The Talbots CEO Discusses Q2 2010 Results - Earnings Call Transcript

Sep. 8.10 | About: The Talbots, (TLB)

The Talbots, Inc. (NYSE:TLB)

Q2 2010 Earnings Call Transcript

September 8, 2010 10:00 am ET

Executives

Julie Lorigan – SVP, Investor and Media Relations

Trudy Sullivan – President and CEO

Mike Scarpa – COO and CFO

Analysts

Adrienne Tennant – Janney Capital Markets

Steven Gregory [ph] – Mandalay Research [ph]

Jennifer Black – Jennifer Black & Associates

Richard Jaffe – Stifel Nicolaus

Stacy Pak – SP Research

Janet Kloppenburg – JJK Research

Betty Chen – Wedbush Securities

Marni Shapiro – The Retail Tracker

Dana Telsey – Telsey Advisory Group

Roxanne Meyer – UBS

Alex Fuhrman – Piper Jaffray

Susan Sansbury – Miller Tabak

Randy Konik – Jefferies

Operator

Good morning, ladies and gentlemen. On behalf of Talbots, we would like to welcome you to the Talbots, Incorporated conference call covering its second quarter 2010 earnings results. Today's call is being recorded. And at this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. I would now like to turn the call over to Julie Lorigan, senior vice president of investor and media relations.

Julie Lorigan

Thank you. Good morning, everyone. And welcome to Talbots' second quarter 2010 earnings conference call. Today, we have with us Trudy Sullivan, president and CEO; and, Mike Scarpa, Talbots' chief operating officer and chief financial officer.

We will be disclosing non-GAAP financial measures in this presentation. For a reconciliation of these non-GAAP measures to the corresponding GAAP measures, please see the table attached to this morning's earnings release available under the Investor Relations section of our Web site.

As a reminder, certain statements to be made today are forward-looking. These are based on assumptions and expectations of future events, which may not prove to be accurate. They involve substantial risks and uncertainties. Actual results may differ materially from those expected or implied. These forward-looking statements may be identified by such terms as will, expect, believe, anticipate, outlook, target, plan, initiative, estimated, strategy, and similar terms or variations.

All of our outlook and financial expectations and plans as well as our assumptions underlying this information constitute forward-looking information. We direct you to the cautionary statement being read at the end of this presentation and included in our earnings release issued today as well as in our recent SEC filings, all of which are available under the Investor Relations section at our Web site at www.thetalbotsinc.com.

A replay will be available from approximately one hour after the conclusion of the call until end of day September 10th, 2010. The webcast will also be available on the Investor Relations page of our Web site.

With that, I would like to turn it now to Trudy Sullivan.

Trudy Sullivan

Thank you, Julie. Good morning, everyone, and thanks for joining us. In a moment, I will discuss Talbots' results for the 13-week and 26-week periods ended July 31st, 2010. Mike will cover our financial performance and comment on our outlook for the third quarter and full year. After that, I will make some closing remarks and we will be happy to take your questions.

Overall, we're pleased with our second quarter and year-to-date performance. We have maintained the momentum that began last September and again achieved strong operating results as we continue to implement our strategic initiatives aimed at continuous improvement in profitability.

Throughout the quarter, we remained focused on achieving our goal of maximizing margins, with an emphasis on full price sales. We successfully managed expenses and inventory, and achieved better than expected year-over-year adjusted earnings per share. Our performance for the quarter and year-to-date demonstrates the steady progress we are making. And we are pleased with our team to continue the sound execution.

A few important highlights from the quarter include a strong year-over-year improvement in adjusted operating income, which, excluding special items, was $12.5 million or 4.1% of net sales versus an adjusted operating loss last year of $10.5 million. While we were able to drive improvement in a number of our key selling metrics to last year, top line sales decreased 1.3%, reflecting our decision to stay true to our original promotional event calendar and not react to what became an aggressive promotional environment. We were in a very healthy inventory position and did not feel the need to overreact to the environment. We ended the quarter with a 14.4% increase in full price selling, with markdown sales declining 21%, compared to a year ago.

Comparable store sales decreased by 1.4%. However, as incremental red-line in store sales were included, comparable store sales would have been flat in the quarter. Our second quarter direct marketing sales were flat compared to last year, reflecting the shift of a "Best Customer" event out of Q2 and into Q1.

In the second quarter of 2010, we saw increased customer traffic on a sequential basis. And while the number of transactions was down mid single digits, the rate of conversion was up in the mid 20% range. Units for transaction were up mid single digits, which, combined with essentially flat unit retail, drove a low single-digit increase in dollars per transaction, reflecting the favorable mix in full price to markdown selling.

