Charming Shoppes Q3 2007 Earnings Call Transcript (CHRS)

Charming Shoppes, Inc. (CHRS)

Q3 2007 Earnings Call

November 21, 2007 9:15 AM ET

Executives

Dorrit J. Bern - Chairman of the Board, President, Chief Executive Officer

Eric M. Specter - Chief Financial Officer, Executive Vice President

Steven Wishner - Senior Vice President of Finance

Gale H. Varma - Executive Vice President - Human Resources

Analysts

Scott Krasik - CL King

Holly Guthrie - Janney Montgomery Scott

Liz Dunn - Thomas Weisel Partners

Jeff Stein - Key Bank Capital Markets

Eldico Hildress - Waterstone Capital

Steve Christo - The Clark Estates

Presentation

Operator

Greetings ladies and gentlemen and welcome to Charming Shoppes’ third quarter fiscal year 2008 results conference call. At this time all participants are in a listen only mode. A Question-and-Answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press *0 on your telephone keypad. As a reminder, this conference is being recorded.

With us today are Dorrit Bern, Chairman, CEO and President of Charming Shoppes, Eric Specter, Executive Vice President and Chief Financial Officer, Steven Wishner, Senior Vice President of Finance, and Gale Coolick, Director of Investor Relations.

I will now turn the call over to the host of this call, Gale Coolick. Ms. Coolick, you may now begin.

Gale Coolick

Thanks, Diego. And thanks to everyone for joining us this morning.

Today’s discussion will contain certain forward-looking statements concerning the Company’s operations, performance, and financial condition, including sales, expenses, gross margin, capital expenditures, earnings per share, store openings and closings, and other matters. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those indicated.

Information regarding risks and uncertainties are detailed in the company’s filings with the Securities and Exchange Commission including the company’s annual report on form 10K for the fiscal year ended February 3, 2007. Our complete SafeHarbor statement and today’s remarks are available at www.CharminShoppes.com.

Net sales for the quarter ended November 3, 2007 were $669.4 million, a decrease of 4% compared to net sales of $695.3 million for the quarter ended October 28, 2006.

During the quarter, the Company experienced downward trending traffic levels and response rates at each of its brands. As a result, the Company experienced a lower sell-through of Fall merchandise and was more aggressive in clearing seasonal inventory, leading to deeper than planned markdowns.

Net sales for our Retail Stores segment were $588.8 million for the quarter, a decrease of 4%, driven by net sales decreases at each of our retail brands, and partially offset by the addition of our outlet business and net sales increases at each of our retail brands related e-commerce businesses. This compares to net sales of $615.3 million for the quarter ended October 28, 2006. Consolidated comparable store sales for the Company’s retail store brands decreased 8% during the quarter, and by retail brand were: Catherine’s, a 6% decrease; Fashion Bug, a 7% decrease; and Lane Bryant, a 9% decrease.

Net sales for the Company’s Direct-to-Consumer segment were $79.0 million for the quarter, compared to net sales of $79.8 million for the prior year period, a decrease of 1%. This decrease is significantly below the double digit declines the Company had experienced in the first half of the year. We attribute the improvement in the sales trend to new creative, marketing, and product offerings for many of our titles.

We reported a net loss in the third quarter of $3.6 million, or $(0.03) per diluted share,

compared to net income of $19.4 million or $0.15 per diluted share for the corresponding period ended October 28, 2006. The year over year decline in operating results is primarily attributable to lower than planned sales, a decline in gross margins and negative expense leverage on sales. Each of the Company’s brands and operating segments delivered lower operating results compared to a year ago. Operating results for the three months ended November 3, 2007 include a net pre-tax benefit of approximately $4.7 million related to the Company’s purchase of the Lane Bryant credit card portfolio on November 1, 2007. We will provide additional detail on that benefit later on in the call.

Consolidated gross margin for the quarter was 27.3%, a 350 basis point decrease compared to 30.8% in the year ago period.

The consolidated Merchandise Margin declined by 150 basis points. This decrease is primarily related to deeper than planned markdowns.

The consolidated Catalog Advertising Expense ratio, as a percentage of total sales,

increased by 80 basis points, related to increased circulation and investment in internet

online marketing.

Consolidated Buying and Occupancy expense increased by 130 basis points compared to a year ago, primarily related to higher Occupancy expense as a percent of sales as a result of negative expense leverage on declining sales.

