Jones Apparel Group, Inc. F1Q08 (Qtr End 04/05/08) Earnings Call Transcript

Jones Apparel Group, Inc. (JNY)

Q1 2008 Earnings Call

April 30, 2008 8:30 am ET

Executives

Wesley Card – President & CEO

John McClain - CFO

Analysts

Jeffrey Edelman - UBS

Robert Drbul - Lehman Brothers

Jennifer Black - Jennifer Black Associates

Todd Slater - Lazard Capital Markets

Brad Stephens - Morgan, Keegan & Company

David Glick - Buckingham Research

Virginia Genereux - Merrill Lynch

Carla Cassola - JP Morgan

Presentation

Operator

Welcome to the Jones Apparel Group 2008 first quarter earnings conference call. (Operator Instructions) On this conference call the company will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 about its businesses. These statements are based on current expectations of future events and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

For a detailed discussion of these risks and uncertainties and other important factors that could cause actual results to differ materially from the company’s expectations, the company directs your attention to its Annual Report on Form 10-K for the fiscal year ended December 31, 2007 including but not limited to the statement regarding forward-looking disclosure and item 1(a) Risk Factors therein and to its other filings with the Securities and Exchange Commission. The company does not undertake to publically update or revise its forward-looking statements as a result of new information, future events or otherwise.

Before we begin the company would like to point out that once again this quarter supplemental slides are available on the company’s website for download. I would now like to turn the call over to Wesley Card, President and CEO; please go ahead sir.

Wesley Card

Good morning everyone, welcome to this morning’s conference call to cover our first quarter 2008 performance. Earlier this morning we were pleased to report results which were generally in line with our expectations. We continue to operate in a very challenging retail and economic environment with the department and specialty store registering poor comparable store sales results throughout the first quarter.

Adding to the overall environment were the impacts of an early Easter and the concurrent cool weather. As was the case in the fourth quarter of 2007, women’s apparel in general continued to be particularly difficult.

As I had noted in last quarter’s conference call spring 2008 product orders from our wholesale customers were conservative. In addition retailers entered the year with relatively lean inventories so overall our wholesale orders were substantially shipped as originally booked. Due to the promotional environment our markdown support during the quarter was higher than the same period last year which is reflected in the first quarter margins.

As the first quarter of 2007 was the strongest quarter we had in 2007 it is our toughest comparison. Still our own chain of company operated retail stores reflective of the overall retail climate were somewhat weaker than expected notably in our apparel outlet doors. As you may recall I had called this out as a concern during our last conference call. The good news is that with heavy promotions we were able to quickly clear the slow-moving merchandise and our resulting quarter-end inventories were current.

The overall total comparable store sales for our own chain were down by 8.7%, down 4.8% in footwear and accessories and down 17.4% in our apparel outlet locations and down by 9.5% in our Canadian retail operations. We are confident that with the inventories in line and our other initiatives underway we are well positioned to show improvement in our retail chain results from here on forward.

As John will review in more detail, we tempered our outlook slightly for 2008 to reflect the current retail and economic climate. Our forecast now reflects a range of earnings per share of $1.20 to $1.35 per share. This is marginally a function of the conservative orders our wholesale customers placed for third quarter and a similar trend which is now anticipated for fourth quarter given overall economic conditions.

We are very encouraged however by the tone of business so far in the second quarter. Warmer weather and pent up demand fueled a significant pick up in our retail sales overall during the first part of April. We are noting this trend in both our wholesale customer results and in our own store comps which are into positive territory quarter-to-date with very solid gross margins. If this trend continues it could perhaps bode well for a pick up in the back half particularly in the fourth quarter and enable us to meet the top half of our range.

In the meantime we remain focused on managing conservatively in a very tough environment. With that overview I am now going to turn the call over to John McClain to cover our results in detail; John.

John McClain

Thank you Wes, good morning everyone. Throughout my discussion all amounts related to adjusted results from continuing operations unless otherwise noted. Adjusted results exclude the impact of transitioning our l.e.i. business to Wal-Mart, of exiting the Moderate Sportswear business and other one-time items which aggregated $19 million in the first quarter 2008 and severance and other expenses associated with the strategic operating initiatives which aggregated $10 million in the first quarter of 2007. Continuing operations also excludes the results of Barney’s for all periods.

As Wes noted the first quarter of 2008 was a very challenging period for department and specialty stores and our own chain of retail stores. In comparison first quarter of 2007 was a strong period for Jones and the industry overall.

For the first quarter total company net revenues were $982 million compared with $1.08 billion in the prior year. The exit of the Moderate Sportswear lines impacted the quarter comparisons by approximately $100 million. Total company operating income was $59 million versus $93 million last year and the operating margin was 6% versus 8.6%. The primary items impacting operating income and operating margins were the higher level of markdowns required, the liquidation of excess inventories in several segments at very low margins, and the higher level of promotion required on the apparel side of our own retail stores. Adjusted EPS from continuing operations was $0.37 for the first quarter compared with $0.46 last year.

