Jones Apparel Group Q3 2007 Earnings Call Transcript

Jones Apparel Group, Inc. (JNY)

Q3 2007 Earnings Call

October 31, 2007 8:30 am ET

Executives

Wes Card - President and CEO

John Mcclain - CFO

Analysts

Jeff Edelman - UBS

Bob Drbul - Lehman Brothers

Jennifer Black - Jennifer Black & Associates

Brian McGough - Morgan Stanley

Todd Slater - Lazard Capital Market

Brad Stephens - Morgan, Keegan

Virginia Genereux - Merrill Lynch

Omar Saad - Credit Suisse

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Jones Apparel Group Third Quarter 2007 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference call is being recorded today, the 31st of October, 2007.

On this conference call, the Company will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 about their business. These statements are based on current expectations of future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

For a detailed discussion of these factors and uncertainties, I direct your attention to the annual report on Form 10-K for the fiscal year ended December 31st, 2006, including, but not limited to, the statements regarding forward-looking disclosure and the information concerning trends and risk factors included in the management discussion and analysis of financial condition and results of operations therein and to their other filings with the Securities and Exchange Commission. They do not undertake to publicly update or revise the forward-looking statements as a result of a new information, future events or otherwise.

I will now like to turn the conference over to Wes Card, President and CEO. Please go ahead, sir.

Wes Card

Good morning, everybody. Thank you, operator. Welcome to our third quarter earnings conference call. As is our normal practice, I'm going to begin with an overview of the general retail environment, comment on our businesses and the turnaround effects in progress, and discuss the impact of changes we have implemented.

John will then take you through our financial performance for the quarter in detail and the outlook for the balance of the year. I would also like to point out that this quarter we're using some supplement slides which are available on our website for download.

In general, during the third quarter, our businesses performed better than the revised expectations we had provided to you last quarter. In forecasting the back half at that time, we had anticipated a continuing challenging retail environment, which, as you know, certainly prevailed over the summer months and especially into September. July and August comp store sales for our primarily customers were mixed. However, September showed a marked decline into negative territory.

Given the current environment, which we'll elaborate on in a moment, and the fact that we performed better than expected in the third quarter, all those considered, we're holding our previously issued guidance for continuing operations at $1.20 to $1.25 for the year.

While a number of factors impacted retail sales during the quarter, the most pronounced was clearly the unseasonably warm weather, especially considering the fall clothing and seasonal assortments of footwear that dominated the selling floors in September.

We believe economic factors also affected our target customers, namely, the effect of the housing industry slowdown credit-wise, and a trend towards higher consumer prices, including the continued rise in oil prices. In addition, new jobless claims have recently begun to move upwards.

While industry consensus is that there may be a bounce in sales as the weather inevitably is getting colder, we remain cautious in our forecast, given the current overall economic picture and our concern with the level of promotions that may be required to fuel sales in the fourth quarter. Of course, our own chain of company-operated retail stores are not immune to the weather in the overall economic environment, and they performed at the lower end of our expectations even as we initiated our turnaround efforts.

I'm sure you're all aware that the footwear business, particularly women's fashion in the footwear business, has struggled this year. While we're not immune to these difficulties, we were able to improve sales and profitability through the third quarter with a renewed focus on product design and differentiation among our various brands.

We continue to enhance and improve the product offerings for both our wholesale customers and our owned retail locations. We believe that the size, scale and the diversity of our brands in product offerings are critical to our success and provide a long-term competitive advantage in this challenged market segment.

Before we go through the details of our performance in the quarter, let me address the turnaround activities we're working on in areas of primary focus since the last time we spoke, including an overview of our strategy. My purpose here today is to comment on several of the key initiatives we're working on rather than outline all elements of our turnaround strategy at this point. We believe that these initiatives have set the foundation for our return to enhanced profitability.

As I indicated on the last conference call, we are committed to stabilizing the Company in investing and in strategizing the growth of our core brands. The senior management team and I have been working very hard over the past four months, pulling together all elements of the Jones operating areas into a comprehensive and cohesive strategic operating plan.

Our goal is two-fold. First, we're very focused on enhancing the product and all of the products that we distribute and the appeal of our brands, and secondly, to reduce costs. From a cost-reduction perspective, we're on track to complete our initial target of $100 million in cost reductions by the end of this year, and we are now working on identifying further profit improvement goals as we move into 2008.

While we have a comprehensive plan in place to improve our owned-retail operations, our strategy remains, first and foremost, to be the best department store resource, and we're committed to building on this core competency. We believe that while significant challenges face the department store channel over the near-term, we anticipate that we will remain relatively stable over the next five years.

Further, we believe that our core brands of Jones New York, Anne Klein, Nine West and Easy Spirit, as well as our denim family of brands, including Gloria Vanderbilt and l.e.i, are key resources, and in some departments are the backbone of that channel, as evidenced by their strong market share and their size.

We also see significant opportunity for increased market share based on product excellence and consistency, strong department store relationships and execution, coupled with targeted sales efforts, where we have gap in our distribution and shifts in the competitive landscape.

A main driver of our product enhancement strategy includes developing and maintaining a superior and highly motivated management and creative team and associates, at all levels of the organization. This is what drives excellence in design, marketing and sales, sourcing, systems and technology, and an efficient and streamlined supply chain. We also recognize that people are our most important asset, and we plan to invest in their growth and development through things such as focus training and other programs.

In addition, for the first time in 2008, our entire management team will be unified and share similar incentives towards achieving positive results. We have outlined and are rolling out an incentive comp plan for the top 90 executives in the Company, tied to both divisional and corporate performance metrics, which replaces the existing discretionary bonus plan. These goals include achievement of planned operating income targets, operating cash flow, and for the longer term, include a component of total shareholder return versus our peers in operating cash generation.