Consolidated SG&A expenses represented 28.1% of sales for the third quarter, compared to 26.4% in the year ago period.

Administrative expenses increased by 20 basis points, related to negative expense leverage on declining sales.

Selling expenses increased by 150 basis points, related to negative expense leverage on

declining sales.

Prior to November 1, 2007, a third party provided a proprietary credit card accounts receivable facility for our Lane Bryant retail and outlet stores. On November 1, 2007, we purchased the Lane Bryant credit card portfolio from the third party at par value and subsequently securitized the receivables in the purchased portfolio resulting in the recognition of a pre-tax gain of approximately $6.8 million. In addition, we incurred expenses of approximately $2.1 million in connection with the issuance of approximately 2.3 million new Lane Bryant proprietary credit cards to our retail customer base during the three months ended November 3, 2007. This resulted in a net pre-tax benefit of approximately $4.7 million, which has been recorded as a reduction to selling, general and administrative expenses for the third quarter ended November 3, 2007.

Net sales for the nine months ended November 3, 2007 were $2.23 billion, an increase of 1% compared to net sales of $2.19 billion for the period ended October 28, 2006. Consolidated comparable store sales for the Company’s retail store brands decreased 4% year to date.

Nine months net income was $41.0 million, or $0.32 per diluted share, compared to net

income of $84.0 million or $0.63 per diluted share for the corresponding period ended October 28, 2006, which included pre-opening operating expenses of approximately $7.8 million pre tax related to the Company’s opening of 76 Lane Bryant Outlet™ stores.

Consolidated gross margin for the nine months was 28.8%, a 210 basis point decrease

compared to 30.9% in the year ago period.

The consolidated Merchandise Margin declined by approximately 120 basis points. This

decrease is primarily related to lower margins than a year ago at our Retail Stores segment, as a result of higher than planned markdowns.

The consolidated Catalog Advertising Expense ratio, as a percentage of total sales,

increased by 30 basis points, related to increased circulation and investment in internet

online marketing.

Consolidated Buying and Occupancy expense increased by 70 basis points compared to a

year ago, primarily related to higher Occupancy expense as a percent of sales as a result of negative expense leverage on declining sales.

Consolidated SG&A expenses represented 25.8% of sales for the nine months, compared to 24.7% in the year ago period.

Selling expenses increased by 90 basis points, primarily related to negative expense leverage on declining catalog sales.

Administrative expenses increased by approximately 20 basis points, related to negative

expense leverage on declining comparable store sales and declining catalog sales.

Selling expenses include a net pre-tax benefit related to the Company’s purchase of the Lane Bryant credit card file, as previously discussed.

Our balance sheet and cash flow statement are included with today’s earnings press release, and are subject to adjustment pending our completion of the filing of our 10-Q.

Total Cash, Cash Equivalents and Available-for-sale securities were approximately $63

million at the end of the period, compared to approximately $142 million at October 28, 2006. The year over year decrease is primarily related to lower net income levels and increases in merchandise inventories.

Our Long-term debt at the end of the quarter is $315 million, and includes convertible debt of $275 million, as well as mortgages and capital lease obligations.

We have been active under our share repurchase program, and repurchased 10 million shares during the third quarter. Year to date, we have repurchased approximately 22 million shares. Additionally, our Board of Directors has authorized a new $200 million share repurchase program to be completed over the next several years.

Total Inventory at the end of the period was approximately $498 million, compared to $481 million a year ago, an increase of 3%. On a same store basis, inventories decreased by 2%.

Capital Expenditures were approximately $35 million for the quarter, and approximately $109 million for the nine months.

Depreciation and Amortization for the quarter was approximately $24 million, and

approximately $78 million for the nine months.

The Company has projected free cash flow of approximately $20 million for the fiscal year ending February 2, 2008. On our corporate website, www.charmingshoppes.com, we have posted a GAAP to non-GAAP reconciliation defining our calculation of free cash flow.

We have an updated outlook for the fourth quarter and fiscal year.

For the 13-week period ending February 2, 2008, the Company has updated projections for diluted earnings per share to a loss in the range of $(0.06) - $(0.08), compared to diluted earnings per share of $0.19 for the corresponding 14-week period ended February 3, 2007. This projection includes pre-tax charges of $5.4 million ($3.4 million after tax, or $0.03 per diluted share) related to the Company’s relocation of its Catherines Plus Sizes Memphis, TN operations to its Bensalem, PA offices, as announced on November 8, 2007. This projection also includes an initial pre-tax investment of approximately $10 million ($6.4 million after tax, or $0.05 per diluted share) related to the launch of the Lane Bryant catalog. The Company's projection for the 13-week period includes net sales in the range of $795 to $805 million, compared to net sales of $874 million for the 14-week period ended February 3, 2007.

