Kellwood Company Q3 2007 Earnings Call Transcript

Kellwood Company (KWD)

Q3 2007 Earnings Call

December 7, 2007, 8:30am ET

Executives

Sam Duggan – Vice President Investor Relations and Treasurer

Bob Skinner – Chairman, President and Chief Executive Officer

Lee Capps – Chief Operating Officer

Greg Kleffner – Chief Financial Officer

Analysts

Jennifer Davis - Lazard Capital Market

Jeff Edelman – UBS

Brad Stephens – Morgan Keegan

Jody Kane – Sidoti and Company

Presentation

Operator

Good morning Ladies and Gentlemen. Welcome to the Kellwood Company’s third quarter 2007 results conference call. [Operator Instructions] I would now like to turn the call over to your host for today’s conference, Sam Duggan, Vice President Investor Relations and Treasurer of Kellwood. Please go ahead sir.

Sam Duggan

Good morning everyone. Participating on the call this morning are Bob Skinner, Kellwood’s Chairman, President and Chief Executive Officer, Lee Capps our Chief Operating Officer and Greg Kleffner our Chief Financial Officer.

During this conference call we will be making reference to our third quarter earnings presentation which can be found on our website in the Investor Relations section under presentations. As a reminder to the participants, statements in this conference call that are not strictly historical are forward looking statements within the meaning of the safe harbor provisions of the federal securities laws. Actual results may differ materially due to the risks and uncertainties that are described in the company’s Form 10-K and other filings with the SEC.

Before I turn the call over to Bob, let me briefly address one other topic. As you know, on September 18^th, Kellwood received an unsolicited proposal from Sun Capital and on November 12^th we received an identical proposal from them. As you are also aware our board, in consultation with its financial advisors carefully considered the Sun Capital proposal and determined it is not in the best long term interest of Kellwood and its shareholders.

With respect to today’s call we will not be taking questions on the unsolicited proposal of Sun Capital and we ask that you focus your questions on the matter in the third quarter earnings release.

With that, let me introduce Bob Skinner.

Bob Skinner

Good morning everyone. I will begin my remarks with highlights of the results we recorded today and then update you as to our progress on our key initiatives. Greg will then provide more detail on our financials and guidance; we will then open the call up to take your questions.

I’d like to begin on slide three. The third quarter marked a highly productive period for Kellwood, we achieved the sales and earnings guidance provided when we began the quarter while streamlining our business model to position us for sustained growth and improved profitability in 2008 and beyond. In total, net sales from ongoing operations for the third quarter were $404.1 million, up from net sales of $397 million in the third quarter of fiscal 2006. Gross profit as a percent of net sales rose 340 basis points to 27.4% with both operating segments contributing to this increase. Diluted earnings per share were $.15, representing the high end of our guidance, yet well below a year ago, driven by the lower absorption of corporate overhead resulting from the discontinued Smart Shirts operations and lower sales and profitability of our women’s main stream business.

Our actions to reduce costs stemming from the women’s sportswear reorganization and streamlining of corporate functions are expected to positively benefit 2008 and beyond. Clearly, the brands that have been providing for our growth continued positively during the quarter, with particular strength in Vince contemporary sportswear, our junior brands, Baby Phat, XOXO and My Michelle and Gerber Childrenswear. In addition the acquisitions of Hanna Andersson and Royal Robbins contributed solidly to both our top and bottom lines.

As anticipated, our women’s mainstream brands performance remains challenging and we had prepared for this by prudently reflecting this in our guidance and reducing expenses while continuing to ensure that our brands remain in demand with their core consumers.

The performance of our Calvin Klein women’s better sportswear continues to progress, again, in a difficult environment, and performed in line with its peers. We believe new leadership will assist us to further improve the brands performance.

During the quarter, our efforts to transform Kellwood into a brand focused marketing enterprise generated initial benefits to our company. We increased the percentage of our branded business, both owned and licensed to represent 89% of our total company sales with private label representing 11%. As a comparison for the third quarter last year, branded sales were 84% of total and private label was 16%. In addition, better and above price points represented 29% of our total sales, up from 17% last year. This is in line with our long term strategic and financial plan.

We repositioned Phat Farm to a higher profitability licensing model, allowing the men’s business to capitalize on the broad Phat fashions licensing expertise and marketing capabilities.

