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Ann Taylor Stores Corp. (NYSE:ANN)

Q3 2007 Earnings Call

November 16, 2007 8:30am ET

Executives

Kay Krill – President, CEO

Michael Nicholson – CFO

Maria Sceppaguercio – Senior VP Communications Inventor Relations

Analysts

Brian Tunick – JP Morgan

Dana Cohen – Banc of America

Dana Kelsey – Kelsey Advisory Group

Jennifer Black – Jennifer Black and Associates

Lorraine Maikis – Merrill Lynch

Tracy Kogan – Credit Suisse

Kimberly Greenberger – Citigroup

Adrienne Tennant – Friedman, Billings & Ramsey

Crystal Lanigan – DA Davidson

Barbara Wyckoff – Buckingham

Liz Dunn – Thomas Weisel

John Emrich – Ironworks Capital

[Michelle Pan – UBS]

Samantha Panella – Raymond James & Associates

Lauren Levitan – Cowen & Co.

Operator

Good morning ladies and gentlemen and welcome to Ann Taylor Store Corporation third quarter 2007 earnings conference call. [Operator Instructions] I would now like to turn the call over to Maria Sceppaguercio, Senior Vice President and Communications Investor Relations.

Maria Sceppaguercio

Thank you and good morning everyone. As you know earlier this morning we issued our results for the third quarter of fiscal 2007. We also updated our outlook for the full year. Based primarily on the significant traffic softness we experienced in October and ongoing macro economic uncertainty both of which have implications heading into the fourth quarter.

Here with me this morning to discuss the results is Ann Taylor, President and CEO Kay Krill and our CFO Mick Nicholson. During the quarter we repurchased approximately half a million shares for almost $15 million. Under our $300 million share repurchase program authorized by the board in August. Taken together with the 8 million shares we purchased in the first half of this year we have bought back a total of approximately 8.4 million shares so far this year at a total cost of just under $315 million.

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 provision 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 contained in the company’s filings with the SEC. With that I will hand it over to Kay.

Kay Krill

Thank you Maria and good morning everyone. Before we get into the specifics of the quarter and the outlook for the balance of the year I’d like to share my overall perspective with you on the state of our business and what we are seeing from a broader macro perspective.

Starting with our company, as you know, significant focus for us since the beginning of this fiscal year was getting the Loft product back on track for fall. We have also been focused on a very aggressively managing all the things within our control like reducing inventory levels and improving in store metrics, as well as repurchasing our stock. These strategies along with our ongoing effort to consistently offer our clients compelling product assortments have enabled us to deliver good margins overall despite a very challenging retail environment for the past two quarters.

In the third quarter we achieved EPS of $.66 which is the highest quarterly EPS in our company’s history. However, the significant traffic decline we experienced in October with traffic down approximately 15% versus a minus 9% in September and a negative 5% in the second quarter of this year was far more serious than we and others could have predicted. Clearly, that softness and the lower than anticipated sales had an impact on our third quarter earnings causing us to have a more cautious outlook for the fourth quarter.

Please keep in mind that we still expect to deliver strong EPS growth versus the fourth quarter of last year. Here are some reasons we are optimistic about this growth. First, our product offering in Q4 this year are better than last year, especially at Loft. Second, we have planned our assortments to be more season less so that weather would be less of a factor in our results. Third, we are entering Q4 with healthy inventories and at both divisions. Fourth, we have strengthened our gifting options across all businesses and finally, we launched Beauty in all 350 Ann Taylor stores which we expect to be incremental to us.

If you take the revised outlook for the year and remember that we are reducing our EPS guidance range for the year by less than 5% or about a dime, this translates into fourth quarter EPS of $.44-$.54 versus the $.31 we reported last year, or a growth range of about 40 to almost 75%. Overall we are expecting to report respectable growth for the year in an extremely challenging environment due to a very strong second half. This translates into substantial EPS growth for the quarter in mid to high single digit EPS growth for the year. Overall, respectable growth and a challenging environment but as you know we were expecting more.

With that as an overall context let me know turn to some specifics on the third quarter. Net sales grew approximately 6% to $601 million. Our comp store sales for the quarter were down slightly at a -.4% compared to an increase of 2.6% last year. Ann Taylor comps were down for the quarter, although the division effectively managed through the current macro situation to deliver solid margins and end the quarter in a healthy inventory position.

At Loft, as we expected, our clients responded favorably to our fall assortments and the division achieved essentially a flat comp in a difficult environment. Importantly, the division has been particularly successful in achieving strong in store metrics to help offset the impact of the soft traffic. Loft delivered strong margins for the quarter and entered Q4 in a good inventory position.