The Company's projection assumes high single digit percentage decreases in consolidated comparable store sales for the Company's Retail Stores segment, compared to a 1% consolidated comparable store sales decrease in the prior year.

For the 52-week fiscal year ending February 2, 2008, the Company has updated projections for diluted earnings per share in the range of $0.24 - $0.26, compared to diluted earnings per share of $0.81 for the 53-week period ended February 3, 2007. This projection includes pre-tax charges related to the Company’s relocation of Catherines Plus Sizes and the pre-tax investment related to the launch of the Lane Bryant catalog.

The Company's projection for the 52-week period includes net sales in the range of $3.02 to $3.03 billion, compared to net sales of $3.07 billion for the 53- week period ended February 3, 2007. The Company's projection assumes mid single-digit percentage decreases in consolidated comparable store sales for the Company's Retail Stores

segment, compared to a 1% consolidated comparable store sales increase in the prior year.

Weighted average diluted shares for the full year are projected in the range of approximately 127 - 128 million shares. Our issued and outstanding share count is projected to be approximately 118 million shares at the end of the fiscal year ending February 2, 2008.

This completes our prepared remarks. I’ll turn the call over to our CEO, Dorrit Bern, who would like to make a few comments.

Dorrit?

Dorrit Bern

Oh, thank you, Gayle. Obviously, a very dissappointing conference call in terms of where we think our business is going to be for the fourth quarter. I’m not going to continue to harp on the economy and the weather, but we have still not seen any significant change in the traffic that we are experiencing in all our brands. That includes the outlets as well as the Bug as well as Catherines. We have certainly talked about content issues at Lane Bryant.

Overall in all our divisions it continues to be, even in the first couple of weeks in this quarter, that when we run comparable marketing events we get that loyal core customer who is walking in and is buying, so our conversion rate is up, but we are still experiencing traffic decreases that are causing us obviously issues in the third quarter as well as when we move into the fourth quarter.

We are in a good inventory position and I guess that is the good news. We have talked about for the last six months that we began cutting back in inventory about the beginning of the second quarter because we had a feeling that the economy was going to turn as it did, but we are going to have to get more promotional. We are going to have to be more aggressive in this game that is going on in the retail climate.

We will be ratcheting up marketing events. We simply have to be more aggressive to get her into the store. That is something that we have put in place. We have been working hard at it for the last two weeks and we will be much more promotional as we start the day after tomorrow moving into the fourth quarter.

Overall, in terms of product, it is across all brands. We are not selling coats. We are not selling outerwear. We did see a little bit of a blip in the Northeast when it turned a little cool. But again, overall it is just traffic getting into our stores and buying what we believe in the majority of our divisions to be great content and great merchandise at great prices, but we are not getting them into the store.

So, on that note, let me pass you all back to our conference and to any questions that you may have.

Gale Coolick

Ok, Diego, we are ready for our Q & A session.

Question-And-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the * keys.

Our first question comes from Jeff Stein with Key Bank Capital Markets. Please state your question.

Jeff Stein

First a question for Eric. Wondering first of all, Eric, was the credit card game contemplated in the prior guidance of a loss of $2 million to a loss of $4 million that you issued back on November 8, 2007?

Secondly, did your prior guidance of break-even to $.03 for Q4 contemplate the $.03 after tax charge related to the Catherine’s consolidation?

Eric M. Specter

Alright. Let me take the latter. As we mentioned on November 8, 2007, when we made our update projection for fourth quarter, we did comment that it excluded any of the charges that we had outlined in the November 8, 2007, announcement and that we would at the third quarter call here today update the fourth quarter earnings to reflect what charges would flow through. The answer is on that second question is that it was not included in the projection that was previously made on November 8, 2007.

We now have outlined – the total charge, incidentally, that we had announced on November 8, 2007 – the one time charges being approximately $8.5 million still hold. What we gave guidance today and visibility to is that approximately $5.4 million of those charges would be running now through our fourth quarter. Those numbers could change, but they would be immaterial depending on some of the activity going on on relocations and so on.

