, I’ll simply update you on the numbers. At the end of the first quarter, our availability was a robust $248 million. Our actions are focused on keeping that availability high enough to meet our needs in any economic or operating scenario. Based upon our current forecasts and operating assumptions, we are comfortable with our forward-looking availability forecasts.

This leads into our next slide. We are thrilled to announce today our $350 million amendment and extended revolving credit facility. This new bank deal has all the right and critical elements for us, 4.25 year tenure, a $45 million minimum availability covenant, replacing the spring and fixed charge covenant, better pricing with no LIBOR floor, and represents a smaller, highly supportive bank group. Let me comment on the $350 million facility size, versus the previous $600 million. At the end of 1Q 2010, our calculated borrowing base was $310 million, fully $290 million below the previous $600 million facility size.

Given our highly successful working capital reduction initiatives that have greatly reduced our forecasted borrowing base, as well as our desire to optimize future borrowing needs with current borrowing costs, we are very comfortable that a $350 million facility size is more than sufficient to meet our forecasted borrowing needs. This is indeed a very big announcement for us. The 2008 credit shock and ensuing recession made our liquidity a real concern. Through or Intense focus on cash generation, debt reduction and now this four-plus year bank deal, we now plan to stop talking about liquidity as the main theme on these conference calls going forward.

Thanks for listening, and now I’ll turn the call back over to Bill to discuss our segment results.

Bill McComb

Thank you, Andy. Looking now, here in the slide deck at slide page 18, Domestic based Direct Brands First Quarter Performance. I’m happy to report that our direct brands cut their first quarter loss by over 50%. Keep in mind that given a mixed shift toward our own retail stores, and the fact that we have still December year-end retail seasonality, lends itself to losses in our first quarter, so we’re pleased to see that narrow. 56% of the segment sales were retail this year, versus 51% last year. The over 200 basis point improvement in adjusted gross margin that you see here reflects this mixed shift, as well as reduced markdowns at Juicy and improved IMU and overall gross margin at Kate Spade, offset then by a rather large hit to Lucky’s gross margin in the quarter.

Sales results this quarter, down 6.4% overall, reflect the different stages of strategic progress of our three US based direct brands. This is evident in the clear divergence in sales performance by brand. Juicy was down 12% overall due to the strategic reduction in the wholesale business that we undertook beginning in the second quarter of 2009, which we’ve now fully anniversaried. Comp store sales at Juicy were up 4%. Where Lucky Brand Jeans, the decline in total and comp sales was due primarily to three things.

First, a decleansing or our inventories in the quarter. Second, a decrease in traffic. Third, an under inventoried position primarily in women’s in our full price stores. With our domestic based brand inventories down 21% at the end of the first quarter, we’re now seeing mounting evidence that this is just too low. Dave DeMattei will have more to say on that, as it applies to Lucky in just a few minutes. Although still small in the context of our overall Corporation, the Kate Spade business is doing very well, and the future appears to be extremely bright for this brand.

Sales are growing and margins are expanding, driven by the retail channel where comp store sales are up 20%. We continue to migrate sales to our own stores, with projected sales through the wholesale channel purposely planned down slightly in all four quarters of the year.

Page 19, Recent Comp Store Sales. Comp store sales across our brands diverge with Juicy showing an improvement during the quarter. At Kate Spade we saw a true acceleration. At Lucky Brand they took some very deep markdowns to clear inventory and yet lacked depth on bestsellers and women’s, which hindered sales. The one common theme across the brands is that traffic trends remained subdued across channels, particularly in mall locations. This is beginning to emerge as what I’ll call a soft concern as we look forward. The consumer is not back in force. Those that are shopping want to buy so we’re converting our customer base very well, but I would say that there are many that have still not returned to the stores. Improved conversion and UPTs were the key drivers to same-store sales in the quarter.

Slide 20, Partnered Brands First Quarter Performance. You already know most of the story in this segment. We’re on hiatus with the Liz Claiborne brand in domestic department stores until August, so reported sales are down dramatically. The area that I’d like to call out, though, as the ongoing problem child remains the Liz Claiborne New York Outlet business. We’re not getting the traffic that we need in these large boxes to turn this business, in terms of profitability. After gaining positive traction on the Isaac designed LCNY goods through the first half of 2009 and into the second, the fall season goods just did not perform at all.

And the AUR and the gross margin turned south, reversing the upward trend that we had seen. In the first quarter 2010 these numbers came down even further. We spent the quarter marking down inventory, driving poor margins but outstanding conversions. Here, we have a situation where we have a strong brand name, good location, favorable leases, and a channel that does have momentum, yet we’re not producing positive economics yet. So, we’re in the midst, and I mean literally this week, of changing over our strategy there again.

If you go to any of these locations this weekend, you’ll see the implementation of a formula that more dramatically communicates the strong value proposition of our pricing. The first formula we’ve tested that truly made a difference in traffic into the store, we’ve enhanced in-store presentation and clearly and uniformly communicated the pricing of both our made for outlet and clearance product, identifying and communicating with bold signage to clearance section in the back.

In tests we rapidly cleared aging inventory, which remains a big problem for this business, and at the same time saw significantly improved full price sell-throughs. We’ll take a hit in second quarter as we clear our inventory positions of clearance goods, which will add to the earnings pressure that we forecasted for the quarter.

The goods designed exclusively for outlet will hit the floor in full force this August. These venerable Liz Claiborne New York key items, including Carefree blouses, tees, camies, and basic denim in proven and well-established missy and women’s fits. These are all key items that have historically and currently enjoyed high sell-throughs in our outlets.

We’ll learn in the next four months whether we can retrain the shopper to explore the brand at outlets, given the very strong value proposition communicated at the store level at the lease line. There appears to be the makings of a real profit formula here, once we get the consumer formula right. I think we all agree that our attempts have been too ambitious, I would say, in pursuit of fashion and elevation at the expense of what the core Liz Claiborne New York customer wants, needs, and is willing to spend at outlet.

