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Executives

Edmond Thomas - President and Chief Executive Officer

Steve Benrubi - Chief Financial Officer

Jennifer McEntee - Vice President of Financial Planning and Analysis

Analysts

Lauren Levitan – Cowen and Company

Jeff Van Sinderen - B. Riley

Anna Andreeva - JP Morgan

Stephanie Wissink – Piper Jaffray

Paul Lejuez -- Credit Suisse

Elizabeth Pierce -- Roth Capital Partners

Eric Beder – Brean Murray

Erin Moloney - Merriman Curhan Ford

Janet Kloppenburg - JJK Research

The Wet Seal, Inc. (WTSLA) Q4 2007 Earnings Call March 27, 2008 11:00 AM ET

Operator

Welcome to the Wet Seal Incorporated, fourth quarter 2007 earnings conference call. Today’s conference is being recorded. At this time, it’s my pleasure to turn the conference over to Edmond Thomas, President and Chief Executive Officer. Mr. Thomas, please go ahead.

Edmond Thomas

Good morning everyone, thank you for joining us today to discuss our fourth quarter and fiscal 2007 results. With me today are Steve Benrubi, Chief Financial Officer and Jennifer McEntee, Vice President of Financial Planning and Analysis.

Before we begin, Jenn will provide our Safe Harbor statement. Jenn.

Jennifer McEntee

Certain statements during this call may contain forward-looking information. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company, economic conditions, and market factors and the industry in which we do business, among other things. These statements are not guarantees of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Actual events and results may differ from those expressed and any forward-looking statements due to a number of factors. Factors that could cause our actual performance, future results and actions to differ materially from any forward-looking statements include, but are not limited to, those discussed in “Risk Factors” within our Form 10-K for the fiscal year ended February 3, 2007, and our Form 10-Q for the fiscal quarter ended November 3, 2007, as filed with Securities and Exchange Commission.

On today’s call, we will be discussing comparisons of our fiscal 2007 first quarter results excluding impact of unusual business events or transactions through our fiscal 2007 first quarter results, and we will refer to the fiscal 2007 results as adjusted. These non-GAAP financial measures are provided to facilitate meaningful year-over-year comparison.

Ed?

Edmond Thomas

Thank you, Jenn. I will begin today’s call by providing an overview of our fourth quarter results and priorities for the business heading into fiscal 2008, and Steve will review our financial highlights, and I will provide closing comments and turning the call over to the operator to conduct a question-and-answer period, portion of the call.

We are pleased to have delivered fourth quarter results that exceeded our expectations despite the challenging retail environment. Diluted earnings per share were $0.13 ahead of our $0.09 to $0.10 guidance. This compared to our net loss per diluted share of $0.07 for the fourth quarter of last year.

I am also proud of the accomplishments that we have made in the quarter and several of our key initiatives. As you may remember, in late November we have planned several areas and which we saw our opportunity for improvement and that made significant progress and executing on our action plan over the last several months. We’ve affected significant structural changes in Arden B merchandising and merchandised planning in our occasional organizations including placing the team under the leadership of Sharon Hughes and have already seen improvement in direction. For instance, we have improved our planning, design, and purchasing functions by reengaging our merchants in these processes and realigning their support staff.

We’ve also partnering with key domestic and import vendors to utilize their design and production staffs to bring more market influences to the brand and to place Wet’s reliance on exclusive internally designed product. These changes should lead to shorter lead times enabling us to react to our business and bring our product back to the level of a specialty boutique brand. We have focused on improving merchandised mix at Arden B. We are addressing our lifestyles of our young contemporary customers similar to the Arden B strategy at its inception.

We have also implemented a new inventory planning philosophy promised on quick terms, no buying and to mark down and a focus on bottoms up category and lifestyle planning. In addition to this progress with the Arden B organization, we have made progress in many other areas notably, we addressed overstaffing in our home markets organization including Arden B and field management resulting an annual savings of over $5 million that we began to realize at the start of fiscal 2008.

We eliminated 1.8 million of spending on nonproductive Arden B print advertising. We completed profiles for all 400 of our Wet Sale stores, which are already supporting our efforts and improved inventory planning, and now occasion in the division. We tightened inventory management practices in both divisions, which contributed to leaning inventory positions as of fiscal 2007 year end that will help improve inventory terms and that our appropriate in light of our current retail environment.

We began the process of establishing stronger disappointment in the store labor management from which we began to realize benefits in December and January in the form of labor cost savings, which contributed to beating our previous fourth quarter earnings per share guidance.

We align fiscal 2008 corporate field management and store management incentives more closely with key measures of success, namely comparable store sales growth, merchandise margin improvement, and EBITDA improvement. We moved our outbound shipping business from DHL to UPF and increased the service to stores from twice weekly to 5 days a week resulting in higher service level for the stores at a lower cost. We begin the process of rebuilding our real estate pipeline and strengthening Lombard relationships to position the company for smarter growth when the time is right to do so. And finally, we executed our first lease for an off-mall power center location in Fresno, California which will open before the Back-to-school season.

Despite this progress, this is just the beginning of our efforts, as you saw today Arden B has been underperforming for sometime now, but we believe that this represent a great opportunity if we can revive it. Arden B has been a strong performing business before and we believe that very few other competitors have filled the space in the past several years during which Arden B’s directions straight from its core customer.

In the fourth quarter of 2007, Arden B focused primarily on liquidating excess inventory position, it carried out of October. Arden B’s focus in the first quarter of this year has been and will continue to be moving through inventories that are not well assorted and do not reflect the wants of our customer. By the beginning of May and even more toward beginning of June, you will see a merchandise assortment in Arden B that better balances with what we believe addresses the fashion base like the wear-to-work wants of a young contemporary customer.