As far as the first question goes, we had always in our 2007 plans from the beginning of the year, anticipated that we would be repurchasing the credit card file in the third quarter and, of course, had to make some assumptions (not having the due diligence done on the file) on what the accounting game would need to be so that we had those built into the models and had them built into our projections throughout. Except for the fact now that the transaction has been completed, we have gone ahead and done the accounting for the third quarter earnings release and now we are able to quantify it down to the game that was reported here today.

Jeff Stein

I don’t want to waste too much time on the call, Eric, but can you explain real quickly how the game comes about?

Eric M. Specter

Well, Jeff, I am more than glad to call you after the call. Incidentally, this occurs on any of the files that we previously had acquired – whether it was Fashion Bug years ago, Catherine’s two years ago – except the numbers weren’t as significant. The reason this gained, as we reported today, was $6.8 million is the size of the file with the purchase of the Lane Bryant file was $231 million so it was a significant acquisition as compared to Catherine’s in 2005, just for comparison, was $50 million in terms of total AOR.

Basically what happens is that it is not the purchase of the file that generates the gain, it is the subsequent securitization that we do to take the receivables off balance sheet, put them through our master trust. The accounting under financial accounting standard number 140 which has been in existence a decade requires us to look at the future stream of revenue that we will get from that card file (meaning the yield off the file) and then project out our funding costs and our estimated losses. Without getting into all the mechanics of the accounting standards, the net number alternately gets put onto your balance sheet in what we call an IO strip. Incidentally, it runs through the balance sheet as we delivered today as part of the earnings released it nets into our investment and asset back security. So, that’s where it shows up.

On the P & L, as Gayle mentioned, as all of our credit operations net (which is income) – all net into our selling General and Administrative Expenses.

Jeff Stein

Ok, so is the answer then that you did contemplate that in your guidance for Q2?

Eric M. Specter

Yes.

Jeff Stein

Ok. And one final question real quickly? Can you comment or can Dorrit comment on the early response you’ve seen to the Lane Bryant catalog launch?

Dorrit Bern

I just pulled up the figures this morning, Jeff, and it’s still so teeny. It is only 10 days into really getting the catalog out there. It’s not enough to really discuss. We are still extremely confident, extremely excited, we are in an incredible in-stock position, so we feel that it’s going to be a great asset to the company.

Jeff Stein

Alright. Thank you.

Dorrit Bern

Thanks, Jeff.

Operator

Our next question comes from Liz Dunn of Thomas Weisel Partners. Please state your question?

Liz Dunn

Hi, good morning. My question relates to your planning assumptions and just sort of a theoretical question? If you had gone into the season forecasting the season in line with your current expectations, right? So a negative high-single-digit comp. Would the earnings miss have been a lower magnitude and are you committed to, at this point, forecasting the business for no improvement as we think about a planning assumption for 2008 because I think that one of the extremely frustrating things for us is that we continue to see sort of a “well, this is our current experience, but we are forecasting a little bit of an uptick and then there is a miss of no uptick.” How conservative are you planning 2008 because most of the other retail companies that are reporting are saying they don’t know when it’s going to improve and it looks like we could be headed into recession and they are planning their business accordingly? Do you have that same commitment?

Jeff Stein

Liz, absolutely and these are very good questions and I think you can appreciate us as retail executives sitting here and again it is not across all categories, but generally are made call it five to six months in advance. So, to answer the first part of your question which has to do with this second half of the fourth quarter, one thing we were pleased that we got ahead of in the spring when we saw numbers flattening out and starting to drop in low single digits, we saw enough in the spring to not be as optimistic in the fall season and had pulled down those inventories as talked at the second quarter conference call and fortunately we did that.

Now, obviously, in hind sight we didn’t do it enough. We certainly expected it to be a tough second half when we sat here in the second quarter, but nowhere near the traffic declines and obviously negative comps that we have put on. Certainly, in hind sight we would have cut even further if we had, back in the May-June time table when we pulled these inventory commitments and plans down, had the foresight to think that it would be as bad as it is.

That all said, adjustments are made ongoing. Generally there is five-six months lead times. They are much shorter in product that we are acquiring domestically in certain brands and certain categories. They are obviously further out when we are working with our own direct sourcing arm where obviously you have to make your commitments to acquire the fabric and get the factories to product the product, but we are taking now a very conservative position and you nailed it in terms of we don’t see the catalyst sitting here today and looking at these traffic patterns day in and day out that it’s going to turn any time soon.

