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Executives

James Palczynski – Investor Relations

Kenneth Cole – Chairman & CCO

David Edelman - CFO

Jill Granoff - CFO

Analysts

Scott Krasik – CL King & Associates Inc.

Jeff Van Sinderen – B. Riley & Company

Robert Samuels - JP Morgan

Heather Boksen – Sidotti & Company

Kenneth Cole Productions, Inc. (KCP) Q1 2008 Earnings Call May 6, 2008 4:30 PM ET

Operator

Good day ladies and gentlemen and welcome to the first quarter 2008 Kenneth Cole earnings conference call. (Operator Instructions) I would now like to turn your call over to Mr. James Palczyski; please proceed sir.

James Palczynski

Good afternoon everybody, I would just like to remind you of the company’s Safe Harbor language before we get started.

The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results might differ materially from those projected in such statements due to a number of risks and uncertainties, including but not limited to demand and competition for the company’s products, the ability to enter into new product license agreements or to renew or replace existing product license agreements, changes in consumer preferences or fashion trends, delays in anticipated store openings and changes in the company’s relationships with retailers, licensees, vendors, and other resources.

The forward-looking statements contained herein are also subject to other risks and uncertainties that are described in the company’s reports and registration statements filed with the Securities and Exchange Commission.

With that out of the way, I’d like to turn the call over to Kenneth Cole, Chairman of Kenneth Cole Productions.

Kenneth Cole

Thank you James. Thank you for joining us this afternoon to discuss our first quarter result. With me today is David Edelman, our Chief Financial Officer. I am also very pleased to introduce Jill Granoff who joined Kenneth Cole Production yesterday as our Chief Executive Officer. Before we go into the highlights and our discussion for the quarter, I’d like to say a few words about the change in management.

The search to fill this role for the company has been underway for some time as many of you know and we consider ourselves very fortunate to have retained someone of Jill’s stature and capabilities. Her strong background in building powerful brands along with her significant specialty retail and wholesale experience should help us realize accelerated growth and profitability. As Chairman I will work closely with Jill to define our long-term vision for the business and the key strategies to achieve that vision. In addition as Chief Creative Officer I will now be able to focus more of my time on developing telling and tactical marketing and an even stronger brand identity.

I’m very confident that Jill’s intentions of running the day to day business with the strong management team that we have and my increased attention to delivering great products and messages to the market will [inaudible] and our [inaudible]. Jill started yesterday; I’d like to ask her to say a few words.

Jill Granoff

Thank you Kenneth. I’m delighted to join this great company and its talented management team to help realize the business’ potential. I believe the brand is significantly bigger than the business with growth opportunities across channels and products’ categories worldwide. I’m going to start by gaining a deeper understanding of our business which includes spending time in the field, talking to our customers, store associates and of course our retail partners and licensees.

I will also access our operations and capabilities to ensure we can execute our strategies effectively. I think it’s clear that the Kenneth Cole brand is strong and broadly recognized with a unique voice in the marketplace. I think you will also agree that we have a big opportunity to enhance our business model and leverage our strong heritage.

While we’ll be formulating specific plans and operational strategies in the coming months, I believe we have the ability to resume growth in wholesale, improve sales and profitability in our consumer direct channel and maximize our licensing opportunity globally. There is no question that the marketplace is challenging right now yet with the right strategies and compelling product I believe we can succeed regardless of this reality.

I’m very excited to partner with Kenneth and lead the team to capitalize on the numerous opportunities ahead of us. With a clear focus on building our brands, our talent and our capabilities I am confident that we can deliver increased value for our shareholders. I look forward to meeting many of you and sharing more specific plans to move the business forward as time goes on. Thank you.

Kenneth Cole

Thank you Jill. I will now share with you two highlights from the first quarter. Net revenues for the quarter were $122 million which were in line with our expectations but below last year’s level of $129 million due to a decrease in our wholesale business. Importantly overall consumer direct comps were up 3.4% for the quarter, an accomplishment in a challenging environment. Gross profit margin was up slightly to 41% versus 40.6% last year. SG&A expenses increased slightly versus last year reflecting increased advertising related to the 25th anniversary initiatives and expenses for bringing our men’s sportswear business in-house.

