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DSW Inc. (NYSE:DSW)

Q4 2007 Earnings Call

March 27, 2008 8:00 am ET

Executives

Leslie Neville – Director IR

Peter Horvath - President

Doug Probst - CFO

Debbie Ferree – Chief Merchandising Officer

Analysts

John Shanley - Susquehanna Financial Group

David Mann - Johnson Rice & Company

Jeff Black - Lehman Brothers

Patrick McKeever - MKM Research

Heather Boksen - Sidoti & Co.

Jeff Mintz - Wedbush Morgan Securities

Roxanne Meyer - Oppenheimer & Co.

Sam Poser - Sterne, Agee & Leach

Richard Lindhart - Opus Capital

Brett Hickerson – Nikomus Capital

John Zolidis - Buckingham Research

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 DSW Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Leslie Neville, Director of Investor Relations, please proceed.

Leslie Neville

Good morning. With me today in Columbus are Debbie Ferree our Vice Chairman and Chief Merchandising Officer; Peter Horvath our President and Doug Probst our CFO.

Earlier today we issued a press release detailing the results of operations for the quarter and year ended February 2, 2008. Before we proceed please note that various remarks we make about the future expectations, plans and prospects of the company constitute forward-looking statements. The actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including those listed in today’s press release and in our public filings with the SEC. So with that I will turn it over to Doug.

Doug Probst

Thanks Leslie, good morning everyone. This morning we announced our financial results for the fourth quarter and the full year of 2007. These results fell short of our expectations due in part to a more difficult economic environment which negatively impacted our results. As previously released net sales for the fourth quarter increased 1% to $332.5 million. Same store sales decreased 1.7% for the comparable 13-week period versus an increase of 1% last year.

For the year net sales increased 10% to $1.4 billion and same store sales decreased 0.8% for the comparable 52-week period versus an increase of 2.5% last year. Gross profit for the fourth quarter decreased 520 basis points due mainly to an increase in markdowns. As anticipated occupancy expense deleveraged to last year due to the unfavorable comparison of the 53rd week in 2007 and the increased expense associated with the additional 102 Stein Mart Stores.

During the quarter we also took a $1.6 million associated with the impairment of assets in an under performing store and the severance for associates related to the decrease of shoe processing for Value City Department Stores. For the year gross profit decreased 230 basis points to 26.3%. The merchandise margin rate which is gross profit margins excluding occupancy charges and warehouse expenses, decreased 160 basis points due to markdowns related to clearing end-of-season merchandise and a strategic decision to permanently decrease clearance inventory below historical levels. Clearance units per store were down over 20% at year-end.

SG&A increased 190 basis points in the quarter due to the same store sales decline and the unfavorable comparison to last year where we had a one-time benefit from the reversal of our loyalty accrual. For the year SG&A rate decreased 20 basis points to 20.5% of sales due to a reduction of our 2007 bonus expense. DSW did not award any performance bonuses in 2007. This reduction was partially offset by the $8 million investment for the development of our e-commerce channel. For the year the net result with the 210 basis point reduction in the operating income rate to 5.8% of sales.

Net income for the year was $53.8 million compared with net income of $65.5 million for last year and diluted earnings per share were $1.21 compared with $1.48 a year ago, an 18% decrease. In 2007 our capital expenditures were approximately $100 million and reflects our resolve to invest in future growth. We invested approximately $40 million into new and remodeled stores. We invested another $37 million into our IT infrastructure and our e-commerce channel that we expect to launch in the first half of this year. After this significant investment we remain with over $130 million in cash and short term investments with no debt.

Now to 2008. Given the uncertainty of the current economic climate and declining consumer confidence, we are not providing annual EPS guidance at this time. We are limiting our outlook to the first half of the year and can tell you we expect negative comparable store sales for the first half of 2008 and earnings performance for the first half as significantly below the first half of last year. However even in a challenging environment we will continue our investment in future growth by opening at least 30 stores; launching our e-commerce channel and continuing our investment into our systems infrastructure in 2008.

Now I will turn it over to Debbie for her comments on the merchandise results.

Debbie Ferree

Thank you Doug, 2007 did not meet our expectations as customer shopping behavior made the assessment and reaction to selling patterns more challenging. In addition lackluster innovation of product compromised the amount of fresh fashion to the consumer. Having said this, let me share with you how we are responding and what tactical actions we are taking to support the current retail environment as well as our business model and our long term strategy for DSW.