Our acquisitions continue to perform well. Hanna Andersson and Royal Robbins generated sales of approximately $44 million and produced operating margins in the mid teens. These acquisitions also contributed to our improvement in gross margin for the quarter. We expanded our retail presence as well. During the quarter we opened two Hanna Andersson stores, ending the quarter with 16 Hanna specialty stores. We remain on track with our expansion plans, which include 78 Hanna Andersson specialty stores at the end of fiscal 2012.

In addition, given the strength of the Vince contemporary sportswear business, we signed leases to open two Vince specialty stores in the spring of 2008.

Turning to slide four. We announce the sale of our Smart Shirts operation, which has limited strategic synergies with our other businesses. It has also allowed us to remove a capital intensive and lower margin private label business from our company, while netting Kellwood with approximately $161 million in gross proceeds, which also includes the sale of the headquarters building. We plan to use the funds to repurchase shares and reduce debt. With this sale, Kellwood’s operations are effectively 100% outsourced.

In addition, we made solid progress on our women’s restructuring initiatives. During the quarter, we attracted and promoted key talent and eliminated redundant operations. To this end, we names Hope Brick, Chief Merchandising Officer of the Lifestyle Alliance, Steve Powers, Chief Customer Officer of the Lifestyle Alliance, Sandra Campos, President of O Oscar by Oscar de la Renta and Wendy Chivian as President of Calvin Klein Women’s Sportswear, which you will see on slide five. Each of these individuals possesses the qualities necessary to ensure we have compelling assortments and attentive customer relationships across our brands and businesses while driving improved operating results.

Finally we announced the closure of two redundant distribution facilities and the consolidation of our Koret and Briggs operations in California and Massachusetts respectively to New York, both of which will occur in 2008. We believe these businesses will improve markedly from their ability to be part of our Lifestyle Alliance as well as benefit from lower costs.

In summary, our business and brands performed in line with our expectations this quarter. We are confident, focused and passionate about the execution of our long term strategic and financial plans outlined on slide six, which include annual organic sales growth of 4 to 5%, operating margins of 4.6% today increasing to 9% in 2012, excluding potential future acquisitions and earnings per share growth of at least 25% after a significant increase in 2008 excluding potential future acquisitions.

With that, I would like to turn the call over to Greg to review the financials in more detail.

Greg Kleffner

Good morning everyone. I’ll begin with a review of the third quarter results from ongoing operations and these are summarized on slide seven. Net sales for the third quarter totaled $404.1 million that was a 2% increase from the $397 million in sales last year. As anticipated, sales in our women’s sportswear segment decreased 12% to $276.2 million from $315 million last year.

Organic sales growth was realized across our junior’s and girls businesses as well as licensing revenue from Baby Phat. Sales also rose from the acquisition of Vince. The anticipated impact of lower sales volumes in our mainstream women’s sports wear business, including private label sales and the Phat Farm men’s wholesale business which is being transitioned to a licensing model resulted in the overall decline in sales. Our other top good segment continued to produce solid results in the third quarter achieving a 56% sales increase to $127.8 million from $82 million last year. This was largely due to the acquisition of Hanna Andersson and Royal Robbins as well as strong performance on Gerber Childrenswear.

Gross profit as a percentage of net sales improved 340 basis point to 27.4% from 24% in the prior year period. This gross margin improvement was primarily driven by the acquisitions of Vince, Hanna Andersson and Royal Robbins and the improved product design and performance of the XOXO junior’s brand. Partially offsetting these increases were expected higher markdown allowances for certain of our women’s brands. Both women’s sports wear and other soft good segments achieved higher gross margin rates compared to last year.

SG&A expenses increased $20.7 million to $93.4 million or 23.1% of net sales compared to $72.7 million or 18.3% of net sales last year. The increase in SG&A as a percent of sales as compared to last year was primarily driven by lower absorption of corporate overhead costs and these resulted from the Smart Shirt business being classified into discontinued operations. Also the acquisitions of Hanna Andersson and Royal Robbins, which are higher margin, higher SG&A business models and the addition of 17 new retail outlet stores since the third quarter last year. Also lower sales of our mainstream women’s sportswear brands.

Despite sales growth and gross margin expansion, a lack of operating expense leverage resulted in operating earnings of $17.4 million or 4.3% of net sales as compared to $22.4 million or 5.6% of net sales last year. As Bob mentioned, actions to reduce costs resulting from the women’s sports wear reorganization implementing supply chain savings initiatives and streamlining of corporate functions are expected to positively benefit 2008 by $16 million and 2009 by $32.5 million compared to fiscal 2007.