Earnings per share were $0.04 as anticipated. As you may have read in our release we still have near-term challenges related to the marketplace. We have made progress in our consumer direct and licensing businesses and we are addressing wholesale. I would like to walk you through each of these businesses.

Our consumer direct business has continued to improve. Our outlook for this has remained strong. We saw a very good outlook comp performance in the quarter and expect that momentum will continue. The six new outlet stores we opened since this time last year have all met or exceeded expectations. We are moving forward with additional stores and are currently planning for five new locations that should open before the end of fiscal ’08.

Our e-commerce business is also performing well; although still small the business is growing quickly. Our website is set to re-launch in third quarter with GSI and will include and enhanced both [inaudible] customer service and functionality. We expect this business will continue to grow and become a meaningful part of our consumer direct business.

Although we are making progress in our full price stores we recognize that we have a way to go. We continue to be focused on productivity and profitability and have closed 10 under performing stores since this time last year. We are also in the process of downsizing some stores much as we’ve done in our Walnut Street location in Philadelphia where by the way we were able to reduce selling square footage by more than half and maintain 90% of the store’s volume with 85% in new inventories. We believe there is an opportunity to do this in several other locations.

Our licensing business is also healthy. You should keep in mind that the increase is noteworthy as the comparative was affected by men’s sportswear transition. We saw very good performance from the key categories such as women’s sportswear, men’s and women’s outerwear, children’s apparel and dress shirts. We are excited to note that Le Tigre has now launched. It’s currently in 600 doors domestically with juniors and handbags, with orders for young men’s and women’s footwear to follow in the fall.

Early feedback on the product is very good. We are confident that this will develop into a significant business in relatively short order both domestically and abroad. As we go forward we have a variety of opportunities to drive quality and licensing income. Existing [inaudible] category should continue the rates of growth, Le Tigre is quickly becoming meaningful for us and we are accelerating the growth of our international business.

Our wholesale business is our major challenge as we saw a sales decline of approximately 11% versus last year. This softness is impacted by the tough trends in the marketplace specifically in the [action] products. Replenishment businesses which carry some of our highest margins have slowed. We are also seeing increased dilution due to more aggressive allowances and imposed charge-backs.

However [more] product, more aggressive marketing and improved merchandising should we believe mitigate these trends. We have remained focused on keeping inventories at the right levels and as we grow they are clean and current and were down approximately 11%. We have implemented a number of steps to improve our sales trends in fall and holiday seasons which is typically our strongest time of the year. We have increased our marketing efforts from last year and will continue to market aggressively to drive traffic through our stores and to support our products and the overall brand with the continued promotion of our 25th anniversary initiatives.

We have created a very compelling gift program for the holiday season which we think will increase traffic in our own stores and our DTC to help channel this distribution. We also our updating our core product assortment to move faster selling styles in to automatically replenish those trends more quickly. Finally we continue to invest in our sportswear initiative which is an even bigger opportunities. While we anticipate this year is going to reflect a difficult general environment we are confident that we will return to profitability in the second half and be better positioned for it in ’09. We believe that our brands have the potential to be much larger than they are in every one of our businesses and in all of our distribution points. And we are comfortable that we have the right leadership in place to take advantage of that opportunity.

With confidence in our opportunities we have purchased 1.1 million over the past 12 months of the company stock. And we intend to continue to utilize our share buyback program to drive value to our shareholders and we currently have approximately 4 million shares authorized for repurchase. In addition the Board has approved a dividend of $0.09 per share for the quarter.

In the end I believe we have powerful and viable brands, we have a strong management team and I’m confident that we will deliver the appropriate value to our shareholders and we are very much appreciative of their support.

I’d now like to turn the call over to David to run through the numbers for the quarter in detail and our guidance for next quarter.

David Edelman

Thank you Kenneth, let’s start with the income statement. Net sales for the quarter were $112.5 million down 5.3% versus the year-ago first quarter. Wholesale sales were $74.1 million versus $82.9 million last year, a decline of 10.7%. The decline in wholesale was partially offset by the initial shipment of men’s sportswear that occurred in the quarter. Consumer direct revenues during the quarter increased by 4.3% driven by a store comp sales increase of 3.4% and six new [Allen] Stores but offset somewhat by 11 fewer store locations compared to last year.

