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Ann Taylor Stores Corp. (NYSE:ANN)

Q2 2007 Earnings Call

August 24, 2007, 8:30 AM ET

Executives

Maria Sceppaguercio - Sr. VP Communications and IR

Kay Krill - President and CEO

Jim Smith - EVP, CFO and Treasurer

Analysts

Jeff Black - Lehman Brothers

Kimberly Greenberger - Citigroup Global Markets, Inc.

Jennifer Black - Jennifer Black & Associates

Brian Tunick - JP Morgan

Lorraine Maikis - Merrill Lynch

Lauren Cooks Levitan - Cowen & Co.

Dana Telsey - Telsey Advisory Group

Shaun Kelley - Banc of America

Lizabeth Dunn - Thomas Weisel Partners

Neely J. Tamminga - Piper Jaffray

Samantha Panella - Raymond James & Associates

Robin Murchison - SunTrust Robinson Humphrey

Crystal Kallik - D. A. Davidson & Co

Roxanne Meyer - CIBC World Markets

Marni Shapiro - Retail Tracker

Teresa Donahue - Neuberger Berman

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Ann Taylor Stores Corporation Second Quarter 2007 Earnings Conference Call. At the request of the Company, today's conference call is being recorded. If you have any objections you may disconnect at this time. Following prepared remarks by the Company you have the opportunity to ask questions.

I would now like to turn the call over to Maria Sceppaguercio, Senior Vice President of Communications and Investor Relations.

Maria Sceppaguercio - Senior Vice President Communications and Investor Relations

Thank you. Good morning, everyone. As you know, earlier this morning we issued our results for the second quarter of fiscal 2007. In doing so we also reaffirmed our outlook for the full year. Here with me this morning to discuss the results of the quarter is Ann Taylor's President and CEO, Kay Krill; and our CFO, Jim Smith.

As you know, earlier this month we announced that Jim has decided to resign from the Company to pursue other opportunities. He has agreed to stay on until the earlier of the year September or until his successor is named.

This morning we unveiled the focus of our new concept, which we will talk about a bit later in the call. We also announced, in a separate press release, that we have hired Bob Luzzi as our Chief Marketing Officer. And finally we announced this morning that our Board has authorized a new $300 million share repurchase program, enabling us to continue to return value to our shareholders.

During the quarter we completed our previous $300 million buyback program with the repurchase of approximately 3.8 million shares of our common stock, at a total cost of $137 million. Taken together with the 4.2 million shares we repurchased in the first quarter, we bought back a total of almost 8 million shares in the past two quarters.

As we move forward our share repurchase activity will be influenced by our available cash and market conditions and will like be likely slower case than our previous authorization. In terms of some specifics on store count, during the quarter we opened nine LOFT stores and one Ann Taylor Factory store and we closed one Ann Taylor store. At the end of the quarter our store count was 887 stores comprised of 346 Ann Taylor stores, 483 LOFT stores and 58 Ann Taylor Factory stores. Our square footage at the end of the quarter was 5.2 million square feet, an increase of about 7% versus the second quarter last year. By division, square footage was 1.9 million square feet for Ann Taylor and 2.9 million square feet for LOFT.

Before I turn the call over to Kay, I would like to remind you that our discussion this morning may include forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the Company's current expectations concerning future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially. A detailed discussion of these factors and uncertainties is contained in the Company's filings with the SEC.

With that I will hand it over to Kay.

Kay Krill - President and Chief Executive Officer

Thank you, Maria, and good morning everyone. I would like to start my remarks this morning by stating how pleased I am that we successfully managed through a tough quarter and delivered $0.50 in EPS. We expected loss to be challenging in the quarter given remaining product issues we were working through and the extremely strong performance last year that the division was comping against. What we didn't fully expect was the extent of the though macro economic environment which caused traffic to slow considerably at both divisions and the competitive environment to really heat up the increased promotional activity.

In response, we stepped up our promotional activity and aggressively managed our in store metrics to help offset the traffic softness. And we achieved much success on this front during the quarter particularly at Ann Taylor. At LOFT, we affectively managed through our product issues and we are heading into the third quarter in a healthy inventory position. At the same time, we continue to buyback our stock which also benefited our EPS.

Looking ahead, both divisions are heading into the fall season in good shape overall and with product assortment that we believe are strong. As for LOFT its product offering will be significantly more balanced and brand appropriate.

So, in terms of some specifics for the quarter, net sales grew approximately 1% to $614 million, our comp store sales for the quarter were down 6.2% compared to an increase of 10% last year. While both divisions were down, Ann Taylor effectively managed through the current macro situation and some softness related to its July store set, and delivered good margins for the quarter.

LOFT on the other hand had a tough quarter from a margin perspective as its product issues continue caused the division to be highly promotional to move through units. The good news is we did get through the inventory and we headed into Q3 in good shape.

Gross margin for the quarter was 50.6% which was significantly below last year due almost entirely to LOFT. As you know we were very aggressive promotionally off quarter to keep LOFT's inventory turning. And we were very successful clearing through units. But that did impact our overall margin.

SG&A for the quarter, as a percentage of sales, improved 70 basis points to 42.3%, we continue to believe that there is significant opportunity to reduce our cost structure and we are making progress identifying specific areas of opportunity that we expect to benefit our 2008 margins.

Operating margin for the quarter declined to 8.3% of net sales versus the 11.2% we achieved last year. This was entirely due to LOFT.