With the structural changes I discussed earlier and a refocused merchandised philosophy, we are making every effort to return the division to profitability. Nonetheless, while we are highly focused on taking steps to revive the Arden B business, we will quickly evaluate whether this concept is beneficial to increasing long term shareholder value and respond accordingly.

Sales, we continue to pursue opportunities to drive sales productivity, including executing branded denim top and 25 of our stores applying knowledge gain from our store profiles to category stores based on store profiles similarities and customize merchandise mix accordingly, improving size in Mexico of all stores based on what we are learning from our store profile and field management defect and evaluating markdown on size optimization software for future application.

We also believe we have a significant opportunity to improve upon our inventory planning and allocation shortfalls at Wet Seal. They continue to affect our business through the fourth quarter and into the beginning of fiscal 2008, in the form of inventory mix weaknesses in certain key categories. We will also continue with our efforts to better manage cost throughout the organization through tied up purchasing discipline for both merchandise and non-merchandise aerials modified store labor and field management wage guideline and implementation of cost management growth in 2008 incentive objectives for all our senior management.

We currently plan to open 20-25 new Wet Seal stores and to close the similar number of locations upon lease expiration. Therefore, we expect square footage to be flat to normally up year-over-year. Steve will speak to our first quarter earnings expectations as well as few other methods pertaining to the fiscal year. In summary, I’m proud of our progress, the progress our team has made and executing our initiatives. There is no question that we are currently operating in a challenging retail environment, and we see no indications that this will change in the near term. However, I do believe that we are properly focused on basics of our business and remain confident that as we continue to deliver our action plan, we will be better positioned to compete more effectively in the faster pace.

Steve will now review our fourth quarter and fiscal 2007 year results.

Steve H. Benrubi

Thanks Ed. As we stated in our February sales release, we are now providing segment data for our Wet Seal and Arden B divisions. We have included in the press release issued today our segment sales, operating income and certain other financial data for the fourth quarters and full years 2007 and 2006. We also provide a historical monthly comparable store sales for each of the divisions through our most recently reported fiscal month. We will provide monthly comparable store sales results for each segment in our monthly sales releases beginning in March. Now turning to our fourth quarter financial results. Consolidated sales for the 13-week period ended February 2, 2008 were $179.6 million compared to net sales of 1.66.4 million for the 14-week period ended February 3, 2007.

Sales included a $3.7 million breakage benefit related to unredeemed gift cards and store products. The effect of the breakage benefit is not included in comparable store sales results, comparable store sales for the current year quarter decreased 1.4%. The company recorded a 3.1% comparable store sales increase in the prior year quarter. The additional week in the fiscal 2006 fourth quarter resulted an additional sales recorded for that quarter of $9.4 million. On a comparable store basis our fourth quarter combined transaction comp for store decreased 3.9%, average unit retail in the fourth quarter increased 0.8% to $11.66, well our average number of unit per transaction increased 1.7%. During the fourth quarter, internet sales increased by 1.6% as compared to the same period last year, also for the fourth quarter excluding the impact of the $3.7 million breakage benefit, gross profit was $57.4 million a rate of 32.7% as compared to $55.9 million or 33.6% rate in last year’s fourth quarter. The 90 basis point decrease and adjusted gross margin reflect a 20 basis points decrease in merchandise margins and 70 basis point de-leveraging on buying an occupancy cost.

Net sales in the Wet Seal division increased 15.4 to $142.2 million in the fourth quarter, compared to net sales of $123.2 for the prior year fourth quarter. Comparable store sales increased 2.1% in the fourth quarter, comparable store sales in last year’s fourth quarter increased 4.5%. Wet Seal division net sales and this year’s fourth quarter included breakage benefit of $2.9, and the additional week in fiscal 2006 fourth quarter resulted in additional Wet Seal division sales reported for that quarter of $7.2 million. Net sale on Arden B division decreased 13.6% to $37.3 million in the fourth quarter compared to net sales of $43.2 million for the prior year fourth quarter. Comparable store sales decreased 12.5% in the fourth quarter for Arden B, comparable store sales in last years fourth decrease 0.8%.

Arden B division net sales and this years fourth quarter included breakage benefit of 800,000 and the additional week in fiscal 2006 fourth quarter resulted in additional Arden B division sales reported for that quarter of $2.2 million. Selling, general and administrative expense for the fourth quarter was $46.1 or 26.2% of net sales adjusted for breakage benefit, as compared to $50.7 or 30.5% of net sales in the same period last year. The prior year SG&A included $2.3 million in stock compensation expense associated with the performance share agreement and 300,000 in cash compensation from Michael Gold, a former merchandise consultant to the company.

The contract with Michael Gold ended in fiscal 2006, selling expenses one or two components of SG&A were $37.5 million in the fourth quarter or 21.3% of adjusted net sales as compared to $38.5 million or 23.1% of net sales in last year fourth quarter. The 180 basis point improvement in selling expenses was primarily attributable to reduce store compensation in benefit cost due to improved store productivity and a reduction expenses related to bags boxes and supply. General and administrative cost for the fourth quarter total $8.7 million or 4.9% of adjusted net sales as compared to $12.3 million or 7.4% of net sales in last years fourth quarter. Last years fourth quarter G&A expense included the Michael Goal stock and cash compensation previously mentioned. Additional improvement in G&A resulted from reduced consulting legal and audit fees compared to the prior year.

During the fourth quarter, we incurred a $3.5 million non cash goodwill impairment charge associated with Arden B in accordance with statement of Financial Accounting Standards number 142 goodwill and other intangible assets. Arden B goodwill is now fully impaired, we also incurred 200,000 in after impairment charges associated with certain store assets during the quarter. Operating income for the quarter was $11.3 million or 6.3% of net sales compared to operating income of $4.8 million or 2.9% of net sales in the fourth quarter last year. Interest income in the quarter was 900,000 as compared to $10.2 million of interest expenses in the same period last year.