Gross margin for the quarter was a healthy 56.1% versus the 56.6% we reported last year. As you know, we have been promotionally aggressive to keep our inventory turning but our approach has been strategic and surgical rather than across the board reductions. As we have discussed previously our clients respond favorably to brand appropriate product at first markdown which helped us to achieve good margins in the quarter.

SG&A for the quarter as a percentage of sales improved 70 basis points to 45% versus 45.7% last year. We continue to believe that there is significant opportunity to reduce our cost structure. Mike will discuss SG&A with you a little later in the call.

Operating income increased 7.9% for the quarter and operating margin advanced to 11.1% of sales versus 10.9% of net sales last year. In terms of EPS we achieved a 22% increase versus year ago to a record $.66 in the third quarter versus $.54 last year.

Our aggressive share repurchase activity which reduced our third quarter diluted share count by almost 11 million shares versus year ago contributed approximately $.07 of the EPS improvement.

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 another mixed quarter. Net sales declined 4.4% and comp store sales were also down 4.4% versus a 6.1% comp gain in the third quarter last year. On the other hand our margins were solid as we aggressively managed our in store metrics to help offset the soft traffic. We also ended the quarter with total inventory per square foot down 1% versus year ago excluding the impact of Beauty. This is on top of the 13% decline in total inventory per square foot we achieved in the third quarter last year.

On the product side our overall assortments in the third quarter were brand appropriate, although we could have offered more color, novelty and fashion. Our clients are clearly in a colorful cycle right now and she is spending selectively on items that are currently not in her closet. As a result, anything fashion right and novel is performing well and more basic offerings or wardrobe essentials are moving slower or at a value price.

Strong categories for Ann Taylor in the quarter were dresses, item jackets, textured and novelty sweaters and woven and knit tops, while basic sweaters, pants and non-apparel were soft. For the fourth quarter our assortments reflect a lot more color. A greater penetration of novelty, particularly in sweaters, and a continued focus on dresses and item jackets as well as embellishment and sequins as must haves of the season. We are also focused on occasion dressing for the holidays and of course beauty and gifting.

Earlier this week we launched our Beauty initiative in time for holiday shopping. The offering consists of a fine fragrance named Possibilities, which comes in three sizes as well as a purse spray a body lotion and a gift set. Our Beauty offering also includes an Ann Taylor body care collection consisting of body lotions, body mists and body washes in six scents and will be prominently displayed at the front of the store at launch.

We are very optimistic about this product category given its attractive margin characteristics as well as being ageless, size less and season less. Beyond these obvious category benefits, we believe Possibilities is undeniably feminine and beautiful and captures the positive confident attitude that is distinctively Ann Taylor. We expect our clients to love not only the scent but also the gorgeous bottles.

Another growth initiative for Ann Taylor is our recent introduction of Ann Taylor Collection, which is a higher priced, higher quality collection targeting affluent professional women in 24 of our more upscale locations. The new collection is priced about 40% higher than core Ann Taylor assortments and consists of very high quality suitings, separates and dresses as well as coordinating tops and accessories. Our holiday assortment is just arriving in stores now and we are gaining valuable insights about this higher end offering and we continue to believe Collection will expand the brand in key locations.

From an overall standpoint the Ann Taylor division continues to be well managed and the team is pursuing a number of exciting growth initiatives that we believe have promise. In addition the team is also focused on evolving the brand to ensure it stays relevant. With the progress we’ve made over the past couple of years to strengthen the Ann Taylor division now is the perfect time to undertake this effort. We are currently undergoing an extensive research effort to better understand how our client’s needs and preferences are evolving so that we evolve with her staying relevant and capturing a greater share of her wallet.

As you have heard me say many times in the past, our clients are not standing still so neither can we. We must continually evolve, elevate and innovate to remain successful in this rapidly changing industry.

Let’s turn to Loft. Let me start by stating how pleased I am that our fall assortments have been well received by our clients and that Loft product is again brand appropriate. We have finally put the issues of last year behind us and our product is well positioned for the upcoming holiday season.

In terms of the third quarter for Loft, net sales advanced 9% and comp store sales were down slightly at a -0.3% versus the 0.9% comp decline in the third quarter last year. We achieved strong margins at Loft for the quarter on the strength of healthy in store metrics, it helped to offset the soft traffic environment. In addition, Loft did a good job managing its inventory and ended the quarter with inventory per square foot down double digits.

On the product side our fall assortments were well balanced, had better end use penetration, had more color and novelty and had a more appropriate mix of updated classics versus fashion. Our early fall transitional deliveries were very wear now and given the warm weather were very well received. Our sweater offering was particularly strong in the quarter due to having a lot more color and more season less yarns, versus the heavy wools we offered last year. Wovens and item jackets were also strong as were dresses and pencil skirts which we could have used even more of as she really responded to these new fashion silhouettes. On the other hand pants were a tough category with very little newness to call out and with her opting instead for items she doesn’t already own. In addition, shoes and accessories were also soft.