In terms of EPS, our aggressive share repurchase activity helped us to offset some of the margin softness in the quarter, and we reported $0.50 in diluted EPS versus the $0.59 we reported last year. Looking ahead to the balance of the year, we continue to believe we will achieve EPS in the range of $2.15 to $2.25.

So, with that as a backdrop, let me provide my perspective on the performance of each division. Starting with Ann Taylor, our Ann Taylor division had a mixed quarter. Net sales declined 3.4% and comp store sales were down 3.1% versus a 6.4% comp gain in the second quarter last year.

On the other hand our margins were good and we were successful in aggressively managing our in-store metrics to help offset the impact of the traffic softness we experienced. Aside from soft traffic, virtually all of Ann Taylor's in-store metrics were healthy for the quarter.

On the product side, our May and June store sets performed better than our July store set. Which prove to be too neutral. The emphasis of brown and ivory did not appeal to her the way it did at this time last year, importantly, while she didn't loved the July color offering, she liked it enough to buy an initial markdowns which helped us to maintain good margins.

Strong categories continue to be suits, dresses and knit and woven tops. While sweaters and sports wear were soft. All of the color we offered during the quarter was extremely well received, although in hindsight, we could have used more, particularly in July.

For the fall, we will be offering significantly more color than we had this spring and last fall. For perspective, our color penetration in top is increasing to 41% for both Q3 and Q4 versus only 32% in spring and 25% last fall.

In terms of inventory, we ended the quarter up versus the significant decline we achieved last year but we feel good about the overall composition of the inventory and believe we're heading into fall in good shape.

Looking ahead we feel good about our product assortments and our new initiatives. We have reduced our sweater offerings for the balance of the year, particularly the fourth quarter, to reflect the trend towards knits and wovens. And we will be offering a lot more color and novelty this year than we did last year. In addition, we are also focused on a more season-less gifting offering for the holiday including some lighter weight fabrics and yarns and our launch of Beauty which we are very excited about. We will be in store with our new Beauty collection in mid-November with a fine fragrance and body care collection that you will recall we partnered with Robin Burns to develop.

We will offer gift sets for the holiday gifts giving season and we will use Beauty promotionally in a number of ways to drive trail and giving. We also have a compelling advertising and marketing campaign in the fourth quarter. We are very optimistic about this product category as it is ageless, size-less, season-less and offers attractive margins.

Another growth initiative for Ann Taylor is our celebrations business which is currently offered in 40 stores and online. We plan to further expand the offering to approximately 70 stores by year end and we are very pleased with the initial results of the initiatives we have been testing to further accelerate the growth of the business.

We are confident that our combination of quality, value and service is unsurpassed in this market. And we believe this business offers us additional growth potential.

In addition, later this quarter we will introduce Ann Taylor Collection, which is higher priced, higher quality collection, targeting affluent professional women in 24 of our more upscale location. The new collection will consist of very high quality suitings, separates and dresses, made from luxurious fabric and yarns and include coordinating tops and accessories.

Price points are targeted approximately 40% higher than existing Ann Taylor assortments. We believe Ann Taylor collection will be well received and expand the brand in these key locations. In terms of the Ann Taylor store fleet, we continue to aggressively modernize our store base and are on track... 70% of our fleet updated and brand appropriate by year end. These updated stores have demonstrated over time that they outperform on a comp basis and generate a positive ROI.

So, from an overall standpoint the Ann Taylor division continues to be very well managed by the chain. We feel good about where the business is today and we are confident that the growth initiatives we are layering on will further strengthen the brand.

Turning to LOFT, as we expected and have previously shared with you, LOFT had a challenging quarter. Net sales declined 1.8% and comp store sales were down 10.8% versus the positive 14.2% comp gain in the second quarter last year. As we anticipated, LOFT's overall product offerings during the quarter did not offer an appropriate balance of updated classics versus fashion and did not offer enough color or novelties.

In addition the soft macroeconomic and traffics slowdown also negatively impacted results in the quarter. As a result we were very promotional throughout the quarter to keep our inventory turning. We achieved much success in this area and we are entering Q3 in a healthy inventory position.

On the product side better performing categories included dresses, refined separates, knit and woven tops, while sweaters were particularly weak and our overall relaxed and casual offering were soft. In addition, not offering enough relaxed wear-to-work separates was a big miss, and remains an opportunity for LOFT as we move into the fall season.

Our assortments, beginning in Q3, are definitely more balanced with approximately 30% more color and more than twice the amount of novelties than we offered last year.

In addition, we have increased our relaxed wear-to-work penetration by about 30% and our silhouettes and colors across our assortments are more appropriate to the LOFT brand.

For Q4, we are adding an even greater penetration of color and novelty and wear-to-work will continue to be important. In addition, we have reduced our sweater offering for Q4 to reflect the trend to knits and woven and we have modified the fabrics and yarns to be more season-less.

We are confident that these and other changes we have made are significant improvements that will benefit our results in the back half of this year, particularly in the context of last year's offering. You'll recall the brand inappropriate fashion silhouette, the lack of color, the heavy wool sweaters, during a record warm fourth quarter last year. All of which caused us to be very promotional and resulted in extremely weak fourth quarter margins for LOFT.

Turning to our recent launches Maternity in 20 LOFT stores and online, this business is off to a good start. Client reception has been quite positive and we are planning to add Maternity to an additional five stores in the fall. Maternity is a such a natural brand extension for us and we expect this business to do well.

Turning to our Factory business, Factory delivered another strong quarter and was a positive contributor to our overall margin performance. We believe this business will continue to offer attractive growth for the Company, in fact, our plan to launch a LOFT outlet concept next summer is very much on track and we are enthusiastic about the growth potential of broadening the reach of our LOFT brand to an additional client base.