As part of the unified management approach in better sportswear, for example, we reorganized at the beginning of the quarter the design and production areas under single leadership to provide clear differentiation in style direction for each brand. The design group for better sportswear has been exerting incredible energy and working lots of hours, putting efforts into our product offerings for spring 2008 and beyond.

We are already beginning to note the results of these efforts through customer contacts, and anecdotally from previous with the fashion community. The production teams supporting the better sportswear group have also now been combined into one support team. This will allow for both expense leverage and efficiency, but more importantly, will provide for one quality standard for all of our product lines.

To further bolster our apparel quality initiatives, we began a strong revitalization effort in the QC area, reemphasizing our standards and consistency of quality and fit. Among other things, we are focused on improving the quality of offshore development and are revaluating all of our vendors on a quality, compliance, cost and development-capability basis. We believe all of these initiatives will generate rapid improvement in product excellence and execution as we operate through 2008.

Next, we're focusing on our marketing expenditures and we have put preliminary plans in place for 2008. We're going to maintain significant committed dollars to our very large brands, Jones New York and Nine West, and have been allocating incremental dollars to supporting the growth of our Anne Klein businesses. We believe there is substantial growth opportunity for this label and are investing in several areas, including new in-store fixtures for our Anne Klein, AKAK better price point apparel business, which surely need updating.

We also believe there are significant opportunities for our core brands through online retailing. During the quarter, we established a new position of President of e-Commerce and brought in Ron Offir, an experienced e-Commerce executive, to fill this slot. In just a few months, he has identified some key enhancements that we are implementing quickly, such as an immediate modification to our existing e-Commerce website to allow for increased usability, such as easier and faster access to products for sale and checkout.

There are also plans to increase visibility, in other words, launching e-Commerce sites for other brands, offering greater product selection online, and better utilized high return web advertising. We are already noting some of the benefits of this in our web businesses and other initiatives that we have put in place. Looking ahead, we see e-Commerce as a much larger business for Jones with the potential of it substantially impacting the bottom line.

The final element of our strategy that I want to remind you of is our substantial commitment to technology investment. Since 2005, we have implemented product lifecycle management, assortment planning and ERP system, and move to one version for our warehouse management systems and heavily also in our retail systems.

Since 2005 and to end-year 2007, we have invested a total of about $120 million with an addition of $33 million planned for 2008 on total technology spending.

As a key part of this technology strategy, in November, our better apparel group will migrate to the common ERP platform that was first implemented in jeans wear and moderate sportswear in 2006. Once we achieve that, all major apparel divisions will be operated off the same system, with one remaining smaller unit to follow in 2008.

Efficiencies will be gained, throughout the support, in administrative areas and through development of the flexible and dynamic supply chain. We believe that with these technology and process improvements, we will be at the forefront of our industry in technology-driven operations.

Now, let me go through the performance of our businesses and some of the other things we are working on through this quarter. First in our retail operations, we are cautiously encouraged that our turnaround efforts are beginning to take effect. During the third quarter, we continue to aggressively promote and encourage excess stock out of our system, and we have gained control of inventory levels.

In our outlet stores, new assortments are performing well. As noted, it's going to take us to at least the first quarter in 2008 to completely reset our full-price mall-based stores. However, we have impacted our stores through the way we could given the product lead times, and efforts are starting to show positive results.

Comp store sales during the quarter were 8.7% down, which compared to a 5.1% increase in the third quarter of 2006. Comps were strong in the third quarter 2006 and now we are going up against comps that are much easier as we move into the fourth quarter. Our assumption for the fourth quarter for this year is where comps store decrease to 4.3%, which compares to a drop of about 1% in the fourth quarter of last year.

Along with the improved product assortments, we are investing in both maintenance and technology used in the retail and outlet stores. Our goal is to have our stores once again the best-in-class and properly reflecting our brand image. During the third quarter, we conduct an extensive internal review of store maintenance and upkeep, and we found, frankly, that we have been under-investing over the past several years.

Since we last spoke, all store maintenance and upkeep needs have been catalogued, prioritized and outsourced, for immediate attention. The initial program will cost about $6 million, which is roughly split between capital and expense and will be substantially completed before the upcoming holiday period.

All of these efforts, in terms of merchandise mix, maintenance, technology, have really served to energize and motivate the entire retail associate group of over 3,000 full time associates.

In the retail technology area, we're committed to immediately addressing some key needs, including installation of our broadband communication network covering the entire retail chain. This is going to allow us enhanced use of technology including targeted customer, marketing and loyalty programs and much-improved communication to provide in-store operational support.

Other initiatives include a much-needed register update, which is about half complete, and implementation of a price optimization system and new merchandise assortment planning systems.

Spending on retail technology, which is included in the figures I quoted previously on total tech, have been $21 million from 2005 through the end of 2007, and we have $13 million planned against these projects for next year. We are committed to investing in our core store base to improve operating results as quickly as possible.

In better sportswear, our third quarter selling in the Jones New York and Anne Klein brands, we are generally consistent with our expectations. As you know, the July and August periods are heavy clearance periods and fall opens up towards the end of those months, which was hampered by the weather and economic conditions that I noted earlier.

Given all that, we were satisfied with the selling levels, particularly in Jones New York Signature. Again, it's our leading brand and a top-performer for the stores. The Jones New York Collection business showed improvement over the first half and a modest trend towards more tailored apparel should prove beneficial for that collection as we move into 2008.

