Eddie Bauer Holdings, Inc. F4Q07 (Qtr End 12/29/2007) Earnings Call Transcript

Eddie Bauer Holdings, Inc. (EBHI)

F4Q07 Earnings Call

March 13, 2008 4:30 pm ET

Executives

Neil S. Fiske, President and Chief Executive Officer.

Marvin E. Toland - Chief Executive Officer.

Analysts

Mike Osborne – Unknown Firm

Andrew Berg - Post Advisory Group

Nicholas Capuano - Imperial Capital

J. T. King - Cape Investments

Ross Haberman – Haberman Fund

Pamela Wilson – WL Ross

Presentation

Operator

Good afternoon ladies and gentlemen and welcome to the Eddie Bauer Holdings Inc. Fourth Quarter Conference Call. The recording of this call including the question and answer session will be available for replay later today. Information on how to access the replay is available in the fourth quarter earnings release issued earlier today, a copy of which has been posted to the website www.eddiebauer.com. And now at this time, I’d like to turn the call over to Mr. Neil Fiske, President and CEO of Eddie Bauer. Please go ahead sir.

Neil S. Fiske

Thank you for joining us today to review Eddie Bauer’s Fourth Quarter and Full Year results. Joining me is Marv Toland our Chief Executive Officer. We will begin with some prepared remarks after which we will open the lines for your questions as long as time permits. Let me also remind you that during this call, we may make forward-looking statements relating to the company’s expectations and beliefs concerning our future business and financial performance. These forward-looking statements are based on various assumptions and projections, and are subject to risks and uncertainties, and actual results may differ substantially. These forward-looking statements speak only as of the date stated and as accepted, required by the law, we do not undertake any obligation to update these forward-looking statements. For further details, please refer to the risk factors and cautionary statements in our annual report on Form 10-K filed today with the Securities and Exchange Commission.

We have two objectives for today’s call; first to report on the Fourth Quarter and Full Year results, and second to provide a progress update on our turnaround program.

First the quarter: From a sales perspective, we had a solid fourth quarter, particularly in light of the weak results posted across the retail sector. Total revenues for the quarter were $392.4 million compared to $381.9 million last year. Comp store sales were up 4.8% overall with an 8.6% increase in retail store sales and a 1.9% decline in outlet store sales. Direct sales for the quarter were up 9.7%. The retail store comp is particularly important given that one of our long-terms goals is to drive store productivity back up to the range of $450 per square foot. Overall, I was pleased with our holiday campaign and execution. Catalogues improved in merchandizing, photography, and layout. Retail stores had a clear point of view and better presentation, and across all our channels and our advertising we had a tight focused message. Gross margin dollars were up slightly for the quarter although the margin rate declined. Total gross margin increased to $165.2 million from $164.4 million last year. Gross margin rate declined to 43.8% from 45% from the fourth quarter last year. Most of this decline was driven by higher markdowns as inventories were high relative to sales in the quarter and we had to take more aggressive action on a weaker men’s business. The cost of our Friends Loyalty Program launched in the fall of 2006 was a lesser but still significant factor in the margin decline. Operating income for the fourth quarter declined to $47.5 million from $52.1 million in the prior year fourth quarter driven by higher SG&A costs and lower licensing and shipping revenues. The increase in SG&A costs underscores the importance of one of our five key initiatives – our cost reduction initiative. As we said in our last call, we know that our overhead costs are too high and as however discussed in a minute, we’ve taken action to cut $25 to $30 million out of the operating cost structure of the business in 2008. As we move forward, the tighter cost and inventory management disciplines we are putting in place will allow us to flow more of our gains in sales through to the bottom line.

For fiscal 2007, total revenues were $1044.4 million up from $1013.4 million in 2006. Comp store sales were up 4.4% overall with an 8.9% increase in retail stores and a 2.3% decline in outlet stores. Direct sales for the year were up 8.4%. In our retail stores, we saw per square foot sales increase to $266 from $243 in 2006. Total retail stores square footage at year end was 1.8 million versus 1.9 million square feet at the end of 2006. Outlet stores per square foot sales decreased to $275 from $285 in 2006. Total outlet square foot was roughly flat at 0.9 million square feet. Gross margin was 358.5 million for the year, up $5 million from 2006. Gross margin rate for the year declined 80 basis points to 36.2% versus 37% in 2006. The decline in the gross margin percentage versus the prior year was due primarily to an 80 basis point decrease related to the cost of our Customer Loyalty Program and a 70 basis point decrease driven in part by higher levels of inventory markdowns. These decreases were partially offset by a 70 basis point improvement to gross margin resulting from a decrease in our occupancy cost as a percentage of net merchandized sales.