Turning to our online business, as you know, last quarter we upgraded our websites for both Ann Taylor and LOFT. These businesses continue to grow rapidly. And the upgraded sites offer improved navigation and checkout as well as strengthened stability to accommodate increased traffic. I am very pleased with the continued growth of this channel and expect it to continue to deliver strong growth for us in the future.

And finally, on our new concept; as you know, we hired Mark Mendelson, a well respected and accomplished merchant to lead the team that will launch the concept in the fall of 2008. This morning, we announced that the new concept is targeted at a significantly underserved segment of the apparel market; one that we call the modern boomer.

Well there are a number of companies that currently play in the broader boomer market; we believe that this particular segment has been the most significantly underserved and a huge opportunity for us. As a company, we have a distinct heritage in upscale, sophisticated and stylish fashion, a proven expertise in incubating and building a new concept and a leader in Mark that has incredible passion for this woman and fully understands her needs.

Our approach to satisfying her and building this business will be unique in that we are not approaching this as just another boomer concept. Mark and his team will be fully developing our execution plan over the coming months. We will share more details with you regarding branding and positioning as we get closer to launch. I expect there to be a good deal of speculation over the coming months regarding these things, but we are not going to comment on time. We do believe the new concept has the potential to be $1 billion business and we are more excited than ever.

On the marketing side this morning we announced that Bob Luzzi, who some of you may know, will be joining us as our Chief Marketing Officer reporting to me. Bob is a seasoned Creative Marketing Executive with a wealth of experience and a demonstrated track record of accomplishment in this industry, as well the Beauty industry. We are trilled that he has joined our team and we are excited about the experience, creativity and expertise he will bring to Ann Taylor.

Before I turn it over to Jim, to take you through the financials for the quarter, let me spend a moment on SG&A. As you know, we recently launched a company-wide initiative to drive down our cost of doing business with the objective of reducing SG&A as a percentage of net sales by 200 basis points.

During the past quarter we hired a senior executive with expertise in this area to lead our efforts. We have also engaged JC Penney [ph] to partner with us to perform a benchmarking study of our peers and a deep dive of our cost structure. We will begin to map-out exactly where the opportunities are and the plan to achieve them. This process is now underway. We will have a preliminary recommendation from the team during the third quarter which we will build into our 2008 plan.

At this point I'm going to turn it over to Jim to take you through the financials for the quarter. Before I do, I would like to make a comment, as you know, Jim will be leaving the Company and this is his last conference call as our CFO. He has been with the company for over 14 years and has made significant contributions to our growth and success. So, Jim, on behalf of our Board, shareholders and associates, I want to thank you and wish you well.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Kay. Good morning to everyone. Starting with sales, net sales were $614 million up nearly 1% from $610 million in the second quarter last year. This growth largely reflected the expansion of our store base versus Q2 last year and the continued growth of our Factory and Internet businesses. Partially offset by the decline in comp sales for the quarter.

By division net sales declined for both Ann Taylor and LOFT for the quarter, specifically at Ann Taylor sales were $217 million and at LOFT sales were $310 million, down 3.4% and 1.8% respectively versus a year ago. Comparable store sales for the quarter decreased 6.2% with Ann Taylor stores down 3.1% and LOFT down 10.8%.

Gross margin as a percentage of net sales decreased 3.6 margin points to 50.6% in the quarter versus a gross margin of 54.2% in the second quarter last year. This decline largely reflected margin softness at LOFT standing from aggressive promotional activity throughout the quarter to keep our inventories turning.

SG&A in the quarter declined to 42.3% of net sales compared to 43% of net sales in the second quarter of last year, despite the negative comp. This improvement reflected reduced performance based compensation, somewhat offset by the de-leveraging impact associated with the decline in comp store sales.

Operating income in the quarter declined 25% to $51 million or 8.3% of net sales compared to $68.1 million or 11.2% of net sales in the second quarter last year. This decline was entirely due to LOFT.

Net income in the quarter totaled $31.7 million or $0.50 per diluted share compared to $43.2 million or $0.59 per diluted share last year. Our weighted average shares outstanding for the quarter were 63.4 million shares versus 72.8 million shares in the second quarter last year, largely reflecting our aggressive repurchase activity over the past year.

The lower share count benefited our EPS in the quarter by approximately $0.03. Our effective tax rate for the quarter was 39.4% and we expect the full year rate to come in at 39.5%.

Total inventory levels at the end of the second quarter was 4% on a per square foot basis versus the 17% decline we achieved last year. In store inventories at the end of the quarter were up approximately 5% versus the 25% decline we achieved last year. We expect inventories to be flat to slightly down in both divisions heading into the fourth quarter.

At Ann Taylor our in-store inventory per square foot at the end of the quarter increased by 14% compared with the 24% reduction we achieved last year. This increase is due to timing associated with earlier receipts of fall product at our distribution center and some impact of the softer sales from July. The inventory in store is good merchandize that is moving well at a good margin.

At LOFT our in-store inventory decreased about 8% on top of the 22% reduction we achieved last year. We are pleased with our overall inventory levels and are comfortable that we are heading into the third quarter in good shape.

Capital expenditures for the quarter totaled approximately $42 million relating primarily to new store openings and information system initiatives. Depreciation and amortization in the quarter totaled approximately $29 million compared to approximately $25 million in 2006.