We continue to intensify our weekend casual offerings with both Jones New York Signature and Jones New York Sport to see somewhat we perceive as a competitive opening. In our casual product lines, in general, performed satisfactorily during the period.

Dresses continue to be strong sellers and the suit offerings remain generally on/or above planned for the season. We continue to believe that Anne Klein, and all of the labels that we market there, offer substantial growth opportunities.

We have completely updated the bridge product, Anne Klein New York and the better label AK Anne Klein starting with the spring 2008 season and we received very positive reactions to the products and are booked on target, at this point.

While the Anne Klein better label AK performed in line with our expectations for fall, the bridge product line was not as strong and the product was clearly off-track. We fixed this for spring 2008 and our new team is very focused on these products.

Nine West Sportswear, which had a very disappointing first half has done a little better so far for fall, still not performing up to our expectations and as you recall we put a new design team in place around the year, and they are focused on the 2008 product offerings. As you also know the Nine West Sportswear label is a more contemporary styling for the missy customer and we think it provides a clear volume opportunity for our department store customers and we need to get this product right.

In summary, we are still the backbone of the better sportswear area in the department stores, and our labels remain top performers in that zone.

Next, onto Moderate, and we have been focusing an exiting the businesses that we had identified earlier in the year. These businesses have completed final shipments of regular customer orders and the fourth quarter will now be dedicated to selling off the remaining inventory and closing down operations. We were not able to sell off any of those businesses, so we are just in a wind-down mode at this point.

Going into 2008, our moderate segment will include Gloria Vanderbilt Jeanswear, Energie junior tops, l.e.i., Junior denim and some other smaller labels. The area is anchored by the Jeanswear group and Gloria Vanderbilt in particular.

This segment was also impacted by the weather conditions in the quarter, although we are performing slightly better than the overall sector in most labels. Core denim items are performing the best and non-denim offerings have been somewhat weaker, even when highly promoted. We also have some new label launches here. We have Nine West Denim and Anne Klein Denim launching in department stores. Bandolinoblu is performing well and we placed a label [Cold Blue] in a major chain for the first time for fall. We are also exploring other private label opportunities in the jeanswear business.

In the Junior area, back-to-school was generally lackluster although the Tops business continued to be very strong under our Energie and l.e.i labels, with a continued strong trend in layering pieces. Junior denim bottoms continue to be soft, and as you know, it has become a very competitive segment.

Turning to wholesale footwear and accessories, we performed satisfactorily here against a very difficult environment, as I previously discussed. The footwear industry, in genera, has slowed, and boot promotions have already started weeks earlier than normal because of the warm weather.

Our brands in general are performing at or above competitive levels, notably Nine West and Anne Klein. Dress shoes are selling, although there has been no big dash in directions for fall, so far. Handbags and costume jewelry also performed well in the quarter. We are hopeful for an overall [bounce] here in sales as the weather cools and promotions start to feel some of the pent-up demand over the fall period.

In summary, we've been very focused, and very productive since the last update. The new management team has been in place for four months now and we are working together towards the common goal of continuing to grow our brands for the further benefit of our shareholders and customers.

With that overview, I'm going to turn the call over to John to go over the financials in details. John?

John McClain

Thank you, Wes. Good morning everyone. The company reported results for the third quarter of 2007 on a GAAP basis with net income of $400 million and earnings-per-share of $3.97, as compared with net income of $63 million and earnings-per-share of $0.56 last year. Included in the '07 results is the $258 million after-tax gain on the sale of Barneys for discontinued operations.

During the remainder of my discussion of the results unless otherwise noted, all amounts will relate to adjusted results from continuing operations.

Adjusted results exclude the impact of severance and other expenses associated with the strategic operating initiatives, the exit of the moderate sportswear business and other one-time items, which aggregated a positive $0.86 in 2007 versus a negative $0.07 in 2006. Continuing operations excludes the results of Barneys for all periods as in accordance with Generally Accepted Accounting Principles.

On the adjusted basis, EPS from continuing operations was $0.51 for the third quarter, compared with $0.59 in the prior year. Total company net revenues were $1.045 billion, compared with $1.078 billion last year. Total company operating income was $89 million versus a $115 million last year, and the operating margin was 8.5% versus 10.7%.

Now let's look at the results by segment. The wholesale better apparel revenues increased 1.3% or $5 million, and gross margin was 31.1% versus 35.8% in the prior year. This change is due to a higher level of markdowns, a shift in product mix and high [off price] sales.

SG&A for the better wholesale segment decreased by approximately $4 million and as a percent of net sales decreased to 18.6% or 19.8%. This decrease is primarily attributed to the realization of savings from the strategic initiatives implemented in the prior year.

Segment operating profit margin was 12.5% versus 16% last year. Wholesale moderate apparel revenues were $266 million compared with $288 million last year reflecting the continuing impact of our excelling moderate sportswear product lines.

Gross margin was roughly the same at 22.5% versus 22.2% last year. SG&A decreased by $1 million and the SG&A, as a percent of sales, was 15.7% compared with 14.7% last year. With the exit of the Moderate Sportswear line, we've taken steps to address the cost- structure of the business and have recently announced that we will be closing two distribution centers in South Carolina at the end of January 2008. Segment operating margin was 6.8% versus 7.5% last year.

Wholesale footwear and accessories revenue has increased by 6%, or $17 million. There was increased shipping in our handbag business and the addition of the new Anne Klein, New York line in footwear and the AK Anne Klein line in jewelry. Gross margin improved to 29.7% from 28.9% last year, due to better inventory management. SG&A, as a percent of revenues, was flat at 15.6%. Segment operating margin improved to 14.1% from 13.3% last year.