Licensing revenues also grew increasing 4.4% versus the prior year despite a difficult year-over-year comparison due to the inclusion of sportswear related licensing income in last year’s first quarter. Gross margin during the first quarter improved 40 basis points to 41% versus 40.6% last year. This is primarily the effect of a shift in mix towards consumer direct and licensing which each carry higher gross margin rates than wholesale.

SG&A expenses rose 1.9% to $49.1 million from $48.2 million in the year-ago quarter. SG&A as a percent of sales increased by 280 basis points to 40.1%. This requires some discussion to understand the numbers. We have reduced our core expense run rate. This was achieved primarily through a 5% reduction in corporate headcount, a reduction in depreciation and cost reductions in certain G&A categories such as insurance and technology. We expect our cost cutting to drive total expense dollars for fiscal 2008 down slightly versus last year. This includes the effect of the investment we are making for infrastructure in men’s sportswear and the incremental marketing budget.

These two items are also responsible for the quarterly year-over-year increase. As a result of these factors operating income for the first quarter was just over $1.1 million compared to $4.3 million in the year-ago quarter. Interest and other income in the quarter was approximately $300,000 versus $1.3 million in the year-ago period. This reflects the lower interest rate environment, the switch from use of overnight money markets to treasury securities and a $550,000 write-down to reflect a mark-to-market of our marketable securities.

In the quarter we bought back approximately 413,000 shares at an average price of $16.45. Net income for the period was $807,000 or $0.04 per fully diluted share in line with our guidance compared to $3.4 million or $0.17 per share in the year-ago quarter. Turning to our balance sheet, controlling our inventories was a focus for us during the quarter. Consolidated inventory was down 2.1% versus the prior year’s period. Wholesale inventory which includes inventory for the ramp up of our sportswear business was down 11.5% versus the prior year’s period. Consumer direct inventory for the quarter was up 8.6% which we believe is an appropriate level based on the trends in that business and new planned store openings.

In general we are satisfied that inventory is at the appropriate place both in terms of its mix and its dollar value. Accounts receivable are current at $60.4 million versus the year-ago level of $65.6 million. At the end of the quarter we had approximately $71.5 million in cash versus the year-ago level of $92.2 million. Note that we bought back approximately $26 million of stock since this time last year and we spent approximately $13 million to date for the LeTigre transaction.

We continue to have no long-term debt. The Board approved a quarterly dividend of $0.09 per share payable on June 12 to stockholders of record as of May 22. Now I’d like to address our outlook for the second quarter. We expect to see a net loss in the range of $0.11 to $0.13 versus our year-ago profit of $0.16 per share. We are currently expecting second quarter consolidated net revenue in the range of $108 million to $113 million versus the $119 million we recorded in the year-ago quarter. There are few items driving these comparisons but our outlook for wholesale is the single largest factor. Our reaction [inaudible] business is under significant pressure and we expect that due to slower sell-through rates we will see a reduction in our replenishment business.

We are also seeing increased sales dilution because of increased markdowns and allowances. This impacts both sales and gross margin rates. As Kenneth mentioned we are implementing a number of strategies to improve our results. They are not anticipated to impact the second quarter but should help the second half results. Also with respect to second quarter you should factor in lower interest income as a result of our decision to invest cash in treasury securities and you should bear in mind that licensing income is forecast to decline slightly in the second quarter due to the difficult comparisons of having sportswear royalties in last year’s number.

Thank you. I’ll now turn the call back to Kenneth for closing comments.

Kenneth Cole

Thank you David, I’d like to take a moment to thank our employees for their hard work and continued dedication, our customers for their loyalty, and our shareholders for their ongoing support.

We would now like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Scott Krasik – CL King & Associates Inc.

Scott Krasik – CL King & Associates Inc.

You’ve thrown out some sort of general statements about improvement in the second half of the year but when I look back you haven’t had an up EPS quarter since the fourth quarter of 2006 and you just seem to be losing share in wholesale. Why do you have any confidence at all in the second half improvements?