In terms of some specifics on our outlook for 2007, we continue to expect earnings per diluted share to be in the range of $2.15 to $2.25. Overall, the primary drivers of our performance are expected to be: comparable store sales growth in the low single digit range for the fall season resulting in full year comparable stores sales growth approximately even with the year ago, net square footage growth of approximately 7% for both the fall season and the full year, gross margin expansion for the fall season of approximately two full margin points versus the prior year with the third quarter down versus a year ago and the fourth quarter up significantly versus a year ago.

For the year this translates into a gross margin rate decline of approximately 0.5 margin points. SG&A expenses as a percentage of net sales even with the year ago for the fall season resulting in a full year rate slightly below a year ago.

Finally we expect total inventory per square foot decline in the mid single-digit range at year end. In terms of new store opening for fiscal 2007, we plan to open approximately 35 LOFT stores, 15 Ann Taylor stores and 10 Ann Taylor Factory stores. We also plan to close approximately 10 stores in fiscal 2007.

With that I will turn it back to Kay.

Kay Krill - President and Chief Executive Officer

Thanks Jim. Before we move to Q&A, I would like to leave you with a few thoughts. First, the first half of this year was tough but we have managed through it very well. Both divisions are heading into the back half positioned for success with brand appropriate balanced product assortment and healthy inventories, as well as new growth initiatives being launched or expanded. Importantly, our comparisons in the back half eased considerably, particularly in Q4 versus those we were up against in the first half and this contributes to our confidence in our outlook for the year.

In addition, we are making progress with our cost reduction efforts and tightly managing the business through this period of macro softness. And finally, we continue to be focused on driving shareholder value, be it through our growth initiatives, our ongoing inventory management, our cost reduction efforts or our share repurchase activity, all of these levers are important drivers for increasing shareholder value.

So, with that let's open it up to your questions.

Question And Answer

Operator

[Operator Instructions]. Your first question is coming from Jeff Black from Lehman Brothers.

Jeff Black - Lehman Brothers

Hi. Good morning, everybody. Thanks.

Kay Krill - President and Chief Executive Officer

Good morning.

Jeff Black - Lehman Brothers

I guess the first question would just be the grill down a little bit more on the expense rate. Where specifically have we made some... are we getting traction? Where we may cut so far? And if you look at the second half, we are planning for better sales but we are planning for little bit worse SG&A performance. What costs are layered on here in the second half? Is it marketing spend going up? Is it the new concept that's weighing on things? Just a little more clarity around that will be helpful. Thanks.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Sure. I guess, there's a couple of questions in there. First, I'll talk about the expense reductions. We started talking about this on our March call. And as Kay just talked about, we thought as we engaged an outside firm to help us look at these costs. The costs we have seen currently, deductions have not been large, Jeff. We are making incremental cuts. We are taking a hard look in our home office payroll, and the reason you see the decrease in the spring season and the increase in the fall season, a lot of that does have to do with performance-based compensation. As you can guess with the tough spring season we have, there weren't large accruals and there wasn't a large payout as apposed to last spring season when we had a stellar spring season and we had higher accruals for our performance-based compensation. We are expecting in the fall season this year that we will have performance-based compensation which is embedded in the guidance we gave. Whereas last, we had a tough fall season, so the performance-based compensation was down. That's probably the biggest driver between spring and fall and what's driving the rate.

Jeff Black - Lehman Brothers

And --

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

And we do continue... we do continue to take a hard look at expenses though.

Jeff Black - Lehman Brothers

And what are costs for this year and for next year from the new concept? Have you broken those out yet or can we get some indication of that?

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

We have not broken them about. There are some incremental costs in the fall but we have not talked about them specifically. And we are not going to get until '08 at this point.

Jeff Black - Lehman Brothers

Okay, great. Thanks. Good luck in future endeavors, Jim.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Jeff.

Operator

Thank you. Your next question is coming from Kimberly Greenberger from Citigroup.

Kimberly Greenberger - Citigroup Global Markets, Inc.

Thank you. Good morning, everyone. A follow up --

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Good morning, Kim.

Kay Krill - President and Chief Executive Officer

Good morning, Kimberly.

Kimberly Greenberger - Citigroup Global Markets, Inc.

Just a follow up to, Jeff 's question; on the bonus accrual, Jim, could you quantify perhaps the basis point impact, the benefit to Q2, and any... if you can look back to 3Q and 4Q last year, what sort of benefit did you realize from the reversal of that bonus accrual? And then secondarily, Kay, do you think that the in-store merchandise assortment that we are seeing here towards the end of August, is that fully reflective of where you like it to be or do you think we are going to see gradual progress as we work our way through the second half? Thanks.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

As far as the second quarter, what I will tell you is our de-leveraging cost is between a 100 and 130 basis points due to the comp sales increase, and I will tell you through the top of my head, I don't have what the impact last fall; the exact numbers.

Kay Krill - President and Chief Executive Officer

Kimberly, August is trending a much better than July, overall, and I am particularly pleased that LOFTs new store set is being well received. What you are seeing in the stores right now is our transitional deliveries for both brands. We have another store set being set this weekend for both divisions as we had into the September month; mid-month will be our true fall delivery. So we definitely are expecting each brand to get a little bit more colorful as we get into the fall season, but August is starting off okay.

Kimberly Greenberger - Citigroup Global Markets, Inc.

Perfect. Thanks, Kay, and good luck here.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Kay Krill - President and Chief Executive Officer

Thanks.

Operator

Thank you. Your next question is coming from Jennifer Black from Jennifer Black & Associates.