While DSW has always been a value proposition and we are confident that our unique business model will allow us to continue to increase market share in 2008. We are also scrutinizing aspects of our merchandise assortment that will emphasize our DSW foundation of selection, convenience and value. First sharper pricing and showing a deeper value to the consumer on commodity items is key. One of the ways we will accomplish this is through taking advantage of additional in-season opportunistic buys. Our inventory position is one of liquidity and our business model allows for much flexibility in buying. The combination of these two allows us to take advantage of opportunity buys while at the same time protecting us from risk.

Next we are focusing and editing our vendor offering and our assortments to ensure that we have what customers want. This will satisfy her desire for the latest trends and best brands while at the same time making us more important to our core vendor partners. This will create win-win growth and profit for both of us as well look toward the future. We were pleased with the results of our Q4 strategy to extend the regular priced selling season on transitional items such as pumps and boots as customers reacted to buy-now wear-now trends. 2007 was a record year for boots and DSW with AUR and gross margin in this category at record levels.

In addition while it is a small piece of business in Q4 a more robust strategy in sandals for warm doors and fashion stores exceeded our expectations and provided us with invaluable insight into early trend reads and an indication into what customers across the country will respond to this spring. The remainder of the category had negative comps in Q4, specifically in the casual area we were disappointed with our Young Attitude results as the flat trend and balkanized trend continued to slow and a dominant fashion trend has yet to emerge from the market. Some of this business has shifted into Young Attitude dress where we did see strong positive comps.

For spring I’m encouraged by the product offering I am seeing. There is excitement in footwear as color, prints, natural bottoms and flat sandals have all emerged as important must-haves. There is a good synergy between footwear trends and ready-to-wear in dresses and skirts putting us in a good position to capitalize on our core business. As we move into 2008 we are closely monitoring trends remaining flexible and managing our inventories cautiously. With our fashion right assortment and our value proposition we believe this environment represents an opportunity for DSW to become more relevant than ever to our customers and continue to capture market share.

With that I will turn it over to Peter.

Peter Horvath

Thank you Debbie, 2007 was a difficult year at DSW. We feel short of our expectations ending the year with negative comps and earnings below last year. Like many retailers, we felt the affects of a difficult economic environment. Despite these pressures we remain committed to our long term growth strategy by investing in the future even in tough times. We hold ourselves accountable for the factors within our control and we will continue to address business improvements through improved execution and smart management of inventory, expenses and customer traffic.

As we enter 2008 it seems likely that we will continue to face a challenging economic environment. As a result we’ll remain focused on improving our current performance while remaining true to our long term strategies for growth. These include disciplined inventory management, delivering a remarkable customer experience and continuing to grow market share. I’d like to share how we’ll position ourselves in 2008.

Number one; disciplined inventory management. Our semi-annual sale events helped us to manage the targeted clearance levels. By entering seasons with inventories positioned flat or down, faster expected turns and content mixed more towards current fashion than clearance we consistently position the business for upside while mitigating downside risk. We ended the year with inventory down on a cost-per-foot basis and clearance at the lowest level ever. As we enter 2008 inventory levels will be appropriate providing a reasonable level of protection against continued comp store weakness.

Number two; remarkable shopping experience. We remain committed to offering our customer remarkable shopping experience. This idea permeates all we do from our remarkable locations, store design, execution of the service model, loyalty program and more. We continue to grow our presence in top markets and in the best retail locations around the country. This year we opened 37 stores in new and existing markets. The overall real estate strategy continues to perform as expected; 2007 new stores are trending to superior sales-per-foot to the chain average and delivering targeted profitability rates. We ended this year with 63 stores that incorporate elements of the new design and now have five remodels where we are reading sales lift in former capital planning decisions.

Initial indications are positive and customer comments have been incredibly favorable, however we will be conducting formal customer research over the next six months to better understand the impact of the new designs. Last fall we launched our new service model. We’re beginning to see it delivered with consistency across all stores. This service model is about providing customer engagement that is defined by the terms passionate, friendly, helpful and real. Fellow shoe lovers who are enablers who love shoes and want to talk to customers about them. By every measure our loyalty program continues to strengthen and improve. Improved retention rates and increased enrollments are driving member growth. Last year we gained 1.3 million new members bringing our total to 8.5 million members. We understand the power of this important asset and continue to nurture and improve the relationship we have with these loyal members.

We’re on track to launch e-commerce during the first half of 2008. We understand the multi channel customers represent significant growth potential for DSW and we’re excited by the prospect of combining e-commerce with our successful and growing loyalty program. We’ll provide more color around what we are planning and specifics around timing as the launch approaches.

Number three; gaining market share. Year to date sales increased $126 million over last year, up $144 million on a 52 to 52-week basis. Although our comp store result for the year was negative we continued to increase market share due to new store growth at DSW and expansion in the Stein Mart lease business. In 2008 we’ll open at least 30 new stores and launch our new e-commerce channel. So we look forward to another year of significant market share growth.