Operating loss for fiscal year 2007 declined to $28.4 million from a loss of $118.6 million for fiscal 2006. The 2006 results included a $117.6 million impairment charge relating to the company’s goodwill. Excluding the impact of the 2006 impairment charge, the company’s operating loss increased by $27.4 million primarily driven by a $30.6 million increase in the company’s SG&A expenses during 2007. These expenses included $16.4 million of non-recurring costs including expenses associated with the company’s terminated merger, the resignation of the company’s former chief executive officer, and an estimated legal settlement. Marv will provide more detail on EBITDA and net income later in the call.

Looking ahead to 2008, we remain focused on the five key initiatives of our turnaround – one, clarifying our brand positioning and rebuilding our brand identity; two, revamping and upgrading our merchandized assortment and match the brand position; three, using our marketing more effectively; four, cutting cost and generating cash flow; and five, building the talent and the organization we need to win. We reiterate that we’re at the beginning of a multi-year turnaround and that restoring Eddie Bauer to its position as a premium active outdoor lifestyle brand is going to take time. That said, I’m pleased with the progress we’re making in each of these five areas. In branding, we’ve clarified the essence of our positioning; getting Eddie Bauer back to its heritage as an active outdoor lifestyle brand that differentiates itself on quality, value, service, and style. We’re bringing that heritage back in a modern way through marketing and product development. In merchandizing we’re pursuing a product direction that better aligns with our brand positioning with focus on rebuilding our historic strength in outerwear and restoring Eddie Bauer as a true dual-gender brand with a much stronger men’s business. Our legacy in outerwear is strong. Eddie Bauer patented the first down jacket, developed flight jackets for aviators in World War II, and outfitted over 30 major mountaineering expeditions over 3 decades including the first American to summit Mt. Everest and several worldwide first ascents of the major peaks. We’ve created a new design team focused on bringing back that historic strength in outerwear, active wear, and gear. This team is headed by Tony Krohn whom we hired from The North Face to be our new Divisional Vice President for research, development, and design. We are also putting a concerted effort into improving the quality and the value perception of the brand. Our new head of sourcing, Ron Hall, will be instrumental in that effort. In marketing, we’ve upgraded the quality of our creative across all channels from in-store presentation to better models and photography on our catalogues to the February launch of our new www.eddiebauer.com website. The changes are distinct but evolutionary. We know we need to walk our customer through this transition. Expect continued evolution and elevation of our core marketing particularly as we head into the summer and fall seasons.

On the cost front, we’ve put in place a major cost reduction program that will take $25 to $30 million out of the operating cost structure of the business in 2008. The target excludes one-time items from both this year and last year and is based on a 52-week to 52-week comparison. We targeted four major areas for reduction; the first is corporate headcount. In January we announced the elimination of 123 positions or 16% of corporate staff. We expect to incur about $2.5 million this quarter in severance costs associated with the reduction in headcount. The second target area is professional fees and outside contractors. With a full executive team now in place, we expect to cut back substantially on the company’s use of outside consultants and professionals. We’re also cutting back on the use of contractors to perform work in various functions. Next, we’ve taken a hard look at our marketing expenses and concluded that we have the opportunity to be more focused and cost effective in our marketing. We are concentrating on fewer bigger ideas and cutting out small unproductive activities or promotions. We’re also seeing opportunities that better target our catalogue investment for a higher return. We expect marketing expenses to be down substantially year over year starting in 2008. Fourth, we’re cutting costs in non-merchandized purchasing in areas like supplies, telecommunications, equipment, and facilities. We’ve also cut out nonessentials in all department budgets. New budgeting and financial management disciplines have been put in place to manage costs more aggressively.

While we’re on the topic of costs, let me address the issue of our Groveport distribution facility. As you know, we’ve been exploring a number of strategic options for the facility including a possible sale to a third-party fulfillment provider. We were unable to reach satisfactory turns of an agreement especially given the criticality of this function to our customer experience. Therefore, we’ve made the decision to operate the facility ourselves and have taken up substantial overhead costs. We remain open to exploring new ideas, but in the interest of expediency and getting our cost down this year, we’re concentrating our effort on running a leaner more efficient distribution center. Overall, our cost reduction program is comprehensive and far-reaching and will put Eddie Bauer on better financial footing.