Your point of asking us – and we are not here to make projections on where our earnings and sales will go first quarter (we will do that at the appropriate time at our fourth quarter call), but clearly we are looking at running the business much tighter on much lower inventories and taking a look at all other aspects of the operating and capital plans in order to ride out what clearly is a much more significant down turn than any of us in retail anticipated.

Liz Dunn

Ok, well, just a comment that we really don’t have the stomach to watch a low-single-digit comp assumption become a mid-single-digit comp assumption become a high-single-digit comp assumption again. I think people are expecting conservatism and you are going to be rewarded for conservatism followed by performing in line with expectations. Thanks. Good luck.

Jeff Stein

Ok. Thanks, Liz.

Operator

Our next question comes from Holly Guthrie with Janney Montgomery Scott. Please state your question.

Holly Guthrie

Good morning, everybody. Question regarding your promotions and what you had put out there when you first started to see things soften up a bit and how you might change them going forward and then, you guys have been through several, several cycles. Are there any things in the past that you have seen help improve your business – things soften and start to improve? What can we look forward to?

Dorrit Bern

Sure, Holly. What we are finding is that when we run comparable events, you know, how we do the same calendar to calendar/day to day (what we did last year) we are finding that we are not generating enough traffic to make those days. As retailers what we don’t like to have to do is continue to ad events, but what we have found is that is simply going to be a price of entry in this cycle that we are in. As I mentioned in the beginning of the call, we are going to be adding events. We are going to be using different media. We are going to be sharper and more aggressive and deeper in our promotions. But, we are still not going to give ourselves any credit for any kind of sales lift off of our current trend because, back to Liz’s point, we don’t want the buyers thinking we are going to get through this by sinking a lot of dollars into marketing to give them some sort of relief on their comp trends and then have them buy too many receipts going into the spring season. You know how that all works.

So, we want to be and are as pessimistic as possible. We are going to be moving expenses out of the operating side of the business and into the marketing side of the business and really take as many expenses out of the company in order to make sure we have the proper promotional cadence to get her into the store because, as I said, she is not.

So, that’s where we are at. We are looking at every promotional event. We are doing more. We are going deeper. We are using different media in addition to direct mail, but we have got to come up with the dollars to support the more aggressive spend in marketing and that has to come from the expense side.

Holly Guthrie

Ok, just a follow up. Besides different media, is there anything else you are looking at to maybe get a different additional customer into particularly the Bug who may be more middle income that feels a little bit more strapped or upper income that feels a little more strapped so there might be a compelling – you know, I don’t know if you have thought about anything you can do there?

Dorrit Bern

Sure. Well, we did have unfortunately a lot of this environment is clouded. We had a very successful Gitano launch which was a proprietary exclusive brand to us – a brand that the Bug girl – the moderate girl – knows very well that we have in the store this year and that has been successful. Those are the kinds of – there was a great brand launch. We talked to a lot of new customers. It paled in comparison to the amount of lack of traffic – of customers coming into our stores.

Yes, we are going to continue to talk about that brand, promote that brand, make sure that the customer knows that we have got to get Loveable by Hanes and Gitano in the store doing well with B Street. So, there is a lot of exciting things going on that we don’t talk about because obviously the numbers are tough.

We will continue with those initiatives because they are working.

Holly Guthrie

Ok. The second part of my question was just going back in history over the last couple of decades that you all have been in the business for long periods of time.

Dorrit Bern

Eric wasn’t grey then.

Holly Guthrie

Obviously marketing to support the brand. I know it was probably some aspect of what you did, but what else inside corporate will the share repurchase continue or will you think about cash differently? How do you think about different initiatives? Also, if there is anything that led us out of prior recessions as far as demand? Is it just traffic or is it better conversion or is there something we could look at several months or quarters out?

Dorrit Bern

Right.

Eric M. Specter

Holly, let me comment on the operating side and maybe elaborate a little further than what I said to Jeff. Certainly, in all of the prior downturns we take a very proactive initiative around looking at our entire operating cost structure, both within the stores as well as what we could call our corporate and home office overheads. Certainly, what we announced on the eighth gives you some sense of the kinds of thought process of things we are looking at to work at in what we believe is a much more difficult and prolonged down turn in the retail environment. You can expect that we will be doing further pullbacks in our operating and overhead cost structure partially to Dorrit’s comment because we believe we are going to need to fund the brands with additional marketing dollars. To your point of – we need to be able to reach a broader audience and go beyond our core credit card customer which we are pleased with has been coming into the store and has been spending at about the average dollar transaction and if not slightly higher than a year ago, but we need more of them.