We continue to make good progress against our long term growth strategy despite short term business challenges and operating in a more challenging general economic environment. We’ll continue to proceed cautiously in this uncertain environment while controlling the factors that will strengthen our capability and lead to long term shareholder value.

With that I’ll turn it back over to Leslie to introduce Q&A.

Leslie Neville

Okay, now for the Q&A. Please limit yourself to one question and one follow-up on the first round. You’re welcomed of course to get back in the queue in the same manner as you did originally.

Question-and-Answer Session

Operator

Your first question comes from John Shanley - Susquehanna Financial Group

John Shanley - Susquehanna Financial Group

Pete, you had previously indicated on the last conference call that product margins would be impacted in the fourth quarter based on taking some heavy markdowns which you obviously did, has this…and that was intended to keep the first quarter pretty clean and basically with fresh merchandise and so on, has that policy changed at all, are you basically feeling that the promotional environment is going to likely continue into the first quarter and that’s the real reason for the reluctance to give us any guidance in terms of EPS results in the moving into ’08?

Peter Horvath

Yes, it’s more about just matching the inventory to the sales trend and clearly in the fourth quarter we were unable to do that and we always focus on managing inventory first knowing that opening seasons clean is really the key to having the opportunity to change a trend. We’re going to continue to monitor sales trends and make appropriate adjustments to inventory. It’s less for us, as you know, we’re an everyday value model, and it’s less about promotion. We do leverage our loyalty program with benefits that come with the program such as gift-with-purchases, et cetera. Basically we stick with our value priced proposition as Debbie noted in the conference earlier comments. The end of the season we clean up what ever is left and that’s what we saw in the fourth quarter.

John Shanley - Susquehanna Financial Group

Okay fair enough. Debbie we just got a new 30% off spring promotional flyer. Is this anniversarying an existing promotion and are you…is there any concern now that some of the spring merchandise that you have in the stores may not be moving as quickly as planned and therefore you’re doing some early promotions?

Debbie Ferree

First of all this is not anniversarying anything that we did last year and as we said before we remain committed to our value proposition. We’re pleased with some of the trends that we’ve started to see emerge, as I mentioned to you the color, the prints, the natural bodies and the flat sandals. Has been said many times before, traffic obviously is a concern to all of us and what we were doing here is we’re testing this concept to see if we can address traffic and also drive some regular price, some additional regular price.

Peter Horvath

John, we’re glad you got the email; that’s a 30% off email I believe you got, 30% off one regular priced item. Our clearance product has been moving very well and the weather was cold going into Easter. We wanted to give our best customers, which apparently we’ve got you selected as one, the opportunity to come in and get a deal on a regular priced item and hopefully when you go redeem that, which we’re hoping you will, you’ll buy a couple of units.

John Shanley - Susquehanna Financial Group

I see, so it’s more of a promotional for just stimulating store traffic is that correct rather than a clearance?

Peter Horvath

It’s targeted; it’s very targeted. There might be 40,000 people that respond in the course of a few weeks, so it’s not a massive, broad thing.

John Shanley - Susquehanna Financial Group

I see okay. Thanks a lot.

Operator

Your next question comes from David Mann - Johnson Rice & Company

David Mann - Johnson Rice & Company

As it pertains to your first half guidance, I guess I can understand why the first quarter should be down significantly but when you look at the second quarter you had a pretty [inaudible] margin decline last year so are you trying to tell us that both quarters should be down a lot or how should we start thinking about the sales and margins in the first two quarters?

Doug Probst

It’s a combination of sales margins as well as some expenses. We don’t anticipate, as we said in the script that the e-commerce channel will be up and running until the first half, later part of this half. There are additional expenses we’re incurring until that opens. Margins will be difficult given the fact that we have negative comps and although we’ve measured our inventory and kept it conservative moving into it, we have to be prepared that it may not be appropriate enough given what the sales trends might be. So David I know that may not answer your question particularly but I can take another question if you’d like.

David Mann - Johnson Rice & Company

I guess the core of the question is you did have drop in the second quarter in gross margin, so even with that you’re still cautious about the second quarter, is that reasonable?

Doug Probst

Yes.

David Mann - Johnson Rice & Company

Okay and then just one other quick question, you talked about sort of stepping up your opportunistic buying of commodity items, can you just refresh our memory on what percentage of the inventory might commodity goods represent that you can perhaps target with this promotional or sharper pricing?