Moving now to slide 21. This is what I call our momentum chart for partnered brand. It shows, using red minuses and green pluses, the directional momentum of each of the important partnered brands businesses. We just discussed that outlets saw deteriorating position as traffic stalled and clearance product piled up. We certainly hope that our new tactics as tested will deliver and believe they will.

At the same time, the outlook at our licensed DKNY Jeans business is getting better. We have been able to improve product considerably for fall and holiday, and given our current view of wholesale sales and margins going forward, we project a positive operating profit for this business in the fourth quarter. Liz International has no changes to report right now, although we are exploring expansion of the brands through licenses in some markets around the world, and I hope to be able to report a green plus sign here during the second half.

Finally, Monet and Kensie are tracking with positive momentum and are stable right now, and, of course, the Liz Claiborne domestic business model has strong momentum with our partners. In fact, turning here to slide 22, called JCPenney update, here are some important highlights from the JC Penny analyst day two weeks ago. Many of you will know that Mike Ullman announced they will be launching 30 product categories with the Liz Claiborne name in August 2010. They also reported that Liz Claiborne is their shoppers number one recognized brand name, and that Liz is the most desired brand at better pricing.

JCPenney sees the brand as a storewide traffic-driving opportunity, and their own research supports that new customers will enter the store to buy the brand. In support of the brand, they will be eliminating what they refer to as some peripheral brands to make space for the launch and that the Liz & Co. business today continues to show very strong momentum with double-digit year-over-year sales growth and gross margins that continue to expand.

We’re very pleased with the collaboration between our companies and the highly motivated nature of the combined team to relaunch the brand in these great stores, we could not be happier. JCPenney will give the brand outstanding treatment in store, and we know from experience how successful they are in rolling out and flawlessly executing floor sets.

Turning to slide 24, International-based Direct Brands. We showed two very different Mexx businesses here, Canada and Europe, as you’ve seen in the past. Total sales were essentially flat in Canada for the quarter, while Mexx Europe is troughing, as I said earlier in the call, with product problems stemming from poor quality and bad fit. Issues that I blame on the lack of leadership during the transition period to our new management team. Comps for the quarter were down 10% at Mexx Europe, and adjusted gross margins for the segment remain depressed at 48%.

You heard in February from Thomas Grote about his plans to restore and re-energize the Mexx Europe business, a business with highly renewable brand equity throughout continental Europe. We’ve said the first signs of vitality will come from comp store sales in September through December, and wholesale sell-throughs in that same period. We’re completing fall and winter wholesale markets now, and we’re encouraged by the early reads. Western Europe orders for August and September are down only 7% on the core businesses versus last year. The decreases there were driven by accounts that didn’t come to the showroom at all.

In Eastern Europe receipts were actually up 8% for August and September, a very encouraging and important sign. We know wholesale will lag retail, so the prospects of a meaningful recovery of lost sales at wholesale will require at least one to two full seasons of positive consumer reaction. Wholesalers applauded the embrace of quality fabrics and manufacturing, the improved value of money that is obvious in the products, the commercialness of the line, including big changes in the assortment strategy.

We’ve also received positive comments on both the look and feel of the marketing campaigns which begin in September. At this point, there is nothing else to say about that business except we are keeping our heads down and focusing on fall.

Now, I’d like to introduce Dave DeMattei, our CEO at Lucky Brand. Dave began in his new role on January 4. I’ve asked him to come and share some early thoughts about the brand, including why he chose to come to Lucky Brand, early observations on the brand vision, what he focused on in the first quarter, and why he made the decisions he did on inventory, and how it will help straighten out the performance of this very important business, and how he sees the business going forward.

Like Thomas Grote, Dave would prefer to not make comments at all in advance of actually just delivering the improvement and unlocking the potential of the business. But, since many have asked questions about his insights and progress to date, we’ve gone ahead and asked him to join us on the call today. So, let me hand it over to Dave. Dave.

Dave DeMattei

Thanks, Bill. I’m very excited to lead Lucky Brand into its next chapter, and I’m pleased to have this opportunity to share with you why I joined Lucky, what Creative Director Patrick Wade and I have done in our first 100 days here, and our initial thoughts on the strategic direction. The first slide outlines Patrick and my backgrounds. We’ve been fortunate enough in our careers to have worked with some of the very best specialty retailers, in turnarounds, in startups, and in high-growth businesses, Gap, J. Crew, and Coach, to name a few.

My experiences have taught me success in this business is a result of doing many things well, setting high standards, instilling a sense of urgency, and holding people accountable for results. So, what attracted me to Lucky? First and foremost, it’s a great brand that has a track record of success since the brand was founded in 1989; its American heritage is genuine and authentic. The brand is synonymous with denim, consumers already love the brand and the fit of the jeans.

By further evolving the product and marketing, we can build on all the good things the brand represents, expanding its reach to even more consumers. I like that the brand is rooted in denim. It’s a large market that provides a great foundation for the business. I also like that the brand stands for quality, and is priced positioned in the mid to high-end of the denim market, but not too high. This will allow us the latitude to innovate and create compelling product stories and tasteful store environments, but still have a broad appeal price wise.

Beyond denim, I see ample room for additional category development in non-denim bottoms, knits, woven, accessories, and footwear, among others. With 192 full-priced stores and 46 factory stores, I like that the chain is not over penetrated. Beyond stores, e-commerce can be much bigger at Lucky. On the operations front, there is an opportunity to evolve the approach on the back end in product development and inventory management, as well as on the front end in our stores to incorporate more specialty retailing best practices.

Like most of the brands of Liz Claiborne Inc., Lucky has only recently started the cultural shift from being primarily a wholesaler to being a true vertically integrated specialty retailer. To me, Lucky is a fabulous brand with untapped opportunities to build sales and drive profits, and we are moving forward quickly.

Let me share with you some of our initial thoughts on where we see the brand going. We see the new Lucky brand as the authority on all things denim, from quality to fit to fashion. While staying true to the brand’s rich southern California heritage, we will update and evolve the product assortment through a four-point strategy.