Finally, in the area of talent and organizational development, we have made substantial progress. We’ve built our senior leadership team including our new CFO, Chief Legal Officer, Senior Merchant, Head of Sourcing and Supply Chain, and Head of HR, and we’ve attracted talented leaders like Tony Krohn for key positions throughout the organization. Importantly, our re-organization in January not only streamlined the organization, it will make us stronger and more focused. Among the key changes we announced, we consolidated departments and eliminated redundancies, we scaled back support functions to mission critical operations, we re-aligned the merchant team under Kimberly Berg, the company’s new Senior Vice President and General Manager of Merchandizing, we moved merchandized planning and allocation under Marv Toland to give us better inventory discipline and a better length between our financial and merchandizing strategies. We established a new sourcing and supply group under Ron Hall, the company’s new Senior Vice President. We moved all design functions to report directly to me, and we consolidated all customer facing operations, notably stores, the call center, and customer service under Ann Perinchief, Senior Vice President of Retail. This gives Ann full end-to-end responsibility for customer service and for getting us back to the standard of legendary service that made Eddie Bauer famous.

Across the company, we are looking to streamline and simplify the business, doing fewer things better. In some cases, that means shutting down initiatives or ventures that take a lot of effort but are not producing good results. Our joint venture in Germany is one such example. In discussions with our German partners, we have neutrally concluded that the venture as structured is not economically or strategically attractive. Based on these discussions, we have received a formal termination notice from our partners and are therefore moving to terminate the venture in February 2009 while evaluating the potential for more simple licensing arrangement with the third-party for the use of the Eddie Bauer name in Germany. We’re reviewing our investment of $3.8 million in a joint venture and will likely incur an impairment charge related to some or all of this investment in the first quarter of 2008.

Overall, I’m pleased with the progress we’re making in each of our five key initiatives. The team and the organization as a whole is focused, energized, and confident in our ability to deliver on the vision. With that, let me turn it over to Marv.

Marvin E. Toland

Thank you Neil. I’ll spend the next few minutes reviewing the financial results in more detail; then we will open the line for questions. As Neil addressed for the fourth quarter ended December 29, 2007, total revenues were $392.4 million compared to $381.9 million in the fourth quarter of 2006. The revenue breakdown versus prior year fourth quarter is as follows: Net merchandize sales of $377.6 million compared to $365.2 million. Shipping revenues of $99.3 million compared to $10.0 million. Licensing royalty revenues of $3.4 million compared to $4.7 million in the same period of 2006. Royalty revenues from foreign joint ventures of $2 million and other revenues of $0.1 million, both of which were flat over the same period in 2006. Q4 net merchandize sales for retail and outlet increased 1.2% to $274.2 million and our direct channel including sales from our catalogues and website increased 9.7% to $103.4 million. This compares to $270.9 million of sales from the company’s retail and outlet stores and $94.3 million of sales from its direct channel in the same period last year. Gross margin for the fourth quarter of 2007 totaled $165.2 million representing an increase of $0.8 million from $164.4 million for the fourth quarter of 2006. Gross margin percentage for the fourth quarter of 2007 decreased to 43.8% compared to 45% a year ago. The decrease in the company’s gross margin percentage during the fourth quarter reflected higher levels of inventory markdowns of 60 basis points as well as an increased cost of 40 basis points associated with our Customer Loyalty Program in 2007 compared to 2006.

Operating income in the quarter declined to $47.5 million from $52.1 million for the fourth quarter of the prior year driven by the increase in SG&A expenses during the fourth quarter and lower licensing and shipping revenues. Increases in SG&A were primarily driven by higher levels in advertising and marketing costs, increased sales-related costs, higher payroll benefit and professional fees offset by lower store closing costs, distribution costs, and depreciation. We reported net loss for the fourth quarter of 2007 of $18.2 million or 0.59 per diluted share compared to net income of $63.2 million or 2.11 per diluted share in the fourth quarter of 2006. The change was partially driven by a one-time $36.8 million tax expense associated with the sale of certain receivables related to the Spiegel private label and affiliate credit cards account that we call SAC receivables which were transferred to Eddie Bauers as part of the Spiegel plan of re-organization. This is a somewhat complicated transaction, so I want to take a minute to explain it. As part of the Spiegel re-organization, Eddie Bauer assumed responsibility for the SAC receivables in exchange for 10% of the benefits of any collections or the sale of the SAC receivable, with the other 90% going to the Spiegel Creditors Trust. However, Eddie Bauers is responsible for taxes on 100% of any proceeds from collections or sale of the SAC receivables for which we can use net operating loss carry forwards. In December we sold the SAC receivables for a total sale price of $113.9 million. At that point, we recorded tax expense on the majority of the $113.9 million in proceeds from the sale, but ultimately we only received 10% of the proceeds. Our Form 8-K filed December 10, 2007, contains a more complete description of the sale of the SAC receivables. Also included in fourth quarter 2007 results are non-operational income of $5.2 million related to a non-cash fair value adjustment on the company’s convertible note embedded derivative and the $9.3 million gain we recognized from the sale of SAC receivables. Income tax expense for the fourth quarter of fiscal 2007 increased by $93.8 million to $75.1 million compared to a benefit of $18.7 million in the fourth quarter of 2006. Increased tax expense for the fourth quarter 2007 was primarily due to higher tax expense for cash collections associated with the sale of SAC receivable, and non-cash increases to our valuation allowances for net operating loss carry forwards. Income from continued operations before income taxes, interest expense, depreciation, and amortization expense or EBITDA for the fourth quarter of 2007 was $59.9 million when excluding certain non-recurring and non-operational items compared to $67.8 million for the year ago fourth quarter. The decrease was driven mostly by higher SG&A expenses and lower gross margin dollars after adjusting for depreciation. EBITDA is a non-GAAP financial measurement that we believe is an important metric because of the key factor how we measure operating performance. EBITDA included non-cash stock-based compensation expense of 2.1 million in both the fourth quarter 2007 and 2006.