There were no conversions of notes this year or as last year there was an $11 million non cash charged to interest expenses to hide up unamortized discount, deferred financing cost and accrued interest upon conversions of notes. The effective tax rate was 0.3% for the fourth quarter, which included an adjustment to achieve our full year effective tax rate of 1.6%. Operating income in the Wet Seal division was $25.3 million in a quarter compared to operating income of $16.1 million for the same period last year, operating margin was 17.8% in the fourth quarter as compared to 13% in the same quarter last year for Wet Seal.

Operating Loss in the Arden B division was $5.4 million in fourth quarter compared to an operating loss $2 million for the same period last year. Previously recorded during fiscal 2004, we established a 100% tax valuation allowance in accordance with FAS-B 109 accounting for income taxes, which required the differed tax asset to be reduced by evaluation allowance if it’s more likely do not with some or all of the differed tax assets will not be realized in the foreseeable future. Our deferred tax assets consist principally of net operating loss carried forward, so we have established the tax valuation allowance for financial statement purposes. These NOLs do not begin to expire until the year 2023.

In 2007, we used approximately $20 million in federal net operating losses, the $138 million remaining balance will be available for use in 2008 to 2025. The majority of these NOLs are subject to annual limits, however we believe we will have sufficient NOL carry forward available to us in fiscal 2008 to cover regular taxable income for the year.

Similar to fiscal 2007 now, we will be subject to a minor amount of alternative minimum taxes in fiscal 2008 and currently estimate our effective tax rate will be approximately 3%. Net income in the fourth quarter was $12.2 million or $0.13 per diluted share based on $96.7 million weighted average shares outstanding. This compares to a net loss of 5.7 million or $0.7 per diluted share in the fourth quarter of 2006, based on $79.3 million weighted average shares outstanding. We ended the year with a strong balance sheet; at year end we had cash and cash equivalent of $100.6 million. We generated 28.5 million of cash from operations in the fourth quarter and incurred $5.2 million in capital expenditures which included $2.4 million on new store construction cost.

At the end of the fourth quarter inventory totaled $31.6 million representing a decrease of 7.7% as compared to the end of the fourth quarter last year, in spite of store count growth during the year, which is due to improved inventory management and our plan to maintain conservative inventory position that we ended 2008. Average inventory per square foot decreased 20% at the end of the fourth quarter as compared to the prior year end.

Consolidated sales for fiscal 2007 were $6011.2 million compared to net sales of $564.3 million for 2006. As mentioned previously, current year sales included $3.7 million breakage benefit related to unredeemed gift cards from store credits. While prior year sales included $3.7 million benefit on modification of our Arden B customer loyalty program as well as $9.4 million benefit from inclusion of the 53rd week.

Comparable store sales for 2007 decreased to 1.1%. The company reported 6.1% comparable store sales increase for 2006.

Net sales in the Wet Seal division increased 14.7%, $478.4 million for 2007 compared to net sales of $417.1 million for fiscal 2006. Wet Seal division comparable store sales increased to 1.2% in fiscal 2007. Wet Seal division of comparable store sales in 2006 increased to 8.8%. Net sales in the Arden B division decreased to 9.8% to $132.8 million in fiscal 2007 where the net sales of $147.2 million for 2006. In Arden B division comparable store sales decreased to 8.2% in 2007.

Arden comp sales in fiscal 2006 decreased to 1.1%. Consolidated operating income was $19.3 million or 3.2% of net sales in fiscal 2007 compared to operating income of $15 million or 2.7% of net sales in 2006. In fiscal 2007, operating income in the Wet Seal division was $69.2 million or 14.5% of sales as compared to operating income of $47.2 million or 11.3% sales for the same period of last year and operating loss in the Arden B division in 2007 was $15 million as compared to operating income of $2.9 million in 2006.

Consolidated net income in 2007 was $23.2 million or $0.23 per diluted share based on $100.9 million weighted average shares outstanding. This compares to a net loss of $12.8 million or $0.18 per share in fiscal 2006 based on $72.6 million shares outstanding.

Turning to our first quarter 2008 guidance, we estimate earnings per diluted share in the range of $0.04 to $0.06. This guidance is based on the following major assumptions. Total net sales between $140.2 million and $143.2 million versus $138 million in the prior year first quarter. Comparable store sales between negative 7% and negative 9% versus the 2.7% consolidated increase in the prior year first quarter.

Gross margin rate between 31.3% and 32.4% of net sales versus 35% in the prior year, a decrease driven mainly by de-leveraging effect on our occupancy costs from the forecasted comparable store sales decrease and reduction in merchandise margin versus a relatively strong prior year result and current year SG&A expense between 28.7% and 28.8% of net sales versus 30.1% in the prior year.

Operating income in the first quarter is estimated to be between $3.4 million and $5.3 million versus $6.6 million in the prior year first quarter included an operating income, our store pre-opening expenses of approximately $100,000 in this year’s first quarter versus $1 million in the prior year first quarter.

Interest income in the current year first quarter is estimated to be between $500,000 and $600,00o versus interest income of $1.2 million in the prior year. We expect first quarter income tax expense of between $100,000 and $200,000.

Finally we estimate weighted average shares outstanding of $97 million in the current year first quarter, but, the change in the company’s stock price can cause the weighted average share count to change significantly.

We estimate growth capital expenditures for all of fiscal 2008 that between $28 million and $30 million, with offsetting land loaded improvement allowances of approximately $4 to $5 million for a net cash impact of $24 million to $25 million. This includes $18 million to $20 million for cost associated with opening 20 to 25 new stores as well as for remodeling of existing stores on these renewals and old store locations.

We anticipate closing a similar number of stores when their leases expire so, we estimate flat to nominally positive store count growth in fiscal 2008. With that now, I will turn the call over to the operator to begin the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Lauren Levitan with Cowen And Company.