For the fourth quarter our approach is significantly different from last year. Our assortments are compelling with significantly more color and novelty than last year and with a strong statement in must have items, such as holiday dresses, white novelty shirts, item jackets, fashion cardigans and overall embellishment and shine.

We have reduced our basic sweater offering in favor of novelty sweaters and we have modified our fabrics and yarns to be more season less. Our assortments for the quarter are focused on wardrobing our clients with versatile product that take her from day into evening.

Turning to our recent launch of Maternity earlier this year in 20 Loft stores and online. This business is off to a good start and we just added another five stores bringing the total number of stores that carry Maternity to 25. Client reception has been positive and we are gaining important learning’s about this business which is such a natural brand extension for us.

Finally on Loft, as you may know we opened the doors to our 500th Loft store earlier this month. I was with Loft just nine years ago when we opened our very first Loft store and opening our 500th in such a short period of time really speaks to the power and reach of the brand that we created. I am extremely proud of our success.

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. Our online business continues to grow rapidly and our recently upgraded sites offer improved navigation and check out as well as strength and stability to accommodate increased traffic. I am very pleased with the progress we’ve made with this channel and expect it to continue to deliver strong growth for us.

Finally, on our new concept. We continue to make very good progress, we have hired a top notch team, we have created a brand book to clearly define the brand internally, we have secured real estate and we are developing the product line for the fall 2008 launch. We continue to believe this represents a significant growth opportunity for the company with the potential to be our next billion dollar business.

We are approaching this modern boomer client in a unique and compelling way that we believe will really resonate with her. At this point I want to turn it over to Mike to take you through the financials for the quarter.

Mike Nicholson

Thanks Kay and good morning everyone. Let me just start by saying that it is great to be here at Ann Taylor and I look forward to working with the team to position the company for continued profitable growth in the years ahead. Over the past month I’ve had the pleasure of meeting several of you and I’m looking forward to meeting more of you in the coming months. Let’s jump right into the results for the third quarter.

Net sales advanced 6.1% to $600.9 million versus $566.3 million in the third quarter of last year. This growth largely reflected the expansion of our store base versus Q3 last year and the continued growth of our factory and internet businesses partially offset by the modest decline in comp store sales for the quarter. By division, net sales of Ann Taylor stores declined 4.4% versus year ago $213.5 million and net sales at Loft were up 8.9% to $296.9 million. Comp store sales for the quarter decreased 0.4% with Ann Taylor stores down 4.4% and Loft down 0.3%.

Let me spend just a moment on comp sales. You’ll recall in our October sales release last week we indicated that our October results were unfavorably impacted by timing associated with a promotional program that spanned two quarters. The impact in the month of October was a negative 1.3 comp points for the company and a more significant 2.9 comp points for Ann Taylor. The impact for the third quarter was a far less significant 0.4 comp points for the total company and about one comp point for the Ann Taylor division. Both of these impacts will reverse themselves in the fourth quarter.

Turning to margins. Gross margin as a percentage of net sales decreased by 50 basis points to a still strong 56.1% in the quarter versus the gross margin of 56.6% in the third quarter last year. This decline largely reflected the impact of aggressive promotional activity throughout the quarter at the Ann Taylor division in response to slow traffic and a highly promotional retail environment. Looking ahead to the fourth quarter we are optimistic that our gross margin performance will significantly improve versus the depressed level we reported last year.

SG&A in the quarter improved by 70 basis points to 45% of net sales compared to 45.7% of net sales in the third quarter last year despite our soft comp performance. This improvement primarily reflected lower performance based compensation expense and reduced long term benefit costs associated with the modification during the quarter of certain long term benefit plans partially offsetting these positive factors was the impact of the de-leveraging in the quarter.

Let me spend a moment on SG&A before we move further down the P&L. As you know, we are in the process of evaluating our entire cost structure with the goal to reduce SG&A as a percentage of sales by approximately 200 basis points over the next few years. Since last quarter the company has undertaken an exhaustive review of our entire cost structure and is currently in the process of evaluating and prioritizing the various opportunities we have identified to improve our profitability. We remain confident that we have significant opportunity in this area and has we finalize our plans over the coming months we’ll update you more fully.

For now, let me just state that was we sit here today it is our expectation that we will begin to realize some productivity benefits beginning in late 2008 with the lions share of the benefits impacting 2009 and beyond. At the same time we will begin to roll out Loft Outlet next summer and our new concept next fall. These significant growth initiatives will require investment spending as you would expect. So as you think about 2008 and beyond it’s important to consider the timing of not only the productivity benefits we expect but also the investment spending to support our long term growth and we’ll be updating you on the timing of what we expect for 2008 early next fiscal year.