Net interest expense in the third quarter was $7 million, up $4.1 million from the year ago period. Interest expense in the third quarter was $8.4 versus $8.1 million last year and interest income was $1.4 million in the third quarter compared to $5.2 million in the prior year period. Lower interest income was due to lower average cash balances invested in the third quarter as a result of utilizing our cash for the acquisitions of Vince, Hollywould, Hanna Andersson and Royal Robbins.

Our effective tax rate for the third quarter was 34.8% which compares to 35.8% last year. This was lower than our expected third quarter tax rate of 44% due to certain state tax items that benefited diluted earnings per share by $.02. The effective tax rate for the third quarter was lower than our expected annual effective tax rate of 39% this year due to discrete items which benefit the full year tax rate being recorded in the third quarter under 1048.

As a result, third quarter 2007 net earnings from ongoing operations was $4 million or $.15 per diluted share, which is the high end of our revised guidance, excluding Smart Shirts. This compares to net earnings from ongoing operations of $10.6 million or $.41 per diluted share in the third quarter last year.

Turning to the balance sheet, our inventory at quarter end increased 20% to $160.6 million from $133.7 million in the prior year period. Excluding acquisitions, inventory was down $2 million compared to last year. We are very comfortable with the quality of our inventory as the fall selling season winds down.

For accounts receivable, our amounts totaled $216.1 million and this was down 18% from last year. Our day sales outstanding improved to 46.8 days from 55.6 days last year. Excluding Hanna Andersson’s catalog and retail operations day sales outstanding improved 5.5 days from last year.

Finally, our total debt including the debt of Smart Shirts remained relatively flat at $511.2 million resulting in a debt to capital ratio of 47.6% at quarter end versus 44.7% last year.

Capital expenditures including Smart Shirts for the third quarter totaled $7.3 million and depreciation expense was $7.8 million. For 2007 we now expect capital expenditures and depreciation expense to approximately $29 million and $31 million respectively. These capital expenditures primarily relate to IT systems and enhancements, Smart Shirts manufacturing and retail stores. Smart Shirts will be approximately $8 million of the capital expenditures and $8 million of the depreciation.

For our guidance please reference slides eight and nine. We are confirming our previously issued guidance for both fiscal 2007 and 2008. Our fiscal 2007 guidance is reiterated on slide eight. We continue to expect net sales from ongoing operations to range from $1.5 billion to $1.55 billion versus $1.514 billion in fiscal 2006. Operating earnings on an ongoing basis continue to be estimated in the range of $68 million to $73 million versus $64.4 million last year.

Net earnings from ongoing operations is forecasted in the range of $17 to $20 million versus $23.2 million last year. Diluted earnings per share on an ongoing basis continues to be estimated in the range of $.66 to $.76 per share which compares to actual earnings per diluted share of $.90 in fiscal 2006.

During fiscal 2007, we anticipate incurring an approximately $28 to $31 million in restructuring costs in conjunction with the previously announced reorganization of women’s sportswear, transformation of the Phat Farm men’s business to a solely licensing model and the streamlining of our corporate functions.

For fiscal 2007 we expect free cash flow, operating cash flow, excluding working capital changes and cash restructuring charges, less capital expenditures and dividends to be in the range of $50 million. This compares to free cash flow before changes in working capital of $69 million in fiscal 2006. The lower anticipated free cash flow was due to the additional capital expenditures in 2007 and lower net earnings.

Our guidance for fiscal 2008 is reiterated on slide nine. We continue to expect net sales from ongoing operations to be approximately $1.55 billion which compares to our 2007 guidance range for net sales from ongoing operations of $1.5 to $1.55 billion. Operating earnings on an ongoing basis are still expected to approximate $92 million which compares to our 2007 guidance of $68 to $73 million. Net earnings from ongoing operations continues to be forecasted in the range of $32 million and this compares to our 2007 guidance range of $17 to $20 million.

Finally, fiscal 2008 diluted earnings per share on an ongoing basis continues to be estimated as $1.50 which compares to our 2007 guidance range of $.66 to $.76 per share.

I want to reiterate again our five year financial plan that we first communicated last month. As Bob indicated, our plan is for 4% to 5% of annual organic sales growth and operating margin target of 9% in 2012 increasing from 4.6% today, and again, this is for existing businesses and excludes potential future acquisitions. In our annual earnings target per share growth of 25% or more after the significant 2008 increase excluding potential future acquisitions.

I would like to now turn the call back to Sam who will facilitate the Q&A session.