So, it’s a combination of a lot of things of going deeper into our active files in mailing which again will be (inaudible) in the fourth quarter, but also broadening the marketing reach. An example of that would be what we are breaking here today at Lane Bryant for the first time since we’ve owned the company – running a national cable television promotional ad obviously with the objective of getting a broader large-sized audience into the stores over the next five or six days.

These are the kinds of things we are looking at, but what I can say on cash flow is that we are committed to the shareholders that we will do everything we can to offset the decline in sales and earnings to preserve free cash flow. That would go for 2008.

Whatever it would take to preserve operating at a lower retail and earnings environment, we will look to the operating and capital side to offset and in order to preserve some level of free cash flow for the shareholders.

Holly Guthrie

Thank you and good luck.

Dorrit Bern

Thanks, Holly.

Eric M. Specter

Thanks.

Operator

Our next question comes from Scott Krasik with CL King. Please state your question.

Scott Krasik

Hello?

Dorrit Bern

Hi.

Eric M. Specter

Hi, Scott.

Scott Krasik

Hi, sorry. Ok. Eric without giving specific guidance, obviously, for next year, maybe talk about gross margins and how they are being impacted this year and maybe what we can expect directionally, but specific to each operating business of why you think they should be higher going forward?

Eric M. Specter

Well, certainly we are not pleased with – put the sales aside in terms of the negative comp store sales. Again, when you are planning for results that are going to be more optimistic than dropping high single digits, you have to as a retailer (and again we are committed to keep our inventories clean each season) – eventually those units get sold. It is just a question at what price?

Clearly, what we have been experiencing here in the second half in addition to the declining sales has been pressure on the gross margins in order to keep moving those units at the planned inventory turns in order to get to the levels and targeted inventories by brand that we had set up in terms of where they need to be at the end of the season.

We are taking deeper promotional and deeper markdowns in the fall and holiday product as we speak in order to hit those levels. We are pleased that overall on a comp store basis our inventory levels are down (low single digits right now) and we would project that at year end our total inventory levels will actually be down closer to mid to high single digits. So, we are doing a good job on managing the inventories, but there is a cost to that which is lower gross margins.

As we look out, what we will be doing is tightening the inventories even further. We are going to go into the spring season, not only with overall inventories, but also with lower fall holiday bucket inventories (I’ll use the term bucket) in terms of that portion of the inventory which should reduce clearance markdowns into the first quarter on the hopes that we would get better sell-through on our spring side products.

We certainly are going to and have tightened up our spring side inventories in terms of our outlook and we would anticipate that these margins that we are seeing – and again, the margins are across the board – I do want to point out in Gayle’s prepared remarks that as you know, Scott, the reported gross margins are a combination of our gross margin from product net over buying and occupancy expenses so that what’s happening right now with the declining sales base is causing margins to drop because of the negative leverage increasing our percent to sales of buying and occupancy. That’s probably directionally half of the margin erosion in this third quarter and projected for fourth.

Of course, the other half of the depressed gross margins for taking steeper and more aggressive promotional markdowns.

Again, we will be looking at and managing those classifications differently and as I mentioned overall tightening inventories. Even if we continue seeing a sluggish retail climate that is putting pressure on sales, we could start to see some moderation and improvement year over year or quarter over quarter of the gross margin.

Scott Krasik

Let me ask you this? How is a full year of Lane Bryant catalog advertising expense because I think that runs through cost of goods? How will that impact gross margin next year?

Eric M. Specter

Well, what we are seeing here in virtually days into launching the catalog. Obviously we will rationalize that advertising spend to sales once we analyze after Christmas where we sit with customer count and put together our program for 2008.

I know I mentioned this at the second quarter call. There should not be a concern that the $10 million pretax investment that we have talked about all throughout the year making here in the fourth quarter – that should not be taken as if we are going to be making $10 million investments each quarter throughout next year. That is not the case at all.

There is a lot of reasons for the one time build just to get that catalog launched. Clearly we will be putting together more rational plans associated with the sales and margin plans as we look at it after Christmas.

Scott Krasik

Ok. Then, just a couple of quick ones. Eric, as it sits now, where are you modeling year end cash and debt levels to be?