Jennifer Black - Jennifer Black & Associates

Good morning, everyone, and Jim --

Kay Krill - President and Chief Executive Officer

Good morning.

Jennifer Black - Jennifer Black & Associates

Jim, good luck to you.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Jennifer Black - Jennifer Black & Associates

I have enjoyed working with you.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Jennifer Black - Jennifer Black & Associates

Kay, can you give us a little more color on your luxury line in terms of color, competition, prospects, just a little bit more. That would be helpful.

Kay Krill - President and Chief Executive Officer

On the Ann Taylor collection, Jennifer, is that what you are talking about?

Jennifer Black - Jennifer Black & Associates

Yes. That's what I am talking about.

Kay Krill - President and Chief Executive Officer

Okay. It's really a higher end fabric assortment. It is all Italian yarns and fabrics. It is primarily wear-to-work focus not casual focus. It consists of suits, jackets, pants, skirts, dresses, cashmere sweaters, handbags and more elevated shoe assortment. And it's in 24 stores, and we fully expect this to appeal to our current client base that wants a higher quality product, as well as attracting new clients. And it's about 40% higher per category than our existing Ann Taylor assortment. By category, like a dress... an Ann Taylor dress might be 148 to 158 and collection is 195. Jackets go up to 369 and pants up to 199. So it's about 40% higher.

Jennifer Black - Jennifer Black & Associates

And are the margins similar to that of Ann Taylor?

Kay Krill - President and Chief Executive Officer

Yes, they are.

Jennifer Black - Jennifer Black & Associates

And then secondly, can you talk about your accessory and footwear businesses at both of your brands? Thanks.

Kay Krill - President and Chief Executive Officer

Our access... for go forward?

Jennifer Black - Jennifer Black & Associates

Just... yes, for going forward what you see, and... exactly.

Kay Krill - President and Chief Executive Officer

Well I think the accessories and shoe businesses are going to remain about a similar penetration of the business that we had for the spring and summer season. We're seeing a little bit more strength in the accessories end, and the shoe end at this point in time. Accessories continue to be an important part of our wardrobing concept for both divisions and we are seeing jewelry and belts, and probably wraps being and capes coming on a little bit stronger in the fall season.

Jennifer Black - Jennifer Black & Associates

Okay. Thanks a lot. Good luck.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Take care.

Operator

Thank you. Your next question is coming from Brian Tunick from JP Morgan.

Brian Tunick - JP Morgan

Hi, thanks. I guess... just turning to the balance sheet, I guess, really focusing on the cash for a second. In your second half earnings guidance, you factor in the completion of this new share repurchase program, and is there a new philosophy from the Board regarding your cash balance or potential, I guess, leverage with all these new growth initiatives for next year and ongoing share repurchase programs. Are you going to be drawing down your revolver and is that something that the Board will be comfortable with?

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Well, what I will talk about, we just complete the $300 million program. We do have cash on our balance sheet of about a $115 million. Historically, when we announced the program like this last one, we had about $315 million cash on our balance sheet, so we had adequate resources there to cover it up immediately. What we look at is our total capital structures, you know Brian, which includes, taking a look and making sure we understand that, we really do have a $1.5 billion of debt out there due to our leases that aren't on our balance sheet, so we do constantly look at that. As you can tell we are comfortable probably at a minimal level being at this $115 million to $120 million in cash, but we do feel the need to maintain cash on our balance sheet to fund our working capital needs. And you are right; our first priority for cash is still going to be investing in new stores, the renovations in stores, and the new concepts. We think it's important to return value to shareholders through cash, through share repurchases, but we think it's more appropriate still to invest in the first two first, and then when we do have the cash we are going to buyback some shares. Now, so having said all that, we will be slower in our buyback than we historically have been. We will not be as aggressive.

Brian Tunick - JP Morgan

Okay. Good luck, Jim.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Lorraine Maikis from Merrill Lynch.

Lorraine Maikis - Merrill Lynch

Thank you. Good morning. You had to use promotion quite a bit to move the product over the past quarters and just curious, as you're building your 3Q and 4Q margin guidance. What type of macroeconomic climate have you included in that, and have you included continued markdown pace that you've been experiencing over the past two quarters?

Brian Tunick - JP Morgan

From a markdown point of view, what we've done is you can see on LOFT as where we talked about being very promotional throughout the whole spring season. We are hedging the fourth... third quarter down 8% to last year on top of being down 25% the year before. So we feel pretty good about our inventory levels as we go in; and we expect them to continue to be down throughout the season. So, we'll have less inventory than we did a year ago, entering into the fall season and throughout the fall season. So, no, we don't anticipate the same markdown cadent in LOFT that we had during the spring season.

Kay Krill - President and Chief Executive Officer

And the fourth quarter as well, our inventory levels for the fourth quarter in both divisions will be down substantially as well. We had gone through a thorough review of our fourth quarter assortment. We've cancelled sweaters, we've rebalanced the assortment and we feel very comfortable with the inventory levels going into November and December, and I think that's really important for you all to understand, because we had a pretty terrible fourth quarter last year. We had too much inventory. We had the raw inventory. We had a lot of weather sensitive categories in our assortment. We do not have that this year. We also have from, a third and fourth quarter perspective, we have planned... for most planned promotional activity at higher margins baked into back half of the year to really try to offset some of the traffic softness in order to get through the back half of the year strong from a margin perspective.

Lorraine Maikis - Merrill Lynch

Thank you.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Lauren Levitan from Cowen.

Lauren Cooks Levitan - Cowen & Co.