Debbie Ferree

Yes, there’s really two ways I’d like to answer that. First of all, we do have…there has always been a focus towards supporting key commodity items and I talk about those as big key items. That focus has not changed, that is consistent, and it continues to move forward. Where I think there’s an opportunity is to take advantage of more of the in-season off-price opportunities than we ever have before. As you know, that is becoming smaller component of our business as we continue to do inline and product development toward make-ups and that has become the bigger portion of our business. What I’m going to be doing is I’m going to start adding in a little bit more of the in-season opportunistic buys so that I can put some more of the deeply valued prices offered to the customer on the floor.

David Mann - Johnson Rice & Company

And is that already in the stores? How quickly can that ramp up?

Debbie Ferree

Well you know, David, we’re buying in-season opportunities all the time, but as these lists come available from the market, which they’ve already started to become available this season and we’ll take advantage of those opportunities as they become available.

David Mann - Johnson Rice & Company

Great thank you.

Operator

Your next question comes from Jeff Black - Lehman Brothers

Jeff Black - Lehman Brothers

Doug, on merchandise inventories where do they come in for the year?

Doug Probst

Virtually flat to last year on a cost-per-square-foot basis and clearance inventory levels were down over 20%, units were down 20% per store for last year.

Jeff Black - Lehman Brothers

So what’s the balance sheet number, what’s the line item merchandise inventory on the balance sheet?

Doug Probst

We haven’t put a balance sheet out and the main reason we didn’t was just because there are some small percentage of our cash and short term investments that may get reclassified to long term, I would say less than 10% of that, so at this stage we didn’t release a balance sheet but on a cost-per-square-foot basis as I said, it’s flat to last year.

Jeff Black - Lehman Brothers

And then since you brought it up, the $130 in cash, how much of that is short term investments and are you talking about auction rate securities that need to be reclassified and what’s the impact of that?

Doug Probst

Of the $130 million virtually its all cash or treasuries and there’s a portion of that, as I mentioned about approximately 10% is in auction rate securities that we’ll find out over the next couple of weeks whether those will be classified as short term or long term.

Jeff Black - Lehman Brothers

So when are we getting a balance sheet do you think in the next couple of weeks when that happens?

Doug Probst

With the 10-K correct.

Jeff Black - Lehman Brothers

And then any comments on operating cash for the year, where does that come in?

Doug Probst

Well the cash flow from operations, the free cash flow is about $70 million but the total cash difference, I mean from the year-end cash and short term investments was $170 million last and its close to $130 million this year.

Jeff Black - Lehman Brothers

Okay and on the CapEx for ’08 what are you still planning, is it closer to $80 than $100 or how should we look at that?

Doug Probst

Its actually right in between there, about $90 million is what we’re expecting.

Jeff Black - Lehman Brothers

And then finally on the e-commerce, you’re going to start selling in the second half I presume, is that third quarter and what kind of sales targets should we anticipate from the investments?

Doug Probst

Well we’re not necessarily planning those sales targets directly or communicating those right now because Jeff there’s two angles to it. One is that it could be coming…additional sales in the stores, and there could be sales online but we do see it as collectively as being a incremental move for us. But as we’ve always said Zappos.com out there doing close to a billion dollars is a really high number. We don’t nearly expect it to be that. But to a lot of the other dot com retailers have sales in the $20 million range, $40 million range and at some point in its first 12 months of operations we would like to hope or we’d like to think it could do break even in its first 12 months of operations as far as the P&L impact. But right now we’re not giving specific sales numbers for that channel in particular.

Jeff Black - Lehman Brothers

And then on the Stein Mart business, how did that impact the quarter just in terms of EPS, I know you give the sales numbers I think?

Doug Probst

It’s incremental but again its geography that screws it up mostly because there is about a 30 basis point negative impact on our gross profit for the quarter because those charges pay for the Stein Mart business. Our share of their expenses is charged to gross profit and there’s virtually no expenses there. So the additional stores were definitely incremental and we are pleased with that business. They’re struggling a bit but we’re confident that that was a good thing for us to take on, those additional stores.

Jeff Black - Lehman Brothers

Okay fair enough. Thanks a lot.

Operator

Your next question comes from Patrick McKeever - MKM Research

Patrick McKeever - MKM Research

Just with regard to the first half of 2008 guidance, what are the macro factors that play into your cautious guidance on the first half? What are some of the things that you’re most concerned about and then secondly as we think about same store sales, and the guidance, the negative guidance for the first half of the year, should we be thinking more in terms of traffic taking a hit or ticket or a combination?