Looking at the full fiscal year ended December 29, 2007, total revenues were $1,044.4 million compared to $1,013.4 million in fiscal 2006. The total revenue breakdown for 2007 is as follows: Net merchandized sales of $989.4 million, an increase of 3.4% over $956.7 million. Shipping revenues of $34.2 million, an increase of $0.2 million. Licensing royalty revenues of $13.8 million, a decrease of 11.8% from $15.7 million. Royalty revenues from foreign joint ventures of $6.3 million, a decrease of $0.3 million over 2006 and other revenues of $0.6 million, a slight increase over 2006. Net merchandized sales for 2007 included $711.4 million of sales from the company’s retail and outlet stores and $277.9 million of sales from our direct channel. This compares to $700.1 million of sales from the company’s retail and outlet stores and $256.5 million of sales from our direct channel in 2006. Gross margin for fiscal 2007 was $358.5 million representing an increase of $5 million in the gross margin for the same period last year. Gross margin percentage for the year declined to 36.2% compared to a gross margin percentage of 37.0% for 2006. The decline in the gross margin percentage versus the prior year was due primarily to an 80 basis point decrease related to company’s Customer Loyalty Program and a 70 basis point decrease in merchandized margins driven in part by higher levels of inventory markdowns in the current year. These decreases were partially offset by a 70 basis point improvement in gross margin resulting from a decrease in the company’s occupancy costs as a percentage of merchandized sales. Operating loss declined to $28.4 million during fiscal 2007 from $118.6 million for fiscal 2006. As noted earlier, fiscal 2006 loss included $117.6 million impairment charge related to the company’s goodwill. Excluding the impact of the 2006 impairment charge, the company’s 2007 operating loss increased by $27.4 million primarily resulting from a $30.6 million increase in the company’s SG&A expense during fiscal 2007 as compared to the prior year. SG&A expenses during fiscal 2007 as Neil noted reflected $16.4 million of non-recurring expenses in the first quarter of 2007 associated with the company’s terminated merger, resignation of the company’s former CEO, and a litigation settlement. SG&A for the full year excluding non-recurring items increased by $14.2 million. These increases were driven by higher levels of advertising and marketing costs, increased sales related cost, higher payroll and benefits, rent and relocation expenses to our new corporate offices as well as higher professional fees. These increases were offset by lower store closing costs, distribution costs, depreciation, and IT cost.

The company’s net loss for the year was $101.7 million or a loss of $3.33 per diluted share compared to a net loss of $212 million or a loss of $7.06 per diluted share in 2006. The 2007 net loss included several non-recurring expenses totalling $19.7 million including a loss on extinguishment of debt of $3.3 million reported during the second quarter and $16.4 million in non-recurring expenses in the first quarter previously discussed. Included in the 2007 results are non-operational income of $10.5 million related to a non-cash fair value adjustment of the company’s convertible note and a $9.3 million gain on the sales of SAC receivables. The 2006 net loss of $212 million included a goodwill impairment charge of $117.6 million recorded in the 2006 third quarter and non-recurring expenses of $3.6 million. Income tax expense for 2007 was $69.2 million compared to income tax expense of $65.5 million in 2006. Income tax expense for 2007 and 2006 included $30.6 million and $71.3 million respectively related to non-cash increases in the company’s tax valuation allowances and tax expenses associated with the sale of SAC receivable previously discussed. Income from continued operations before income taxes, interest expense, depreciation, and amortization expense or EBITDA for 2007 was $41.9 million when excluding the above-mentioned non-recurring and non-operational items compared to 56.4 million in the prior year. The primary driver was higher SG&A expenses previously discussed. Included in EBITDA is non-cash stock-based compensation expense of $9.9 million in 2007 as compared to $10.2 million in 2006.