Lauren Levitan – Cowen and Company

Thanks good morning Ed and Steve and thank you for breaking out the segment profitability, I’m hoping you can help us get some sense where you believe these businesses should be performing in terms of operating profitability. Maybe if you could give us a sense of what was peak operating margin for both Wet Seal and Arden B and what are realistic near term and longer term operating margin targets?

And then specifically with respect to Arden B, you talked it about how you got some expectations that need to be met or you consider other options for the brand, can you give us some sense as to what timeframe you are considering for that and is it possible to really judge the effectiveness of some of these changes given, how difficult the environment is? Thanks very much.

Steve H. Benrubi

Okay Lauren, I will speak first to the Arden B question, I guess on historical results in 2001 which is the year we’ve talked about, going a few months back now and in performance Ardent B achieved about a 12% operating margin before any corporate G&A allocations and then we believe that with the merchandising initiatives and the inventory management effort we have now. There is no reason why we can get back to that kind of level at some point. I will give it to Ed, I guess as far as the second part of the question.

Edmond Thomas

Related to the second part of the question, its obvious that last year’s results particularly in the second half of the year was very negative and a lot of that was caused by both a combination of those merchandised mix and inventory being over planned. My expectation for that business is beginning in the fall from that we should see significant improvement on the both of sales side and on the profitability side. I were not as for a long in terms - we were not as for a long in the first quarter because of the transition and the restructuring of the division as what I have -- would like to have been, but, I feel very confident that’s again starting in April into May in a big way in June that we will fill the need of the core customer with the fashion basics casual segment in the wear to work segment which is really been missing for quite a bit period of time as part of the merchandised mix and also having more occasion merchandised in the merchandised mix for last several months has been a high markdown liability for us. So, I don’t have a specific, we are expecting to see a median improvement starting in the back half and we don’t have a specific timetable but as I talked to you but before that if under evaluation but, we believe that it is a great opportunity for us to get it back to historical levels.

Levitan Lauren – Cowen and Company

How about on the Wet Seal side any perspective and peak operating margin then where you think you could be relative to those given the expense moves that you have made and given the increased initiatives on expense control there?

Steve H. Benrubi

I think on the Wet Seal side you know, we have made the move that we could – we know we could do immediately however, I still think there is upside on the operating margins in that division we have a number of longer term initiatives underway, you know, like markdown optimization and changes to our physical distribution process and we also see some opportunities and store productivity along the way. Some of those are longer term initiatives with that we will take as a while, plus I think there is tremendous upside on the sales side of Wet Seal despite the fact that the last couple of years we have been at peak sales per square foot going back to pre IPO period. I think that we’ve identified a number of opportunities in the Wet Seal division like size optimization that really we think can drive sales and better mix management within the inventory that we have.

Levitan Lauren – Cowen and Company

Thank you, and good luck.

Steve H. Benrubi

Thank you.

Operator

Our next question is from Jeff Van Sinderen with B. Riley

Jeff Van Sinderen - B. Riley

Good morning, nice work on profitability on Q4. I wonder if you can give us a sense of the operating loss contribution from Arden B to corporate in other words what would the P&L look like if we stripped Arden out and you have done in past but any color any quantification can you give us there would be helpful?

Edmond Thomas

Sure Jeff, and we look at the business or number of ways and then if you look at the corporate cost for the year I think you know that roughly $35 million for fiscal ‘07 if you were to split that somewhat inline with our store count base in the two businesses, I mean that’s how we feel roughly the contribution of those costs allocated between Wet Seal and Arden B. I mean that you know, of course with two divisions we have a certain cost base and it be would be hard to say, you know, what those numbers are quite you know, with Arden B standalone or Wet Seal standalone but on allocation basis you know splitting by store count I think it is pretty reasonable.

Jeff Van Sinderen - B. Riley

Okay. And then as we are heading into 2008, is there a difference that you are seeing in terms of the operating loss run rate in Arden that we should expect for this year or we still kind of in the same, I know its early in the turnaround Arden we are you looking at things improving mid this year, but is there anything different about Q1 in terms of operating profitability, in terms of the run rate?

Edmond Thomas

Well, we did disclose you know today also the comp store sales breakout by division in February and as I talked about the first quarter it is tough from the comp basis for Arden B, because of the transition and the merchandise that really is not going to realize until late in the quarter early second quarter. So, from a trending standpoint, there is not a lot of sales productivity improvement there in Q1 anyway to improve things, so its more of a second quarter and second half opportunity for Arden to be moving the operating income trend from where it was last year.

Steve H. Benrubi

Yeah and to add to that, you know, the back half of last year we had very significant markdown from that division and I think while we built our sales stock, we know that you know, the divisions still doing over $400 per square foot and we know our customers still there. And I think that we have a great opportunity to built sales once we get a merchandise mix going up against relatively soft numbers in the back half of the year.

Jeff Van Sinderen - B. Riley

Okay. And then, since you are breaking up the comp division, if you can just give us a sense of what kind of assumptions you are making for Q1 total for each division?

Steve H. Benrubi

We are not taking that stuff at the moment anyway as far as forecasting by division, but again I mean you did see February’s comp which came into a consolidated 8.2% down that’s very much inline with the overall quarter guidance that we have given as well. But that’s kind of as much as far as color on the divisions for Q1.

Jeff Van Sinderen - B. Riley

Okay and then, your inventories running down about 20% of what I believe, how much of that decline is attributable to Arden versus Wet Seal and are there other factors that we should focus on then and I guess how should we expect Q1 inventory then the preferred basis?

Steve H. Benrubi

They are both contributing fairly substantially to the numbers that you are seeing at the end of the fourth quarter and there is a minor shift mix with the stores that we open at Wet Seal during the year and Wet Seal stores on average has a little bit less inventory than an ordinary store will have, but that’s not a huge factor. So, they are both contributing significantly. I don’t know that you’ll see the same kind year-over-year decrease at the end of Q1 that we are seeing at year end but we are still managing inventories in both divisions conservatively based on the environment.