Before I discuss the segment results and our updated guidance for 2008, I’d like to highlight some balance sheet and cash flow items. Accounts receivable were $492 million at the end of the first quarter versus $527 million in the prior year, a decrease of 7%. Accounts receivable turn on an annualized basis was 7.7x for the quarter compared with 7.88x last year. The portfolio remains very healthy from an aging perspective.

Inventory was $465 million at the end of the quarter versus $537 million in the prior year, a $72 million decrease or 13%. The most significant decrease was in our jeans wear group with the exit of certain Moderate Sportswear lines and a reduction in the number of weeks’ supply in our replenishment programs. We continue to focus on our inventory position and the timing of purchases to keep inventory at optimal levels; doing so helps reduce the amount of liquidation and promotion. On an annualized basis inventory turn for the quarter was equal to last year at 5x.

During the quarter we used $65 million of cash in operations which is a $113 million improvement over the prior year’s quarter where we used $178 million. This improvement was primarily due to lower inventory and accounts receivable balances, the impact of the exit of the Moderate Sportswear lines, the receipt of a tax refund and the absence of the final payment related to a transition service agreement with Polo Jeans Company in 2007 partially offset by lower earnings.

There were no share repurchases during the quarter and we await the final settlement of the accelerated share repurchase program which will occur no later than July 19, 2008. As part of the final settlement we believe that we will receive an additional 3.1 million at that time.

Total debt was $781 million, down $303 million from the prior year. This decrease reflects the pay down of short-term debt that was funded by a portion of the cash from the sale of Barney’s in September, 2007. Our revolver remains undrawn and we ended the quarter with approximately $200 million in cash. Our ratio of debt to total capitalization net of cash was 22.5% and we remain financially strong. At its meeting yesterday, the Board of Directors approved the quarterly dividend of $0.14 per share.

Now I’d like to discuss the first quarter 2008 results for each of our segments and update our segment guidance for ’08. This information is included in the slides that we posted to our website today.

For the quarter wholesale better apparel revenues were $371 million compared with $383 million last year consistent with industry trends for women’s apparel. In sportswear Jones Signature and Jones Sports performed well while results at Nine West and Jones Collection were down. Suits and dresses performance met our expectations with increases in both Anne Klein and Nine West suits and Evan-Picone dresses.

Segment operating profit margin was 15.8% in ’08 versus 18% in ’07 but in the tougher retail environment in ’08 and the higher level of markdown assistance which accounted for over 90 basis points of margin reduction. For 2008 we forecast revenues ranging from $1.2 billion to $1.24 billion and operating margins of 10% to 11%.

In wholesales jeans wear, formerly called Moderate Apparel, revenues were $229 million compared with $308 million last year primarily reflecting the impact of exiting certain Moderate Sportswear product lines which were about $100 million lower this year then last.

Segment operating profit margin improved to 9.1% this year compared with 8.2% last year reflecting improved margins through better inventory management and lower air freight costs in jeans wear and the absence of the lower margin Moderate Sportswear lines.

For 2008 we are increasing our forecasted revenues to a range of $790 million to $830 million reflecting our new forecast for l.e.i. at Wal-Mart for the remainder of the year and the full-year impact of exiting the Moderate lines. Operating margins will range from 7% to 8.5%.

In wholesale footwear and accessories revenues were $273 million this year versus $266 million last year. The increase was primarily due to increased sales in handbags and in sales from our international licensees. Segment operating profit margin was 9% versus 12.6% last year reflecting investments in marketing and personnel, increased markdown assistance, the impact of inventory liquidations, and lower margins in our wholesale jewelry business. For 2008 we forecast revenues ranging from $1.05 billion to $1.1 billion and operating margins of 9.5% to 10.5%.

In retail revenues were $159 million compared with $172 million last year. Revenues were down primarily due to the closure of our Steinmart retail locations early in 2007 and a decrease in same-store sales of 8.7%. During the quarter we were impacted by the continued highly promotional retail environment and the impact of our turnaround efforts where we were promoting excess inventory in the apparel stores which negatively impacted revenues by about $6 million. Segment operating profit margin was negative 15.4% versus negative 10.5% last year.

Footwear results showed improvement versus last year while apparel results were lower due primarily to the $6 million impact of the promotional efforts I just mentioned and the general softness in women’s apparel. For 2008 we forecast revenues ranging from $745 million to $790 million and an operating margin ranging from a negative 1% to a negative 4%.

Since our last forecast economic conditions worsened and the slowdown in the economy is much more apparent. What we saw in the first quarter was that the consumer wasn’t shopping, whether it was the impact of home lending crisis, the high cost of gasoline, or the unseasonably cool weather. As a result retailers have ordered conservatively for the third quarter which is driving our revision in our 2008 guidance to a range of $1.20 to $1.35.

In summary the total company guidance is net revenue ranging from $3.62 billion to $3.78 billion; operating margin ranging from 5.4% to 6.4%; interest expense of approximately $48 million and an effective tax rate of approximately 36%; weighted average shares outstanding for the full year of approximately $84.5 million which includes the receipt of the 3.1 million shares from the settlement of the ASR in July; operating cash flow of $145 million to $185 million; capital expenditures of $85 million to $95 million, this includes $30 million in technology, $10 million of new retail stores, $30 million of major and minor remodels of existing retail stores with the remainder spent for distribution centers, showrooms and office space.