On the balance sheet as of December 29, 2007, we had a cash balance of $27.6 million after a voluntary pre-payment of $20 million on December 27, 2007. Inventory levels were above the year end 2006 levels due to early receipts of merchandize and a build-up of excess inventory. Inventory reserves increased by $4.1 million to $8.8 million. We are focussing on cleaning up this inventory prior to the 2008 year end and being much tighter on our inventory discipline. Eddie Bauer ended the year with 391 stores, a decrease of 3 stores from 2006. We opened 11 retail stores and 1 outlet store during the fourth quarter and closed 2 outlet stores. At year end, the company operated 271 retail stores and 120 outlet stores.

Now looking forward to 2008, let me briefly touch on three topics: Capital expenditures, number of stores for 2008, and bank covenants. We are expecting capital expenditures that of landlord allowances to decrease to approximately $24 million in 2008 compared to $36.9 million in 2007 due to opening fewer stores, less IT spending, and the non-reoccurrence of our headquarters move. We are planning to open approximately 13 stores in 2008 versus 29 stores in 2007. We don’t see a significant increase in the size of our store base until we get our sales per square foot up substantially. Until that time, we may see year to year fluctuations in the size of our store base.

Finally, we are monitoring our term loan covenants for the first quarter closely. Based on our recent forecast and what we know today, we are currently on track to meet these loan covenants, although the margin for error is small. That concludes my remarks Neil.

Neil S. Fiske

Thanks Marv. With that, let’s open up the line for questions.

Question-And-Answer Session

Operator

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question today, please press *1 on your touchtone telephone. If you are joining us on a phone that has a mute function, please make sure that the mute function is turned off to allow your signal to reach our equipment. Once again, if you’d like to ask a question today, please press *1 on your touchtone telephone. We’ll hear first from Trevor Hamilton of Peninsula Capital.

Mike Osborne – Unknown Firm

Hi Neil, it’s Mike Osborne.

Neil S. Fiske

Hi Mike.

Mike Osborne – Unknown Firm

Hi. I have a couple of questions, one on the cost side and one on the sales side. On the cost side, you mentioned your goal is to take $30 million out of overhead, $30 million from what number – there was a lot of some one-time stuff in there with the termination of the former CEO and that kind of stuff, what’s the kind of run rate baseline that we should be starting from as we think about taking $30 million out of – that’s the cost question – and then the sales question is; can you talk over the next 2 or 3 quarters specifically – you spent a lot of time on costs and restructure on this call, but can you talk about what you’re going to do to drive the sales line because at some point it seems like you can cut, but you have got to grow to the top line to get to prosperity here…

Neil S. Fiske

Okay, let me get both of those questions. First, on the cost side, just to be clear about a couple of things, when we say that $25 to $30 million cut, we’re taking out all the non-recurring things from both this year and last year so that it will be a true apples-to-apples kind of cut in the cost structure, and the vast majority of that $25 to $30 million cut will show up in the SG&A expense, and the only other apples-to-apples thing to bear in mind is we’ll do it on a 52-week to 52-week comparison – that’s because we have an extra week in this fiscal year compared to last year, so on a true 52-week to 52-week comparison, you’ll see the $25 to $30 million production flow through to the SG&A line. With regard to the question on growth, we completely agree; part of this in a turnaround is – you stage out various initiatives to have impact over a sustained period of time given the product development cycles in the parallel which are typically about a year, that we’ve merchandize changes that we’ll start to see as a result of our new direction. We’ll show up a little bit in the summer because we could have some minor impact on that when I came in, more in the fall, but I think particularly we’ll be set up well for the holiday season, and obviously, the first thing that drives the business is great product, and I wish we could change it faster than that but that’s just the reality of the product development cycle. The second level that we have is our marketing, and our primary marketing vehicle is our catalogue. We put out 80 million catalogues a year, and I think we’ll just see over the course of the summer and fall season is a fresher, more up-to-date look to the Eddie Bauer brand, more consistent with our positioning as an active outdoor lifestyle brand, and we would hope that those changes and elevation of marketing will also start to drive the path line, and I think when we put all those together given the timely impact, marketing, and product together, you are going to be looking at the fall season to see the changes in top line of a dramatic sort. So, does that answer your question?

Mike Osborne – Unknown Firm

Yeah, just one followup on the cost side – what was the total amount in fiscal 07 of one-time non-recurring type charges in the $441 million SG&A number?

Neil S. Fiske

$16.4 million non-recurring.

Mike Osborne – Unknown Firm

And most of that is in Q4?

Neil S. Fiske

Most of it was in 2007, most of it was in Q1.

Mike Osborne – Unknown Firm

Right. Okay great. Thank you.

Neil S. Fiske

Thanks Mike.

Operator

Our next question today will come from Andrew Berg from Post Advisory Group.