From a merchandise perspective, we maintained the strong (inaudible) path that we have seen in the first quarter, again driven by key items, including the super (inaudible). We saw good performance from tops, driven by knits and sweaters, where we have strong response to our new and updated feminine knits as well as our core sweater assortments. Our accessory business increased in the high 20s in comparable sales, and was one of the strongest categories in the quarter driven by belts, fashion accessories, and jewelry.

As we noted last quarter, we are significantly setting up our brand awareness efforts this year to additional innovative events marketing, additional processing, and PR initiatives. In the second quarter, our marketing included increased catalog circulation aimed at customer reactivation and increased prospecting via the Web to capture new customers. We are gaining traction on new customer acquisitions, which is up double digits to last year. Further, we are seeing reactivated buyers returning at a greater rate. And we are experiencing increased productivity from our retained customers.

We just completed our summer 2010 best customer intent to purchase survey, which measures our customer's perception of our merchandise and creative directions. As such, our net better merchandise score again was up by double-digit percentages from last year. This continues to be a positive indicator of our customer reaction to our "Tradition transformed" brand, et cetera.

And now, I'd like to update you on three of our key corporate initiatives. First our store segmentation strategy, as a reminder, we are pursuing opportunities to increase our sales per square foot productivity by sorting our stores along two customer dimensions, customer lifestyle and climate. As planned, we initiated our segmentation strategy across our store base with our August deliveries. We will conduct further customer research later this fall by way of measuring our progress here.

Let me update you on our store refresh and re-image initiative. As discussed last quarter and with an initial focus on the premium and classic stores, we had targeted 14 stores in three key markets to begin our refresh program in August. I'm pleased to say that we finished all of these refresh projects. The early reception to the renovated stores is very positive. But it is too early to gauge the impact the re-image initiative will have on our sales. We will learn, adjust, and apply what worked from this effort to additional stores going forward. Our plan is to roll out these multi-year initiatives over time and refine our strategy as necessary.

Lastly, our upscale outlet concept, an important growth initiative is performing in line with our expectations as the customer continues to respond positively to our "Wear Now" merchandise assortments. We currently have 18 upscale outlet stores, and are on track to open an additional 10 stores in the back half to end the year with 28 in total.

Looking at the third quarter, with August being a small volume transitional month, the true highlight was the launch of our new denim program mid-month, offering four new styles and eight washes, supported with a strong marketing and promotional campaign. The customer response has been tremendous. And in the first few weeks, we've far exceeded our plans selling over 65,000 pairs of jeans. Feedback from our customers at stores as well as social media sites like Facebook and Twitter has been overwhelmingly positive. We're pleased with our denims potential as we go forward.

We've also made a change to how we flow product this fall compared to last. Rather than deliver heavy fall merchandise in early August, we opted to flow the heavier fall products in early September. That way, our customer can enjoy fresh and inviting deliveries post-Labor Day, where she is most likely to engage in buying. This has resulted in lower quarter-to-date sales versus a year ago. But we're confident that with the new fall products becoming available this week in stores and in the rest that we can quickly reverse that trend.

We have the majority of a quarter ahead of us. And we are guiding to positive top line sales growth for the period. We have a strong marketing program in place to support a compelling merchandise assortment. As you know, we added brand advertising to our medium next – beginning in the third quarter. We just launched our national print advertising campaign, featuring Linda Evangelista, with the September issues of MORE, Vogue, In Style, Elle, and Oprah; with additional regional advertising just being installed in those markets where we are refreshing stores.

Our campaign has been generating enormous buzz throughout the retail industry and the bloggers here alike. We will continue with the strong direct mail campaign, including increased catalog circulation, greater penetration of online search and banner advertising as well as the continuation of our successful hostess events, where we will partner with leading fashion and lifestyle experts to draw interest in local communities.

Like many retailers, we will continue to look cautiously at the second half of 2010. The economic recovery has certainly experienced stalls in starts in the last several months. And there's no indication that volatility is over. While we are mindful of the current consumer sentiment and economic condition, we continue to be confident in our strategy. We are entering the fall season with a strong inventory position, a compelling merchandise assortment, and key initiatives already in place. And we are encouraged as the first marketing event of the season, our denim launch, is off to a great start. We believe we will drive continued improvement across our business and a long term sustainable growth and profitability.

With that, I'll turn it over to Mike to review the financials. And then, I'll be back with some closing comments.

Mike Scarpa

Thank you, Trudy, and good morning, everyone. I will now cover the details of our second quarter and year-to-date financial performance. Total sales were $300.7 million, compared to $304.6 million last year, down 1.3% and below our guidance for the low single-digit increase. Store sales were $250.8 million, compared to $254.9 million last year. Comp store sales decreased 1.4% percent for the 13-week period. Direct marketing sales in the quarter, which include catalog and Internet, were approximately flat to last year at $49.9 million due to a change in our promotional calendar. We believe a truer measure of performance is on a year-to-date basis as direct marketing sales increased 13.5%, compared to last year's first half.