Doug Probst

My comments would be on the macro factors is that clearly its traffic and to the second part of your question we’re just seeing that slow down and obviously for the last six or seven months, we’ve just seen a steady decline in consumer confidence which kind of boils in all the external factors that are going on out there to be it a five year low and by other factors people are suggesting it might go even lower. So we’ve just got to believe that…we hope it gets better but we can’t expect it to get better so we have to plan our business cautiously. Obviously the opening of our dot com business is another factor that we have to see how it goes when we open and that’ll make it a little more clear and we’re still in the process of finalizing the switch over of shared services and figuring out the impact of that with the change in the Value City ownership.

Patrick McKeever - MKM Research

Okay and then, I don’t know if you’ll answer this or not but your same store sales decreased 1.7% in the fourth quarter and you’re guiding for negative comps in the first half of the year, has business slowed from the first quarter or is this just more caution on what might be to come over the next few months?

Doug Probst

We’re not going to give any details towards the current performance of 2008.

Patrick McKeever - MKM Research

Okay, thank you.

Operator

Your next question comes from Heather Boksen - Sidoti & Co.

Heather Boksen - Sidoti & Co.

The last time we…well I guess it’s a two-part question here, one, are you planning any special promotions around the time everybody starts receiving these tax rebate checks and two, last time these checks were mailed out did you see any notable change in…notable pick up in sales?

Peter Horvath

Basically nothing special around the tax rebate checks. I think what we focus on is our most valuable and critical asset our loyalty programs. So it’s more of a one-to-one marketing approach and it’s about giving, understanding what groups of consumers, clusters of consumers, what will induce them to incremental behavior and providing them benefits that create that behavior. As [John Chandley] mentioned earlier one of those is to simply say early in the season, 30% off one regular priced item. I think in about a week or two, it’s a gift-with-purchase for select members and so on, so really we hope that there’s a positive benefit from the tax rebate checks for all retail and we’ll wait and see but we’re not doing anything specifically targeting that because it really wouldn’t fit the overall promotional strategy or brand position or DSW.

Heather Boksen - Sidoti & Co.

Okay, last time though these checks got mailed out did you see any notable impact to your sales?

Peter Horvath

We really don’t have any information around that.

Heather Boksen - Sidoti & Co.

Okay and one just quick housekeeping question, you said the $90 million in CapEx for ’08, how much of that is stores, how much of that is IT or anything else?

Doug Probst

Stores is $45 million to $50 million of it.

Heather Boksen - Sidoti & Co.

Okay, thank you.

Operator

Your next question comes from Jeff Mintz - Wedbush Morgan Securities

Jeff Mintz - Wedbush Morgan Securities

Obviously 2008 is looking like its going to be a difficult year but if we look a little further out do you still feel that some of the long term goals that you’ve laid out for a 10% operating margin, do you still think that’s achievable over time?

Doug Probst

Yes we absolutely do, clearly not in the short term because of what we’re facing but as well look back at our business over the past couple of years, there are certain quarters where we hit that 30, 20, 10 mark that we’ve always wanted to achieve. Obviously we want to do that for four straight quarters. But margin improvement is where we’re going to get this business to lead to that double-digit operating income and we believe even though we’re investing into the short term for future growth in IT and our dot com business that in the long term we certainly see this as a double-digit operating income business.

Jeff Mintz - Wedbush Morgan Securities

Okay great and then you mentioned the shared services agreement and the impact on SG&A; do you have any sense of just how we should think about the quarters of SG&A? In the past the third quarter tended to be a lot higher and in 2007 that wasn’t the case; the quarters were roughly even. How should we be thinking about ‘8, should we look for roughly even SG&A across the quarters?

Doug Probst

Generally yes, but remember last year we had some, we did have some adjustments, one-timers in the third quarter for example we reduced that bonus accrual. So there would be some odd comparisons to last year but generally that rate should be the same throughout the year. The one difference becoming when the dsw.com business launches we will have sales going against the expenses that we have inherent in our business but until that launches obviously it’ll be more pressure on SG&A because there’ll be no sales yet in that channel.

Jeff Mintz - Wedbush Morgan Securities

Okay, thanks very much.

Operator

Your next question comes from Roxanne Meyer - Oppenheimer & Co.

Roxanne Meyer - Oppenheimer & Co.

First as it relates to merchandise, I know you mentioned categories that so far seem to be doing well, I’m wondering if you could talk to what categories you think you may be over exposed to and also just following up on you had mentioned the second part of your strategy was that you’re editing your vendor offering, if you could give a little bit more color as to what you’re doing there, thanks.