Eric M. Specter

Well, the debt levels will be fairly consistent with what we reported here today. The majority of the debt $275 million of the $305 million is our convertible (inaudible) so that will stay. It will come down a little bit for the current maturities. We are paying off one other mortgage and lease hold.

Total debt levels could be $4 million of $5 million lower than where they sit at the end of the third quarter.

Now, cash, we are at our low point in cash on a seasonal basis each year due to the fact that we have funded our full holiday inventories right at the end of the fiscal quarter. What you will see is that we reported today on our balance sheet that our inventories were $498 million. At year end those numbers will be significantly lower in the low fours. As a projection, somewhere in the $4.1 million range. What will happen now is that our cash – even off the lower earnings projections that we made here today for the fourth quarter – we will get a significant boost in cash flow as we would normally get every fourth quarter as that inventory is sold down. We will be in excess of $100 million of cash on our balance sheet at the end of January.

Scott Krasik

Alright. So, versus about $145 million a year ago?

Eric M. Specter

Correct.

Scott Krasik

For the year somewhere north of $100 million?

Eric M. Specter

Correct.

Scott Krasik

Ok. Then, just lastly, Dorrit, it is nice to see you guys buying stock back – particularly below book value. Where does management step up and buy stock for themselves at these depressed prices?

Dorrit Bern

Well, I think we’ll have to wait to see, Scott. We have been in a blackout so I think we will have to wait and see.

Scott Krasik

Ok. I think investors would appreciate that.

Eric M. Specter

Thank you.

Dorrit Bern

Thank you, Scott.

Operator

Our next question comes from Eldico Hildress with Waterstone Capital. Please state your question.

Eldico Hildress

Yes. Can you tell me what your availability is on you bank line at the end of the third quarter?

Eric M. Specter

The bank line is fully available - $375 million line.

Eldico Hildress

Correct me if I am wrong – is there a borrowing base adjustment?

Eric M. Specter

The borrowing base adjusts as a result of a number of factors – primarily inventory levels.

Eldico Hildress

Ok. Kind of speaking to what the gentleman was just asking about. Last year I see in fourth quarter you guys actually didn’t generate a whole lot of free cash flow. I am sure your inventories came down, but there are things you had to pay for and we are expecting lower earnings this year. So, the top third of the cash flow statement less cap-ex – I can’t imagine that you are expecting that that is going to be positive this year, do you?

Eric M. Specter

No, as we mentioned today – and we do have a GAAP to non-GAAP reconciliation up on our web site. The difference in what happened last fourth quarter if you look at our inventories actually built year over year – not from third to fourth. But, if you looked the fourth quarter we were not happy with our ending inventory levels last January. Most of the reductions in inventory that we have talked about since the second quarter conference call all are about to happen here as we move into the fourth quarter.

So, what you will find is that we will have (talking year over year) mid to high single digit reductions in overall inventory at the end of January. That is part of how on our cash flow statement we are able to generate the cash flow that we projected here now for the year to be about $20 million in free cash flow, but it will be significant here in the fourth quarter to move our overall cash position which we reported here today at $63 million to over $100 million.

Eldico Hildress

And that goes to what you were talking about doing what you can to preserve free cash flow for the shareholders. Would you guys borrow on your bank line to actually buy back shares?

Eric M. Specter

That is a discussion we would have from time to time with the Board. How far we would go. At the November 8, 2007, announcement we talked about this new $200 million authorization being able to be acted on over the next several years out of free cash flow.

That would be a discussion we would be taking up with our Board at the appropriate time.

Eldico Hildress

Lastly, the stock price is getting pretty low and in better LVL environments financing would be easier, but just in that vein…have you guys been approached by anybody?

Eric M. Specter

I can’t really speculate or comment on that at this point.

Eldico Hildress

Thank you.

Operator

Thank you. Our next question comes from Steve Christo with The Clark Estates. Please state your question.

Steve Christo

Hi, guys. I think it would be helpful for shareholders if you could talk about the profitability of each of the divisions or brands and maybe what you guys expect in the future as well as how we can get there?

Eric M. Specter

Sure, Steve. Let me comment. Gayle, of course in the prepared remarks made an overall comment obviously when you are going from a profitable quarter to an unprofitable one as we just reported here today in the third quarter, all of our operating brands had reductions in operating earnings year over year.