Retail segment revenues were $177 million compared with a $194 million last year. Revenues were down, primarily due to the closure of our Stein Mart retail locations earlier this year. Comp store sales were down 8.7% in our own footwear and apparel stores for the period, and during the quarter we were impacted by the higher promotional activities to clear excess inventory in the unusually warm September weather.

Result gross margin was 48.4% compared with 51.5% last year. SG&A expense as a percent of revenues was 56.5% as compared with 49.1% in the prior year, and this increase was due to lower sales level and a higher store count when we exclude the Stein Mart locations. Segment operating margin was negative 8.2% as compared with 2.4% in the prior year.

Finally, results for the quarters at Barneys of discontinued operations were $0.03 of earnings-per-share, which excludes the gain on the sale of Barneys and this is $0.01 per share above the high-end of our previous estimate.

Turning to the balance sheet and cash flow items, accounts receivable were $506 million at the end of this quarter year versus $524 million in the prior year, a decrease of 3.4%. Accounts receivable churn was 7.4 times versus 7.3 times last year and the portfolio remains current from an aging perspective.

Inventory was $590 million at the end of the quarter, versus $552 million last year. These increases were primarily new in two areas. First, in footwear and accessories, due to the timing of receipts and shipments increases which were related to new product lines in footwear and increased sales in handbags. And second, in the denim group where we had increases to support our replenishment programs. We have adjusted our denim plans, going forward, and the clean-up of any excess inventory that is considered in our current earnings estimate. Inventory churn was 4.8 times versus 5.1 times for the prior year period.

We used the $111 million of cash from operations during the nine month period, while we generated $153 million of cash during the prior year nine month period. This decrease is due to lower EBITDA cost related to exiting the Moderate Sportswear businesses, cost related to other strategic initiatives, including severance, higher working capital needs and the impact of exiting the Polo Jeans Company.

As I mentioned during our last call, the prior year's cash from operations was unusually high due to the positive working capital impact of exiting the Polo Jeans Company in 2006, while 2007 includes negative impacts from exiting the business. 2006 in excess, we were collecting cash for Polo and in 2007 we had a turnaround incentive in cash.

Share repurchase. During the quarter we utilized a portion of the proceeds from the Barneys sale in two ways. First, we repurchased 5.1 million of shares of our common stock for $95 million through out share repurchase program. We have approximately $300 million remaining under the current share repurchase authorization.

Second, we entered into a $400 million accelerate share repurchase program, which we refer to as the ASR program. Part of the ASR program we received approximately 15.5 million shares upon entering into the program in September and then at the end of the initial evaluation period in late October, we received an additional 2.4 million shares. Total number of shares that will be purchased under the ASR program will not be know until the program is complete, which will be no later than July 19, 2008. It is possible that we could receive additional shares at the completion of the ASR program up to a maximum of approximately 3.1 million additional shares.

Total debt was $783 million, down $197 million from the prior year period. This reflects the use of a part of the cash from the sales of Barneys to repay our short-term debt. At the end of the quarter we had cash on hand of $109 million and our ratio of debt to total capitalization, net of cash was 24.3%.

During the quarter the rating agencies downgraded our debt by one-notch, which leaves us just below investment grade status. Nonetheless, our access to capital remained strong and the downgrade had a minimal impact on our financing course. We continued our discussions with the rating agencies focusing on our roadmap to return to investment grade, primarily through improved operating margins. And at the meeting yesterday, the Board of Directors approved the quarterly dividend of $0.14 per share.

Now, I would like to provide a little guidance on the full year for continuing operations, where we forecast net revenue would be approximately $3.9 billion. Operating margins are expected to be approximately 6%. These margins reflect the level of markdowns in the fourth quarter, consistent with current trends, a difficult [bedim] retail environment, similar to the challenging retail environment we experienced in September, and the initial cost of the program to improve the maintenance of our retail stores.

Interest expense of approximately $46 million, and equity and earnings of unconsolidated subsidiaries of approximately $4 million, and the effective tax rate was approximately 34.7%. Weighted average shares outstanding for the full year of approximately 101.5 million shares and with the impact of all the shares repurchases we completed, weighted average shares for the fourth quarter of approximately 85 million.

Operating cash flow in the range of $90 million to $100 million, which is down slightly from our last call. This is due to the timing of shipments and payments for inventory, and slightly lower earnings. Capital expenditures will also be in the $90 million to $100 million range.

As Wes has mentioned, we have been investing heavily in technology and realizing savings, and now we will begin to invest more in retail.

Depreciation and amortization will also range from $90 million to $100 million.

In summary, our guidance for 2007 adjusted EPS remains at a range of $1.20 to $1.25 for continuing operations, plus $0.11 for EPS from discontinued operations, excluding the gain on sale for the discontinued operations, with a total of $1.31 to $1.36.

Benefits from our share repurchases and lower tax rate are offset by the current retail trends, both in our own retail stores and those of our customers, and by the cost of our initial programs, which improve the maintenance of our retail stores. The retail landscape improves with the trend towards the upper end of our range.

That concludes my comments and I'm turning the call back over to Wes. Wes?

Wes Card

Thanks, John. Before we open up for questions, let me just reiterate a few key points. Our goal is first and foremost to be the leading supplier to the department store channel.

Since we last spoke at the meeting with the top management and most of our major department store customers, and discussing with them partnership and growth opportunities, I'm really very encouraged by these conversations. The feedback they are giving us is consistent with our own plans to deliver quality and style and excellent product with outstanding execution to the department store customer.