Second quarter cost of sales, buying, and occupancy was well ahead of last year at 65.1% in net sales versus 72.3% last year. Merchandise margins accounted for 620 basis points of the improvement, of which roughly half was driven by an increase in initial mark-ups and the other half due a strong mix of full price to markdown selling. We also realized buying and occupancy leverage of 100 basis points in the quarter due to lower costs.

SG&A expenses in the second quarter were $93.1 million at 31% of sales versus $94.9 million at 31.1% of sales last year. This represents a $1.8 million expense decline over the prior year. We were able to continue to generate improvement in SG&A dollars and as a percentage of sales while increasing our investment in marketing and store visuals as well as adding back certain employee-based benefits in the quarter.

Adjusted operating income for the second quarter increased $22.9 million to $12.5 million or 4.1% in net sales, compared to the same period last year. Our adjusted earnings per share from continuing operations of $0.14 were well above our previously announced expectation.

Moving to the balance sheet, we ended the first quarter with total accounts received – we ended the second quarter with total accounts receivable of $156 million versus $163 million last year. Our receivables remain in excellent condition. Year-to-date, Talbots' charts penetration continues to represent approximately half of our total sales volume.

Merchandise inventories at the end of the quarter were $130 million, down 10.4% to last year's $145 million. This decrease is due to lower levels of markdown merchandise inventory and a decrease in in-transit inventory as a result of a change to our merchandise flow strategy.

Total debt outstanding at the end of the quarter was approximately $37 million, down $460 million from last year's balance of $497 million. Based on forecasted debt levels, we continue to believe we have sufficient funds under our term loan to continue to invest in our strategic initiatives.

Cash provided by operating activities was $10.6 million, compared to $41.3 million last year, reflecting a decrease of $30.7 million. This decrease was primarily due to the payment of merger-related costs as well as changes in certain working capital items, most notably inventory, offset by higher adjusted operating income.

Before commenting on our outlook for 2010, let me update you on our strategic partnership with Li & Fung, which has been in place for about a year now. Our supply chain leadership continues to be actively engaged in managing this relationship. And we are pleased with the recent progress. Like many retailers, our mark-ups for fall and holiday were impacted by continued pressures in commodity prices and freight. Together with Li & Fung, we were able to source our products more efficiently, with a focus on increasing our presence from countries with lower costs and trade preference agreements with the United States.

We also have recently re-bid our freight contracts. And we're able to offset a substantial portion of cost pressures we were facing there. We continue to expect higher gross margins in the second half of the year, compared to last year.

Turning now to our 2010 outlook, for the full year, we anticipate top line sales growth in the range of approximately low single digits, compared to last year, below our previously announced guidance of a 3% to 5% increase. This reflects our current year-to-date results and our conservative posture going forward given the uncertain macro environment and cautious consumer mindset.

Full year adjusted earnings per share, excluding special items, are now anticipated to be in the range of approximately $0.84 to $0.92 per share, an increase over our previously announced guidance of $0.75 to $0.83 per share, reflecting our improved second quarter results. Our gross margin rate is expected to increase by approximately 550 basis points versus the year ago as a result of stronger full price selling, increased initial mark-ups, and continued discipline inventory management.

SG&A expenses are expected to be in the range of $410 million to $420 million, reflecting increased marketing investment, a critical component to our long term growth strategy, and the reinstatement of certain operational employee-based benefits that were suspended as part of our 2009 cost reduction program.

Capital expenditures for 2010 are planned to be approximately $40 million, up $20 million from last year. A majority of this increase will be allocated to refreshing and renovating our stores as well as IT initiatives.

For the third quarter of fiscal 2010, we expect total sales to increase approximately low single digits compared to last year's third quarter. We anticipate adjusted earnings per share to be approximately in the range of $0.22 to $0.28 per share versus last year's adjusted income of $0.31 per share. Our gross margin rate is expected to increase by approximately 150 basis points to 200 basis points versus a year ago. And our SG&A will be in a range of $110 million to $112 million as we continue to make investments in marketing, store segmentation, and store re-imaging.

In closing, we have made steady progress in our financial results of the last 12 months driving significant improvement in operating income and restoring a strong balance sheet. That said, we believe the second half of this year is a critical time to begin to reinvest in the business to drive sustainable growth and profitability over the long term.

Thank you, and let me turn it back to Trudy.

Trudy Sullivan

Thanks, Mike. In closing, we are pleased with how we are positioned going to the back half of the year and remain confident in our ability to execute as we move forward. While we are continuing to implement our turn-around initiatives, we have made significant improvements to our brands, products, and marketing and believe we are moving into a new stage focusing on those initiatives that will drive both top and bottom line growth. We are also operating with a substantially improved capital structure, which will enable us to continue to invest in these initiatives.