Jeff Van Sinderen - B. Riley

Okay. Good and then, finally on the markdown optimization program you talked about, when might we see that start to be deployed?

Edmond Thomas

Well, we’ve already, we’ve already started discussions internally in with of our software provider. I would expect that -- most likely we would not implement that till the first quarter of next year. We have too many other initiatives in place and I advised -- actually size is the much bigger opportunity for us than markdown optimization. So, our concentration right now is really changing on merchant, adjusting our buy brake to get a better size array into our stores particularly in the Wet Seal division, and we will follow that up with optimization sometime next year. So, I would say in both actual implementation of optimization software, you will see it more next year than this year. We are in the discovery phase right now.

Jeff Van Sinderen - B. Riley

Okay, fair enough, thanks very much and good luck this quarter.

Edmond Thomas

Okay, thank you.

Operator

Our next question is from Anna Andreeva with JP Morgan.

Anna Andreeva - JP Morgan

Hi, thanks so much. I was hoping you guys could talk a little more about the sales productivity at Wet Seal, it sounds like you still think there is room to drive that higher, maybe some of the initiatives and you could discuss outside of that size optimization. Do you have a goal for sales productivity that you hope to get to over the next couple of years? I guess is there still an AUR story that we should expect for ‘08? And also an update on the third party brands, I am assuming that’s part of your initiatives to drive that sales productivity higher. Could you maybe share some of the learning’s from the denim test?

Edmond Thomas

Sure, I think that -- do we have a specific dollar amount goal for the division, no, but we now and that we can drive those sales higher. I think some of the initiatives we have under way right now, is we had a significance difference in the number of styles we were giving our middle volume stores versus the higher volume stores. We already have under way a process where we will the middle and lower volume stores more of the same fashion, I think the lower volume stores were somewhat penalized and will probably too basic, and I think that provides us a pretty good opportunity to drive additional sales.

I wouldn’t say we are making significant changes in terms of the number of skills that we are carrying, but in certain skills, I think you will see us go more into depth, part of it being size and part of it just putting in more depth. And we know enough from our customers that we are missing some sales because of being out of size or fast sell throughs, and as you know in the fashion business, it is very fast. And as far as the denim testing goes, we just put the brands. we're carrying about four brands right now, hydraulic would be one that we're carrying that we actually carried in the stores before, and they've been in the stores for about three weeks right now, and the initial sell-through on those brands are very good, and we will continue to monitor it for the next couple of months, and we positioned ourselves to expand that into a significant amount of stores for back-to-school if we get more comfort on those tests.

Anna Andreeva - JP Morgan

Okay and what are AURs like on the third party brands?

Edmond Thomas

They're a little bit higher, obviously in branded the margins are a little lower than what our margins run, but we don't expect it to have a material impact on our overall merchandise margins.

Anna Andreeva - JP Morgan

So how should we think about your average unit retails just directionally for the year? Sounds like there should be a little bit of room to drive that higher?

Edmond Thomas

Well I think that it will I think I communicated pretty clearly that I felt like we weren't selling enough bottoms, but I think it just kind of expanding to that, we have a concentrated effort here to sell more outfits, and so that should be a top with a bottom obviously or a -- jacket with a top, and I think there is room to drive average dollar sales up.

Anna Andreeva - JP Morgan

Okay. That's helpful. And, Ed, I have a question just about the environment out there. It is definitely a pretty challenging for everyone, but I was just wondering just looks like fashion space had a pretty decent holiday and then things began to slow in the month of February and then continued into March. What do you think is driving that? Is that more of a traffic issue? Are you guys seeing any regional differences or is it just we're late in the fashion cycle? Are you seeing I guess any change to the fashion cycle out there?

Edmond Thomas

Well, I think it is a combination of a bunch of things. We don't have traffic counters in our store, but certainly from what we can tell, traffic is erratic, and I think people show up for the big event but in between it tends to tail off a little. I think in early Easter is also very difficult to get a good read on what the rest of the quarter or the rest of the first half is like, but there is no question that it is challenging, and we in terms of our sales, as we expected, we had pretty decent results the week before Easter, and that's continued into the first couple of days of this week, but it is not enough really for us to be able to forecast this environment going to get better sooner rather than later. So I think there is a lot of different factors going on in the first quarter with the shifts and the other thing that’s very difficult to read right now it school breaks, where school breaks are all over the place this year, so we have early spring breaks and we have some later ones and so it is very difficult to read for our forecasting process, but and lastly I think there really wasn’t a discernable dominant fashion trend and we knew that coming in to the first quarter. So, I think it’s really combination of lot of things.

Anna Andreeva - JP Morgan

Okay that’s helpful and just finally given the tough environment out there, what are you embedding in terms of promotion cadence in you guidance for 1Q?

Steve H. Benrubi

We are not doing anything different promotionally then what we normally would do in the Wet Seal division for sure. In Arden B, you know, we are still clearing out, we’ve not been as promotional as we were during the fourth quarter up until a week ago, which was really intended. We will end up both divisions pretty clean on inventory and I think if there was one flaw, we had coming out really not a flaw at one weakness we had coming at a holiday was in the Wet Seal division, we sell through our fashion much faster than they expected and came out inventory wise with a little less fashion and what we would have liked. We planned our inventories down for the first quarter and actually for the first half and that was intentional and we just have built up in the last couple of week have got in our fashion mix, balance of the mix up to where we planned it.

Anna Andreeva - JP Morgan

Okay, great. Thank you so much. Good luck guys.

Operator

Our next question is from Stephanie Wissink with Piper Jaffray.

Stephanie Wissink – Piper Jaffray

Thanks guys, I have a few just a couple of housekeeping questions to start. Ed, could you just remind us what is the exposure of the auction rate securities in your cash balance and then secondly the comp leverage point for this full year on an annualized basis?