Kenneth Cole

That’s a good question. Certainly the trend right now isn’t ideal and nor is the environment but last year if you might remember we had kind of a non-recurring SAP hit which was a cost that doesn’t exist in our fourth quarter this year we’re not going to be anniversarying. We have better SG&A numbers that we’re up against because of some of the changes that we addressed. We have better stores. We have closed 11 unproductive stores and we opened eight more productive stores. Sportswear if you remember last year in the fourth quarter we had only the expenses but none of the revenues to offset it because we had just started the fourth quarter [inaudible]. Also on the revenue side we have a gifting program that is unique to us oddly enough but a pervasive one that we’re very excited about in all the stores to drive business in the very important fourth quarter. And we have an anniversary campaign, our 25th anniversary which is [inaudible] in the fourth quarter and the whole awareness initiative and all that sort of stuff. So there’s a lot of thing going on and we think that when these two come together we think we feel pretty good for the second.

Scott Krasik – CL King & Associates Inc.

Did your full price retail stores, how did they comp in the quarter?

Kenneth Cole

They were off a little bit obviously but they were offset obviously by positive [breakout] stores. They have improved but they haven’t improved enough and we believe we can make considerable enhancements there.

Scott Krasik – CL King & Associates Inc.

In some of this reaction replenishment business are you getting replaced by Macy’s private label and can you get any of this market share back or how can you get this market share back in the department store channel?

Kenneth Cole

One of the problems in the reaction business and its invariably cyclical when you have a wholesale business model, invariably you need to support it with inventories; product performs well through third party channels. You need to sustain and maintain an inventory. You try to avoid having to take mark it down because that’s where your margins become eroded. So but invariably at some point that business hit the wall so unfortunately we had that happen as an element of our reaction. So we’re accelerating some newer products. They’re starting to show early signs that are very positive so we’re going through that little transition unfortunately it happened both pretty much at the same time. We have lost market share, I don’t know how much of it went to private label, but I think that we’ll get it back. I think our biggest competitor is really ourselves. When we execute business and then we don’t [market] it.

Scott Krasik – CL King & Associates Inc.

Apparel you sort of rushed it out and the channel was a little bit sloppy because there was old merchandise there, where are we in terms of, are the channels clean with the new product yet and what’s the outlook for fall?

Kenneth Cole

The channels are still not totally clean and we’re dealing in retrospect the product we needed a little more of a core basic element to the line which we’re trying to accelerate into the marketplace. We’re running a more [course] men’s sportswear business now. We’re only selling in up 85% available to buy, we’re holding back opportunistically to fill and replenish the core businesses. We’re running a much cleaner tighter business and we’re reacting to trends better than we have and the business isn’t quite progressing as we had hoped but we’re confident that we’ll start seeing that improving by the back half of this year.

Operator

Your next question comes from the line of Jeff Van Sinderen – B. Riley & Company

Jeff Van Sinderen – B. Riley & Company

Can you give us a little more color on what’s happening at your full price retail stores in terms of recent full price selling, markdowns, inventory management, and how you feel the assortment is or how you feel the assortment needs to be modified there in terms of concentration and content?

Kenneth Cole

The retail stores are, the gross margins are improving and the revenues are improving. Our trend is better in regular priced goods than it has been. We believe especially now having closed certain of the least profitable of the stores we think you’ll see that get even better. The merchandise is I think it’s more on line and the price point is not quite as high as we had brought them in at certain points. The margins are healthier. We’re still moving products now, culturally for the stores as opposed to the third parties and we’re trying to adapt them to the stores and we’ve consolidated a lot of the operating synergy between outlet and retail. We’ve looked at them together and finding a lot of efficiency there as well. And we have a lot of businesses opportunistically that are performing well. Handbags is one that we’re very excited about looking forward especially the back half of the year.

Jeff Van Sinderen – B. Riley & Company

So as far as what’s driving the comps is that your full priced retail stores, is it the transactions being up, is it UPT, can you just us a sense of that?

David Edelman

When we give our numbers it actually a consolidated base of outlet and retail together but basically our UPTs are up very slightly. Our sales per square foot is up a little bit about 4$% and I think traffic; we’re in the process of installing traffic counters in all our stores. We had test and I think in the next couple of months we’ll have full information on traffic, but our traffic is down.