Debbie Ferree

So in regards to your first question, there’s really no category right now that I feel that we have liability, inventory liability against right now. According to our spring strategy that we articulated earlier the things that we articulated that we expected performance out of are hitting their mark which is the color, the prints, the natural bottoms and the flat sandals. Our core business, as you know, is dress shoes and I’m pleased with our dress shoe performance up into this time. So there really isn’t anything that I see today that I’m feeling uncomfortable with. I just want to go back and reference that the traffic issue obviously is a concern to all of us and that to me would be the most overriding reason why we wouldn’t be able to sell through as much as perhaps we would have originally anticipated.

And the next part of your question was the vendor offerings, I think its very, very important that we continue as we always do to identify who the key volume and profit players are within our business model and continue to put an accountability on our vendor partners to continue to perform to the expectations that both of us need to deliver on. So as we continue to evaluate those brands or those items that do not perform, we weed those out. And I would tell you that this year in my mind, I’m marching to two words; that’s focus and edit. So we’ll be very finely focused on our core businesses and we will edit out those items, businesses, categories that are not performing to expectation to help us continue to make our short and long term objectives.

Roxanne Meyer - Oppenheimer & Co.

Thanks Debbie for that clarity. Is there…are you able at this point to talk to maybe the percent of your vendor base that maybe you are dropping or changing around?

Debbie Ferree

No I’m not, I’m just telling you that it’s an ongoing process and it’s something that I’m looking at each and every week. The other advantage here is, is that you want to be more important to your big key vendor partners and you want to reward those people that are performing well and you need to weed out those ones that are not so its an ongoing process for me and something that I’m looking at right now.

Roxanne Meyer - Oppenheimer & Co.

Okay great. And then I’m just curious why given the environment you’ve chosen to stick to your store opening plans and maybe why you didn’t maybe chose to open fewer stores this year.

Peter Horvath

We absolutely discussed why should we or shouldn’t we continue with our plans and the simple answer, which is a good one, is that first of all our balance sheet is strong and we’re not running a negative cash flow business and the new stores provide the highest return on capital of any investment we can make. We’re very pleased with the returns and new stores, also many of the past stores, so it seems like it’s just the best use of our cash is to invest it in stores. And we’re trying to be very careful that we don’t outgrow or we don’t get too…that we don’t start compromising our standards that we’ve developed over the past few years and take bad sites because just trying to move top line with new units. Also this environment for those who have cash and have a strong operating model on new units, this can be an advantageous time. Being the first in a new center or taking over a space from someone who had to vacate, there’s a lot of opportunities out there so we’re hoping that the situation provides us with some opportunities in the market. So the short answer to recap, is that it’s simply the new units are positive cash flow very quickly and it’s smart to do that to pay for things like infrastructure investments et cetera.

Roxanne Meyer - Oppenheimer & Co.

Okay thank you very much for that detail and best of luck.

Operator

Your next question comes from Sam Poser - Sterne, Agee & Leach

Sam Poser - Sterne, Agee & Leach

Just a couple of questions, can you tell us what your total square footage was at the end of the year please?

Doug Probst

Sure, its 6.6 million feet for DSW Inc. and for DSW Stores 5.8 million.

Sam Poser - Sterne, Agee & Leach

Thank you and can you talk about…are you narrowing the assortments and going deeper as part of this strategy?

Debbie Ferree

It’s a blend. First of all there has always been a focus on maximizing key fashion items and that will be a continued focus in this business as we continue to identify the big items that customers want so I would just tell you that’s an ongoing thing and to the degree that we can identify more of those big items that actually bodes well for the business. I think the most challenging thing we’ve seen over the last six months Sam has been customers have been kind of fickle about what they wanted. When we go back in every single week, we study by SKU what the customer is voting on and what is she trying to tell us and I tell you the degree of differentiation between two items that are frightfully similar; they like one and they don’t like the other. I mean it’s a mystery to me but what we try to do every season is when we build our assortment is what are the key must-haves by category and looks that the customers want and so we will continue to march to that merchandising strategy.

Sam Poser - Sterne, Agee & Leach

And then one last thing Doug, I spoke with you some time ago regarding the, I guess you converted to JDA but there have been some issues with some of the server power or so on that you may have to support all those systems. The systems investment in the CapEx that you look like you’re going to use this year, how far along are you to where you need to be now as far as getting everything up and running, to be able to really work the systems as needed?

Doug Probst

Okay let me just address the other question real quick by the way Sam, the end of period…end of year square footage was 6.1 million feet for DSW Stores, we gave you an average at that 5.8 million, the average for the year. So its 6.1 at the year-end. I didn’t know exactly which question you asked. As far as the IT is concerned, we are in the very early stages of fixing our infrastructure. We breakdown our spend into designing, building and running the systems and right now we’re focusing most of our attention in dollars onto running and creating the infrastructure, the foundation of our business to then start adding those systems that can improve the operational performance of the business. But right now it’s focused on the infrastructure and the foundation of IT and we are in the first quarter of that game right now.