Thank you, and, Jim, best of luck to you in your future plans. Kay, I guess you just had touch on this but hoping you could elaborate a little bit more in terms of what you are assuming about the macro and the back half. I know when you made your original plans for the year they might have assumed different trends in the competitive environment and for consumer backdrop overall. I am wondering what your thoughts are relative to consumer behavior and if you think that there is more of an impact and more exposure at either the Ann side or LOFT. And then related to that, could you talk about marketing plans for the back half? Should we expect marketing dollars to be flat, lower or higher than the year ago? And will the allocation and the emphasis be any different? And then lastly, with the inventories up at Ann Taylor stores, is there any impact on the Beauty launch included in there, and I know, Jim, you called out that some of that was higher due to the weakness we saw in July. How does that inform the gross margin thoughts for Q3 or we... should we expect that Ann Taylor stores will be more promotional than a year ago to clear that excess goods? Thanks.

Kay Krill - President and Chief Executive Officer

Okay. Let me just start with the macro issues. What we have seen in the second quarter is definite slowdown in traffic. Ann was down 5.3%, and LOFT was down 5.3%, interestingly, for the second quarter and national mall traffic was down 5.6%. So we were pretty much in line with the mall average. What we do feel, though, is that our product, going into the second half of the year is much better at both divisions than it was last year. And at LOFT, it's significantly better, and that alone is a big factor from a comp perspective. Aside from that, LOFT was a big drag last year in the entire back half of the year, especially, the fourth quarter. Ann was also soft due to the high penetration in weather-sensitive merchandise, as we had those record warm temperatures throughout December and January. But as a result, while we had a pretty good third quarter, we had a very soft fourth quarter. We expect, really, Beauty to be incremental and we think that the third quarter we will have a solid quarter based on our better product assortments, more color, more novelty, better balance from an end use perspective, better marketing initiatives, and our fourth quarter should be dramatically better based on our product assortments for this year, and everything we've done to really get us in a better position from a gifting perspective vis-à-vis last year.

Lauren Cooks Levitan - Cowen & Co.

What levers do you have --

[Multiple Speakers].

Lauren Cooks Levitan - Cowen & Co.

Kay, if you've underestimated the macro factors relative to the improved product, because I think... I understand your points on the improved product. I am just curios what you can do in season if you've underestimated the macro drivers like reach mall traffic?

Kay Krill - President and Chief Executive Officer

What we try to concentrate on is we are not anticipating traffic levels to get better. We are not planning for them to get better. We are focused on our in-store metrics, what we can control from an in-store perspective to increase our conversion, increase the DPTs and the increase the UPTs. That's what we're focused on.

Lauren Cooks Levitan - Cowen & Co.

And then marketing plan?

Kay Krill - President and Chief Executive Officer

I am not going to get into marketing specific plans, Lauren, on the phone for competitive reasons.

Lauren Cooks Levitan - Cowen & Co.

Okay. And how about the inventory levels at Ann as we go into Q3?

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

We are comfortable with them. Yes, we would like them a little bit lower. But it's implied in our guidance that we just provided this morning, the markdowns we have taken to move through that inventory.

[Multiple Speakers].

Kay Krill - President and Chief Executive Officer

... primarily related to the July sales mix.

Lauren Cooks Levitan - Cowen & Co.

Great. Thank you.

Operator

Thank you. Your next question is coming from Dana Telsey with Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Hi everyone. Can you please touch a little bit about on the outlet malls? We have heard about that and how... that they have been doing well both in terms of profit contribution. What are you seeing there? How is the merchandise assortment there given that you've made it all different or maybe a more exclusive than what you have in the Ann Taylor division? And also, can you touch upon expense control? You did a good job this quarter. What levers are you using to drive that expense control? Thank you.

Kay Krill - President and Chief Executive Officer

All right. Let me touch on Factory real quick, Dana. Our Factory concept as far as our merchandising philosophy is really built on taking Ann Taylor bestsellers from last year, colorizing them to this year's color pallet, and offering them about 30% to 40% less than price and that whole philosophy and that concept, that strategy is working very, very well. We are seeing decreased traffic in the Factory environment as well, but our in-store metrics are very, very strong based on the product and based on our marketing efforts.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

In earnest, we have said before, the expense control long term we have the game plan in place to reduce those costs but short term it's just continually looking at discretionary spending and home office payroll and some of the in-store payroll.

Dana Telsey - Telsey Advisory Group

Is the system position... thank you.

Kay Krill - President and Chief Executive Officer

Operator, are there any further questions?

Operator

Yes. Your next question is coming from Shaun Kelley from Banc of America.

Shaun Kelley - Banc of America

Hi, guys. Thanks. It's Shaun Kelly for Dana Cohen. Just wanted to see if you could give us a little bit more color, Jim, may be on where the comp leverage point is going to be for the back half of the year given kind of all those moving around with bonus accruals and then for the fourth quarter... if you could just remind us how much the 53rd week contributed to last year, that would be helpful? Thanks.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

from a comp point of view, what we kind of said, we're going be at as a percent of sales about approximately the same as we were last year, and we did talk about low single-digit comps, and historically that's what we talked about. It's usually two to three comp points, that will get you to leverage on your SG&A expenses. So that's about where we are, and as far as the 53rd week, we never broke that out last year Shaun. Thank you.

Operator

Thank you. Your next question is coming from Liz Dunn from Thomas Weisel.

Lizabeth Dunn - Thomas Weisel Partners

From Thomas Weisel. My question... I know you are not providing any details on exactly what your spend on the boomer customer is going to be but can you talk a little bit about your decision to go after this market, and specifically, whether or not you think there will be any threat of cannibalization to your existing businesses, also what have you taken away or learned from some of the failure that some of your competitors have had in trying to address this market?