We recognize that we are in a challenging environment and are planning conservatively, but we remain committed to ongoing operational improvement and steady progress in our initiatives to deliver long term shareholder value.

And with that, we would be happy to take your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time, we will be opening up the call for the question-and-answer session. (Operator Instructions) Your first question comes from Adrienne Tennant with Janney Capital Markets.

Adrienne Tennant – Janney Capital Markets

Good morning, and congratulations on the progress to date.

Trudy Sullivan

Thanks, Adrienne.

Adrienne Tennant – Janney Capital Markets

My question is really on guidance as one giant question. First of all, can you – Mike, can you give us the share count that the $0.80 – was it $0.84 to $0.92 as predicated on. I'm just wondering if that's – I just want to make sure that we're not adding up the four distinct quarters, right because the share – the weighted average share capital for the year is quite different?

Mike Scarpa

Right.

Adrienne Tennant – Janney Capital Markets

So this will be, what, $67 million or something?

Mike Scarpa

The share count will be roughly $67.2 million.

Adrienne Tennant – Janney Capital Markets

Okay, for the full year. Great. So when we do that, and let's say I take to the higher end of the third quarter range, the implication for fourth quarter is roughly in line to slightly higher than the current consensus of $0.14? Am I getting too detailed there?

Mike Scarpa

About right.

Adrienne Tennant – Janney Capital Markets

Okay. Great. And then, can you give us any color on – for the comp's month today, obviously, that's included in the current comp items. So I'm trying to figure out. There has been historically a spread between total sales and comp because direct has been accelerating faster? It didn't happen in this quarter? And I'm trying to figure out, should we go back to using a couple hundred basis points spread between total sales and comp?

Mike Scarpa

I would basically use about a 100 basis points there.

Adrienne Tennant – Janney Capital Markets

100 basis points for it. Okay, great. And then, my final is on the tax. It seems $48 million that's a one-time. So we should not do any adjustments for that going forward in Q3, Q4.

Mike Scarpa

That's right.

Adrienne Tennant – Janney Capital Markets

Okay. Wonderful.

Mike Scarpa

Okay.

Operator

Your next question comes from the line of Jeff Black with Barclays Capital.

Steven Gregory – Mandalay Research

Hello?

Trudy Sullivan

Hi.

Steven Gregory – Mandalay Research

Can you hear me?

Trudy Sullivan

There's a funny echo going on in the background there, Jeff.

Steven Gregory – Mandalay Research

Yes, this is Steven Gregory [ph] from Mandalay Research [ph]. A couple of questions, a couple of months ago in the Wall Street Journal, there was an article published regarding e-commerce initiatives, how company like yourselves are being into e-commerce growth initiatives for 2011 to really their business to the next level. I'm curious, Trudy, what is your vision through your – what your e-commerce business will look like in the next three years? And how do you plan to get there to let the (inaudible) that Talbots is well positioned for future growth?

Trudy Sullivan

What I would encourage to do is when we have our investor day on October 5th, we'll give you very detailed plans according– around the growth of our channels. Obviously, e-commerce is placed on a very critical part of our business as it does now as well in the future. But I would say stay tuned for October 5th.

Operator

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

Jennifer Black – Jennifer Black & Associates

Good morning, and congratulations on the great progress you guys have made.

Trudy Sullivan

Thanks, Jennifer.

Jennifer Black – Jennifer Black & Associates

I have just a few questions. I wondered how the new fashion translates into plus sizes. That's my first question.

Trudy Sullivan

Okay. In terms of our denim wash and just–

Jennifer Black – Jennifer Black & Associates

Denims as well as just – majority of the pieces, leopards, jackets.

Trudy Sullivan

All of that translates extremely well to both the woman sizes and the petite sizes. I'll tell you, our women's customer is one of our most loyal and actually spends the highest percentage of whole price of any customer that we have. And I would say she's delighted to have access to this kind of fashion in her wardrobe. Really, I will say anything that's leopard in (inaudible) is just going in now, the whole product around – surrounding the Linda Evangelista's photo shoot. But the reaction to leopards, literally, as we're taking out of the box has been fantastic across all of the product segments.

Operator

Your next question comes from the line of Richard Jaffe with Stifel Nicolaus.

Richard Jaffe – Stifel Nicolaus

Thanks very much, guys. Just a question on one-time expenses and what we should anticipate for next three quarters, they were more than anticipated this quarter. I'm wondering what we should look forward over the next Q3, Q4. And also similarly, interest expense with the refinancing, how we should anticipate interest expense, particularly with the lower inventory levels in the third and fourth quarter.