This is down a bit from the last forecast as we continue to review spending and move some spending into ’09. And depreciation and amortization of $90 million to $100 million. We are still operating in an uncertain economic and retail environment. At this early stage in the second quarter sales have begun to pick up but it’s difficult to determine if that increase will be sustained. Depending on the extent of the economic slowdown and when consumer spending picks up will dictate where in the range we will perform.

That concludes by comments and I’ll turn the call back over to Wes.

Wesley Card

Thanks John, I’m now going to walk through each of the four segments of our business, our efforts to enhance the appeal of our brands and the other underlying trends and initiatives driving our results.

Beginning first with Better Sportswear, our collections continue to evolve to focus on a more modern approach in styling and assortments and this is readily evident in our current product offerings. The Jones New York brand continues as the backbone of the department stores sportswear category with Jones New York Signature continuing as the stand out performer in this segment. Our design team did a great job modernizing the Jones New York Collection for fall 2008 and we are now merchandising the line with a stronger emphasis on key items including jacket replacements, and novelty fabrics moving away from traditional suited looks.

Jones dress and Jones New York suit both performed satisfactorily in the period. Suits are beginning to show some strength while the recent strong dress demand seems to be leveling off a bit. Even given the fall order reductions I mentioned earlier, Jones New York Signature shows increases reflecting the strength in casual products. Career has been the most challenging area and while our product has been much improved, orders were reduced in this label. This will reflect in less penetration per door for career however overall floor space won’t be affected. This action could prove very beneficial if product performance improves in the back half.

Our investment in Anne Klein has begun to register improved results. We substantially enhanced the styling of our AK Anne Klein better product over last season and we’ve seen some positive results from our stepped-up marketing activities. As an example, we dropped an insert for AK Anne Klein with El Magazine to approximately 800,000 subscribers which were tied to in-store events, store windows and other promotions across all of the product categories for that label. This effort required flawless execution and collaboration with our retail partners and generated excellent sales results.

We are maintaining our efforts to nurture and develop the Anne Klein New York Bridge label and we continue to view this space as a growth opportunity. Our customers in this distribution tier are looking forward to our spring 2009 product offerings under the new design team. We are very encouraged by the direction the product line is taking and the spring 2009 season could well be an important inflection point for us with this brand.

Nine West sportswear product offerings have also been greatly improved for fall and the speed to market initiatives we discussed on the last call were very favorably received by our customers. Given the current economic environment and the past performance of this brand customer orders were significantly reduced for fall and our forecast reflects that. We are being very patient here. Our customers want and need us to succeed with this initiative and we will continue to evolve this brand to capitalize on what we perceive as a much larger volume opportunity.

Moving next to wholesale footwear and accessories, our key brands Nine West, Easy Spirit, AK Anne Klein, Bandolino, Circa Joan & David and Enzo Angiolini, continued to perform relatively well in a tough footwear climate. These labels are all well differentiated and department store penetration has increased. Seasonal items such as sandals are selling extremely well this spring especially in bright colors. Nine West handbags are performing much better at retail; average unit prices are moving up strongly from the entry level promotional price points. Handbags continue to do very well in our own stores where matching to our footwear is readily apparent. AK Anne Klein handbags were introduced this spring and the initial consumer response to this line has also been very positive.

Our costume jewelry business, while only about 5% of segment sales negatively impacted results in the segment this quarter. Demand in costume jewelry was very challenging beginning late in the fourth quarter of 2007 and continued right into first.

The international retail component of footwear and accessories continues to grow in double-digits and is dominated by Nine West, also includes some Anne Klein and Easy Spirit products. The segment continues to be strong growth point for us and we are actively pursuing options to tap into the outstanding growth potential of our international markets more directly. Our products are being well received by our international partners in over 48 countries with over 1,000 retail locations. In the near-term we are working very closely with our partner in Asia who is planning to maximize opportunities for Nine West sportswear with an aggressive rollout in China with a label being redesigned and resized for the local market as well as pursuing a growth opportunity in Asia for footwear and accessories.

Turning to the jeans wear segment our movement away from Moderate Sportswear and the repositioning of the jeans wear brands with l.e.i. moving to Wal-Mart and the introductions and balancing of our other labels, will begin to show some results in the back half of the year. As we move into fall we had a well balanced portfolio of brands for all consumer segments as well as some private label for just about every major retailer. Gloria Vanderbilt and its product extensions will anchor the Moderate jeans business along with our Energy Junior tops brand. l.e.i. as you know is transitioning to Wal-Mart and we have developed other labels soon to be tested to fill the void left at the department stores being vacated.