Andrew Berg - Post Advisory Group

Hi guys. When you talked about the increase that you saw in the direct channel, can you give me a little sense of what was driving it… on what categories… because you did a nice job there?

Neil S. Fiske

In the direct channel, I think it was frankly improvement across the board in all categories. We had a very good growth rate in outerwear which is consistent with our stated strategy to regain our strength there. We put more pages against outerwear, put more focus on it, and we got paid back for that. I think the second big improvement that we had over the course of the fourth quarter is we got more and more focused on gifting and telling a stronger clear gifting message, and as we released each of the holiday books in succession, we thought that they got better qualitatively in terms of photography and presentation, but as they played out we also saw improvement to the overall result of the books as we went through the holiday season and all of the categories leapt in.

Andrew Berg - Post Advisory Group

And with respect to online and the progress you’re seeing now, are you pleased with how that’s coming along with your head behind schedule for what you’d like to see out of it?

Neil S. Fiske

I think that we’re quite pleased with our new www.eddiebauer.com website as you know that has been in development for quite some time. We made a decision not to launch it in the fourth quarter and put any of our fourth quarter volume at risk and that’s why we turned it on in February, and so far so good, and we’ve had very good customer response to it. One of the things I look for on the website is the thing we call conversion which is how many people would actually visit the site convert into orders and our conversion has been strong, which tells us at the end of the day customers are liking what they’re seeing and liking the site. Clearly, I think we have tremendous opportunity over time to grow the direct business. Our business has not kept pace over the last 5 years with the growth in the whole sector and as we get the brand clear and we get the merchandize right, we see a significant opportunity to really grow the direct business even more.

Andrew Berg - Post Advisory Group

Okay. With respect to inventory levels, how quickly are you guys looking to clear out the excess inventory. Is that something we should think about in the next quarter or so – let it through the online and the other outlet channels to try and get it down as quickly as possible just to generate cash and get it off or you’re going to be a little bit more deliberate about it you think?

Neil S. Fiske

Let me give you a little bit of an overview comment on that and then have Marv take you through more of the timing of it. So, just to back up a little bit on inventory, I think frankly there are a number of factors in the third quarter and in the fourth quarter that led to the build up that we had. We put a fair amount of inventory investment into the outlet business. The outlet business obviously has been soft for several quarters now and starting with the outlet business, we got backed up on inventory, had more than we should have had frankly for the performance of the business and even the time of the year we were over-assorted, had too many styles, too many choices and outlets, and that just compounded the problem. In our business model, the way we should be running this should be very fast turns in outlet and they should be, if anything, lean on inventory so that they have capacity to take the overflow from the retail stores. So, obviously if you start from a position where your outlets are over-inventoried, it makes it very hard to flow the product from the retail stores to the outlet and certainly we saw that in holiday, but we also saw that particularly in January and February as we came off the holiday time period and we had a fair amount of inventory that we needed to work through in outlets. So, we need to clean up outlets, get them back to where they should be, and we’re chipping away at that on a steady and regular basis. We’ve increased reserves for some of the charges that we now need to take to get into a better inventory position. Once we get outlets in a better position, it will be much easier for us to flow excess inventory from the direct business and the retail business into outlets and move it clearly. Meanwhile, until we get outlets into a better position, we’re doing more now to what we call self-liquidate in the retail channel and in the direct channel so that we don’t compound the problem in outlets, and I really think this is several quarters where we are going to need to be working on this until we get our inventories back to where they should be.

Marvin E. Toland

Andrew, I think Neil probably answered both halves of your question there, but just to reinforce, we’ve taken steps to stop any increases in excess by being more focused on clearance at end of season for the winter season, but for some of the excesses that we had that were – we just had more classic and not seasonal – we’re going to move those through the remainder of the year to optimize the cash proceeds from, so we’re both stopping the bill and then proceeding with cash maximization in mind on the excess that had already built.

Andrew Berg - Post Advisory Group

Okay, you got me to pick up a couple of things over the holidays and subsequent two… So, the strategy is working at least a little bit over here…

Neil S. Fiske

Keep buying, thanks.

Andrew Berg - Post Advisory Group

Thanks guys.

Operator

As a quick reminder, it is *1 on your touchtone telephone to ask a question. We’ll go to Nicholas Capuano of Imperial Capital.

Nicholas Capuano - Imperial Capital

Hey guys. Just a couple of quick ones; if you could just comment on the current retail environment – obviously it is difficulty out there, but just wondering what your take on the environment and traffic you’re seeing and what kind of tactical programs or strategies do you have in place or are you modifying some of your tactics to deal with it?