Mike Scarpa

Well, we'll start to build up our debt levels as we enter the third quarter. So in the second quarter and end of the year should be historical lows from a debt perspective. So we would still model close to $3 million of interest expense, both in Q3 and in Q4. As far as one-time charges, obviously, we had the $3.48 million [ph] adjustment, which was roughly $5.5 million of the total. And we had merger-related costs of approximately $3 million. We'll continue to see merger-related costs of approximately $2 million to $3 million over the remainder of the year. And I could say that $ 3.48 million [ph] was a one-time issue.

Operator

Your next question comes from the line of Stacy Pak with SP Research.

Stacy Pak – SP Research

Hi. Thanks. I think the new product was fabulous, Trudy.

Trudy Sullivan

Thank you, Stacy.

Stacy Pak – SP Research

I guess a couple of questions, one is I wanted to – how should I interpret it. I was looking back at Q1, and the full price selling increased 21% and the markdown was down 31%. And now, in this quarter, full price selling increased 14% and markdown selling decreased 21%. So I'm wondering how to look at that. That's number one.

Number two, Mike, you levered buying and occupancy on a negative 1% comp. Was there something else in there or should we continue to look for that kind of leverage point.

Number three, Mike, can you comment on what's going on in payables.

And then finally, Trudy, this is what I understand on the comp quarter to date, what you're saying is it's negative quarter to date because of how you flowed the product in this year relative to last. But you expect to be about a plus 1% or so comp for the quarter, is that correct?

Trudy Sullivan

No. We're going to the low single digits for the quarter, Stacy. And in terms of full price markdown between first and second quarter, I mean the second quarter is a more promotional quarter. So you would expect of the decline in our markdown sales. It's not quite as the increase we had in the first quarter full price. We will really shifted to a key item – key item business when we get in the second quarter so that I will tell you that the actual throughput on units on a full price was greater than the comps. There's been a slight decrease in the AUR on full price because we are pushing key items.

Mike Scarpa

Off of just from a perspective in terms of the full price and markdown, second quarter last year inventories were down almost 28%. So as we start to mitigate the down inventories, I think you're going to start to see these markdown sales continue to decrease in terms of an overall percentage.

Couple of points on payables last year, obviously, we had high debts levels. We were squeezing our payables a little bit. We are happy to report that we're currently below our vendors at this point. So payables are down about $24 million for the quarter.

Cost of sales, buying, and occupancy, we continue to talk with our community and look for opportunities there. And also, we see some – as we haven't really invested in our store base, we see some of the depreciation starting to fall off. But I wouldn't – I wouldn't model a few – a full 100 basis points at this point because we're going to be opening up some new outlet stores, et cetera. So we expect that that may hurt the leverage a little bit.

Operator

As a reminder, in order to allow time for everyone's inquiries to be entered, please limit your questions to one. Your next question comes from the line of Janet Kloppenburg with JJK Research.

Janet Kloppenburg – JJK Research

Hi, everybody. Congratulations on a nice quarter.

Trudy Sullivan

Thanks, Janet.

Janet Kloppenburg – JJK Research

A couple of questions on the August comp trend, I'm confused. The decision to flow less heavy products in was the right decision given the trend, and offset I think by what you're saying was the very strong reception to denims. So what went wrong in August? And why would you say the comps were where they ended up?

Also, if you could talk a little bit about inventory levels, it seems that you're down 10% inventory levels could be a constraint to comps through the third quarter. Maybe you could give us an idea of how to look at the end of the quarter. And lastly, I'd sure love to know when markdown levels will be comparable to last year so we won't have that pressure affecting the comp numbers. Thanks so much.

Trudy Sullivan

I think the right way to look at the third quarter, Janet, is to really look at the guidance. We're guiding to low single-digit increases in the quarter. We made a conscious decision not to bring in heavy products early. And we started the quarter very clean from a markdown perspective. So we're actually – we're pleased with where we are. We're pleased with the decision. I think it's timed right to the consumer's interest in buying that kind of product.

And from what I can see in the world at large, there're not a lot of people selling a lot of heavy fall early in August. So we have the benefit of putting in a floor set, actually, this week this year that is totally fresh to last year's. So we're actually are quite pleased with how the quarter is developing. And of course, the denim launch was and will continue to be a very important addition to the third quarter business. So we're feeling – I think the best way to evaluate our third quarter because of this shift, is to really rely on the guidance that we've provided.

And Mike, I'll let you talk about the inventory.

Mike Scarpa

Yes. From an inventory perspective, we ended the quarter down over 10%. Roughly, half of that is based on the flow of inventory that Trudy just spoke about. So our in-transit levels were down year-on-year, which drove about five of the 10% decline. As far as the inventory at the end of the third quarter, we're modeling right now to be anywhere from 7% to 10% up over where we were a year ago. And again, a substantial piece of that is going to be based on, again, flow of product as we're front-loading our inventories into the fourth quarter to take advantage of pre-Thanksgiving sales.