Point one, return to our denim heritage. We will carry a modern mix of heritage-based products that reinforce the brand’s denim authority and authentic personality. The brand will distinguish itself through good craftsmanship, fit, washes, and quality. Denim will also be expanded beyond just bottoms to all categories. The women’s denim collections will incorporate seasonal fashion items, while menswear will focus on classic, easy to wear pieces, without the moment appeal.

Point two, the surplus collection. Lucky will provide customers with a new take on the classic khaki. We will put our individual stamp on this all-American staple by using quality cotton and heritage-based detail through our proprietary denim wash process will give each item an authentic, lived-in, Lucky Brand look.

Point three, Lucky Legend. Legend is the premium denim designer component of our brand. The label is differentiated by authentic designs, extensive wash techniques, and special details. We plan to test a freestanding Lucky Legends concept stores, possibly as soon as 2011.

And, finally, point four, embracing our artistic roots. Lucky has long enjoyed a fruitful association with artists. We employee many talented artists to execute everything from our American inspired T-shirt design, to special details in our stores. We will stay true to these roots through photography, vintage American signage, as well as a collaboration with the artists. So, what have we accomplished in the first 100 days. First, we did a deep dive into our inventory position.

Second, we looked at our product and the buy plans for fall and holiday 2010. Third, was a talent review, making sure we have the right people in the right jobs, and identifying capability gaps that needed to be addressed.

And last, but definitely not least, in fact, most urgently, was to re-work our in-store visual displays and collateral to elevate the taste level highlight a variety of products beyond just denim and to deliver a look and feel for the brand, one that better communicates the rich American heritage and authority in denim. Here are some of the images of stores we have touched with the new visual package. What you are seeing is the creation of shop concepts and color stories, making the stores easier to shop, and allowing customers to see how outfits can be put together. Here, you see classification merchandising and key item presentations.

Our windows are now merchandised to call attention to products, provide wardrobing ideas, and allow customers to see inside the store. On the inventory front, we found several things. First, some of our denim inventory was aged and broken in key sizes. Our factory outlet inventories needed rebalancing.

Third, our current inventory levels in women’s fashion were too low, and have been impairing sales in the first quarter. Fourth, our receipt plan will perpetuate the lack of women’s goods into the second quarter. In order to clear aged inventory and rebalance our factory outlet stores, we took very aggressive markdowns to move the goods.

At the same time, sales in our full priced stores were restrained by the lack of women’s fashion inventory, where the category tracked down 35% in those stores, in line with our decline in inventory. Looking at denim only, we actually experienced slightly positive comps.

As I mentioned already, the lack of women’s goods will continue into the second quarter. For fall, inventories will begin to come back in line with where they should be. However some of our deliveries will be late given we re-did a significant number of items in the line. This could restrain our ability to drive sales in the third quarter to the degree we’d like, but certainly to a lesser extent than in the first half, when we simply did not have the goods to sell.

For holiday, we were able to influence the product line assortment and order quantities on a more timely basis than fall, which is a good thing. We are working closely with Li & Fung on production and expect them to ensure we have on-time delivery of high quality goods.

To create a top performing retail business, we need top talents. I’m happy to say we found many terrific people already on board at Lucky. More importantly, we found an organization that has a passion for the brand and a strong desire to drive the business to the next level. We have also been able to quickly attract new people with different skill sets to Lucky as well.

Our executive team is a combination of new hires in merchandising, design, stores, operations, inventory planning and allocation, creative services, and visual merchandising, along with existing executives and finance, human resources, design, wholesale, and sourcing. We feel great about the team.

Looking out, we are just beginning to formulate our longer-term strategic plans surrounding our store fleet, our e-commerce business, our wholesale distribution, international expansion, marketing, and additional category development. When we have these plans fully developed, we will share them with you. Suffice to say, we will not be satisfied with anything less than top tier performance, and we are acting with a high sense of urgency to get there. Bill.

Bill McComb

Okay, thank you very much, Dave, for that discussion. I certainly encourage everyone to track the progress in stores visually, now through August, and then, of course, into the fall. I certainly look forward to seeing the results myself. At this point, I’d like to open the call up for questions.

Questions-And-Answers-Session

Operator

Thank you. (Operator Instructions) Your first question is from the line of Edward Yruma with KeyBanc.

Edward Yruma - KeyBanc

Thanks very much for taking my question, guys. With the Liz Outlet stores, I know you indicated you’re repositioning, I think, some of the fashion there, and also your merchandising, and so forth. Are you contemplating any more structural changes, i.e. store closures?

Bill McComb

We look at this all the time. We look at are there opportunities to downsize more these stores? In the last three years we’ve gone from just over 140 down to 92, and we’ve gone from an average of 15,000 square feet to about 8800 square feet. And those have been really essential changes. In the idealized world these stores would be probably half the size that they are. Are we contemplating changes? Honestly, at each lease we look at opportunity to adjust the size of the box.

That said, we generally have favorable lease positions with these stores, so that the large square footage isn’t really choking us. This is truly a matter of getting the consumer proposition right. What we tested, which I just indicated on the call, was a pretty dramatic change in what I’m going to call the in-store visual merchandising and marketing. We love the results, and we decided that we want to aggressively roll that out and get the learning all through the second quarter.

Also, we knew that we needed to significantly move along the clearance process so that the new merchandise that comes in August is fitting underway of clearance, which has been a problem for us for nearly two years. So, we’re going to move through it, but at the end of the day, to answer your question, I would say door by door we continue to be very opportunistic about what the opportunities are there.

In the end, they are really good leases. I mean, I think that there are plenty of strategic options and strategic flexibility should we determine that this isn’t going to work, but I don’t think that that’s where we are right now. We see that this consumer still has a big affection for the Liz brand. We need to get it over the threshold, and I think the window approach that we’d taken was too soft, too lifestyle oriented, and not hard-hitting enough in terms of the value proposition inside. So, that’s what you’ll see if you go to stores.

Edward Yruma - KeyBanc

One follow-up if I may. Can you help us quantify the impact of the DKNY Jeans business, and steps you’re taking to stabilize that. If I recall correctly, I believe there was a fairly onerous license there, so is there any way for you to exit that? Thank you.