In fall we commenced shipments of Style & Co. and Charter Club as well as Epic Threads for girls which are private label brands for Macy’s. Nine West jeans are beginning to show some traction as is Bandolinoblu in department stores. We remain very enthusiastic about the launch of l.e.i in Wal-Mart. Early selling results of some available l.e.i. product in certain Wal-Mart doors have generated excellent results. We are planning to support the July brand launch with an outstanding marketing effort that we will be excited to tell you more about once details are finalized. The launch commences in the United States in approximately 3,000 doors in July and begins in fourth quarter in 200 doors in Canada. Product extensions in footwear, underwear, watches, and other categories are being actively pursued and interest is very high. We are truly excited about the growth opportunities for this brand.

Finally turning to our domestic retail operation of about 1,000 doors I am very encouraged with our turnaround efforts and results to date. We are noting positive trends in our footwear and accessory stores and improved profitability with gross margins up and the inventory turning well. The loss in our footwear concepts was narrowed in the first quarter which is traditionally a low volume and promotional period where we lose money. This was more than offset as we previously noted by higher losses in our 288 outlet apparel doors where first quarter was impacted by the softness in women’s apparel in general and the impact of our aggressively moving on excess inventories.

We now have current inventories in our doors. We believe that the merchandising changes and product enhancements we are making to our women’s sportswear lines will ultimately reflect well in our retail operations. As I had mentioned on the last call, we were about to open seven AK Anne Klein footwear and accessories doors, we now have eight doors operating and are very pleased with the early results. This concept could well be a significant growth vehicle for the future.

Before we open up for questions I’d like to just make a few comments about our strategy and vision for the future. First there is no question we are operating in a very difficult and challenging environment. We have made excellent strides in our products from both an operational and cost perspective that unfortunately are not being reflected in our results at this point. We will continue to manage thoughtfully and conservatively as we move through this period. Second while we are committed to solidifying Jones Apparel Group as the top department store resource, our vision for the future includes regaining our position as the best supplier of branded lifestyle apparel, fashion footwear and accessories, selling into a varied portfolio of channels. We have great confidence in the strength of our core department store brands; Jones New York, Nine West, and Anne Klein all have high brand value, consumer recognition, and customer loyalty and we have substantially improved their design and consistency and quality of fit.

In addition and as important we have excellent working relationships with our key department store customers who depend on our superior brands and superior execution. We are focused on maximizing our penetration in this distribution tier and are pursuing various alternatives to fill what we perceive are the white spaces in the channel. We are further pursuing opportunities in the tier just above our better department store core business. Anne Klein New York and Bridge apparel, footwear and accessories are a key example of our initiatives in this effort.

Below our core businesses we believe there are openings in upper moderate sportswear and then we have opportunities with some of our under utilized labels as well as access to other potential names to fill that void. Obviously the l.e.i. initiative is a significant movement into the mass channel and offers significant growth opportunities. Supporting all of these initiatives will be our continued development of [fast] fashion capability, our investments in technology and the leveraging of our operational infrastructure to drive cost effectiveness.

It is my view that as the economy and climate improves the steps we have taken and our efforts underway will put us in excellent position to generate revenue growth and improved profitability.

We will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from Jeffrey Edelman – UBS

Jeffrey Edelman – UBS

It sounds like pretty close to a turning point we too have heard that department store sales have shown some improvements, I guess my first question is do you feel as if those are going out at full price and secondly if all the stores have really cut back quite a bit on their orders, do you think we’re past that high point in inventories relative to sales expectations?

Wesley Card

I think in April what we saw when the weather turned warmer which really was literally the first day of the second quarter there was clearly some pent-up demand that fueled pretty strong business across all the categories and as I noted our retail comps are actually in the black so far quarter-to-date. I think that the margins have also been concurrently pretty strong with that. So there really was good take-out, some pent-up demand, I think the rebate checks coming out could be a positive and tax refunds as well start to hit. I don’t think it would be prudent to say that this is a, we can count on this strength continuing at exactly the same rate for the balance of the year but it was clear that seasonal items as the weather warmed showed much better take-out initially and that helps a lot in terms of the first half because it starts to clear inventory as well as generate regular price selling. So we were quite pleased with that as a good start to the quarter but obviously have to continue to be concerned about the challenges as we go through the year.

I do think and finally the last part of your question I think its prudent for the department stores to order conservatively for the back half, I think that makes sense and I’m hoping that the channel will be clear and that as demand picks up naturally with holidays you have a chance for better regular price selling and better take-out at those first markdowns.

Jeffrey Edelman – UBS

Would you discuss how you feel your position with your management team today, it looks like its been fairly stable, are we seeing any more strengthening or what can we see on that front?

Wesley Card

I think we’ve been very steady; there’s been no turnover at the top levels. We are very pleased that [Rick Baterno] came back to Jones and is now running the wholesale business. So I think we’ve got good solid veterans in all of our spots. We brought in some new design talent as people know and I think we have some other additions. It’s a good time to pick up good strong talent and I feel we’re really well positioned and the lack of turnover as you know makes a huge difference.

Operator

Your next question comes from Robert Drbul - Lehman Brothers

Robert Drbul - Lehman Brothers

First off can you just give us an update on your e-commerce initiative?