Kay Krill - President and Chief Executive Officer

As we stated in our release, Liz, we believe that this segment of the market is really the most underserved, and as a company, we really have a distinct heritage and upscale on stylish fashion that we believe that we can bring to bear in this market and that's what I mean by modern boomer. There are number of companies that currently play in the broader boomer market and our participation will reflect who we are as a company.

Lizabeth Dunn - Thomas Weisel Partners

Okay, what about cannibalization, because I mean I know your target is late 20s --

Kay Krill - President and Chief Executive Officer

No, we don't think so. We did a lot of white space analysis when we decided to go into this concept, and there were actually several different avenues that we could have gone down, but we really sized this as the biggest opportunity and we do not expect cannibalization because it really is a different age group that we're going after.

Lizabeth Dunn - Thomas Weisel Partners

Okay. And then just as you talk about August trends being a little bit better than July, is that traffic or what you are calling controllable metrics? Thank you.

Kay Krill - President and Chief Executive Officer

It's not traffic. It's really controllable metrics, and better product assortment.

Lizabeth Dunn - Thomas Weisel Partners

Okay. Thank you. Good luck.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Neely Tamminga from Piper Jaffray.

Neely J. Tamminga - Piper Jaffray

Hey, great. Good morning, guys. Real quick question for --

Kay Krill - President and Chief Executive Officer

Good morning.

Neely J. Tamminga - Piper Jaffray

Real quick question for you on just people and infrastructure, I mean, you've got a lot of great initiatives on deck here. Kay, how are you managing the people side of this, not just process and systems, I'm just wondering have you been leaving any holes, have you been making any sort of pretty key hirers in your view below the press release level? Could you give us some insights there?

Kay Krill - President and Chief Executive Officer

I really feel good about where we are as a senior team. I mean really with the addition of Mark Mendelson running the new concept, we have a strong leader in Ann Taylor, leading the Ann Taylor business. We have strong leadership in LOFT. We just filled the marketing job. We have added a few new hires underneath that we have not done press releases on but are senior levels that I think are adding a ton of value so far. And right now, the only opening we have is Chief Financial Officer position and I am very grateful and thankful to Jim to stay on until a successor is named for that role. So, I really feel like we are in good shape.

Neely J. Tamminga - Piper Jaffray

And in terms of collection, Kay, have you moved someone from the Ann Taylor business over there, or --

Kay Krill - President and Chief Executive Officer

Oh no.

Neely J. Tamminga - Piper Jaffray

Or is this a whole separate --?

Kay Krill - President and Chief Executive Officer

We are absorbing that, Neely. That's being managed through the existing team as much of our initiatives are being managed through the existing team.

Neely J. Tamminga - Piper Jaffray

Excellent. Thank you. Good luck.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Samantha Panella from Raymond James.

Samantha Panella - Raymond James & Associates

Good morning. I was just wondering where you are in terms of the workforce management system. I believe it's fully implies at Ann Taylor, where are you at with the LOFT? Thank you.

Kay Krill - President and Chief Executive Officer

We have totally ruled out the workforce management system in Ann Taylor and the Factory division, and we are half way there in LOFT and expect to be finished in the next two to three weeks.

Samantha Panella - Raymond James & Associates

And are you seeing... what are you... can you give us any color in terms of what you are seeing on the comp basis in those stores, in terms of the LOFT --

Kay Krill - President and Chief Executive Officer

What we are seeing is... excuse me.

Samantha Panella - Raymond James & Associates

I am sorry. In terms of LOFT.

Kay Krill - President and Chief Executive Officer

What we are seeing... what we are seeing in the Ann Taylor and Factory division because they obviously, Ann Taylor went first and then Factory and now LOFT going. As we have seen increased conversion, which is what we were hoping to see.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

And as far as the LOFT, we are just rolling head out now, as Kay said, and will be in a few weeks. And as you know there is a learning curve once you roll out of these systems, took some time to add. So, we really will see the full benefit of this in next year.

Samantha Panella - Raymond James & Associates

Great. Thank you very much.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question comes from Robin Murchison from SunTrust Robinson.

Robin Murchison - SunTrust Robinson Humphrey

Hey, good morning.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Good morning.

Kay Krill - President and Chief Executive Officer

Good morning.

Robin Murchison - SunTrust Robinson Humphrey

One... the fit model for the Ann Taylor collection, I assume is the same. And the second question is, notwithstanding last year's markdowns in sweaters, how would the merchandise margins compare on that versus the knits that you plan to build in the season-less fabric for the fourth quarter?

Kay Krill - President and Chief Executive Officer

The fit model is the same for collection, Robin, because our fit... we want our fit to be consistent throughout the brand. The only fit that will be different will be the new concepts.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

And when we are looking apples-to-apples, yes, not taking into account all the markdowns we had to take last year, it's comparable margin rates, whether it's the sweaters or it's the knit tops. They are in the same ballpark.

Robin Murchison - SunTrust Robinson Humphrey

Thanks. And good luck, Jim.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Crystal Kallik from D. A. Davidson.

Crystal Kallik - D. A. Davidson & Co

Good morning, everyone, and, Jim, obviously everyone is going to miss you. So, good luck to you on that.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Crystal Kallik - D. A. Davidson & Co

Also, you talked about workforce management and anymore updates you have with the progress in assortment planning?