Sam Poser - Sterne, Agee & Leach

So then when do you foresee the game ending?

Doug Probst

Well it’s always a continuous improvement but I would say throughout this year we’re going to be significantly better at the end of this year than we were last year and we’ll be even more improved at the end of 2008 so it’s a progressive thing. I can’t say we’ll ever be done but it’s certainly something that we see that we’ll be spending as we already said in 2008 and into 2009.

Sam Poser - Sterne, Agee & Leach

Okay thanks.

Operator

Your next question comes from Richard Lindhart - Opus Capital

Richard Lindhart - Opus Capital

Two questions, any geographic, major geographic differences as you look out among the comp store performance and what kind of drag are you seeing in your comp stores from the Stein Mart Stores?

Doug Probst

We don’t have any negative impact from the Stein Mart Stores. That’s really not a concern but as far as the fourth quarter comp performance I guess out in the West was the best and the Central part of the United States was the lowest but the range of that is about three percentage points.

Richard Lindhart - Opus Capital

Great thank you.

Operator

Your next question comes from Brett Hickerson – Nikomus Capital

Brett Hickerson – Nikomus Capital

I was just wondering on the whole change of ownership in Value City, refresh my memory, on your Q3 call did you give any kind of color about what the increase to your SG&A might be from that ’07 to ’08 and if you didn’t could you now?

Doug Probst

We’re still in the middle of that, we’re operating in good faith negotiating how that change should happen and no we didn’t’ say anything but we do expect there to be some increase related to that. But at this stage we can’t frame that up.

Brett Hickerson – Nikomus Capital

And then is it something I guess ratcheted back down after you can kind of digest it in ’09, I guess that leads to the percentage of revenue that probably gets ratcheted back down because you kind of take more full ownership of your own overhead and then lever it over the next couple of years, is that the plan?

Doug Probst

That is the plan and the expectation yes.

Brett Hickerson – Nikomus Capital

Okay and then lastly is there any change in mix or performance, we don’t talk about it much, but on the men’s side of the business versus the women’s side of the business?

Debbie Ferree

No, nothing significant. The men’s strategy continues to take hold and we start to see more and more positive results. There’s a little bit less of a mix in the young men’s business because I think we moved a little bit fast on that. The place that we’re seeing the strategy really take hold is in the casual area and we’re pleased with the results there.

Brett Hickerson – Nikomus Capital

And so Debbie would you say that men’s is actually maybe comping a little better than women’s?

Debbie Ferree

It’s about the same right now.

Brett Hickerson – Nikomus Capital

Okay, thanks.

Operator

Your next question is a follow-up from Jeff Mintz - Wedbush Morgan Securities

Jeff Mintz - Wedbush Morgan Securities

You know we’ve been hearing a lot about costs increasing in China and I’m wondering if you have started to see any impact of that from your vendors.

Debbie Ferree

Yes, what I would tell you as an overriding comment is we are committed as a company to providing a compelling value to our customer and we will make adjustments as needed. We are hearing, from the market place, and we’re just starting to get the prices in now for third quarter, we’re hearing anywhere from about a 5% to a 15% increase. Obviously we’re pushing back and even the vendor community is trying to protect as much of that as possible and mitigate the risk around that. So but we continue to march to our strategy which is offer compelling value to the consumer.

Jeff Mintz - Wedbush Morgan Securities

Okay but in the context of that strategy I assume that you’d be attempting to protect margins against those whatever increases do come through?

Debbie Ferree

Definitely.

Jeff Mintz - Wedbush Morgan Securities

Okay thanks.

Operator

Your next question comes from John Zolidis - Buckingham Research

John Zolidis - Buckingham Research

A couple of things, first could you, number one can you talk about the difference in the actual fourth quarter performance versus what was implied in the previous guidance especially in light of the fact that comps came inline with your guidance. And then number two you’ve talked a lot about getting the inventories in shape and protecting the merchandise margins, I would assume that you would agree that even in a negative comping environment if the inventory is properly positioned you could actually see merchandise margins stabilize or improve. Is there any sense in which that could happen at some point during 2008? And then lastly number three I understand you don’t want to give any parameters around shared services. You had talked offline in the past about the incremental expense being about $6 million to $8 million. Should we believe that that’s no longer valid and then on the e-commerce, you gave us very detailed information in terms of the incremental expected for e-commerce back in 2007, can you please tell us what kind of expenses are incremental for e-commerce in 2008.