Wesley Card

Lot’s of very positive things going on there. Business was up very nicely throughout the quarter in the Nine West and particularly in the footwear brands. We’ve stepped up email activities, we’ve stepped up advertising, and the websites were redone. I think we added Nine West dresses onto the website in the first quarter. It’s the first time we’ve put apparel product on models. We’ve been offering free shipping. We’ve been testing that. The competitive landscape in the internet pretty much requires some free shipping. We had not done that. When we did that we saw dramatic improvement in sales and the ROI including the freight cost was very positive. So we are continuing to test that out. So lots of really solid initiatives with what we’ve got.

The platforms are being changed. We will have a new platform in place for supporting the infrastructure. That’s going to allow us to ship out of any stock that we own. For example, customer comes in, we’re already doing this now, customer comes in and doesn’t have a size in stock and the store will able to easily translate that into an order where we have the shoe in another store. We’re offering free shipping on that product as well and that’s been another nice initiative so I think the infrastructure supporting all of this is setting us up very well for the future.

Jones New York apparel is now slated to come online in October. We may actually be ready to do it in September and we are going to be using the stock that we own to support our outlet stores to support that business. So we are going to actually have apparel on models. One of the comments we get from people visiting the Jones New York website is they can’t buy product and so we’re going to start there. Anne Klein will be rolled out early next year. So with the platform we have we can very cost affectively rollout any of our labels. As I had noted earlier we now have a President running that division, [Ron Ofear] who is a real pro and we’re seeing excellent results as we move forward.

Robert Drbul - Lehman Brothers

Could you just elaborate more on the new product assortments in the full-price stores and how your expectations may or may not have changed?

Wesley Card

In the footwear doors the product has been re-assorted in both the regular price stores as well as the value channel. The value channel we hit first which are the outlet stores, the back half of the fourth quarter of last year and we have seen significantly improved results throughout both of those channels. I think in the apparel side with the slowdown and the softness at retail and frankly some of our product offerings from last year, we’ve talked about it a lot, needed improvement, needed to be more modernized. I think that generated some of the softness in first quarter but as we move into second and particularly in the back half, the products are going to be much better. We have actually studied, the team has studied very carefully the layouts of those doors and how we merchandise the product and we have some very interesting projects in place to improve the overall selling in all of our doors. So I feel retail is on a clear track, inventories are clean, much better product in the stores and we are going to start seeing some positive results as we go forward.

Operator

Your next question comes from Jennifer Black - Jennifer Black Associates

Jennifer Black - Jennifer Black & Associates

I wondered if you could talk a little bit about the softness in the apparel outlets, do you think it’s product or traffic driven or both and then any comments you have on the overall outlet environment and overall outlet traffic.

Wesley Card

I think outlet traffic as with mall base picked up dramatically when the weather turned in April. We see positive comps there in the footwear and accessory doors in particular. Apparel we had a very soft fourth quarter and what we talked about in the last call and was a little bit the case in the first quarter, it’s that first markdown that’s not turning. So I think you have build up of inventory throughout both our stores as well as the regular channel and the consumer just slowed down to the point where take-outs were just much narrower than what we’ve experienced. And we had to clear those goods and we were able to do it very quickly.

What I’m very pleased about was when we marked down the Jones New York and Anne Klein products in our outlets, just by word of mouth, no marketing, the customers just streamed in and we moved 500,000 units in several weeks just by word of mouth and the loyalty of a customer. So I think the customer base is there. I think they slowed down a bit. I don’t think the products were terribly exciting. I think as we got into warm weather with brighter colors and as we go into fall with some newness in the lines I think that will bode well for us. The outlet business is very profitable and traditionally and its one that we are very focused on so it might be good to call out that out of the 1,000 doors roughly 700 are footwear, accessory and apparel doors.

Jennifer Black - Jennifer Black & Associates

Do you feel like that you’ve gotten the footwear issues taken care of in the outlet stores?

Wesley Card

Absolutely starting towards the end of the fourth quarter the products assortments are excellent and we are seeing it in the constant in the margins. Inventories are turning better. Gross margins are up. And we narrowed the loss against last year which was one of our better quarters in the first quarter in the footwear and accessory side. What’s also working really well there is the, as I noted earlier the matching of the handbags, you see in accessories, you see it so clearly when they’re in one door. In the department store they’re in different departments, you don’t see the visually the same affect and the store manager’s tell us that they see customers coming in and really getting it; matching things us and really relating well to that product.

Jennifer Black - Jennifer Black & Associates

Any new line extensions for Anne Klein and I wondered if you could update us on how many doors you’re in and do you see that increasing?

Wesley Card

We are pretty, door-wise; we’re fairly well penetrated even though the business, I don’t have the exact door count counting all of our retail customers. The key with Anne Klein is more penetration per door. We’re trying to intensify and broaden the offerings. It’s about in total; it’s roughly just over $300 million business. As you know Jones is around an $800 million business so it’s not nearly as much penetration per door. The key, what we’re focused on there is making it into more of a lifestyle brand around the core career product that we’ve generally marketed in apparel. The footwear AK Anne Klein is doing very well. We just added a sport component, casual which has just been outstanding product that was exclusively at Macy’s for awhile and now I think its being ready to be rolled out more broadly which is a casual shoe initiative. The handbags, jewelry, all of it doing very well. So as a total package, I think we just think there’s lots of opportunity there to continue to grow that business.