Trudy Sullivan

And just one last comment. I think that we've been nothing but consistent in terms of managing our business for superior margin and for superior operating results. And we're not in the business of sacrificing those two metrics to try to buy cheap comps. It's just not how we run the business and I think we've been very consistent for the last – certainly, for the last year. And we think it's the right road for the long term health of the brand, and certainly the correct road to build shareholder value.

Operator

Your next question comes from the line of Betty Chen with Wedbush Securities.

Betty Chen – Wedbush Securities

Congratulations on a great quarter. I was wondering if you can speak a little bit more to the survey you mentioned earlier, Trudy. I think we continue to also hear customers react very positively to the new merchandise direction. Can you tell us a little bit more about the intent to purchase survey conducted in the summer? What is she telling you? And any difference between lapsed or new, or new acquisitions that you're trying to prospect. Thanks.

Trudy Sullivan

This is a survey that we've run every season with our best customer. And it really is to measure the net promoter's score, which is the difference between people who are viewing what we're doing favorability versus not. We have been pleased to see steady progression in the last several seasons where this net promoter score has been significantly up on a percentage basis. So we read that as indication among our very best customers that she is reacting well to what we are doing.

And the second part, Betty, is we've just recently really started probably the fourth quarter last year where we stepped up our prospecting and reactivation activities, both through the Web and through our increased circulation on reactivation. And we were very pleased with the growth we saw in both reactivated and new customers in the second quarter. So our retained customers are holding steady but their productivity is up slightly, and we're seeing significant increase in both lapsed and reactivated customers coming back to the brand, which should be favorable indicators as we wrap into the back half of the year.

Operator

Your next question comes from the line of Marni Shapiro with The Retail Tracker.

Marni Shapiro – The Retail Tracker

Hi, guys. Congratulations on a great quarter.

Trudy Sullivan

Thanks, Marni.

Marni Shapiro – The Retail Tracker

And congrats on the jeans. I sent the email around to several people to buy them.

Trudy Sullivan

It's exciting. If you go on Facebook and look at the comments, they're really super.

Marni Shapiro – The Retail Tracker

Well, on that note, you've had a great launch of pants and that business continues. You've have a great launch now with denim and that business continues. So if you were thinking about the brand's bigger picture and you're looking at now the tops business. Is it jackets? Is it – you've done an outstanding job on wovens. Is it sweaters? Is there another area that you can put that kind of focus to that you'll turn your attention to next?

And then if you could just, on the housekeeping side, remind us about the real estate for the back half of the year? What's left to do, outlets and regular stores openings and closing? Thanks, guys.

Trudy Sullivan

Okay. Well, Marni, you're on the right track. As we've had great success in picking classifications, it's kind of reinventing them and re-launching them. And I would – you should expect to see that we have a very exciting event as we get into the end of September, beginning October, along those lines. And that's as much as I want to say because I don't want to give it away. But we are learning from the positive momentum we can get by re-launching categories and I think we really have just a fantastic opportunity on another category as we get into October.

And Mike will give you the rundown on real estate.

Mike Scarpa

Yes. As far as upscale outlet goes, we have approximately seven upscales that we plan to open in the second half of the year, which will mean a net 10 openings overall for the full year, which is right on schedule. As far as our regular stores, we're planning on closing close to between 10 and 13 stores over the next six months.

Operator

Your next question comes from the line of Dana Telsey with Telsey Advisory Group.

Dana Telsey – Telsey Advisory Group

Good morning, everyone. The stores look great. I love the new white doors. And the merchandise margin improvements that you've got have been very impressive. How do you think about future opportunities to the merchandise margin and the buckets of where the gains are coming from? And lastly, on the new updated white door stores, how are they doing? Is there any change in terms of what you're expecting for the pace for 2011 and then updated ads that you're doing bringing in a different customer? Thank you.

Trudy Sullivan

Well. I'm glad you like the store's look. We're actually quite excited about it. And then, we just finished the refresh project about 10 days ago. So it would be very premature for us to predict anything from the refresh stores on a 10-day basis. That said, I will tell you that we are extremely pleased with the results that we're seeing out of these stores.

There's a significant uptick both in the consumer acceptance. If you've been in, and they really do look beautiful, and we see encouraging signs in performance, so just stay tuned. As I said in my opening remarks, we'll do a lot of research the end of September, early October to really go back and measure exactly how this is resonating with the customers. But we have picked three markets. These three markets are up and running. Local, regional advertising goes in there this week. Based on the read-and-react over the next several weeks, we will then formulate our plans for 2011 and beyond. And we will talk more about this on our investor day on October 5th.

Mike Scarpa

Yeah. And as far as margin opportunities, again, we'll be laying that out in the investor day. But we're pleased also with the progress we've made in terms of 2010. Our first half of the year margins were up 1000 basis points over where they were a year ago. And we're projecting third quarter to be up 150 basis points to 200 basis points. So full year, we expect to come in about 39% versus 33.5% last year. And we have initiatives set with Li & Fung that we'll take you through on investor day and hopefully we will continue the progress that we're – that we've made so far in margins.