In short, we have a clear strategy in place to reach new and existing customers hand-in-hand the overall appeal of our brands through our own retail channels and online distribution network.

At the end of the day, we're only as successful as our products and we have the right team for merchandising to design, quality control, distribute, and to see that the best possible products are available to our customers.

While we're just at the beginning of this turnaround process, we believe we have all the elements for success in place. And we're on track to reestablish Jones Apparel Group as the best-in-class among our competitors in all aspects of our business.

So, with that operator, we're now going to open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jeff Edelman from UBS.

Jeff Edelman - UBS

…in the right direction. Two questions, one given the environment, have you seen anything in the way of cancellations in terms of products that had been ordered looking forward?

Wes Card

Jeff, I didn't hear the first part of that Jeff?

Jeff Edelman - UBS

Have you seen any cancellations in orders up to this point?

Wes Card

I think we had seen some cancellations for the back half earlier in the period when we first revised guidance at mid year. So, since then in the apparel side, I think we're still on the track that was laid out. Footwear and accessories are little more sensitive to current conditions and I think there's been a little bit of slowdown. But we feel that the plans that we have in place are now achievable and we'll get the numbers.

Jeff Edelman - UBS

Great, thank you. John, what is the comparable number for the fourth quarter to be looking at? You reported $0.45 last year. But I guess if we exclude Barneys and Moderate, the numbers are probably close to $0.35. Am I correct?

John Mcclain

Yes. I think its $0.32 last year.

Jeff Edelman - UBS

Okay. Thank you.

Operator

Thank you. Our next question comes from Bob Drbul from Lehman Brothers.

Bob Drbul - Lehman Brothers

Hi. Good morning.

Wes Card

Hey, Bob.

Bob Drbul - Lehman Brothers

Wes, just two questions really. The first question that I have for you is when you look at your retail business, how should we think about near term targets? Like you talked about the recovery starting in '01, like how are you thinking about in planning that business as you look forward, given the results? And how quickly can that recovery take place?

Wes Card

Well, I think Bob, given the retail climate, I think it's tough to forecast against that. I think as the retail climate improves generally, as you know, most of the footwear comps that you are seeing are up very substantially. In fact, some of the comps we are seeing are up more than ours and we believe we are in a turnaround effort. So I think that complicates the process. We are seeing a turnaround now in the outlet operation, comps have been improving as we reset the assortments in the mix and that's a very profitable part of our business.

I think the mall stores we're seeing some improvement, but I think next year is going to be the key. Fourth quarter was profitable for us last year and this year's fourth quarter, the assumptions we have, are roughly a breakeven on a fully allocated basis for the retail stores. So, I think we are going to see steady progress. How rapid that's going to be and how rapidly it shows up through 2008, I think it's going to depend a little bit on the climate, but one thing we fundamentally feel. We have the right brands, we have good locations, we have a great management team that's on it, so I think we are going to bounce back quickly assuming the consumer cooperates.

Bob Drbul - Lehman Brothers

Okay. And then, just a question on the inventories and John called out too, I think footwear and accessories and handbags, and then the denim side. In total, what's the level of closed out inventories that you have and how does that compare as you look at last year's results when you are going into the fourth quarter?

Wes Card

I think, we have a little -- may be a somewhat higher level this year, partially impacted by the incredible amount of promotion and purging we've been doing in our retail [doors]. We generally run about 10% in terms of off-price to total sales and it varies around that quarter-to-quarter. So, I don't think there is an excess inventory issue. I think in denim, we probably stocked-up too heavily on some of the replenishment products earlier in the year given the climate in the back half, we are now eating into that and reducing production levels going forward. So we are going to bring those in line pretty carefully. But we move quickly on off-price as we go through the year. So there is no real issue there as we look forward.

Bob Drbul - Lehman Brothers

Great. Thank you very much.

Operator

Our next question comes from Jennifer Black from Jennifer Black & Associates. If you could please, go ahead. I am sorry. You are now on the talk-listen mode. Please go ahead.

Jennifer Black - Jennifer Black & Associates

Good morning, Wes.

Wes Card

Good morning, Jennifer. How are you?

Jennifer Black - Jennifer Black & Associates

Great, thank you. I wondered if you could talk about any changes in the floor space you are getting in the department stores, is it getting larger due to some of the woes of your competitors or is it about productivity per square foot or is it both?

Wes Card

Well, I think in most of the brands, we are probably holding the same. I think in the casual offerings we are starting to get more floor space, especially in '08. We have added a weekend casual element to Jones New York Signature and are obviously pushing very hard on Jones New York Sport. So, I think we are going to be picking up some space. In the collection areas, I think we've been pretty consistent. In Anne Klein, which is our main growth opportunity in the department stores, I think we are pushing very hard for increased penetration in floor space.

We are doing new fixturing program for AKAK, which is going to really enhance the look of the product on the floors, in the better stores and with a new product coming in we'll push very aggressively for additional product classifications and rollout to try to develop more of a lifestyle concept around AK Anne Klein.

Jennifer Black - Jennifer Black & Associates

Are you opening any new doors with Anne Klein or AKAK?

Wes Card

We are pushing hard to roll out doors within the chains that we service, which are the major department stores. And I think -- we really, what we are confident about is the product that we are seeing this spring that and we'd like to -- historically we've grown based on product performance and not trying to force goods into the channel. So, I think overtime, we'll see door rollouts as we go through 2008.

Jennifer Black - Jennifer Black & Associates

Great. And just one other question, I wondered if you could talk about any changes you might see in your channels of distribution from just like on a larger view?