Jennifer Black - Jennifer Black & Associates

Would you foresee that business ever getting as large as your Jones New York business?

Wesley Card

I wouldn’t forecast it but we certainly, that’s the expectation.

Operator

Your next question comes from Todd Slater - Lazard Capital Markets

Todd Slater - Lazard Capital Markets

I was wondering just if you can sense with the exit of the Moderate businesses, what kind of a lift should that provide to the operating margin, maybe you can give us some sort of color around what benefit that should provide.

John McClain

When you look at that for the entire year, we had said last year it was probably about $250 million on a full-year basis that gets pulled out of that and that that was some very low single-digit margins. That should provide a little bit of guidance.

Wesley Card

We’re driving more towards the upper single-digits now Todd. You can see that in the quarter-over-quarter analysis, for first quarter we were up and I think that’s what we’re targeting now.

Todd Slater - Lazard Capital Markets

Is that where you expect the l.e.i. operating margins to come out in that sort of high single or is going to be double?

Wesley Card

Right now I would say mid to high singles, but it’s hard to tell. It depends on where the relative volume ends up. We’re going to do well over $100 million in the back half alone.

Todd Slater - Lazard Capital Markets

If you get to more than $250 million annually is that a double-digit operating margin?

Wesley Card

I would say, I’m not sure operating with Wal-Mart because prices have to be sharp that you get the double but what’s going to happen is its going to leverage the infrastructure in that whole division. But I think you’re going to see the division as a whole move up and with licensing income as we start to license out these other product categories, l.e.i., that’s going to help bring that operating margin up as well.

Todd Slater - Lazard Capital Markets

Are all the licensees going to be able to distribute alongside you in all the Wal-Mart doors do you think?

Wesley Card

Sure, I mean as much as Wal-Mart wants to roll it out what we’re focused on now are footwear, watches, and the intimate apparel underwear for the teenage girls which there’s already licensees dealing with Wal-Mart that we are talking with that want to roll right into this program.

Todd Slater - Lazard Capital Markets

Did you say 200 or 300 Canadian doors?

Wesley Card

Two hundred.

Todd Slater - Lazard Capital Markets

And then would you expect or hope that can get distributed through other Wal-Mart lets say international geographies?

Wesley Card

Yes we certainly would hope so. I think Mexico we’re looking at. It’s a little trickier because of the import rules in Mexico, not quite sure how that’s going to roll out. But we’d like to be able to develop a business there and that’s really more in Wal-Mart’s court. I think the initial thrust is let’s get it rolling domestic and then they’ll take it from there.

Todd Slater - Lazard Capital Markets

And then cost issues, sourcing in China, could you just remind us what you’re sourcing structure looks like globally and where there are pressures, where there’s maybe some offsets in sort of what you see over the next maybe 12 months on the sourcing side?

Wesley Card

Footwear is a little bit easier because footwear is about 90%, 95% China which is where most of that, inline with industry standards. It’s an issue because raw materials are moving up as well as the inflation in wages and the currency valuation. There were going to be some prices moving up in footwear I think its unavoidable maybe not generally, but there is going to be some price compression. We are just now costing our third and fourth quarter to determine where that’s going to lead. The factories are moving more towards the north and inland in China which to take advantage of lower wage rates and so we’ll see. I think, I doubt that you’re going to see a significant move out of China in footwear and accessories. I think there’s just going to be some price pressures that we’re all going to have to deal with.

On the apparel front they were less penetrated, it’s probably half of our goods in the sportswear area, some of it is natural. All the silk is vertical production so silk and the knitwear is pretty much captive in China. The one advantage that we have at this point is business generally being soft particularly out of Europe and as well as some of the United States vendors, we’ve been able to hold pricing pretty well and we shouldn’t see a significant affect as we get through the rest of this year. It’s hard to tell how that’s going to sort out next year. We do have some ability in the cut and sew sportswear to move into other countries and balance some of that off which most vendors are doing.

Jeans wear is primarily produced in the Middle East, Jordan, Egypt, and those countries and with the fabric being sourced out of China and we’re not seeing a lot of cost pressure there. Part of that is because the Wal-Mart business has much narrower styles, much larger unit runs on narrower styles so that’s helping a lot in production efficiencies and we are able to come in with reasonable costs there against those programs.

Operator

Your next question comes from Brad Stephens - Morgan, Keegan & Company

Brad Stephens - Morgan, Keegan & Company

Your retail margin outlook, you tweaked it a little bit lower, was that due solely to the first quarter or did you take down margins for the remainder of the year within retail?

John McClain

A big part of it is what happened in the first quarter and then what the trends we’re seeing here at the end of the quarter. Hopefully the uptick we’ve seen in the beginning of the second quarter will hold through longer.