Moving back to the P&L. Operating income in the quarter increased 7.9% to $66.6 million versus $61.7 million last year. Operating margin expanded 20 basis point in the quarter to 11.1% of net sales versus the 10.9% in the third quarter of last year. Net income grew 3.8% in the quarter to $40.8 million or $.66 per diluted share compared to $39.3 million or $.54 per diluted share last year. Our weighted average shares outstanding for the quarter were 61.5 million shares versus 72.4 million shares in the third quarter of last year, largely reflecting our aggressive repurchase activity over the past year. This activity benefited our EPS in the quarter by approximately $.07.

Our effective tax rate for the quarter was 39.5% versus 40.2% in Q3 last year and we expect the full year 2007 rate to come in at 39.5%. Total inventory per square foot at the end of the third quarter including the impact of Beauty was down 4% on top of a 3% decline last year. Excluding Beauty the decline was 5% in the quarter.

At Ann Taylor excluding Beauty our total inventory per square foot at the end of the quarter declined by about 1% on top of a 13% reduction we achieved last year. At Loft our total inventory per square foot declined 12% versus the 8% increase we reported last year.

Capital expenditures for the quarter totaled approximately $51 million and related primarily to new store openings. Depreciation and amortization in the quarter totaled approximately $30 million compared to approximately $26 million in 2006.

In terms of some specifics on our outlook for 2007 we expect earnings per diluted share to be in the range of 205-215 versus our previous guidance 215-225 and our key assumptions behind this outlook include the following: comp store sales growth in the low single digit range for the fourth quarter versus the 6% decline we reported last year. I do want to point out that we expect our November comp sales to be up versus year ago due primarily to the Thanksgiving holiday shift and we expect our December comp sales to be slightly below year ago for the same reason. This translates into a full year comp store sales decline in the low single digit range.

Net square footage is expected to be up approximately 1% for the fourth quarter and 7% for the full year. We expect operating margin improvement in Q4 of approximately 200-300 basis points reflecting better product and healthier inventory positions at both divisions this year versus last year, particularly at Loft partially offset by higher performance based compensation in Q4 this year versus last year. The operating margin improvement in Q4 translates into a full year operating margin rate decline of about 50 basis points largely reflecting the gross margin pressure the company experienced during the first half of this year. Finally, we expect total inventory per square foot to be down at year end. We are in the homestretch of fiscal 2007 and we are very aggressively managing all of the things within our control so that we can close the year positioned for success in 2008.

With that I will turn it back to Kay.

Kay Krill

Thanks Mike. Before we move to Q&A I’d like to leave you with a few thoughts. This past quarter and in fact the last nine months have been tough due to the first half product issues at Loft and the more recent dramatic slow down of the retailing environment. However, we have managed the business well during this difficult time and we believe we are heading into Q4 in good shape. Our product at both divisions is brand appropriate and balanced and our inventory positions are healthy. We also have exciting new growth initiatives that are expected to drive incremental business in the fourth quarter.

We are focused on tightly managing expenses through this period of macro softness and we are continuing to pursue opportunities to contain discretionary spending. In addition, you’ll recall that we are up against an extremely weak fourth quarter last year and this gives us confidence that our outlook, while still representing attractive growth is achievable.

Finally, driving shareholder value will continue to be a core focus be it through growth initiatives, ongoing inventory management, cost reduction efforts or share repurchase activity all of these levers are important drivers for increasing shareholder value that we will continue to pursue.

With that let’s open it up to your questions.

Question-and-Answer Session

Operator

Thank you [operator instructions]. Your question is coming from Brian Tunick of JP Morgan

Brian Tunick – JP Morgan

Good morning, thanks Kay, very helpful as usual. Two questions, one on the product cost side we are hearing a lot of things I think wool costs are up 30-40% year over year so just curious was you are doing with your product mix with product costs and then the second question because it sounds like Factory margins are certainly increasing, could you give us some color on where factory margins might be year to date relative to the consolidated corporate margins or where potentially you think this division could be?

Kay Krill

First of all on the Factory margin, we don’t break it out by division Brian, but we are enjoying very attractive margin growth in this channel. As far as the product costs, we are definitely seeing costing pressures as we head into 2008. However, we have many internal sourcing initiatives in play to help us mitigate the pricing pressures stemming from inflation and currency issues and raw material increases in particular. We are on it and we expect to offset some of the external factors with our internal plans.