Edmond Thomas

We’ve no auction rate security exposure, in early December we started you know as the research for coming out, we started getting out of those and moving the government based money markets and move the completely out of auction rates by early January without any incidents at all. So, in a good place there and from the leverage point – you know all else equal we look at the opportunity to leverage when we were up about 3% but as we’ve talked about, there is a lot of cost savings you know going from ‘07 to ‘08 in the business that frankly will allow us to leverage operating margins up operating income margin at comp stores that would be even below flat if it came to that.

Stephanie Wissink – Piper Jaffray

Thanks. its helpful and then just looking now the Wet Seal division last – in this last, excuse me the first quarter guidance you mentioned that there is an assumed reduction in merchandise margins on the consolidated basis, just curious what were the operating margin shifts that happened in merchandise - shift that happened last year in the first quarter with a mix between fashion and basics and in longer term what are the opportunities from a merchandise margins standpoint that Diane and her team are focused on core division?

Steve H. Benrubi

Yeah, I think we did have some favorable mix in our basic versus fashion in Q1 that was helpful last year and in Q1 ’07s merchandise margin, we actually had our strongest merch margin at the year in that quarter. So, for comparison purposes that’s what we’re going up again this year. The merch margin that we’re looking in Q1 this year is actually better than anything we had in the second half of last year, so, sequentially its improvement over that. And I’m sorry, the other part of your question?

Stephanie Wissink – Piper Jaffray

Just in terms of assortment, what are the opportunities from a merchandise level yeah the core division this spring versus last year?

Steve H. Benrubi

I think that the in the Wet Seal division really the merchandise margins have been pretty good and pretty consistent over period of time and I think really where we will see more opportunities in the management of the mix of the inventory more than it’s been let’s say IMU opportunities.

Stephanie Wissink – Piper Jaffray

Okay. Can you talk maybe well some of the categories that you are focused on for this spring?

Edmond Thomas

Fashion denim and spring tees have been two categories that we have with strong in the fourth quarter and we continue to invest in and they have been very, very strong, our shoe business in the fourth quarter was very strong and somewhat softened in February but its come back decently in the last few weeks. And, you know, I think that we have an opportunity in fashion tops business in terms of driving sales, I think one of the categories that’s going to challenge for us is timing a bottom that an alternative bottom to denim we have not really found anything yet but we translate to the rest of the year.

Stephanie Wissink – Piper Jaffray

And then my last one is just if you guys could review the performance of your Wet Seal stores unified operating class as you have opened an annual classes or by mall class A, B and C malls? Thanks.

Edmond Thomas

Yeah, I don’t – I don’t think we’ve not broken out any information based upon the timing of store openings in the Wet Seal business.

Steve H. Benrubi

Yeah, I think most of the openings will take place in the too early in the back half of the year. And in terms of class, we are really all over the place, the more we started, the more we can know we can perform pretty much in type of mall. So, some of our best performing stores are in pretty upscale mall and we have also have from very top lines stores we have also have some very top volume stores in what I would call a B minus or a B mall. So, what’s happened in the real estate area in the last three months is that with a number of store closings in the cut back an expansion with a number of retailers we’ve been provided with significantly greater opportunity across the board and we are going to be very selective with the 20 to 25 stores that we pick for this year.

Stephanie Wissink – Piper Jaffray

How about comparing the last year class at the prior year class on the same basis looking at those annual openings, how are they performing relative to (indiscernible) stores and in dividing that out possibility by mall class as well?

Edmond Thomas

I think that you know the store that we’re open last year were primarily B and C malls, the result amongst those there wasn’t material difference between our performance of whether it was a C mall or B mall, from what I can see so far, I think that certainly some other stores we’ve opened or we probably have better opportunity to drive sales they would some other results and some of those stores with disappointing but overall I am not saying material difference between the type or class of mall, even in the stores that we opened in last 18 months.

Stephanie Wissink – Piper Jaffray

Okay, thanks guys, good luck.

Edmond Thomas

Thank you.

Operator

Our next question is from Paul Lejuez with Credit Suisse

Paul Lejuez -- Credit Suisse

Hi, guys, it is Sara Lewis standing in for Paul. I had a couple quick questions now you had a chance to look further your real estate plans and for further detail I’m was wondering if you could us update on what you think alternate store potential is or each concept secondly, I was wondering, how the remodel stores have been performing and how many we should we expect in 2008?

Edmond Thomas

Okay. The first in terms of the remodels, right now we have about 42 to 45 remodel schedule, renewal schedule for this year which those stores would be remodeled and some stores that are outside that one we have lease expiration in this fiscal year, and we will probably extend those leases and I am sorry that first part of your question.

Paul Lejuez -- Credit Suisse

Just wondering, ultimate store potential particularly the Wet Seal concept has that changed that all?

Edmond Thomas

Okay, no, not really -- I think that you know certainly what’s happened is when 150 stores closed a couple years ago, we’ve identified about 95 of those stores were our best stores in the chain. So, I think that out total store count, we still think that we can be more over 700 stores at Wet Seal and probably about 250 at Arden B and the good part in the Wet Seal is that we know of we wouldn’t going to all 95 of those malls that we know that if we go into a substantial portion of those, those are much higher productivity on stores for us, will be much for higher productivity than our chain average.

Paul Lejuez -- Credit Suisse

Okay. And can you comment at all on comp performance by region, particularly in Florida and California and then in addition to that have you seen any signs of customers potentially trading down to Wet Seal from higher price retailers in this environment? Thanks.

Edmond Thomas

In terms of regional performance through the fourth quarter we have – we did not see any material difference in any regional or country in terms of performance including California and Florida. We have seen recently more erratic performance in California and Arizona than what we had seen in the fourth quarter but, it’s not of a consistent decline. But, in Florida really we haven’t seen as much impact as well we referred other retailers or report.