Brad Stephens - Morgan, Keegan & Company

Wes, you made a comment about dresses, you’ve seen some slowdown in dresses, can you elaborate on that?

Wesley Card

I said tapering off in demand. I think we’ve had a very large increase in business over the last couple of years. Dresses were very strong. I think that’s leveled off so the business is solid at the levels its at and there’s been more attention actually early spring as you know, there’s been some press focus and attention on the fact that dresses continue to be popular but I don’t think we’re going to see a continued dramatic growth in that category as we move forward.

Brad Stephens - Morgan, Keegan & Company

From your experience could you, how long does a cycle run, how long do you think it runs from here and then what usually takes its place after the dress demand starts to wane and then how does that impact Jones in particular?

Wesley Card

Well I think the key for us is we’ve got pretty good balance there because we have dresses, suits, career and casual sportswear all under Jones New York so our theory has always been we have good balance so that as one category strengthens, i.e. Jones Signature and Casual, it offsets a little decrease. Sometimes in a recession from what the merchants tell me and we’ve discussed, you get a return to structure and structured jackets interestingly. People its kind of a recession, people looking for jobs and we’re seeing a little bit of structural change but we are also seeing jacket replacements in these sweaters and sweater-looks, very strong for fall. We’ve got a lot of that in the line as well as less constructed jackets so its kind of a, I can’t point to one specific spot but its important just to have balance and be able to maneuver as you go through these kind of shifts.

Brad Stephens - Morgan, Keegan & Company

I saw an interview with Andy recently and it talked about potentially looking for some acquisitions in the footwear unit, is there anything in particular that you’re looking for, anything with maybe more of a wholesale or retail bend or just looking to add some more leverage to your overall model?

Wesley Card

I think we’re always looking at acquisitions and we see a lot of different opportunities come our way. What we’re focused on, we have a very large better department store business so obviously that’s not a key area for us except perhaps more in the contemporary vain because we lack a good contemporary label. And I think the tier right above us, the [inaudible] Neiman Sachs, we’d love to find a brand or a way to do more business in that channel and the channel directly below us, Kohl’s, Penny’s, particularly in footwear and sportswear, we do a very large jeans and denim business and we have, so its in those areas that I think we could perhaps build a bigger business and then the tier down below.

Operator

Your next question comes from David Glick - Buckingham Research

David Glick – Buckingham Research

Wes I was just wondering if you could give us a little more color on what’s happening in the women’s apparel and accessory businesses in department stores kind of from a broader perspective, why do you see the overall demand for women’s apparel remain weak other than the macro issues, and are we near a point where perhaps growth in the casual part of the business can offset some of the weakness in career?

Wesley Card

I think we are seeing some of that in our business where Jones Signature is offsetting some of the restructuring and career. I think generally the consumer just slowed down in the fourth quarter and then especially right into the first quarter. So whether it was lack of newness, whether it was the weather, whatever, when the weather warmed up in that first week of April we saw a very good take-out on bright colors, wear now apparel, pretty much across the board, bright colored sandals. Sandals are having an outstanding season this year. It seems like the timing seasonally we got exactly right this year. We were set up when the weather turned warm so I think there’s some pent up demand for newness, perhaps for color and hopefully our product offerings as we look into fall reflect that and especially with the Jones career, I think it was in our case it was more too much structured apparel. Its now been more modernized so there’s a lot more like I talked about earlier, jacket replacements, different looks, different bodies, novelty fabrics and I think that’s what’s going to be required to stimulate demand.

David Glick - Buckingham Research

And on the handbag front, you mentioned that as a bright spot. How are you and your department store partners looking at the handbag category? It’s been a very dynamic category for several years. Do you and your partners still see it as a major growth category that can grow faster than apparel and other areas in accessories and does that represent a big opportunity for you?

Wesley Card

I think they still believe very much in the business. It’s a feel-good kind of item that’s popular in difficult times, in a recessionary time. I think they believe in it and they continue to support it. We saw extraordinary growth over the past three years, whether we’ll see that kind of growth. I think we have a smaller market share so it’s helpful for us because we can perhaps with newness and with the strength of product grab a little bit bigger slice of the pie if there’s weakness in other parts of the channel. I think they’re still solidly behind it. I don’t think the general consensus is they’re going to have major growth as we’ve seen over the past few years though.

Operator

Your next question comes from Virginia Genereux - Merrill Lynch

Virginia Genereux - Merrill Lynch

So Wes, I think I understood from your comments, how would you characterize inventories across the channel? You look at lot leaner but how would you say at your retail customers.

Wesley Card

I think the department stores generally are relatively lean. They ordered conservatively. I think they will continue to promote and move goods and I think the last three weeks and particularly if we get the return to warm weather, they could get some good take-out. They’ll be in relatively good shape just in general.

Virginia Genereux - Merrill Lynch

So even with missing plan maybe some of this clearance has helped bring things in better line than they were say back half of last year.