Bill McComb

The license runs until the end of 2012, and what I’ll tell you is, I hope you heard my confidence in that I was projecting that we really believe now that by fourth quarter, we will be back to break even or better positive operating profit in the business. And that means that the curve will bend even significantly in the third quarter, which is one of the reasons that we believe that we will actually get corporately to break even or better in the third quarter. It’s all about product, guys, it’s all about product. We said on the last call that the reason that it is what you would call a fairly onerous license. This is a business that we made money on for nearly 12 years.

When the state of affairs in the department stores, that’s the primary customer, when the markdown rates went from on average 85% or 86% to near 100%, for not only us but all of our peer brands in that zone, that literally evaporated the available profit pool for our licensing. That said, it is a very compelling brand. Macy’s, in particular, really appreciates the brand and has embraced it. And we have done a better job on product for the back half. We hit it right with military, we hit it right with cargo, and denim is a big improvement. We’re taking the AUR up, and the partners are going there with us. So, I’m really proud of what we accomplished in the first quarter there.

Operator

Your next question is from the line of Omar Saad with Credit Suisse.

Omar Saad - Credit Suisse

I wanted to get an update on the JCPenney collaboration. I know you have your design team in there. What are you learning in that relationship so far as you get ready for the second half, and as that company prepares for the second half of the rollout? Where do you stand on that, and how’s that coming so far?

Bill McComb

Well, I don’t want to get ahead of myself, but I will tell you, as I said, those plans have only gotten stronger. And the same goes with QVC. These partners have only, in the six or seven months since those deals were done, they’ve only gotten even more committed to the execution. They both are incredible operators, as I said, and what we did here in this call was actually show you Mike Ullman’s chart.

I think increasingly as we move toward the launch, it’s going to be more and more important for Mike to be able to answer these kinds of questions and characterize, because at the end of the day, they control the actual rollout. But what was significant about his presentation two weeks ago was the level of commitment in terms of the size, the floor, the number of products categories. This has turned into a very important strategic imperative for JCPenney, to bring more traffic into the front door and to win the traffic battle inside the mall locations where they are.

They know that the Liz Claiborne brand has the power and ability to divert traffic patterns within a mall into their front door from the other anchor tenants in that mall. I can only say, it’s great to win with the winner. You want to be with somebody that really wants your brand. These guys love, love, love and appreciate and have studied the true brand equities. Add on top of that, the fact that we are now going into year three in our accelerated partnership, which was Liz & Co. So, I will tell you, in answer to your questions about what are we learning on the design side, actually not a lot. We’ve been learning. Together, we’ve been rewarded for it. In terms of incremental sales and growing gross margins.

So, gosh, what was beautiful about this, Omar, was there wasn’t a lot of rollout risk to this. I mean, this was about Mike and I shaking hands and saying, let’s now go all the way on a deal that we had worked two years together on. So, there weren’t big changes the chain, it was acceleration of success points and the fact that ultimately Penney’s wanted it and they wanted to go all the way. And we no longer are conflicted about holding back the growth because of what was happening in tier 2 department stores. I just look at this as, it’s all things at the wall, and that’s what we’re doing. So, we’re really happy with it. I have a sense, deep down, that this is even going to be bigger than we thought it was, and that’s because, like I said, I think that there’s mutual agreement on the power of the opportunity.

Omar Saad - Credit Suisse

A quick question on Kate. I mean, it’s really standing out here as an out performer in the portfolio. What do you think is that’s due to, is it just earlier in the stage of turnaround, is it something specific with that? The different customer segments across the portfolio? Because it’s really standing out as an out performer.

Bill McComb

I will be really clear. I really think that in all of my reorganizations, if you recall, Kate Spade was handed over to me the day I walked in the building . The Corporation announced that they were going to buy it. It never got integrated into this giant conglomerate. It was the easiest one for me to impact with talent. And get the team right and to organize as a vertical retailer faster. As a result, I think they’re a little bit ahead of the curve, ahead of Juicy and ahead of Lucky on integration of true vertical retailing, merchandising, and design.

We have brilliant people in that company. They have their [mojo], one meeting in that showroom with the whole mobile team there, and it’s the answer. They are united, they are aligned, they know their customer very well. They are using data very clearly. They have tapped a very insightful consumer-based positioning, and they’re executing flawlessly. The stores are beautiful. We re-did every single store. You’ll recall we got rid of eight stores, most of which have been legacy or stores that we quickly had switched over from Sigrid-Olson’s that were not the right ones. We moved those eight out and ten we reinvested, even last year, when we were so capital restrained, we redid every single store.

And we started talking to you all about it last year, that, as we launched apparel, and launched jewelry, and had a new brand vision, and a new team, and all of those things clicked, and great in-store associates, it was the product category, it was the visual merchandising, and the appeal of the marketing, that just clicked. Honestly, I’ll look at you in the eye here through the phone, Omar, and tell you, I feel that’s what’s going to happen at Mexx, I know that that’s what’s going to happen at Lucky, and I think at Juicy, while we had personnel changes that are important, we announced that we have Erin Fetherston on board with [Aaron] Stern, who is the chief merchant that began there about six months ago, I feel the tide turning there as well. And I think that what you’re seeing at Kate Spade is the promise of this model of direct brands.

Operator

Your next question is from the line of Bob Drbul with Barclays Capital.

Bob Drbul - Barclays Capital

Bill, when you guys look at the expectations now for the full year for 2010, where do you think there’s still some risk in your assumptions? As you’ve brought your sales guidance down and your gross margin guidance, do you think that now the way you’re looking at the year is conservative now? Do think that there’s still some risk to it? I guess, can you just give us an update in terms of how you’re thinking about some of the puts and takes that you’re seeing right now.

Bill McComb

Listen, I think that we have been always very conservative as we talked about the marketplace, the consumer traffic buying patterns. I look at some communication from some of our competitors, and I’d say that we err on the conservative side. And we certainly don’t want to get ahead of ourselves with these models. I think the theme that you’ve got to stay focused on is what you’re seeing is sequential improvement. So, even this quarter, we’re saying that second quarter would be basically a parity versus last year in terms of earnings and third quarter will be significantly better and fourth significantly better than that. Sequential improvement is the theme.