Operator

Thank you, your next question is coming from Dana Cohen of Banc of America

Dana Cohen – Banc of America

Good morning, a couple questions. On the gross margin, would it be fair to say that the corporate decline was entirely due to Ann offset in part by increases at Loft and Factory is that the right way to think about it?

Kay Krill

I would say directionally yes.

Dana Cohen – Banc of America

On the SG&A given your comments about the fourth quarter. Is it also fair to think that we are through the last quarter where you reversed out the bonused accrual and that lifts now into Q4?

Mike Nicholson

Actually year on year from SG&A expense perspective in the fourth quarter we will be up against a prior period where there was an accrual reversal so for the Q4 07’ we expect the rate to be in line with our year to date run rate but a slight erosion when we look at it on year on year basis.

Dana Cohen – Banc of America

Year to date is wouldn’t that number probably have been down versus the prior year though?

Kay Krill

Year to date we are down versus year ago.

Mike Nicholson

We’re down almost nearly a point year on year, year to date.

Dana Cohen – Banc of America

What is the Ann Taylor inventory including Beauty?

Mike Nicholson

Up one, inclusive of Beauty.

Dana Cohen – Banc of America

Up one, inclusive of beauty and down one without?

Kay Krill

Yes, on top of a negative 13% decline last year.

Dana Cohen – Banc of America

No problem, thank you so much

Operator

Thank you, your next question is coming from Dana Kelsey of Kelsey Advisory Group

Dana Kelsey – Kelsey Advisory Group

Good morning everyone. Can you give us a little color IMU opportunity, what do you see especially given the costs pressures and a lot of work has been done on the supply chain where are we there? How do you see the impact on margins from the new product extensions?

Kay Krill

I would say the IMU opportunity, Dana, based on my previous answer is that we are working hard to offset the external factors that are going on from a currency in raw materials and inflationary perspective to just basically just stay even with this year. Your other question was sourcing.

Dana Kelsey – Kelsey Advisory Group

Supply chain, exactly.

Kay Krill

We have cut off six weeks in our supply chain and this is the year that we are really staying still and evaluating how we get to the next level. Our focus this year is really managing the IMU and managing all of the external factors that we will be up against as we approach 2008.

Dana Kelsey – Kelsey Advisory Group

And your product extensions Kay with Beauty and the impact on margins there?

Kay Krill

We just launched that this week Dana, but as you absolutely know, Beauty enjoyed very attractive margins, but we just launched it this week and so far so good.

Dana Kelsey – Kelsey Advisory Group

Thank you.

Operator

Thank you, your next question is coming from Jennifer Black of Jennifer Black and Associates

Jennifer Black – Jennifer Black and Associates

Congratulations, I wondered if you can talk about the percent of product you have in basics versus novelty and you talked a little bit about the change going forward but I wondered if you could talk a little bit about that and then are you still pursuing something in the nature of a loyalty program, any thoughts on that?

Kay Krill

As far as a percent of products that’s basic versus novelty, we really chased into the novelty for fourth quarter and the percentages get higher in novelty and higher in color as we approach right now heading into December and definitely heading into 08’. As far as a loyalty program, we are working on that right now. We have nothing to share with you definitively, but it is definitely in the talks in working stages.

Jennifer Black – Jennifer Black and Associates

Great, as far as you talked a little bit about pants versus skirt do you have any color there?

Kay Krill

Yes, skirts and dresses have performed a lot better this year than pants. Pants has not been as strong and as I said in my remarks there’s really no new offering in pants this year vis-à-vis last year where cropped pants and slim pants were really the thing. I think this year the strength of dresses has really overshadowed the pant business.

Jennifer Black – Jennifer Black and Associates

Thank you very much and good luck.

Operator

Thank you, your next question is coming from Lorraine Maikis of Merrill Lynch

Lorraine Maikis – Merrill Lynch

Good morning. I just wanted to clarify on the SG&A side, is your guidance implying that you will begin cutting some expenses out of the business next year but that will be offset by investments in the Loft, Factory and the new concept?

Mike Nicholson

Directionally yes, so we do expect to realize some lift from the expense reduction initiatives which will be partially offset by the investment in both Loft Outlet and new concept that will launch in the back half of next year. With the lions share of the savings we expect to be able to realize on the bottom line in 2009 and beyond.

Lorraine Maikis – Merrill Lynch

The benefit plan savings that you talked a little bit about in the 10-Q last quarter, did you get a one time benefit from that or do you expect that to continue for the next few quarters?

Mike Nicholson

At this point I see it as a one time benefit.