Wesley Card

Yes well I think you saw their numbers in January. I think what the consensus was the numbers looked pretty reasonable given the circumstances in terms of overall retail stocks.

Virginia Genereux - Merrill Lynch

But February and March were tough, we sort of weak sales-wise. I’m just trying to get your sense of where they are sort of here at the end of April.

Wesley Card

Just based on looking at our own stocks I think we’re in pretty good shape.

Virginia Genereux - Merrill Lynch

Can you give me a sense of how much of your SG&A these days is fixed versus variable, if it’s about a billion in SG&A, how does that break down fixed and variable to sales?

Wesley Card

There’s not a lot of variable cost in there. Its sort of semi fixed where you can make reductions but its mostly staffing, marketing, the things we need to support and run the business so I, and then there’s obviously a clear fixed element of leases and depreciation. I don’t know if we have a number to throw out there now but I think we can, what we are trying to focus on is by continuing to streamline and improve the operating systems and processes we’ll get continued improvements in cost there. One of the things I tried not to do this year is to reduce the marketing budgets given the difficulty in the economy just to make up earnings per share. So we’ve been pretty steady. We did cancel out some discretionary items where we felt we could. We moved some money around and I wanted to make sure we supported the three key brands particularly in the back half. If it is difficult the marketing and product are going to be increasingly important.

Virginia Genereux - Merrill Lynch

So for instance, the $10 million I think reduction in SG&A, sort of operating SG&A ex some of these charges in the first quarter its hard to identify anything specific there.

Wesley Card

Well no we eliminated the whole Moderate division. We closed warehouses and we closed two warehouses and we completely eliminated that staffing and where the labels remained, it’s all been consolidated into existing operations. So that’s part of the efforts we’re working on to keep costs more in line with the sales trend.

Virginia Genereux - Merrill Lynch

So this year Wes, $250 million less in sales, how much less SG&A will that be in calendar ’08 understanding that there was a tapering in the, you were cutting it back by the end of ’07 pretty big.

John McClain

Well you also have some things that are pushing in the other direction so the investments that we’ve been making in the technology, that depreciation increases that begin to come through as we put these systems online and you do have for the folks that are there, you do have increases on wages and such that also works in the other direction so we look at it constantly and we are pushing on where we can. But there’s things that are working in both directions.

Virginia Genereux - Merrill Lynch

A bunch of folks had asked on the weakness in women’s apparel, you’ve seen these specialty retailers really struggle that are devoted to Missy apparel, and you said it well that people aren’t responding to first markdown, why is that not sort of more secular in nature and if it is can you sort of reengineer the business such that you’ve got to have price points that are a fair amount lower or you live with lower margins, why is that not sort of a capacity secular kind of thing?

Wesley Card

I think that our brands are more targeted right into the best spot of the business, the better price points. I don’t think prices are the issue. I think it’s been newness and I think on the first markdown can just be a reflection of overall consumer spending and the low consumer confidence and all the challenges that everybody is facing. I do think leaner inventories, more selected brands and the initiatives that the department stores are working on, at least in our channel, are very valid. The [inaudible] Macy’s initiative for example, I think can yield great results. We’re tied very closely to them working on that. We’re supporting it. We think that the way they’ve laid it out for us, its going to generate results and we are collaborating as closely as we can on that because I think the consumer, that’s where they shop for career and apparel generally, our consumer not talking about the people targeted by specialty shops, and I think there’s still very strong business that can be done there. I think lack of newness, probably too much inventory in the channel coupled with the economic conditions have triggered some of that softness.

Because you see it, when you see a spurt when the weather just gets warm for two our three weeks, and you see a strong spurt of business and you trace it right to color and newness and wear now items, it shows that when the product’s right and the other things line up there’s much better take-out.

Operator

Your final question comes from Carla Cassola - JP Morgan

Carla Cassola - JP Morgan

I’m wondering on the l.e.i. side if you have a sense for who you’re taking share from in Wal-Mart?

Wesley Card

I’m not sure we’re taking share. They have a big private label business, no boundaries and I think what Wal-Mart is doing and from everything you’ve seen as well they’re very focused on brands and building a much bigger and better business and we obviously have taken advantage of that with a great brand.

Carla Cassola - JP Morgan

And then on, do you have a leverage level that you are comfortable with or a target that you’re looking to get to either this year or in the foreseeable future?

John McClain

I think when you look at those things we still think some of the investment grade levels are well within our reach so we look at the over 2x interest and the 3x leverage so we think that those are possible.

Wesley Card

I think we’re tracking pretty low on our debt to cap basis. We think we’ll be below 20% by the end of the year but given the climate we want to be cautious with that capital structure and we’d rather be conservative and keep that on a low leverage basis at this point.

Carla Cassola - JP Morgan

So do you anticipate keeping your cash balance a little bit high or would you pay down debt this year?

John McClain

There is no debt that is due this year.

Operator

There are no more questions at the present time; Mr. Card, do you have any closing remarks?

Wesley Card

I would just like to thank everybody for your interest and for attending the call this morning and we’ll keep you up-to-date with further developments as they happen. Thank you very much.

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