I will tell you the risk points are the pace of turnaround at Mexx Europe. Look, it’s a giant question, built into, I think, our stock price and all of the analyst reports. At what point will the change get in line with this bracket? I think that we will see good sell through data at wholesale and positive comps in the fourth quarter there, and there’s a range of what that will deliver in terms of profitability. But, let me say a couple of things. That, from a theme perspective, I feel very comfortable with the margin recovery overall that we’ve discussed.

The Lucky number was intentional and it was important, and I think it’s going to pay a dividend in the back half of the year. I also think that, generally speaking, the sales decline lessening, is a very fair assumption and it’s not too risky. I don’t see risk in our models on the Liz at JCPenney or QVC. In fact, I’m feeling that there’s more upside possible there than downside there. And, I don’t think that we’ve been at all risky in the modeling that we’ve done about the time that Dave needs to bring the productivity on a per square foot basis back at Lucky.

We also talked today about yet an even yet lower cost profile, and I’m not worried about that. I think that that could get better. I think that we have been conservative about Liz Outlets. We lowered expectations all through the year on that on our profit model, and I think that, that’s the right thing to do. So, there you have it. On balance, I would say it’s the right way to look at it. I talk about stretching the breakeven as an important management mantra because it’s a very important thing for this Company, on an annualized basis, to get there. But, I will tell you that the way it all rolls up for third and fourth quarter is pretty solid.

Andy Warren

Bob, it’s Andy. Just to elaborate on a couple things Bill said, I too feel very good about this forward-looking forecast. One thing I don’t want to overplay, but I talked about in my comments, is what we’re seeing with inflation. Out of Asia, cotton prices, clearly air freight is way up, so a lot of this stuff, we’re executing better on. Our air to vessel ratio is down, which is very good. We clearly are managing our factory base more effectively, which is helping. So, a lot of this is proactive management through it, but clearly sourcing pressure and inflation pressure is something that we’re seeing. And it’s a concern of mine as you think about the second half. It is an uncertainty we’re trying to manage and couch very carefully.

Bob Drbul - Barclays Capital

One other question, is on page 19, the recent comp sales, can you share with us April for those three brands and maybe into May?

Bill McComb

Clearly, May is a couple days old. April, the trend at Lucky continued right through April. The trend at Kate Spade continued right through. At Juicy in the year ago figure, we were up against 29 days of a deep discounting in April of 2009. And so, we will actually report, when we report the quarterlies for April at Juicy, we will report a sizable negative comp there. It was a decision that we took back in January, going up against that, to only match about nine days of promotion. And, so they moved a ton of units in April of 2009, and we were deep in inventory there, so it was a good thing.

Again, as you saw earlier, we sacrificed comp for margin and margin, in fact, in April for Juicy, was up. It was up a few points, which is really important, that’s where comps came out. I don’t have any comments on May because, we generally don’t comment on intra-quarter comps, I would never get into intra-monthly comps. But, April, I’ve seen all the reports that came out this morning, and frankly it wasn’t a surprise to me.

We heard from a lot of department store peers that April was soft. There was a weather effect. It was a very wet April. It cooled off after the hottest March on record in the United States. And, there was the traffic shift. So, I think that what you saw in this morning’s industry report on comps was, especially with the specialty retailers in the middle of the mall, who had had healthier results maybe a year ago than the department stores that they were up against, I think some very big promotion events in April of last year. And there’s a similar gross margin AUR comp trade-off going on, in those results.

Bob Drbul - Barclays Capital

And then, just one question for Dave. Dave, first of all, congratulations and best of luck with new initiatives. Can you talk about the just the pricing of Lucky? Do you think that the price points, and where the brand is playing at, are at the right levels, and do you feel comfortable with that strategy?

Dave DeMattei

Well, I said in the prepared remarks the comments on denim. I’m very happy with where the price points are, because as you look at our selling in denim, we spend $79 to $129, it’s been $149, and in men’s especially, we see as much selling at the high end as we do at the low end. So, I think that’s a great span. It allows us to be positioned in wholesale properly. So I’m very happy with that. In terms of the top business, which is something we’re working really hard on, I think we can offer probably a better value proposition there. I’m not sure it’s just about prices, it’s about the quality of the goods, which we’re working very hard on upgrading the quality of the goods. So, I think there’s some room. There’s some room for margin improvements, there’s some room for price improvements. But, generally overall, I’m pleased.

Operator

Your next question is from the line of Kate McShane with Citi Investment Research.

Kate McShane - Citi Investment Research

Hi, good morning. With the relationship you know have with Li & Fung, how does this change how much of an impact inflation could have on your business? Is it the same as if you were manufacturing yourself or is there more flexibility on price because of Li & Fung’s size and scale?

Bill McComb

Remember we’ve never manufactured on our own. We are a vendor-based apparel company. We don’t manufacture. In the past, we did our own sourcing, but we’ve always relied on a very strong vendor community. So that part hasn’t changed. You know, I will tell you that, Li & Fung offers the opportunity for us to take position on piece goods, to potentially do some hedging, at a more corporate level. This is something that we haven’t done recently but we’re now, on a forward-looking basis, looking to do. Even what I’ll call taking some block capacity buys for certain, I’ll call it technologies, wovens, or knits in some of the best factories. This is something that we’re actually looking to do. I think what Li & Fung has been able to help us do, if you recall a year ago, we said one thing that they would help tremendously with was moving us outside of China faster. I am really grateful that we moved to Li & Fung for that reason right now. We were significantly more reliant on China than Li & Fung is required to be they’ve gotten us. Their Turkey office has made a big difference for us with both Mexx Europe and Mexx Canada, and moving into other parts of Asia has been helpful. And right now, the biggest labor pressure is actually China. And, so, Li & Fung has been helpful there.