Now, I know you are looking for a little bit more color. I will say that all of the retail brands remain profitable, obviously at much lower operating margins than a year ago. None flipped into a loss. Nor do we expect with our fourth quarter projection any of our retail brands – they will remain profitable for the full year. Of course, significantly down and significantly means more than half of their operating profit.

Directionally, Lane Bryant still remains (even with their results as we reported today with a 9% comp store drop). Obviously our high single digit drop that we have projected here into the fourth quarter. Again, you will see directionally both Fashion Bug and Catherine and Lane Bryant begin in that high single digit range again. Even with that projection they will remain our most profitable brand both on an absolute operating dollar as well as an operating margin to sales line. Of course, significantly lower than where they were a year ago.

The Fashion Bug business, again being under the same kind of sales and margin pressure as Lane Bryant, saw their operating margins drop in half. Again, with their fourth quarter that will be the case, but they will remain profitable for the year as the Catherine’s business.

Now, the catalog business – there is a number of things going on here. In the fourth quarter is where we get a ramp up in the catalog earnings due to our Figgy Spoon and Gift business which, for all intensive purposes is a fourth quarter business as it virtually has no sales for the first nine months of the year. That gives us a boost so that with the Figgy’s business that we are projecting to be on plan, delivering the sales at operating earnings of a year ago’s fourth quarter. We would anticipate that the catalog business will be profitable here in the fourth quarter.

Although, if you look at the apparel group catalogs as a whole and again we do segment that information on our 10-Q filings and you can certainly look at the second quarter and that will be the case here in third, you will see that through the six and nine month period they are running slight losses on the catalog side.

Steve Christo

Could you guys talk about where you think each of these businesses should be in the future if under normalized operating circumstances and maybe when merchandise is being done better? And this is a comment on that – it seems at this point at this valuation that Lane Bryant itself is probably worth more than this and your other divisions or brands are not even being valued at all by the market. I wonder if you guys could respond to that?

Eric M. Specter

Let me say that clearly we are in a very depressed retail climate that has put significant downward pressure on the margins so, your point Steve is that clearly the operating margins that we are seeing here through the nine months and if I use the projections for the last quarter are significantly depressed from what our normal run rate has been in the last couple of years.

That all said, we believe that they should be higher than what we ran in the last couple of years for a number of reasons. Including distorting our capital investments as well as other investment in our higher margining brands (ie, Lane Bryant). If you look at our store opening plan for this year alone, the lion’s share of the majority of the capital allocation for store improvement (meaning new stores and relocations as in the Lane Bryant brand) we had hand full of stores opening in the Catherine’s and Fashion Bug brand and we are well aware that that is not the place we will be investing capital going forward in terms of adding to their store counts.

Clearly we will be distorting investment to our higher margining brands. Our catalog business, as we have said all along, although it is probably the only bright spot of this third quarter call is that our double-digit drops that we were recording here first half finally subsided in the third quarter and our catalog sales were virtually flat from a year ago and that is on an apples-to-apples comp basis. The Lane Bryant catalog had virtually no sales at all in the third quarter. We did see a moderation and improvement, but their operating margins are nowhere near their historical norm.

Again, the way I would couch it right now, Steve (not to be a projection of what may happen over the next six months as we move into ’08), clearly we should be able to (once we get a more normalized traffic pattern) see the customers and consumers respond in a more normal fashion, certainly get to the run rates of operating margins we have been putting on the last couple of years which are more than double what we are obviously going to do this year based on our fourth quarter projection.

From that base, because of some of the comments I am making here in distorting capital to the higher returning parts of our business, particularly Lane Bryant, we should be able to exceed in a normal environment versus the margins we were recording the last few years.

I don’t know how much more I can go into the fact that this is a severe downward trend. Unfortunately in retail we are a cyclical business and we have experienced these kinds of downward pressures on margin if you look back over the last decade there has probably been two periods – the early part of this decade (2001 and 2002) we saw a similar situation as well as in the late nineties.

This is not unusual except that we would have liked to have been able to start seeing some stabilization from the consumers buying patterns which, clearly based on Dorrit’s opening remarks, we are not seeing here as we turn the first few weeks into the fourth quarter.

Steve Christo

Thank you.

Operator

There are no further questions at this time. I will turn the conference back over to management for closing comments.

Gale Coolick

Thanks everyone for joining us today. Eric, Steve and I will be available on the telephone with additional questions. We hope you all have a wonderful, wonderful holiday. Thank you everyone.

Operator

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you all for your participation.

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