Lorraine Maikis – Merrill Lynch

Thank you

Operator

Thank you, your next question is coming from Tracy Kogan of Credit Suisse

Tracy Kogan – Credit Suisse

Good morning, first a quick follow up on the SG&A, what were your marketing expenses as a percent of sales, were they up or down, where there any new concept expenses in the quarter and then what comp do you think you need to leverage SG&A in fourth quarter in 2008 and then secondly for Kay, the traffic trends in November, I know you have talked about getting a pop at the beginning of the month, has that continued into the second week as well?

Kay Krill

Let me jump in first, you might have to repeat a couple of your other questions because you were going quickly. The traffic in comp for the month of November really with the onset of the cooler weather in November, traffic in comp trends have improved from October’s very low levels, but that being said, we are only half way through the month but we are pleased thus far.

Mike Nicholson

In terms of comp points on SG&A in order to leverage, we need in the direction of two to three comp points to realize leverage and we don’t break out our marketing expenses as percent of sales.

Tracy Kogan – Credit Suisse

Is that two to three the same for fourth quarter and for next years as well?

Mike Nicholson

Directionally yes.

Tracy Kogan – Credit Suisse

Thank you, good luck.

Operator

Thank you, your next questions is coming from Kimberly Greenberger of Citigroup

Kimberly Greenberger – Citigroup

Good morning. Kay, I was hoping you could talk to us qualitatively, if not quantitatively about your comp metrics in the third quarter where you saw improvement, specifically in your in store metrics relative to traffic and what were the items within those metrics that you saw improve here in November. On the SG&A, where those benefits to SG&A, I think Mike did you say one time benefits and if you could just let us know what the SG&A would have been without those benefits, that would be fantastic?

Kay Krill

For the Loft division they were strong across the board, we saw increases in conversion UPTs and DPT. The only metric that was soft was traffic in the Loft division. As far as Ann Taylor goes, we saw strength and conversion over last year but UPTs and DPTs were not as strong as last year and in the Factory division it was strong across the board. What was your other question about November?

Kimberly Greenberger – Citigroup

As you look at November, was it entirely an improvement in traffic that drove your increase or which of those metrics have gotten better in November?

Kay Krill

I would say that traffic is better than October but as far as in store the conversion and UPTs and DPTs are AUR are all better than last year, thus far, I should say, in this volatile environment.

Kimberly Greenberger – Citigroup

Which of the benefits of SG&A were one time and what would the SG&A leverage or de-leverage have looked like without those one time benefits?

Mike Nicholson

Directionally the 70 basis point improvement year on year was primarily driven by the lower performance base compensation expense impact during the quarter as well as the one time benefit associated with the long term benefit costs relating to the modification of the pension plan.

Kimberly Greenberger – Citigroup

Without those benefits would we have seen some de-leverage in SG&A.

Mike Nicholson

Given our comp performance for the quarter, likely yes.

Kimberly Greenberger – Citigroup

Thanks Mike.

Operator

Thank you, your next question is coming from Adrienne Tennant of Friedman, Billings & Ramsey

Adrienne Tennant – Friedman, Billings & Ramsey

Good morning, a quick question on the number of stores that’s implied for the fourth quarter and it looks to me Mike, like the CAPEX is coming in below plan on the $160 million, can you just clarify that?

Mike Nicholson

In terms of store openings, we opened 38 new stores during the third quarter and in terms of our outlook for the balance of year there’s about 20 to go and from a CAPEX perspective we are in the range of about 150 for the year.

Adrienne Tennant – Friedman, Billings & Ramsey

Do you have any thoughts on 2008 on CAPEX?

Mike Nicholson

At this point no.

Adrienne Tennant – Friedman, Billings & Ramsey

On the guidance range, it’s a pretty wide range on the EPS $.43-$.53 how should we be thinking about that on the positive low single digit comps, does the $.43 imply flattish if slightly positive and maybe at the low end of the positive mid single at the $.54 range?

Mike Nicholson

We don’t go into that level of detail as it relates to quarterly earnings guidance.

Adrienne Tennant – Friedman, Billings & Ramsey

Kay, can you talk about behaviorally this customer is not responding as well to pants this season as well as to the non-apparel, I think you touched on it in your opening remarks but what replaces that as a category for you as you go into the fourth quarter?

Kay Krill

Honestly, as far as pants and non-apparel go, I think pants are really affected because dresses and skirts have been so strong so they have primarily offset each other. As far as non-apparel goes, I think that that was definitely self inflicted. I think that we did not have enough newness in the assortment and we didn’t have enough depth in the newness that we did have. For example, patent shoes and handbags were phenomenal we did not have the depth in that category, long necklaces, capes they were products that did sell in accessories we just did not maximize them or have the appropriate depth across the chain. We do have more exciting accessories heading into fourth quarter so we do expect that to perk up I think others have experienced strength in that category but we did not.