Kate McShane - Citi Investment Research

If I could ask a question to Dave. I was curious behind the reasoning why you’re focusing on surplus or khakis and why you see it as an area of opportunity.

Dave DeMattei

I would not say a focus on it. I just think it’s another opportunity in bottoms. Lucky is known for its great fit in bottoms. I think that is the heritage of the brand. I believe that khaki is another staple in everyone’s wardrobe, in the casual wardrobe. And I just think it’s another avenue to explore for Lucky. I also think it’s a not a dominant theme in stores, but I think we are a bottoms company and we haven’t amazing fit. And I think it’s just another way of doing it, and one of the ways we want to approach, it is really the approach we take to denim. It’s all about the proprietary washes and the way we build the product, and that’s something we want to look forward to. And, you heard Bill talk about DKNY jeans, and being right on the military surplus thing, that is the fashion trend.

Bill McComb

Oh, it’s a big trend. All of our brands are…

Dave DeMattei

You can’t ignore it. So, it’ll be a smaller part of our brand. And it’s just something that you want to start to begin to explore. We will be a denim brand and we will continue to do that. Lucky has always explored khaki in their stores. We’re just…

Bill McComb

We’ve done it very intermittently, very erratically, and I think that, Kate, to build on what Dave said, one of the things that Dave walked in the door that he heard actually from a customer is, that we walk their wallets. They come in wanting to buy more. Even those that we convert wish there was more in the store that they could’ve bought. And, so, it leads you down the path of if we have this credibility and authority in bottoms to explore it a little more aggressively.

Kate McShane - Citi Investment Research

I have one last question on Mexx. I know wholesale is kind of the second part of the turnaround story for Mexx. But, I was wondering, with the new merchandise coming in the fall, have there been any new wholesale wins in Europe for the Mexx brand?

Bill McComb

There have been. The relationships with the new team have opened some doors, and allowed us to get in. However, the way that it’s going to work is, it’s the way it works here in the US. You don’t get into all doors. They’ve cracked their way into some new accounts and they’re doing it with nine and ten door tests. In some cases five door tests. And so, they’re going to have to earn their credibility and earn their way, and in general the wholesalers are going to want to know and see how our own retail stores do.

But, there have been lots of fragmented wins that I won’t add up and go through them on a list. If we were Mexx Inc., Thomas would probably be on the call and he would be doing it. But, I would say that there are lots of data points that suggest that we have captured the attention of the wholesalers. They’ve got to see it to believe it. The good ones have given us some important tasks, we’ll have a base to scale from.

And, by the way, we’re just now are selling in October and November, right now, actually this week and next week. So, I talked on the prepared remarks about August and September. Our team feels even better product-wise about the delivery that we will have in October and November. They’re really happy with the quality and the fit, which has been such a problem for us. So, some points of encouragement there.

Operator

Your next question is from the line of Mary Gilbert with Imperial Capital.

Mary Gilbert - Imperial Capital

I wanted to go through the threshold EBITDA margin of 10%. Is that sort of like a $280 million to $300 million. How are you thinking about that, in terms of the top line.

Bill McComb

Say it again, Mary.

Mary Gilbert - Imperial Capital

For 2012, you have your framework for…

Bill McComb

Yes, I know that, yes.

Mary Gilbert - Imperial Capital

So you’re saying by the end of 2012 and so this is calendar year 2012. By the end of calendar year 2012 you expect, and I’m assuming do you mean run rate EBITDA of 10% plus?

Andy Warren

Yes, it means that, at the end of 2012, when you take the ratio for the full year, it should be 10% or higher. What we have not done, and very deliberately, look, we haven’t given sales guidance for 2010. I would never give it to you for 2012. We clearly have long range plans. Every business has a plan, but we haven’t rolled out or pretended to guide 2012. So we – I think what you are trying to get at is what kind of sales level would we expect. The whole point of using the actual ratio is to say it’s a management principle in paradigm. This company ought to be a operating in the double digits on EBITDA margin.

Mary Gilbert - Imperial Capital

Absolutely.

Andy Warren

And it comes down, Mary, when we look at our gross margin construct today, and where we are going, we look at SG&A construct and where that’s been and how we continue to drive cost productivity there, and look at those combinations really gets us confident around that double-digit EBITDA margin in 2012.

Mary Gilbert - Imperial Capital

Okay, basically everything you’re executing on now, and in 2011, is setting the stage for 2012, assuming everything goes okay.

Andy Warren

That’s right, the value of having those kinds of goals, is to use it as a decision-making framework. So that you don’t live with a very diluted EBITDA margin forever. But, to your point, this is two different tenets of a building block towards the goal, and I’m comfortable as I’m sitting here looking through our 2010 forecast today and guidance that we walked you through, that that is the right stepping stone to those goals for 2012.

Mary Gilbert - Imperial Capital

Okay, that’s helpful. Also, so when we’re looking at 2010, I just wanted to get an idea of free cash flow expectations for 2010. So, that would be after considering cash restructuring costs including the benefit of the tax refund that you received, and how we should look at changes in working capital. Do we have a framework there?

Andy Warren

Yes, Mary, working capital, as you know, has been a tremendous source of cash flow for the last 18 to 24 months. It will be a source of cash still for us this year, especially as we continue to wind down all the Liz Claiborne products. Some of these models we’re doing which are working capital free and capital light, allows us to continue to get sources there to cash. But, when I think about the first quarter, which includes some of those sources as well as that cash tax refund, I think in terms of that being a continuation throughout the remainder of the year, I wouldn’t model in a significant continued source of cash from working capital. I think a lot of that has been realized, but we still have to get some out of working capital. But, it will be a whole lot less than we’ve seen the last 18 months.

Mary Gilbert - Imperial Capital

Okay. Okay, yes, so you see a free cash flow positive number for 2010, obviously.

Andy Warren

Oh yes, for sure.

Mary Gilbert - Imperial Capital

Yes.