Neil S. Fiske

I think the environment is bad and my own personal view and observation is that it has gotten tougher since the holiday time period, and it was tough at the holiday time period. I think there is more and more widespread talk and official recognition from various quarters that we are in an economy and when you hear it on the news or customers hear it on the news, it can’t help but sink into their mindset, and we’re seeing in mall traffic continual softness through the first quarter. Clearly you’ve seen that January and February comp results which I think confirm all of our sense that it’s a very weak retail environment right now, and I just think it’s going to be tough. Having said that it is what it is, we’ve got a lot of work that we need to do, and we’re focussed on doing what we have to do to get this business back to prosperity and growth, and the actions that we’re taking I think are the same reactions we should be taking whether or not we’re in a recession or we’re in a period of growth because we obviously need to get this brand turned around, and have had for 8 months an aggressive focus on getting our cost in line, getting the brand re-built from its fundamentals, and I think those would be the same things we’d be doing if we’re in a different macro environment. Clearly, we’d be a little bit more conservative and a little bit tighter on inventory management in the third and fourth quarters than we might otherwise be just to make sure that we don’t carry too much inventory through as we did this year, but other than that, I think our focus is just executed on these five key priority areas.

Nicholas Capuano - Imperial Capital

Okay great, that’s helpful. Another question on the margins, looking at the margins you obviously had a much better comp performance at retail versus outlet – when you look at the margin dynamics and given that you’re trying to get rid of the excess inventory through the outlet, are you having kind of correspondently lower margins at the outlets as well as lower sales, is that hurting your overall margin? I’m just trying to get a sense of – you got better than expected comps at retail if the margins – how have the margins been at retail – your margin performance versus your internal goals and retail versus outlet?

Neil S. Fiske

I think the fair think to say is the amount of inventory that we’re working off has pressure in all the channels because we can’t flow through outlets the inventory that we would normally want to flow to them given their backup, so that backup in turn causes pressure on retail margins as well. Again, we understand the magnitude of the problem. We know what we’ve got to deal, we’re chipping away at it, and we’re going to do it in a way that maximizes our cash and not do anything that I think is overly aggressive and costs us more than we benefit from.

Nicholas Capuano - Imperial Capital

Alright. Okay, thanks guys.

Neil S. Fiske

Thanks.

Operator

Just a final reminder, press *1 to ask a question today. We’ll go to Cape Investments, J. T. King.

J. T. King - Cape Investments

Good afternoon. In the $25 to $30 million of cost savings, you didn’t mention anything on the sourcing side, and I know you all have a new hire there. Can you just comment on what we should anticipate on the sourcing side or what the potential is there for savings; and then the second question was on the $25 to $30 million of savings, when will we see those roll in and can you kind of quantify the four different buckets that you mentioned? Obviously with the 120 or 130 people let go, you would expect to see those sooner I’m assuming, but if we could get some sense of timing and size for the four buckets within that $25 to $30 million as well?

Neil S. Fiske

Okay, so let me hit the sourcing question first and then the timing of the SG&A costs. On the sourcing we see significant upside to our margins by having Ron Hall here, but I think realistically that’s going to take some time as well, again, remember that product development cycles here are about a year, orders are placed long in advance and committed long in advance, and prior to Ron even hitting the ground, a good part of 2008 was already booked and committed, and so, I think we will see some benefit from what Ron is able to bring to the table in 2008, but at the same time, we also know and I think we’ve been clear in our calls today that we have to take some of the savings that we get from the sourcing initiative and put it back into 2 things; one, better quality for the price paid because I think our quality has eroded over time, and two, we think there are a handful of opening price-point positions that we need to get this brand to in order to re-establish the value proposition that we want to have. So some of the sourcing savings short-term we’re going to invest back into quality and back into more competitive price points. Over the long-term, and by long-term I mean 2009-2010, we should be able to see gross margin expansion significantly as a result of having Ron here. We are not counting any sourcing savings as part of the $25 to $30 million costs target. If we’re able to deliver on some of that in 2008, that will be upside to the business case and budgets that we prepared here, but we were just realistic about what we can affect at this point in 2008. Did that answer your question on sourcing?

J. T. King - Cape Investments

It did, thanks.

Neil S. Fiske

Okay. On the run rate of the SG&A costs, they are as you would probably expect, ramped considerably over the course of the year. All of the plans to affect 2008 are in place at this point in time. It’s not like we’re going to keep going through the year and develop more plans for more cost reduction. We’ve identified where the costs are going to come out and how they’re going to flow but if still substantially weighted to Q3 and Q4 this year more than half of the benefit will come out in that time period, and maybe roughly 6 to 7 million of it will come out in the first two quarters of this year. Yeah and I think that the impact in the first quarter just given that things kind of hit midway will be relatively modest, lets say a million dollars or so, and then a ramp. Again, we have broken these severances out by quarter – we understand the impact and are quite confident in our ability to stick to the number in 2008. Does that answer your question?