Other categories in the fourth quarter that I think will continue to strengthen our dresses are still on fire, outerwear has picket up with the colder weather as has cashmere sweaters and all of the weather sensitive items thank goodness with this cold snap have picked up versus last year, as you recall, we had a very warm November and December last year.

Then, also, Beauty, Beauty we launched on Monday and that is going to be highly incremental to the Ann Taylor business.

Adrienne Tennant – Friedman, Billings & Ramsey

Thank you. Mike, just one last quick question. Do you actually have the basis point impact of those two one times?

Mike Nicholson

We are not going to disclose that.

Adrienne Tennant – Friedman, Billings & Ramsey

Fair enough, good luck for the fourth quarter.

Operator

Thank you, your next question is coming from Crystal Lanigan of DA Davidson

Crystal Lanigan – DA Davidson

Good mornings, and let me add my congratulations in a tough environment to pull out the EPS growth. Kay, could you just talk a little bit about just in general what’s happening in fashion for this customer. We are hearing a lot of people say that they are really just isn’t a stronger compelling trend an a group is trying to figure out how much this is macro versus how much of it is just not giving her a reason to buy. Maybe if you could talk in broad terms of how you are looking at this across the industry that would be great.

Kay Krill

We’ve done a lot of internal research, Crystal and we’ve done focus groups and exit interviews to really find out what is going on in her head and really she is being very selective this season as far as what she is buying and because of the warm weather earlier on in the quarter she was just buying what was not in her closet and that was fall dresses, item jackets, patent accessories, all of the new things. As the cooler weather has come on we are seeing more strength across the board and I think as she has changed her closet is picking up more wardrobe essentials. I think she is being very selective and I think newness is the key factor and the key driver in her purchases this fall season.

Crystal Lanigan – DA Davidson

Would you say that personal research is pretty similar feedback as far as Ann Taylor versus Loft, I realize they are pretty distinct?

Kay Krill

I think this trend that I just articulated is really across both brands, and honestly, I think it is industry wide.

Crystal Lanigan – DA Davidson

Thank you very much.

Operator

Thank you, your next question is coming from Barbara Wyckoff of Buckingham

Barbara Wyckoff – Buckingham

I want to commend you on a good job managing through tough times. Kay, it had third quarter for Ann and Loft even though Loft did pretty good, outside of more color and novelty, would there have been anything else you would be doing differently in terms of say the flow, percentage of venues, classification, penetration, etc.?

Kay Krill

I think you hit it with more color. I think we are in a very colorful cycle. I definitely would have had more color in both brands early on. I think that the novelty factor we continue to increase that percentage and it never seems to be enough, that is definitely been an appetite for her and also more fashion. We got stung with having fashion last year and Loft in the third quarter and this year if I had to do it all over again, I probably would have picked that up just a little bit more. The one thing that was successful in Loft that I probably would have done more of in Ann Taylor is Loft had very season less product offerings in August, September, and October so their performance was better because of that I would have had more season less options in the Ann Taylor division.

Barbara Wyckoff – Buckingham

Okay, thanks, and just one last question. Could you just talk about some guidance on 08’ Ann Taylor Loft openings should we use this year as a guideline or should be about the same?

Kay Krill

We’ll provide that next quarter Barbara.

Barbara Wyckoff – Buckingham

Okay, thanks.

Operator

Thank you, your next question is coming from Liz Dunn of Thomas Weisel

Liz Dunn – Thomas Weisel

Good morning, congratulations on a great quarter. I wanted to ask a question regarding the fourth quarter. If I look over your history, you’ve had some years where the magnitude of earnings for the third and fourth quarter were fairly similar. I know the fourth quarter has higher sales volume but lower gross margin because it’s a more promotional season, but with your inventories being in such good shape, it looks like the fourth quarter assumptions could be quite conservative. Can you just address that? In terms of the changes to your pension plan assumptions can just tell us what changed in your assumptions and why?

Kay Krill

I think as far as us entering the fourth quarter we are definitely entering in much better shape than last year and I think that these wild swings that we’ve had in our fourth quarter performance have also been brand driven and last year Loft really drove the decline in the fourth quarter last year. This year we are entering with both brands, I think in good shape from a product assortment and definitely from an inventory level. My only concern Liz is that promotionally and as far as our competitive environment everything that we are reading and hearing is that it is going to get more competitive and more promotional and we are just being very cautious in our outlook because of that. There is really nothing internally for us to believe that we are not going to be on the right track, it’s more of an external influence.

Liz Dunn – Thomas Weisel

Great, and then the pension assumptions, what changed and why?

Mike Nicholson

Essentially, it was a discontinuation or a freeze of the existing plan that was in place and expansions of the 401k plan across the enterprise.