Wes Card

Well, I think, the major department stores were obviously well penetrated in Macy's is a very large, obviously a very good partner of ours. We do lots of business with Bon-Ton. We are working very closely with Dillard's. We think lots of opportunity with Dillard's. We've developed good relationships there. We are working very hard to roll out more business there. I think in the moderate sector we have some opportunities. It's unfortunate in the moderate sportswear business that we've exited those businesses. I think there is room -- the mid-tier channel is looking for suppliers that can supply it up or moderate product profitably with good labels and we are looking very hard at that. So, I think as people exit that some of those businesses there is a need for brands such as ours.

Jennifer Black - Jennifer Black & Associates

Well, looks like you are on the right track and good luck.

Wes Card

Thank you. I appreciate it.

Operator

Our next question comes from Brian McGough from Morgan Stanley. Please go ahead sir.

Brian McGough - Morgan Stanley

Yeah, thanks very much. Am I coming through okay here?

Wes Card

Yes, very good.

Brian McGough - Morgan Stanley

Okay, thanks. So Wes when I look overtime here, I mean your organization, well not your organization, but the organization has moved away from the better department store channel and I guess at the time there was a good reason for it. It went into moderate and then into retail and then Barneys. Now you've got moderate winding down, retail is not really working and Barneys is gone. And it seems like you are back to where you started. So, I'm just wondering how you avoid getting [subbed] into that, you know game of increased gross margin relative to the quarter-to-quarter with markdown money. How do the department stores get to a bigger part of your mix again?

Wes Card

I think that, deal with the last part first. Product is really critical there and we have to add very consistent product across all of our labels. We can't have misses and the inconsistent, which I think we've been over past several years in the product offerings, and that's caused some of the difficulties for us. Where there is an opportunity, we have to seize on it, and I think the better the product, the less volatility, overtime. There is going to be some volatility though and I think footwear and accessories by its nature is also very volatile business.

I think going back to the strategy, our own chain of retail stores has historically been very profitable growth. And I think we fell off track there over the past year or so, and that based on the brands and the locations, we can very quickly get that back on track. And obviously, there is a lot of focus on that. So I think we can successfully operate the retail business, which is about 20% of our business. I think in terms of moderate, we do have a very good business in the mid-tier in moderate channels with Kohl's and JC Penny and others. With our jeans wear businesses, I don't think we should forget that, Gloria Vanderbilt is very heavily penetrated there as is our junior businesses under Energie and l.e.i. I think we need to enhance that. I think we missed the opportunity of Moderate Sportswear. I think it's going to be based on, we're having discussions with some of the big players in that area. We need to move that forward, because I think others are vacating that space.

So I think, and when you look at where we are, I want to remind everybody. The fashion footwear and fashion apparel business is $20 billion in the department stores, according to NPD. It's a huge business. And to be successful here though, we have to remain in the back one of the departments, and it's all going to based on product excellence.

And I think that's in the DNA of Jones New York, Nine West and all of our, that's what got us there and I think that's what we're focused on returning to.

Brian McGough - Morgan Stanley

True. Would you just hit on real quickly what other changes you've made to your design teams because I know you have a lot of different ones, so I instead on hit on all them, but is it that the people have been swapped out or if the team has grown, has the organization changed as far as how product is actually developed, could you just give a little bit of color there?

Wes Card

First of all, we named ones in the better apparels zone we named one Chief Merchandising Officer. So she is responsible for all of the -- and Susie Rieland as we announced is Susan Rieland, Susie has done some of the biggest product launches and best in our industry. She is now responsibility for all of the better labels. In fact, all of our sportswear labels, including the small mid-tier business that we are doing.

She has divided the teams up, they were combined in sort of too much combination, I think trying to work multiple labels of the same designer. So now its very focus is one team now differentiated focusing on Jones New York, one on Anne Klein. And we are I think augmenting some of the talent there. There is a very good talent base, I think, we got a little fence in the number of labels that we're doing and we are looking at bringing in some talent as well to help Susie.

But, I think just differentiating the labels, as you know we brought in a new designer for Nine West, the contemporary labels beginning in the quarter. So just getting it off clearly differentiated and a renewed focus and just a fresh eye, Susie has done our casual offering in Jones New York Signature up until June and now has the whole gamut of our better labels.

So I think a fresh eye working very well with the CEO of division Susan Metzger, they know merchandise, they know their customer and I think we're going to see a tremendous up tick in product offering as we go into next year. Not much by the way in the Footwear business, Andy Cohen has done a great job bringing in some new talent there and I think it shows up in some of the results and in some – in the product offerings and the response we are getting across all of the different labels. So and that really is product -- its sounds straight, but it really is the key to everything that we do.

Brian McGough - Morgan Stanley

Yeah. No. That's helpful. And, if I could just sneak in one last, I am sorry, but as far as your retail business goes, John, with all the capital that's been put into it right now, which I think is great by the way. I am wondering, I am going to assume that's going to take up the comp total just because you'll have a higher asset base that you'll have to sell above. Can you give us a sense as to what you are going to need to comp in that business in order to get margins up?

Wes Card

Brian, I will take that because I think, some of the investments we are putting in there are absolutely required. It's not a comp issue. That the maintenance, store maintenance issues were -- is sort of something we have to do and I think while the investments that we are getting, I think overtime is going to generate better comp store sales and better operations. I think it's hard to measure what the benefit we are going to get out of all that as we move through.

For example; the price optimization system that we put in, a lot of people are putting in price optimization systems and markdown control. Its hard that we put it in and its working very well, but it doesn't give you a good reason in this kind of environment with the heavy promotions and markdowns you need to get back I think into a more normalized period and a little more history to be able to use systems like that. So it's been a good investment, we are glad we did it. It’s very hard to measure the results at this point.