J. T. King - Cape Investments

Okay. Thanks. It did.

Operator

We have a question from Ross Haberman from Haberman Fund.

Ross Haberman – Haberman Fund

Good morning gentlemen, how are you?

Neil S. Fiske

Hi Ross.

Ross Haberman – Haberman Fund

Just a followup regarding going back to the savings – the $25 million to $30 million – correct me… how much of that is going to be used up in other expenses as opposed to falling to the bottom line?

Neil S. Fiske

Well, we would hope that the vast majority of that should fall through the bottom line. By the way the $25 to $30 million is the net number. Obviously, there are a number of inflationary pressures in the business now – rents are going up, shipping costs are going up, we have pay raises in stores and then the home office that we have to fund – all of these things will be funded and we’ll pay $25 to $30 million out net of the cost structure.

Ross Haberman – Haberman Fund

Okay. And then one final question. Did you mention that you are going to close or relocate any stores in a way?

Neil S. Fiske

We did not mention closings and relocations. There is kind of a normal churn of the store base when leases come up and we look at those case by case to see whether it makes sense given the rents, potential rent increases, to stay in that store or not stay in that store. We also candidly have the other side of the equation which is sometimes our landlords want to move us or they will tell us that our productivity is insufficient to hold our space. So, some of these decisions are ours and some of these decisions are the landlord’s. By and large I think we’ve got pretty good relationships with our major landlords, but there are some natural changes that occur in their portfolios that do end up affecting us. And overall, I would expect – as a matter of sort of a guiding principle – for the next couple years our goal would be to keep our store roughly constant. Then as we build our productivity back to more respectable levels, we’d be in a better position to get more stores opened in better locations and earn the return on capital what we should earn when we open a new store. But I don’t think that that model will really kick in until we get well north of $300 a square foot. But I think for the short-term, kind of manage the fleet, keep it as close to constant as possible. There will be some new openings and some closures, but really on the margin.

Ross Haberman – Haberman Fund

Finally, are you fully staffed now – I think you were looking around for a – was it a designer or head of marketing.

Neil S. Fiske

Well we had an interim chief marketing officer last year and we’ve made the decision that that is just not a position that we need at this point in time.

Ross Haberman – Haberman Fund

Okay.

Neil S. Fiske

Most of our marketing is catalogue based that accounts for the majority of our marketing expense and particularly over the short-term as we’re fixing our product line, external marketing has been in a traditional sense print advertising for television advertisement has a very minor role in our brand. So, we looked at it and just said that we didn’t need a chief marketing officer. We were looking for a number of positions and – yeah, I think all of our senior management positions have been filled at this point.

Ross Haberman – Haberman Fund

Okay. Thank you and best of luck.

Neil S. Fiske

Thanks.

Operator

We have a followup question from Andrew Berg from Post Advisory Group.

Andrew Berg - Post Advisory Group

Hi guys. Just a housekeeping – maybe I missed it – what’s the CapEx number for the year?

Marvin E. Toland

$24 million.

Andrew Berg - Post Advisory Group

$24 million was what was for 2007?

Marvin E. Toland

That’s for 2008.

Andrew Berg - Post Advisory Group

Right. The number for full year 2007 was what?

Marvin E. Toland

Net of landlord contribution was $36.9 million.

Andrew Berg - Post Advisory Group

Great. Thanks guys.

Neil S. Fiske

Next question?

Operator

We’ll go to Pamela Wilson with WL Ross.

Pamela Wilson – WL Ross

Yeah. I wonder if you can give us any guesstimates for comp store sales this year.

Neil S. Fiske

No… no guesstimates. I think we’ve been reluctant to provide any sort of guidance on comps or earnings. I do believe that at some point and more further into this turnaround program and we have traction and predictability, we’ll get back to being able to give you more of a tangible and specific top line and earnings, if not guidance, at least a directional sense, but given that we’re really in the turnaround and given that there is a certain amount of macro uncertainty in the environment, I think we’re just going to not give out specific comp store sales projections or guidance at this point.

Pamela Wilson – WL Ross

Can you give us any sense of what you’re seeing in your first quarter so far?

Neil S. Fiske

I can tell you that I think the first quarter in retail in total is tougher than I think the fourth quarter was in retail and from the numbers that I am seeing, it’s tough on everybody.

Operator

Anything further Ms. Wilson

Pamela Wilson – WL Ross

No. That’s it, thank you.

Operator

Ladies and gentlemen, thank you very much and that does conclude our presentation for today. We thank you for your questions. Have a great day.

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