Operator

Your next question comes from the line of Roxanne Meyer with UBS.

Roxanne Meyer – UBS

Great. Thanks. Let me add my congratulations on your progress.

Trudy Sullivan

Thanks, Roxanne.

Roxanne Meyer – UBS

Knowing that your catalog for September has hit ahead of one you set for some of the merchandising stores, I'm wondering if you could share with us some of the big hits so far from the catalog that you're seeing.

Trudy Sullivan

Well, we actually have – along with changing the cadence of our delivery this year, we also changed the cadence of the books that goes along with that delivery. So you actually have – we actually have two September mailings where we had one last year. There's always going to be a slight variance between the direct business and the stores business because there are certain business categories that accelerate in one versus the other. So it's never 100% match.

But all I can tell you is that denim was the big focus of the first September mailing and that has been fantastic. And the whole – the ad with Linda Evangelista is the opening spread of the second September mailing, which actually goes in homes today. The product is arriving in stores as we speak. And at the risk of being way premature, we are getting a very strong reaction to anything that has to do with leopard right out of the box. So we're very, very pleased with that.

Roxanne Meyer – UBS

Great. We'll certainly look forward to seeing it. And then I'm just wondering if you're able to share also how much you're spending per store on your remodels?

Trudy Sullivan

I think we'll probably have more – that more refined when we go to our meeting in October. We're really compiling that now.

Mike Scarpa

But we would expect it to be in the range of, at this point, to be in the $68 to $70 per square foot range. And we're looking at approximately 160,000 square feet that we're refurbishing.

Operator

Your next question comes from the line of Alex Fuhrman with Piper Jaffray.

Alex Fuhrman – Piper Jaffray

Thanks, guys. I just want to touch base on some of the technological initiatives you guys have going on here. If I remember correctly, you guys were evaluating plans to upgrade your inventory systems, and your planning and allocation systems sometime in the back half of this year. I'm just wondering if you can give us an update on the progress there. And also, particularly with regards the planning and allocation systems, what new type of functionality might be available to the company?

Mike Scarpa

Absolutely. We're in the process of implementing the JDA allocation systems with an expectation that fall holiday 2011, we should see the full impact. Obviously, this is a tool that's extremely powerful compared to our excel spreadsheets that we're currently using. We expect big wins out of that. But we're implementing that from an IT perspective. There are also certain infrastructure changes that we have to make. We'll be updating our whole financial systems starting in the next month or so. But those are the two big project focuses right now. And along with allocation and planning, we're starting off with some size and store clustering initiatives with Oracle, so good stuff to come.

Alex Fuhrman – Piper Jaffray

Okay. Thanks, guys.

Operator

The next question comes from the line of Susan Sansbury with Miller Tabak.

Susan Sansbury – Miller Tabak

Hi. Thanks very much. Actually, my question has been answered pretty much. Trudy, you're doing a wonderful job. Good quarter and best of luck for the back half. But, Mike, could you refresh my memory on this tax issue FIN 48? What does this involve?

Mike Scarpa

It's an uncertain tax position that we have set up a liability for when FIN 48 was implemented. We've changed our estimate based on new information and we've increased our reserve to reflect the maximum exposure of that tax situation. Were working with the authorities to resolve this matter. However, from a P&L perspective, we feel like we've put this behind us.

Operator

Our next question comes from the line of Randy Konik with Jefferies.

Randy Konik – Jefferies

Yes. Thanks a lot. My question for you, can you just – if you think about free cash flow generation from this, what do you think is a minimum base run rate for free cash flow? And what would be the maintenance CapEx levels at this point for the business? And then on the balance sheet side of things, when should we expect the company to become debt-free over the next six to twelve months? Just when do you think that would happen? Thanks.

Mike Scarpa

Okay. So from a free cash flow perspective, obviously we're going to talk about this more in another month when we all get together. But the way I look at it is, if we've been able to achieve operating margins in the – call it 6.5% over the past 12 months, and obviously, we want that to grow to double digits along with depreciation and amortization roughly in the $60 million to $65 million range. Less CapEx of – we said we're spending $40 million this year depending on the success of our refresh stores that can potentially grow to $50 million to $60 million the following year.

And as far as debt levels, we're planning on interest expenses of roughly $3 million a quarter for the next two quarters. And we were able to reduce our debt to roughly $37 million at the end of the second quarter. So we're making tremendous progress in paying that back. But as I did mention, we should see debt spike up a little bit in the third quarter as we build up our inventory levels, and then decrease in the fourth quarter as we have a strong cash flow in Q4.

Operator

We don't have time for anymore questions. Ms. Sullivan, please continue with any closing remarks.