Liz Dunn – Thomas Weisel

Okay, so moving from a defined benefit.

Mike Nicholson

That’s correct to a defined contribution.

Liz Dunn – Thomas Weisel

Okay, thank you, good luck.

Operator

Thank you, your next question is coming from John Emrich of Ironworks Capital

John Emrich – Ironworks Capital

Following up on that pension question, small potatoes or whatever it was in the quarter but wasn’t there also an ongoing benefit from making that change?

Mike Nicholson

Not of material an ongoing benefit to the company

John Emrich – Ironworks Capital

Thank you

Operator

Thank you, your next question is coming from [Michelle Pan of UBS]

[Michelle Pan – UBS]

It looks like backing into what must be the number Factory had another huge quarter. I was wondering if you could just give us an update on the trends that you’ve seen there, particularly in October as traffic at the mall kind of softened. Also an update on what’s going online in the business?

Kay Krill

As far as the Factory channel, you are correct they did have a good quarter and we are not seeing the traffic declines in the Factory or the outlet environment that we are seeing in the malls. As you probably heard Steve Tangers report on CNBC the other day they are not expecting any traffic declines going forward so we have enjoyed more consistent business in that channel.

Online continues to be a very healthy business for us and we are seeing double digit growth.

[Michelle Pan – UBS]

Is the online also included in the comp sales?

Kay Krill

No, it never has been.

Michelle Pan – UBS

Thank you very much.

Operator

Thank you, your next question is coming from Samantha Panella of Raymond James & Associates

Samantha Panella – Raymond James & Associates

Good morning and congratulations. Just looking at the collection business are you seeing any price resistance there with your customers? Was it all full price selling and did you have to take any markdowns on that product at an Ann Taylor stores?

Kay Krill

No we have not, it is absolutely a full price business in the 24 stores that we have it in and we are seeing nice sell throughs. As a matter of fact, Holiday will be coming in probably this week or next week into the stores where a continuing to learn about this business and to see what she is going after but so far all product categories are doing as expected.

Samantha Panella – Raymond James & Associates

Thank you and good luck

Operator

Thank you, your next question is coming from Lauren Levitan of Cowen & Co.

Lauren Levitan – Cowen & Co.

Good morning. I was hoping you could follow up a little bit more on some of that commentary for the Q4 guidance Kay and Mike particularly since you are planning for positive comps against the easier comparisons a year ago and with the low inventory the imbedded opportunity margin would still be pretty low for a vertically integrated retailer in the fourth quarter and so we are trying to get a sense of what kind of promotional activity you are planning for and how much of that Kay is already embedded into this assumption are you just leaving a lot in your back pocket until later in incremental promotions and then I have a separate question as well?

Mike Nicholson

In terms of the promotional activity we’re not going to break that out in the impact of that specifically for the fourth quarter but as you can see our earnings guidance forecast is somewhat cautious in light of the macro economic activity, you are absolutely right our guidance does reflect a positive comp versus a negative comp in the prior year and we believe it is prudent in light of the external market factors.

Lauren Levitan – Cowen & Co.

How about on the expense I think you said earlier that we should assume continuation of the current run rate in terms of incentive comp or did I get that wrong?

Mike Nicholson

Year on year we expect some slight de-leverage in the fourth quarter because of the prior year impact performance based compensation expense and our rate for the fourth quarter should be in line with our run rate for the three quarter year to date period.

Lauren Levitan – Cowen & Co.

Your rate for SG&A or rate for total incentive comp?

Mike Nicholson

Total SG&A

Lauren Levitan – Cowen & Co.

The other question I wanted to ask is with respect to the investments for the two new businesses that you called out Factory for Loft and the new concept. Can you give us some sense of the impact of spending that’s been in the business in 07’ and how much that is anticipated to increase in 08’ because I know there is obviously some expenses already in the current numbers.

Kay Krill

07’ is not significant at all, 08’ we will talk about next spring.

Lauren Levitan – Cowen & Co.

Mike referenced that we should be thinking of an up check.

Mike Nicholson

As you think about developing your view of 2008 we think it is important for you to reflect on the savings associated with the SG&A initiative, the bulk of which we believe we’ll realize in 2009 and beyond but for 2008 we need to understand that there will be some investment activity in the back half of the year supporting the two new growth initiatives.

Lauren Levitan – Cowen & Co.

Understood, but obviously the biggest wild card would then be what kind of comp stores sales trend we apply on top of both of those factors.

Mike Nicholson

Absolutely correct.

Lauren Levitan – Cowen & Co.

Thank you and good luck for the holiday.

Mike Nicholson

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

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

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Source: Ann Taylor Stores Q3 2007 Earnings Call Transcript

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