Andy Warren

The other thing that you mentioned is, in the last couple years, we’ve spent and had great return on an enormous amount of restructuring costs. You see that through our total SG&A. Our restructuring costs in 2010 is dramatically less than we’ve seen in a couple years. There will still be some, we have $14 million in the first quarter. But, as we realized that benefit of the cost savings, and had less restructuring costs to achieve those cost savings, that will also help our free cash flow as well. So, we definitely see positive free cash flow this year, for sure.

Operator

Your next question comes from the line of Chi Lee with Morgan Stanley.

Chi Lee - Morgan Stanley

Hi, good morning, everybody. I want to ask a few follow-up questions just on outlets. Some of you mentioned that the value proposition, it sounds like had been eroded a bit. So, given that the comps up are pretty meaningful for you in the first quarter, do you think that the outlet consumer has now been locked into this heavy promotional model in the outlets, and the ASP increases that we’ve seen have been driving the traffic away.

Bill McComb

I don’t look at it that way. I actually think the first problem that we had was that we were not communicating the value proposition that we actually had inside the store at the lease line. So, what I’m suggesting is that we have very strong conversion rates in Liz Outlets right now. I’m very proud of and happy with how our store is converting people. And, actually, the goods, I would actually not say that there is a true value problem. I think we were not competing from a pricing perspective in terms of positioning the store to get a richer base of traffic. If we had a richer base of traffic, we would have different economics in the stores.

And so, what the tests showed was that we had to not focus quite so much on the beautiful lifestyle positioning as if we were a middle of the mall specialty store, but recognize that consumers are looking for called-out value at the lease line level. And that we believe that, that is what made such a difference in the traffic profile in the tests. So that’s what we’re going to change.

The outlet business, generally speaking, it’s very healthy. It’s healthy in terms of, generally speaking across our brands, it’s healthy in traffic, it’s healthy in margin, and it’s healthy at sales level. So, the exception here is what I’m calling the Liz outlet situation, which I think that we need to tune into the key items and value proposition that you want. That’s what we tested. That’s what we’re rolling.

Chi Lee - Morgan Stanley

Okay. The last quarter you mentioned the old Liz inventory comprised around 16% of the goods on the floor. Can you update us on what that is today?

Bill McComb

It’s single digits, but I have to clarify, because this is like, there’s all this nomenclature. That’s the old, old Liz, and then there’s the last years LCNY, and unfortunately, as I said on the call, the fall goods did not turn like the spring goods did. And ended up the AURs ended up having to come down as we brought down price and brought down price and brought down price. And so, now, there’s that 5% that Andy quoted, but there is still a large number of goods that I would say are pre-January. And that need to be moved and they’re going to get all moved out and they’re going to be gone by August 1. And that impacted our guidance and adjusted operating income for second quarter.

Chi Lee - Morgan Stanley

And then, If I could just ask a question. Dave, as you look at the Lucky business, it seems in the past quarters, Lucky, it seems like somewhat of a planning or inventory allocation gap. From a systems and a planning process perspective, do you feel that those tools are in place for you to execute your merchandising plans, or are there still areas for improvement?

Dave DeMattei

I think in the prepared remarks we talked about the wholesale culture shift to the retail shift. I think that’s one that I guess that was my biggest surprise in coming to Lucky Brand, for the number of retail stores they had, that the culture was still so wholesale dominant. So, the direct answer to your question is, no. Are they being put in place? Yes. Specifically, we have had no replenishment system. We are a denim brand with a lot of sizes, and a lot of stock needed to be refilled. So, we are in August implementing a brand-new JDA replenishment system which will be key for us to manage our inventories in-store, and we’re putting a lot of emphasis on inventory management. I think that I’ve spent probably in the last two months most of my time has been spent on inventory management, so, to answer your question, no. To being put in place, we’ve hired some great experienced people that I’ve worked with in my past, and specifically a new VP of Inventory Planning and Allocation, who has great background in this. We are actually in training right now, on the implementation of that system. In addition, we’re working on our distribution to our stores. You know, Michael, you look at weekend sales on Monday and by Friday the goods will arrive replenishing the stock into the stores. That is not how it is now. That will take us time to get there. Again, all opportunity for us, but a good question.

Chi Lee - Morgan Stanley

If I could squeeze in one quick one. Is there any way you guys could just quantify for us what the positive benefit from Li & Fung’s sourcing would have been in the first quarter? Just to help us understand the magnitude of that benefit currently.

Bill McComb

I think you are asking for a number, right?

Chi Lee - Morgan Stanley

Number, directional guidance, anything to help us understand how much that’s actually helping the business today.

Andy Warren

It’s impossible to characterize it across the vast company, where there are so many different answers to that. In some cases it’s country of origin strategy, being able to move out in other areas, and in others it’s just negotiations. In some areas it hasn’t been helpful. In some areas we haven’t realized the benefit yet. We’re right in there. So, I would say it’s everything that we talked about going into it, in general. As being, helping on margin, helping on country of origin strategy. I know that’s not real specific, but…

Bill McComb

Yes, it’s such an amalgamation of distribution channel changes, merchandising changes, opening price points all the stuff we talked about, Chi. So, suffice to say it has been helpful in a lot of key areas, and we continue to see that traction as we get more and more allied with them. But, it really is hard to give you a firm number that really breaks it out that clearly.

Operator

Your next question is from the line of Jennifer Black with Jennifer Black & Associates.

Jennifer Black - Jennifer Black & Associates

I wondered if you could talk about Juicy, where you are with your sku rationalization, and also your strategy on price points. And then, are there any new developments with bird for Juicy? And then Dave, I have a question for you. I wondered where you see the tops to bottoms ratio. I know you’re focused on bottoms right now, but further down the road. Thank you.

Bill McComb

Okay, on Juicy, I would say that, in general, I wouldn’t call it a sku rationalization. I would call it the implementation of a very clear cogent merchandising strategy that does a better job of waiting high turn items and key sellers. We’re way into it. Erin’s work in merchandising decisions will impact fall and holiday. And, I think they’ve used consumer data to drive the buy so that we’re not an inch deep and a mile wide in different classifications, but we’re really heavily weighting certain product categories for fall, including knits and outerwear. That’s pretty much where I would leave that part of your question on Juicy. Pricing changes that we implemented for fourth quarter are rolling through as the base pricing strategy for the business all through this year. And, it’s working. It worked in the fourth quarter and we’re happy with it now. Dave, why don’t you answer more.