Paul Lejuez -- Credit Suisse

Thanks.

Operator

Our next question is from Liz Pierce with Roth Capital Partners.

Elizabeth Pierce -- Roth Capital Partners

Good morning and congratulations on a nice quarter. Most of my questions have been asked but I was just curious at on the marketing some of the initiatives that you had outlined in November give us an update on that, particularly I guess since environment is uncertain, what do you do to keep speaking to the customer et cetera?

Edmond Thomas

Well, I think that you know one other things that we’re very strong out here is using our internet, our web, and we have two with both divisions we have two pretty significant databases of customers that we market to pretty extensively and so, keeping our customer connected that's one form that's probably one of the most effective forms if the traffic is just not in the mall. And then in terms of Arden B, we've taken a position that we don't want to market to the customer until we feel the merchandise mix is corrected, and I think we will go back -- there is no question we will go back to more direct mail, late second quarter which is been very effective for that division in the past and then you know the other thing that we’ve working on starting with the Ashley Simpson announcement we've made today which I consider part of our grassroots type of marketing as you will see a lot more cross promotions with the entertainment industry starting with the Ashley Simpson deal that we announced this morning. And we are going to walk before we run with that, but we think that’s a great opportunity for - to further extend to our customer. And we also get the advantage of the - with the cross promotion with the entertainment industry or the record label to - where they will market for us too.

Elizabeth Pierce -- Roth Capital Partners

Okay, that was actually my second question, was about the Ashley Simpson line maybe can you just give us a little more information, you know, on the product and then do you have other celebs lined up and with this would this be something that you would do at Arden or strictly at Wet Seal?

Edmond Thomas

We do not at this point, we are in discussions with the number of people for Wet Seal, but we do not have - we have not signed or agreed to any, there is a lot of interest in doing stuff with us. And as far as the Ashley situation, it’s not a lot of SKUs, its probably a dozen SKUs. It is all tops which she was influence in design of that, and depending on our initial test of three months with that we could expand that further with her. And as far as Arden B goes, right now I will focus on getting product right period, so and managing our inventory, so we don’t have any short term plans with Arden B and I don’t think really it’s a necessary thing on the marketing side as much as it is a merchandise mix issue.

Elizabeth Pierce -- Roth Capital Partners

Has Sharon had a chance, when you think about who that Arden B customer is and how they think about her and her lifestyle. And – no, obviously there was as you pointed out a lot of evening type wear in the assortment for the past several months. But, what else has she - her impression of the brand and how maybe it has changed or how she is thinking about it, if you could just shed any light on that?

Edmond Thomas

Well, first of all Sharon was involved in the development of Arden B back in ‘98, so she is very familiar where we were targeting that customer and really where it continued to be through two different changes of management up until a couple of years ago. And she strongly believed that our customer in that young contemporary age range is nearly in need of more wear-to-work and casual merchandise that really does not allow the specialty retailers out there doing it, and you only find it in a department store, and so she is really confirming what we thought a number of months ago, and that's where she is adjusting the merchandise mix. We got a lot - we probably moved it way too trendy fashion forward and again she is more trend right, but also our customer is telling us that we don't have enough casual and wear-to-work merchandise in the mix.

Elizabeth Pierce -- Roth Capital Partners

And is she still thinking about this being collection-based or more item-based?

Edmond Thomas

She definitely is not thinking of it in terms of collections, and it will be much more item based, But there will be what I will call a lot more related suppurates in the mix and color will not be the dominant thing, although, color will play, but certainly I would expect an increase in the SKU count in the assortment with Arden B from what you've seen in the last twelve months.

Elizabeth Pierce -- Roth Capital Partners

Okay, that’s very helpful. Alright that’s it, best of luck, thanks.

Edmond Thomas

Thanks.

Operator

Our next question is from Eric Beder with Brean Murray.

Eric Beder – Brean Murray

Good morning.

Edmond Thomas

Good morning.

Eric Beder – Brean Murray

Could you talk a little bit about your corporate overhead? I know you talked in the beginning of the call; we talked about the $5.5 million. Is that correct to assume that's going to be declined in the corporate overhead this year for ‘08?

Edmond Thomas

The 5 million is spread actually between the cost of sales area and to a lesser extent in the G&A numbers. The bigger piece of that was really in the buying arenas at Arden B and a little bit in Wet Seal. So, if you're taking that 5 million number, more of it is actually in there than G&A. I think something that we aren't really quantifying but we're seeing the benefits of starting in December and January and is reflected in our guidance in Q1, is store productivity improvement, just driving a better labor as a percentage of sales cost through stronger discipline in the stores, and that's not part of the 5 million number, but it is something that comes through in the selling costs, if you look at Q1 and then going out over the year.

Eric Beder – Brean Murray

So, I guess what you're saying is there will be when you do your divisional breakouts, the corporate overhead section there will be reductions there, but it is not going to be entire $5 million?

Steve Benrubi

That's correct.

Eric Beder - Brean Murray

Okay. Does that 5 million include Gary's salary, Gary not being replaced?

Steve Benrubi

It does.

Eric Beder – Brean Murray

Okay, in terms of -what are the advantages of shifting from two to three shipments a week to five, and where does that flow in terms of either savings or other pieces here?

Edmond Thomas

Well, in a store where at our average volume where you have a pretty small staff. The biggest efficiency comes out of work flow, moving the workflow within the store and enabling stores to get product out in the store faster, and it also enables us if we're a little bit late with receipts for whatever reason, into this warehouse to get the fashion on the floor much faster than what we've done in the past, and so where our customer at the Wet Seal division is in the mall much more often than probably any other segment. That it’s really important that we have newness in the inventory mix on a daily basis. So really, going back fundamentally what we did here for years, we're changing back to that philosophy, so it is a combination of really getting fashion out on the floor on a more timely basis and also it could be a huge productivity improvement for us.