Brian McGough - Morgan Stanley

Got it. That’s a fair answer. Thanks, Wes.

Operator

Our next question comes from Todd Slater from Lazard Capital Market. Please go ahead

Todd Slater - Lazard Capital Market

Good. Thank you and congratulations on your work. My questions mostly have been answered. I am just wondering at this point, Wes, what's you operating margin goal, what you are now setting or shooting for in the current structure now?

Wes Card

Well, I think Todd, the mix of businesses between wholesale businesses and about say 20% retail on an ongoing basis. We need to get back above 10% operating margin. I want to get the double-digit. I can't put a timeframe on it. But the entire team here is focused on enhancement in operating results. And I think that's what generates the cash flow. And when we are operating at that level, we are very strong cash generator and it involves kept inventories and receivables are under good control.

So, that's my ultimate goal. I can't put a timeframe on it. I think next year, we'll see improvement over this year and we're going to work to get there as fast as we can.

Todd Slater - Lazard Capital Market

Okay. Best of luck.

Wes Card

Thank you.

Operator

Our next question comes from Brad Stephens from Morgan Keegan. Please go ahead.

Brad Stephens - Morgan Keegan

Hey. Good morning, guys. Can you breakout the ready-to-wear versus the footwear comps for this quarter for us?

Wes Card

The footwear comps were roughly 10% down and the ready-to-wear comps were mid-single digit. They performed better than the footwear. That's I think a function of the merchandise assortments. They were offshoots of the merchandise manufacture for those divisions and I think we are pretty much on track as a result.

Brad Stephens - Morgan Keegan

Okay. When you look at the moderate division, given you are exiting a couple hundred million dollars in revenues and you've alluded to closing down some distribution centers. How should we look at profitability of that segment going into '08?

Wes Card

I think that the jeanswear business has generally performed in the low double digits, although l.e.i. is still in a turnaround situation. We are trying to move that up. It has been operating in a low single digit. So, I am guessing we are going to be in the upper-single digits given that blend and then hopefully, as we get l.e.i. back on track, we can move that needle up and get the total weighted average above 10%.

Brad Stephens - Morgan Keegan

All Right. Good luck guys.

Operator

Our next question comes from Virginia Genereux from Merrill Lynch. Please go ahead.

Virginia Genereux - Merrill Lynch

Thank you. Wes and John, the revenue outlook for the fourth quarter is less than I would expect, I mean even with when retail is a bigger portion of the mix. But do the declines at wholesale accelerate pretty materially?

Wes Card

Well, we are winding out of the Moderate businesses, which I think has a big impact on that. And I think we had reasonably strong shipping in the third quarter, which I think also would offset a little bit import. But I think the main contributor is Moderate in the retail component.

Virginia Genereux - Merrill Lynch

So, if Moderate was down 14%, it’s going to be down a lot more than that. I mean you basically were not shipping the stuff that you are getting.

John Mcclain

We are just shipping of prices and we are just winding down businesses.

Virginia Genereux - Merrill Lynch

Okay.

John Mcclain

We cannot break it down at that level, but --

Virginia Genereux - Merrill Lynch

Okay. And to the question somebody else posed about margins at Moderate next year. What are the stranded costs? Can you quantify for us the stranded cost from the 300 million of volume that you are getting out of?

Wes Card

I think it probably is somewhere around $8 million or $9 million in terms of absorption. We’ve got to take on the other divisions. But I think that as we will complete this final system's implementations, that’s where I think, we are going to be able to reduce against that.

Virginia Genereux - Merrill Lynch

Right. And then sort of coming back to the fourth quarter, you are talking about margins. Your outlook implies margins below 3%, and not much in the way of EPS contribution. And again, is that all Wes said, retail margins probably will continue to trend negatively and wholesale is just a less of a contributor?

Wes Card

I think I have to go back to the opening comments. I think we are looking at a climate that is very unpredictable for fourth quarter and not just us I think you are seeing in everybody's numbers. And I think we are forecasting conservatively to be sure that if the climate continues to be negative and we don't get a bounce back from the weather, that we are covered on markdown exposure. And I think it's reflective, it's industry-wide. I don't think it's a Jones situation.

And so, I think we want to be cautious with the result. I think if there's a bounce on the weather, we could be in relatively good shape, because the first markdown is critical to profitability for both the stores and us. And I think that's where hopefully we will see as we got the normal promotional events coming up for Veteran's Day and others as we go through the back half for the fourth quarter. And we're hoping for a bounce in pent-up demand.

We have seen, just anecdotally, but and it is not a trend. But when the weather cools, we will see a pop and a significant pop in our comps, whereas, Labor Day, we saw a precipitous drop. The weather was 90 degrees, and a typically strong retail weekend, and we got a huge drop just given the extremely hot weather. So as that steadies out we're hoping for some pent-up demand and I think the industry is thinking the same way in the fourth quarter.

Virginia Genereux - Merrill Lynch

Okay. That's great. And then sort of bigger picture on the margins wise, your wholesale businesses have been particularly better, it's still a pretty high margin business considering the margin pressure that the department stores have seen and you saw what a double-digit plus -- low double-digit whatever its going to be this year, sort of the better business. As you invest more in those brands as you've talked about, I mean is that the appropriate level, can you sustain that level?

Wes Card

Yeah. I think that that's been -- even though we are in the low double-digits. Historically we are still well below where we've been on historical averages. So I think it is sustainable but I think we can improve it. I think footwear as well is, is back in the same range of double-digits. So I think that is the numbers you're quoting against a very difficult retail year.