Dave DeMattei

Yes, Jennifer, I know I’ve talked about the heritage of the brand being bottoms, but I hope you heard me that I think there’s massive opportunity in the tops area. I think, if we look at fall, and our planned category expansion, moving Lucky from a jeans and graphic T-shirt shop, to a fully vetted lifestyle concept is really what you’re doing. We see huge opportunity in wovens. Wovens in the first half of the year has been one of our strongest categories because we have the inventory and we have cute product. Women’s we really didn’t have any wovens in our line, or none to speak of. We think wovens, sweaters, basic, not basic knits but just non-graphic knit tops, camies, outerwear, those are all huge opportunities for Lucky. And that is where, if you look at sku extension, and in our women’s tops is probably the single biggest point of where we think the opportunities are for the brand. And that’s what we’re going after in the second half of the year, and in 2011 as we begin primarily to look at our product concepts for 2011.

Jennifer Black - Jennifer Black & Associates

As far as the tops to bottoms ratio, would you see that as the potential to be 2 to 2.5.

Dave DeMattei

In my life, I’ve seen it somewhere between 2 and 3 to 1. We’d like to get it there. I’m not prepared to give you a number. But, I think, directionally, you’re on track, that’s what I’ve historically seen in my career, and that’s what the merchants that I have seen in their career.

Jennifer Black - Jennifer Black & Associates

And then, Bill, what about Juicy Couture, the Bird for Juicy Couture.

Bill McComb

It continues to roll out at wholesale. Wholesalers like it a lot. Nordstrom loved it. So, we’re moving forward with it. We’re broadening it. It was almost what you could call a test last year, and it tested very, very well. We like it because it’s almost demographically or psycho-graphically the next stage post-Juicy, but has a lot of core Juicy elements to it. So, it’s labeled Bird by Juicy Couture, and, you’ll see more of it this fall.

Jennifer Black - Jennifer Black & Associates

My last question, with Kate Spade, which looks great by the way, I wondered if you are rolling it out to any more doors at Nordstrom.

Bill McComb

Yes, I believe that they are. I don’t have the details of front of me but both apparel and jewelry has rolled all the way, completely. And, apparel is rolling out each season more and more doors. Very happy with it at Nordstrom.

Operator

And do we have time for one more question and that is from Jim Chartier with Monness, Crespi, Hardt.

Jim Chartier - Monness, Crespi, Hardt & Co.

Good morning. Just a couple questions. First one, could you rank the impact of the numerous factors under reduced 2010 outlook, in order of magnitude.

Bill McComb

Well, I would say, again I just have to clarify for the record, we haven’t given an outlook on 2010. So, what we’ve done is we’ve provided in effect, there is a first half reduction, but we haven’t been put a specific number out on the second half. We continue to be bullish about the operating profit sequential improvement that you’ll see. But, what you saw as it relates to the second quarter situation was real pressure from Mexx Europe. We said that factory outlet at Liz was going to have a significant clearance to rebase for August, and Lucky Brand, Dave talked about what he did in first quarter will continue in second quarter so he’ll have a big gross margin hit in order to drive and clean out those stores. Those are the three things, the only three things that have really changed here.

Jim Chartier - Monness, Crespi, Hardt & Co.

Okay, with 2010 less likely to be breakeven for the year, your kind of strategic decisions could be more aggressive in terms of clearance. Lucky and Mexx Europe were big reasons behind that.

Bill McComb

That’s right.

Jim Chartier - Monness, Crespi, Hardt & Co.

Is that fair?

Bill McComb

Yes, absolutely.

Jim Chartier - Monness, Crespi, Hardt & Co.

Then, on Mexx you mentioned a press release you saw some encouraging signs other than some wholesale wins that you talked about. What else I guess is encouraging there?

Bill McComb

Products samples. The product itself. So, and, this isn’t me saying it, because I would tell you not listen to me because I’m not European and I haven’t been in the industry over there. But, the folks that are on this team, and that have enjoyed great success in other places for years and years and years were able to be very clear about why in the last four or five years Mexx went astray. It was on the merchandising side and on the product side in terms of both design and technical product development. And, I would say that just the samples alone, the level of the quality price of the fabrications, the price - the value for the money, the pricing relative to that. The execution is terrific. It’s one thing to have the idea, it’s another thing to actually have the samples in the room where you’re touching them, looking at them and seeing our ability to execute. So, that I think is probably the most important callout. Look, it’s still in front of us. The consumer hasn’t touched it yet.

And so, I don’t want to get in front of us on it and I’m very aware this is a difficult turnaround. But, I can only look at how the team is functioning, how clear their vision is, how aligned they are, how they’re executing, what the partners are saying, and the partners are vendors, the partners are would be retailers. And our franchisees that own and run stores that are our partners, we have a very big, strong feedback loop from them and it’s very positive. The Russians, which is probably our single biggest wholesale account, it appears as retail in Russia. To us it’s wholesale. They believe it’s the best product they’ve seen in ten years. It’s good to hear that. It’s all super, super, super early leading stuff. The consumer hasn’t touched it.

Jim Chartier - Monness, Crespi, Hardt & Co.

Right. And then for DKNY, can you give us a little more color on why you’re confident that that will return to profitability in the fourth quarter?

Bill McComb

What? I feel like I said that already. It’s 100% about the product that we showed the customer, and what the customer is looking to buy. We have visibility right now into the back half of the year on that business, and so we’re giving you specifics about customer reaction to product and what orders are penciled to be.

Operator

There are no further questions at this time. Mr. McComb, do have any following comments?

Bill McComb

I don’t. I want to thank you all for dialing in. Thank you for being patient and listening, and look forward to talking again soon.

Operator

Thank you all for participating in today’s Liz Claiborne first quarter 2010 conference call. You may now disconnect.

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Source: Liz Claiborne Inc. Q1 2010 Earnings Call Transcript
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