Trudy Sullivan

So thank you everyone for joining us. I hope we'll see you in October when we can share some more information on our longer term plans. And I appreciate talking with you, and talk to you soon. Thank you.

Operator

Thank you. This concludes the Talbots, Inc conference call. We will now proceed with our forward-looking statements. In addition to the information set forth in this transcript, you should carefully consider the risk factors and risks and uncertainties included in this company's annual report on Form 10-K and quarterly reports on Form 10-Q as well as in this transcript.

This transcript contains forward-looking information within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by such forward-looking terminology as expect, achieve, plan, look, projected, believe, anticipate, outlook, will, would, should, potential, or similar statements or variations of such terms.

All of the information concerning our future liquidity, future financial performance and results, future credit facilities and availability, future cash flows and cash needs, and other future financial performance or financial position as well as our assumptions underlying such information, constitute forward-looking information.

Our forward-looking statements are based on a series of expectations, assumptions, estimates, and projections about the company are not guarantees of future results or performance and involve substantial risks and uncertainty, including assumptions and projections concerning our liquidity, internal plan, regular price and markdown selling, operating cash flows, and credit availability for all forward periods. Our business and our forward-looking statements involve substantial known and unknown risks and uncertainties, including the following risks and uncertainties.

The continuing material impact of the volatility in the US economic environment and global economic uncertainty on our business, continuing operations, liquidity, financing plans, and financial results, including substantial negative impact on consumer discretionary spending and consumer confidence, substantial loss of household wealth and savings, the disruption and significant tightening in the US credit and lending markets, and potential long term unemployment levels.

The satisfaction of all borrowing conditions under our credit facility, including accuracy of all representations and warranties, no events of default, absence of material adverse effect or change, and all other borrowing conditions; any lack of sufficiency of available cash flows and other internal cash resources to satisfy all future operating needs and other cash requirements; the ability to access on satisfactory terms, or at all, adequate financing and sources of liquidity necessary to fund our continuing operations and strategic initiatives and to obtain further increases in our credit facilities as may be needed from time to time; the success and customer acceptance of our merchandise offerings; the risks associated with our appointment of an exclusive global merchandise buying agent, including that the anticipated benefits and cost savings from this arrangement may not be realized or may take longer to realize than expected; and, the risk that upon any cessation of the relationship, for any reason, we would be unable to successfully transition to an internal or other external sourcing function.

The ability to continue to purchase merchandise on open account purchase terms at existing or future expected levels and with acceptable payment terms and the risk that suppliers could require earlier or immediate payment or other security due to any payment concerns; the risks and uncertainties in connection with any need to source merchandise from alternate vendors; any impact to or disruption in our supply of merchandise, including from any current and any future increased political or other unrest in various Asian countries, which are our sources of merchandise supply or any other disruption in our ability to adequately obtain alternate merchandise supply as may be necessary.

The ability to successfully execute, fund and achieve the expected benefits of supply chain initiatives, anticipated lower inventory levels, cost reductions and all current and future strategic initiatives; any significant interruption or disruption in the operation of our distribution facility or the domestic and international transportation infrastructure; the risk that estimated or anticipated costs, charges and liabilities to settle and complete the transition and exit from and disposal of the J. Jill business, including both retained obligations and contingent risk for assigned obligations, may materially differ from or be materially greater than anticipated.

Any future store closings and the success of and necessary funding for closing underperforming stores; the ability to reduce spending as needed; the ability to achieve our 2010 financial plan for operating results, working capital and cash flows; any negative publicity concerning the specialty retail business in general or our business in particular; the ability to accurately estimate and forecast future regular-price and markdown selling, operating cash flows, and other future financial results and financial position; the risk of impairment of goodwill and other intangible and long-lived assets; and, the risks and uncertainties associated with the outcome of litigation, claims, tax audits, and tax and other proceedings and the risk that actual liabilities, assessments and financial impact will exceed any estimated, accrued or expected amounts or outcomes.

All of our forward-looking statements are as of the date of this transcript only. In each case, actual results may differ materially from such forward-looking information. The company can give no assurance that such expectations or forward-looking statements will prove to be correct. An occurrence of or any material adverse change in one or more of the risk factors or risks and uncertainties referred to in this transcript or included in our periodic reports filed with the Securities and Exchange Commission could materially and adversely affect our continuing operations and our future financial results, cash flows, prospects, and liquidity.

Except as required by law, the company does not undertake or plan to update or revise any such forward-looking statements to reflect actual results, changes in plans, assumptions, estimates or projections, or other circumstances affecting such forward-looking statements occurring after the date of this transcript, even if such results, changes or circumstances make it clear that any forward-looking information will not be realized. Any public statements or disclosures by us following this transcript which modify or impact any of the forward-looking statements contained in this transcript will be deemed to modify or supersede such statements in this transcript.

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