Virginia Genereux - Merrill Lynch

And then the way that you're going to sustain or improve that or these, sort of systems and systems initiatives and better products I guess?

Wes Card

Better product comes absolutely first, better, consistent product.

Virginia Genereux - Merrill Lynch

Okay.

Wes Card

I think the offerings that we're showing to people now, people are very encouraged by what they're seeing coming out of our design group for 2008. And we feel very good about that.

Virginia Genereux - Merrill Lynch

And lastly then if I may, the cash flow, you said operating cash flow will be I'm sorry what this year John?

John McClain

It's somewhere in the neighborhood of $100 million.

Virginia Genereux - Merrill Lynch

Okay. So free cash flow is basically going to be breakeven, right, that's pre-CapEx, right?

John McClain

Correct.

Wes Card

Yeah. Don't forget the Barneys.

John McClain

Yeah.

Wes Card

$400 million and other -- almost $800 million of available cash.

Virginia Genereux - Merrill Lynch

Yeah, I understood that. But I guess normalized cash flow, what would you say Wes, if free cash margins were here then, for a lot of years. Free cash flow was in excess of net income, what do you think about the relationship between free cash flow and net income going forward, what would you say it should be?

Wes Card

Well, I don't really think about that way, but I think obviously if operating margins improve you are going to see an immediate rise in operating cash flow. I think capital expenditures, which you are netting against that, will moderate a little bit next year and then further as we go forward. So I think free cash generation is going to move back to historical norms.

Virginia Genereux - Merrill Lynch

Okay. Thank you.

Wes Card

Thanks.

Operator

(Operator Instructions). Our next question will come from Omar Saad from Credit Suisse. Please go ahead.

Omar Saad - Credit Suisse

Thank you, Good morning.

Wes Card

Good morning.

John McClain

Good morning.

Omar Saad - Credit Suisse

Question to John, I was looking to see if we could get a little bit more color around the non-recurring charge we saw this quarter. I think it was about $49 million related to restructuring and a lot of the initiatives you guys have going on. It seems to have accelerated a bit here. Are we coming to the close -- are we coming near the -- coming to the end of this program and these efforts that you guys have been going through or should we see those kinds of levels going forward?

Wes Card

Yeah. I think that, most of that -- a lot of that had to do with the exiting of the Moderate brands, where we had to significantly markdown orders and take markdowns against keeping the goods flowing into our retail customers, as well as the severances that we had for all of the restructuring activities and some of the management changes and others. So they are kind of all detailed that.

Absolutely Omar, I hope we are getting towards the end of all this restructuring. I think the moderate piece was biggest component left. There is always going to be some amount of severance or tinkering the dealing, but we need to steady out and that's been our focus. To steady out on what the core of the business is now and move forward.

Omar Saad - Credit Suisse

Okay.

Wes Card

And it's chewed up a lot of cash too.

Omar Saad - Credit Suisse

Sure.

Wes Card

And it's something that we need to put behind us.

Omar Saad - Credit Suisse

Is it possible, Wes [you were] talking -- can you help us break that out between what's coming out of SG&A versus what's coning out of gross margins. Is that possible?

Wes Card

I think you saw there is a follow-up on that level deep down. I think it's pretty well laid out in the Reggie tables in terms of all the details but I don't want to…

Omar Saad - Credit Suisse

Okay.

Wes Card

Anytime after the call if you want to.

Omar Saad - Credit Suisse

Okay, sure. And then I think someone had asked previously a question on inventories. I was a little bit surprised, I think inventories last quarter were down a little bit and they are back up again, is it simply kind of a weather issue backing up or is it something else under the line that's going on there?

Wes Card

Well, I think the two factors, John pointed to is that some of the footwear products are coming in a little bit earlier and we are very comfortable with where we are at in wholesaler footwear area against orders. Replenishment in the jeanswear business, we did build inventory there. And part of that's declined there I think we also were trying to build our weak supply on hand to the level of we really didn't need to. So, we've cutback on that and it's good basic product that we'll use up and cutback on production. So generally, our inventories are in good shape with just a modest increase but I think we will come back into line.

Omar Saad - Credit Suisse

Okay.

Wes Card

And I think last year’s balance was a little bit low than it normally been.

Omar Saad - Credit Suisse

Okay. And then, last question. Wes, as you look to deploy the capital and then kind of allocate your resources, what are the top one or two brands that you think have the biggest opportunities for the company?

Wes Card

Obviously, I think they are inclined. I think we’ve talked a lot about that. I think it’s, if you look at the size of the brands and I think it’s a good shot that we attach to the slides today. Nine West and Jones are roughly 20% of our businesses. They are very large, very well penetrated brands and I think while there is incremental growth there you are not going to get dramatic growth given the distribution, but we should get incremental growth in casual and other areas that we talked about. Anne Klein is about 8% of our business and it’s a very well recognized brand and with a differentiated product there is no reason why that can’t grow. I am not going to say it’s going to grow the level of Jones or Nine West, but it certainly has plenty of opportunities to grow.

So, I think that’s the main focus from a brand standpoint, but we are focused on each of these key brands and making sure that we have the mall operators shape as well as they can. And then I think on retail, we are very focused on getting our retail chain back to normalized operations.

Omar Saad - Credit Suisse

Okay, great thanks for the questions.

Wes Card

Thank you. Operator is that the last question.

Operator

Yeah.

Wes Card

Okay. Listen, thank you everybody for participating on the call and for your interest as we move through our turnaround efforts and improvement efforts and we will continue to update you on things, as we move through the fourth quarter. Thank you.

Operator

This does conclude today’s presentation. You many now disconnect.

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