Doug Probst

First as it relates to the guidance and the actual results, our comps were negative 1.7. That was inherently to the low end of our range because we said zero to negative 1 for the year which equated to a plus 2 or down 2. So for the fourth quarter we were down 1.7 versus a inherent negative 2 guidance for the fourth quarter. So we finished on the low end of that range. But also as we looked at our winter sale and how aggressive we had to be to move the inventory, for example we ran the winter sale 19 days this year versus seven days last year. We had to be aggressive to move the inventory to make sure we started the season clean in inventory and we believe we are at that goal. So that’s how I would frame up the difference from our expectations and what actually came out.

Peter Horvath

On inventories, I’d say sure we do hope that there’s…that merchandise margins could stabilize or improve this year. However, especially up against last year’s second and fourth quarter, however we’re reluctant to make any commitment to that given the uncertainty of the external environment. If it was just us, maybe we could be more sure at this stage of the game. I think the whole idea is that by trimming, slimming down the environments, the inventories and keeping them lean and staying agile and open, you should be able to improve on last year. However right now we’re still unsure about what the sales trend will be and we’re just trying to stay on top of it.

Doug Probst

And back to the shared service question John, the way it got framed up was…I’ll give you the facts as it relates to 2007. The charges that RVI gave to DSW for services provided in 2007 are approximately $9 million. That includes finance, risk management, human resources and a variety of other things. In 2007 though we also charged back to them approximately $18 million which is mostly related to our IT. The reason we can’t be more specific at this stage is because we’re still figuring out how those services will be provided to all the entities involved and how that should be appropriately shared and the entities involved would include Value City and would include RVI, [inaudible] Basement and DSW. So we’re in the middle of that stage and based on those historical numbers of us charging them $18 million and them charging us $9 million, that can start to frame up what the total dollars that are moving around at least historically and your modeling would similar to ours as we figured out what that impact would be to DSW go forward.

The final question you had was regarding dsw.com and yes we spent about $8 million in 2007 related to that channel getting up and started. The fourth quarter spending for that business was approximately $3 million. And until that…that’s basically a fixed expense. The expenses related to that business as it gets up and running and sales start to come in, the expenses will go up but they’ll be paid for to some degree by sales so I would assume that there’s at least a $3 million spend in that business as a non-variable cost until it got up and running and then the variable costs start to be added.

John Zolidis - Buckingham Research

Okay so just to summarize a couple of those answers to make sure I understand them. First with regard to the fourth quarter miss, it looks like comps were at the low end of plan but basically markdowns were greater then you had estimated.

Doug Probst

Yes.

John Zolidis - Buckingham Research

Okay and the second with regard to the inventories and the merchandise margins, you’re trying to get the inventories down but you’re not confident that you have them low enough to avoid further merchandise margin erosion.

Peter Horvath

Well its more like we’re just not, we’re not clear on what the sales trend will be so we want to stay conservative with our view at this time.

John Zolidis - Buckingham Research

Okay and then for the e-commerce we should be looking about $12 million for the full year prior to the expenses associated with actually operating the site?

Doug Probst

That would be fair. Some of those expenses would start to go down because the development expenses, it’ll be up and running so that should start to go down throughout the year so that should tail off so I think the $12 million might be a little high but for the first quarter the $3 million would be the assumption.

John Zolidis - Buckingham Research

Okay so there’s still some front end loaded kind of development costs in the first half.

Doug Probst

Until it gets up and running, yes.

John Zolidis - Buckingham Research

Okay, all right thanks a lot, good luck. Hopefully get the environment going in the right direction here.

Operator

Your final question is a follow-up from Sam Poser - Sterne, Agee & Leach

Sam Poser - Sterne, Agee & Leach

One last thing, Debbie with the systems evolving do you have the visibility and the technical wherewithal to be able to let’s say just get the right shoes in the right place at the right time as affectively as you need to, to execute as well against the goals that you have at this time?

Debbie Ferree

Yes, Sam, we have the same systems today as we have in the early years of DSW and we continue to look forward to even more improvements in those systems but having said that we have the capability that we need right now to be able to read the results on a weekly basis. To make informed buying decisions. We have information, some very good, solid information from our planning allocation partners that help inform the allocation of that merchandise. So I would tell you we have right now what we need to be able to get the job done, yes.

Sam Poser - Sterne, Agee & Leach

Thank you very much and success.

Operator

Ladies and gentlemen this concludes our Q&A session; I would like to turn the call back over to management for closing remarks.

Leslie Neville

Thank you very much for joining us today as always. Please feel free to follow-up with us with a call to our home offices. Thank you.

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Source: DSW Inc., F4Q07 (Qtr End 02/02/08) Earnings Call Transcript
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