Kay Krill - President and Chief Executive Officer

Other than it's fully rolled out in the system right now. Everyone is using it for their '08 assortment building. So it's out there, it's live.

Crystal Kallik - D. A. Davidson & Co

Oh! great. And then, Jim, I know, it sounded like Kay outlined quite a bit going on with longer term cost reduction initiatives. So, is it safe to say when we look at the second half as far as the near term cost reductions, is it fairly even between Q3 and Q4 or should we assume any disparity between those two quarters?

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

We didn't break it out by quarter. It's really for the... the fall season will be comparable to last year.

Crystal Kallik - D. A. Davidson & Co

Thanks very much. And again, good luck.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Roxanne Meyer from CIBC.

Roxanne Meyer - CIBC World Markets

Good morning. Most of my questions have been answered, but just a quick one. How many SKUs do you plan to have in your Ann Taylor collection, and are you concerned that in the backdrop of the macro-economic environment that it may be hard to gain attraction in the near term?

Kay Krill - President and Chief Executive Officer

It is a more limited assortment for Ann Taylor collection. I would say it's going to take up about 250 square feet. It's not that large, and --

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

And you got to remember, it's going to 24 of our best stores that have the capacity for it. So we feel comfortable about it.

Roxanne Meyer - CIBC World Markets

Okay. Great. Thanks.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Marni Shapiro from the Retail Tracker.

Marni Shapiro - Retail Tracker

Hey guys. Jim, I will add my congratulations. We will miss you.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Marni Shapiro - Retail Tracker

If you could talk a little bit about, just to clarify, the inventory reduction in the back half of the year. Is this related to the edits, Kay, that you talked about in producing sweaters or is it an across the board initiative? And if it is an across the board initiative, does that imply that the SKU count is down as well or is it just total inventory count that's down?

Kay Krill - President and Chief Executive Officer

The back-part of the year in this inventory management, Marni, is the third quarter we have gone into it in LOFT... let me just speak LOFT specifically right now, and a better inventory situation going into the quarter. We absolutely have taken our inventories down for the third and the fourth quarter to try to get higher productivity out of the process. So, we did take specific categories down in fourth quarter, most recently sweaters because of the existing trend towards knits and woven. But when I say we took sweaters down, we did chase knits and wovens in dresses which have been doing really well. So, we feel like we got out of product that was not going to be performing well and back in the product categories that have been trending well, really, for the past six months.

Marni Shapiro - Retail Tracker

Great. And then in Ann Taylor?

Kay Krill - President and Chief Executive Officer

In Both divisions. In both divisions, but we went into third quarter in Ann Taylor a little bit higher than we would have like to, but that was primarily due to early fall receipts in Ann Taylor at the DC, and also our mix to our July sales plan, based on not having enough color. But as we said it's going very well in initial markdown and we expect the third quarter inventory to be in good shape for Ann and to come further down for the fall season.

Marni Shapiro - Retail Tracker

Great. And --

Kay Krill - President and Chief Executive Officer

In the fourth quarter I mean.

Marni Shapiro - Retail Tracker

If you could also just talk a little about the balance, your refined assortments have looked consistently really good at Ann Taylor and have been very improved at LOFT. Could you talk about your balance resource, how you feel about the refined versus the casual assortments of the two brands?

Kay Krill - President and Chief Executive Officer

We feel like we are in pretty good shape with that going forward. Our causal business in both brands is a little bit more polished as we head into the back half of the year versus the second quarter, we get a little bit more refined overall. But we feel our penetrations are about the same as we go into the back half of the year in Ann Taylor. And in LOFT, as we said, really our biggest miss in the second quarter was not having that relaxed wear-to-work component in the store. And we have definitely ramped that up for third quarter and fourth quarter. And also part of our learning last year in fourth quarter in Ann Taylor as we had too much occasion product and not enough work product. So, we have corrected that as well.

Marni Shapiro - Retail Tracker

Great. Thanks guys. Good luck.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. Your next question is coming from Teresa Donahue from Neuberger Berman.

Teresa Donahue - Neuberger Berman

Good morning, guys. A couple of questions. First of all on the inventory situation, you indicated your expectation that you expect to be down by the end of the year at both divisions. How much of that is predicated on comp versus some flexibility you might have to make adjustments since season end. Secondly, on the new concepts, I am thinking that perhaps you are thinking that existing concepts are perhaps too old and too casual. Am I correct in looking that's the assessment of the competitive environment there?

Kay Krill - President and Chief Executive Officer

Well. First of all, I am not going to talk about competitors. I am only going to tell you what we are doing and what we are focusing on, and I feel like, I have been as clear as I could be at this point in time. As I said, I will share later, much further down the road, about branding and positioning vis-à-vis our competitors. But right now, I am not going to get into that conversation.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

And as far as the inventory levels go, we said we will be down mid single-digits by year-end, and we feel comfortable with that. We feel there is a flexibility. As you know, that's just a point in time. Our inventories will be following throughout the fourth quarter.

Teresa Donahue - Neuberger Berman

Thanks

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thank you.

Operator

Thank you. This ends the question-and-answer session of today's call. We will now turn things back over to Ms. Krill for any closing remarks.

Kay Krill - President and Chief Executive Officer

Thank you, everyone for your participation and interest in Ann Taylor, and have a great weekend.

Jim Smith - Executive Vice President, Chief Financial Officer and Treasurer

Thanks everyone.

Operator

Thank you. This concludes today's conference call. You may now disconnect, and have a great day.

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Source: Ann Taylor Stores Corp. Q2 2007 Earnings Call Transcript
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