Sam Duggan

Before I open the call to take your questions I would like to remind participants on this call that we ask that you limit your questions to the third quarter earnings release that we made today. We will not be taking questions regarding the unsolicited proposal from or in response to Sun Capital. Operator, we are now ready to take questions.

Question & Answer Session

Operator

[Operator Instructions] Our first question comes from Todd Slater with Lazard Capital Market.

Jennifer Davis - Lazard Capital Market

This is Jennifer Davis in for Todd. Congratulations on a good quarter in a tough environment. I was wondering if you could talk a little bit about your $1.50 08’ guidance, why you feel confident or comfortable with it in this environment.

Bob Skinner

We gave that guidance, Jennifer, about four weeks ago and at the time we certainly took the challenging environment, the retail environment into account when we gave that guidance. On our slides today as well as a month ago when we announced those plans we also gave a fairly detailed roll forward from this years anticipated earnings to next year as we continue to believe that our strategic and financial plans are real and achievable and take into account both our internal improvements and a challenging external environment.

Jennifer Davis - Lazard Capital Market

So you really haven’t seen much of a change in the environment for better or for worse in the last month or so?

Bob Skinner

That’s correct Jennifer.

Jennifer Davis - Lazard Capital Market

Could you give a little bit of detail on the progression of the $1.50 for the quarters that back end loaded or is it kind of lumpy in Q2 and Q4 or how should we expect to see that flow?

Bob Skinner

At this point we are just giving the guidance on the full year and when we get to the end of the year then we will look at the quarters more closely for you all.

Jennifer Davis - Lazard Capital Market

Thanks, good luck.

Operator

Thank you, our next question is coming from Jeff Edelman with UBS.

Jeff Edelman – UBS

A couple of questions, Bob could you address the women’s sportswear, I know you don’t want to get too specific with brands, the cost cutting, efficiency moves really make a lot of sense, but you’re still posting declining sales. Is there point out there where you envision some troughing there or is it still a struggle to maintain floor space?

Bob Skinner

There certainly is a point where we expect our sales to increase. Right now we are very pleased, Jeff, with the women’s business in our modern alliance and this is Vince contemporary sportswear, our junior’s business Baby Phat, XOXO, My Michelle and Candies, all posted very strong quarters and have had solid performance. Our sell troughs at Calvin Klein have continued to improve though we have noted that they still need to continue to improve further. We believe with the consolidation into the lifestyle alliance of Sag Harbor, Briggs and Koret we’ll be able to focus those businesses better and direct them to the right retail partners and to the right consumer groups and to see sales improvement based on that in the future.

Jeff Edelman – UBS

Are you seeing better sell through in the latter three to give you any encouragement or is this just kind of hope down the road?

Bob Skinner

We are seeing better sell throughs but they need to improve further still again, the women’s sportswear environment has been challenged in both the main stream space and in the better space. While better than year earlier, we believe we can improve them further still and that is our intention.

Jeff Edelman – UBS

Finally, could you give us some sense of the run rate in gross margin that you are achieving today excluding the markdowns, to give us some sense where can we look a little further out if we get to a more normal period?

Bob Skinner

Our gross margins have improved significantly as we noted.

Jeff Edelman – UBS

I understand that, that was even with women’s moderate sportswear. Maybe I can rephrase it. Of the recorded gross margin, how much is that being negatively impacted today by markdowns and closeouts?

Bob Skinner

There certainly is an impact, Jeff, and again because we’ve been conservative and prudent in our forward financial planning we are planning our gross margin assumptions plan for a similar level. If there is a positive change to that it will be to the better, but our planning assumptions again, assume the same challenging retail environment that we are currently facing.

Jeff Edelman – UBS

I understand thanks and good luck.

Operator

[Operator Instructions] Thank you, our next question is coming from Brad Stephens from Morgan Keegan.

Brad Stephens – Morgan Keegan

Within your women’s sportswear business, and obviously you run a lot of different lines, can you give us an idea of the level of accommodations that are being required this year versus last year as a percent to total?

Bob Skinner

I’m not going to give you a percent, but I’ll certainly give you some comparison year to year. I would say there has been an increase, albeit, not a dramatic one from year to year and again our planning assumptions for the future continue to include a challenging environment, we’ve taken that into assumption. Having said that, we still expect the level of margin improvement that we attained in this quarter, that new run rate to continue for the future on gross margin percentage.