Eric Beder – Brean Murray

And you talked before about changes at the DC in terms of how you deal with product and making it hang already, where are we with that and is that still a kind of late '08 or early '09?

Jennifer McEntee

Yeah. We are in the process right now; we’re entertaining, we've had three different firms take a look at it with us. We're in the second rounds of review with those firms. The window of opportunity to make that change is probably early first quarter of '09, so I would not expect anything to be done before that, but we'll have a more definitive schedule the next time we have our call.

Eric Beder – Brean Murray

Okay, thank you and good luck.

Jennifer McEntee

Thanks.

Operator

Our next question is from Erin Moloney with Merriman Curhan Ford.

Erin Moloney - Merriman Curhan Ford

Hi, good morning. I think most of my questions have been answered. I think just the one I have left is just on the square footage plans for '08, and I apologize if I mistaken here, but looks like you changed that more to flattish this year versus 5%.. Was that most on the closures you were expecting or where was the difference there?

Steve Benrubi

I think, we have for a couple of months been in a position of saying we're roughly going to be flat for the year, so the 20 to 25 we came to that, I think, around the first of the year or back in December even, and then looking at the growth, it will essentially all be on The Wet Seal side for what we open in '08, and then the store closures of a similar amount split between Wet Seal and Arden B maybe about evenly between the two divisions.

Erin Moloney - Merriman Curhan Ford

Okay. What would the timing be throughout the year kind of roughly for the opening and closures?

Jennifer McEntee

Significant amount of it is in the back half of the year on both the openings and the closures.

Erin Moloney – Merriman Curhan Ford

Okay, Great. That's helpful. Thank you.

Jennifer McEntee

Welcome.

Operator

And we will take our last question in the queue -- it is Janet Kloppenburg with JJK Research.

Janet Kloppenburg - JJK Research

Hi, guys.

Edmond Thomas

Hi, Janet.

Janet Kloppenburg - JJK Research

Hi, nice quarter. Couple of questions, it sounds like the outlook for the first quarter may also include a some markdown pressure at Wet Seal maybe some pressure on the operating income or our operating margin line there, is that a fair statement?

Edmond Thomas

No, I mean I did talk earlier about this, this is the first quarter of last year being a very strong merch margin performance.

Janet Kloppenburg - JJK Research

You did, yes.

Edmond Thomas

Year and this years Q1 is actually sequentially for the merch margin better that the second half. You know either quarter in the second half of last year. So, we feel, you know from a Wet Seal inventory position we feel pretty good about the mix. With that said, we thought there was some opportunity and fashion that we might have been a bit light as we came into the quarter, but we feel like in the last week or two we have gotten that to the place we want to be. In this no, there is no unusual marked on activity in Wet Seal.

Janet Kloppenburg - JJK Research

Do you think that the operating margin or the operating income can increase at Wet Seal in the quarter? Ed.

Ed Thomas

It will not. Well, obviously we'll talk the quarter when we get there, we added a point, yes well we were talking forecasting by divisional results.

Janet Kloppenburg - JJK Research

And do you think the loss will be greater at Arden B because of the markdown pressure similar to what we saw in the fourth quarter?

Edmond Thomas

Yes, the markdown is definitely, you know the markdown sales performance Arden B are definitely worse than Wet Seal, but like Steve said, we're not in a position to really forecast that at this point in time by division.

Janet Kloppenburg - JJK Research

And Ed, when you say you see no trend in the bottoms business, does that suggest that the shorts business is not good for you guys or you don't see it being good this spring?

Edmond Thomas

Well, I think there is a trend in - our fashion denim business has been extremely strong. Shorts are improving as the weather gets warmer. I think what I was trying to say was that we haven't found an alternative bottom to denim that's been strong. Our dress business continues to be good, and just really an alternative pant to denim is really where we have not found that yet.

Janet Kloppenburg - JJK Research

I'm not sure that exists. When you look at your expansion plans, do you expect that next year we might see an acceleration in the program?

Edmond Thomas

I think that we are positioning ourselves to accelerate our growth by redeveloping the real estate pipeline, and I feel pretty good about where we're at because we really did a major overhaul of where we were going versus where we want to go, and so we will be -- when we see more consistency in terms of our performance and our environment, I would expect that we will accelerate our growth and will be in a very good position to do it when we're ready to do it.

Janet Kloppenburg - JJK Research

Okay. A couple of questions, it sounds like Arden B’s position is going to take a few more months, and then if it gets to be where you want it to be, do you think you could be profitable in the back half of the year?

Edmond Thomas

I don’t know, I think it can be profitable in the back half of the year and I think at very least we know that the losses that we've incurred will be substantially reduced.

Janet Kloppenburg - JJK Research

Okay.

Edmond Thomas

So, you know even just simply by managing the inventory is better.

Janet Kloppenburg - JJK Research

And then when you look at Back to school as do you see any discernible fact in terms of merging that may help the business?

Edmond Thomas

Yes. But, I’m not going to I don’t want it to.

Janet Kloppenburg - JJK Research

So, I don't care that you tell me it, but been a little discouraged there hasn't been a real strong fashion trend in the universal sense out there, and I am hoping that you see something you're more encouraged for the back half.

Edmond Thomas

Yes, and that combined with I just think that we have some -- we recognize some of our own opportunities internally that I think can drive our business during back-to-school.

Janet Kloppenburg - JJK Research

Okay. Great. Lot’s of luck to you guys. I will talk to you later.

Edmond Thomas

All right, thanks now.

Operator

And with that this does conclude the question and answer portion. I would like to turn the call to Ed Thomas for closing comment.

Edmond Thomas

We would like to thank everybody for attending our conference call today. And, we look forward to speaking with you in the future. Thank you.

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Source: The Wet Seal, Inc. Q4 2007 Earnings Call Transcript

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