Brad Stephens – Morgan Keegan

I don’t have the slide in front of me right now but I believe for next year from the pre-acquisition businesses, you expected something like $15 million decrease in sales, which I assume the other soft trending north and the Legacy Women’s turning south, is that correct?

Bob Skinner

Yes.

Brad Stephens – Morgan Keegan

Since that time, we’ve seen Target say that apparel is starting to struggle, I think Wal-Mart has gone to another round of consolidation, pulling back in inventory with its key vendors and I believe you do a lot of your Gerber baby business through those two channels, so can you give us some color on how that business is trended and what you are expecting for next year from those businesses?

Bob Skinner

From Gerber, Brad?

Brad Stephens – Morgan Keegan

Yes.

Bob Skinner

Yes, our Gerber business we called out is a solid performer, a very positive performer during the quarter and our business with all of our top customers you happened to mention two of them Target and Wal-Mart has been quite good. While they’ve called out, to your point, issues with their apparel business I’m not sure that was focused on infant apparel, layette, which is where Gerber focuses and does a wonderful job. Very good quarter for Gerber, very solid business and certainly we plan for that to continue.

Brad Stephens – Morgan Keegan

Last question, maybe for the acquired businesses, or for the Legacy, where do you think that you need to add some bench strength within management?

Bob Skinner

We certainly added significant new talent and we assigned people in a positive way and we called those out, whether it’s our Calvin Klein business, our Lifestyle business, our O Oscar business, we’ve made very positive personnel moves, so it’s always our intention to continue strengthening our team and evaluating it so that we can bring the best possible product to market.

Brad Stephens – Morgan Keegan

As you transform to more of a retail model, are there spaces you are going to need to fill within management?

Bob Skinner

I think that is a fair assumption. When we brought on Hanna Andersson, we brought with Hanna, for example, a very experienced retail merchant team and they are responsible for the significant roll out of Hanna Andersson stores that we are talking about over the next four to five years, for example.

Brad Stephens – Morgan Keegan

Best of luck guys.

Operator

Thank you, our next question is coming from Jody Kane with Sidoti and Company

Jody Kane – Sidoti and Company

I just wanted to go back to the $1.50 guidance and the environment. The $1.50 is based on a challenging environment is that correct?

Bob Skinner

Yes.

Jody Kane – Sidoti and Company

Even though that is 70% growth, it is still, you think, conservative and achievable in a challenging environment?

Bob Skinner

I think it is largely based on items that we can impact ourselves, so things that are within our control and that’s what we’ve put in the detail roll forward that we gave last month when we gave that guidance, Jody, and again, today in our slide presentation. Yes, again, external environment has been considered, but largely we are focused on things within our control at Kellwood.

Jody Kane – Sidoti and Company

If the environment started to improve it would be upside to that number.

Bob Skinner

Yes, if there was a significant change in the operating environment for the better, which we would all hope for there would be upside.

Jody Kane – Sidoti and Company

As far as Sag Harbor goes, I know last year you spend a lot on advertising and really had to push for the brand. Is there anything you are doing this year that is significant?

Bob Skinner

The push was actually the larger for Sag Harbor in 07’ than in 06’ and then the results of that are that in the women’s wear daily brand 100 index we moved from the low 90’s to the 60’s. I think the largest from 90^th place to 60^th place, I think the largest move of any brand so we are very pleased with the results of our advertising campaign and currently our plan is to continue that in 2008.

Jody Kane – Sidoti and Company

Do you feel that increased brand awareness, Sag Harbor has improved the sales of the brand and how retailers see the brand?

Bob Skinner

I think it’s helped significantly with our brand positioning, combine that with new fashion, with new assortments where we very much plan for our clothes to be more up to date in our main stream offerings, primarily led by Sag Harbor. The answer is yes to all of the above, significantly helped with our brand positioning.

Jody Kane – Sidoti and Company

A final question just on the gross margin. Now that it is up to the sort of 27%, do you see a flaw there or could it continue to go up or just come back down or is that a new level for you?

Greg Kleffner

I think that probably will go up slightly from there as we go a little more direct to consumer and things and work on expenses and all.

Jody Kane – Sidoti and Company

Great, thanks.

Operator

Thank you, there appear to be no further questions at this time, I’d like to turn the call back over to management for any closing remarks.

Bob Skinner

Once again, I’d like to reiterate that our management team remains focused on successfully executing the strategic priorities outlined in our long term strategic and financial plans that we described to you last month in November. Thank you again for joining us and we look forward to talking with you in the future.

Operator

Thank you that does conclude today’s conference call. Have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!