Jeff Van Sinderen – B. Riley & Company

I didn’t really hear all of what you said on the apparel launch, I was just wondering if you can give us a little more color on that in terms of reorders, booking trends, markdowns at retail, again this is the men’s sportswear launch and do you feel you have the product right there or does it need to be modified and then also are you going into more doors with that? I think you said you were pulling back in terms of open to buys and then also are you diversifying channels there yet?

Kenneth Cole

I think it’s a little early to answer all of that question. Right now we have the business is still relatively small and we don’t, I’m not sure I can get into, the product, we felt we missed certain classifications which we’re addressing as we speak before we grow the business and create a critical mass we’re trying to address in its current state. The market continues to tell us the opportunity is there and we are, we believe that in our business we’ll be able to support that.

Jeff Van Sinderen – B. Riley & Company

Can you give us any more color on the sourcing and supply picture, do you anticipate significant cost pressure to develop there this year?

Kenneth Cole

Cost pressure on sourcing the men’s sportswear?

Jeff Van Sinderen – B. Riley & Company

Yes, just generally in terms of your footwear, in terms of your other product that you’re wholesaling or that you’re selling through your retail stores, in terms of sourcing are you finding that it’s costing you more, that you’re seeing some cost pressure on the sourcing front?

Kenneth Cole

Prices have come up. We did not adequately anticipate it in some ways, adequate for this current probably Q1, probably might of in Q2, but we’re being a little bit more proactive as we look to the back half of the year.

Jeff Van Sinderen – B. Riley & Company

Do you have any auction rate securities, I assume you do not?

David Edelman

We actually do, we have $8 million of auction rate, they’re classified on our balance sheet as investments under long-term securities. They’re not in the cash number that we reported.

Operator

Your next question comes from the line of Robert Samuels – JP Morgan

Robert Samuels - JP Morgan

Jill, I know you’ve only been there for a few days, but sort of as an outsider looking in, can you sort of give us your perspective on what the biggest problems in terms of the brand what you think is the low-hanging fruit and sort of the easy things that you can address in the first six to 12 months?

Jill Granoff

Well its day two, so it is still very early. But without a doubt one of our focus will be the consumer direct channel. We think that there are certainly opportunity there and as Kenneth talked about we will look at right sizing our stores to drive greater productivity and we will also be looking at expanding outlets where appropriate. Those have done quite well and we think we have a lot of opportunity on the internet front and certainly from a licensing perspective we think there are opportunities in the international marketplace. So these are some of the things that we’ll look at. There are also some classifications that we feel have greater potential and as you’ve heard we think sportswear and handbags are some areas where we might see growth. But it’s really very early to put any specific plans in place right now.

Robert Samuels - JP Morgan

Have you seen any lift from the most recent advertising campaign?

Kenneth Cole

Its hard to quantify that but we’re getting great feedback and the campaign going forward you’ll see is a little bit more focused on the products but continues to speak to the social, meaningful and relevant social message.

Operator

Your final question comes from the line of Heather Boksen – Sidotti & Company

Heather Boksen – Sidotti & Company

Maybe to get back to what Scott touched on earlier, with respect to what you’re seeing in the back half of the year that gives you confidence, you mentioned some of the cost issues that don’t repeat and you having men’s sportswear revenue in the fourth quarter, is there anything on the wholesale line, the wholesale footwear especially that you’re seeing that makes you optimistic? And are we expecting that part of the business to be up in the back half of the year?

Kenneth Cole

The wholesale business is, we’re not expecting it to be up by year-end. We’re kind of preparing for, we’re proportionately optimistic but we’re not expecting it to improve. We’re just managing it more prudently and more carefully. We are running a much more affective and test and react initiatives. We’re testing better and reacting more efficiently and more productively and quickly and we believe to enhance margins and hopefully, to promote inventories and better turns.

Heather Boksen – Sidotti & Company

In addition to just general economics one of the things that’s been hurting industry wide has been a lack new fashion trends, is there anything you’re seeing there you think that might be a catalyst for footwear sales going forward?

Kenneth Cole

We know what the trends are and we’ve got several different business leads and are you asking, is this a fashion question or is this a business question?

Heather Boksen – Sidotti & Company

It’s a fashion question.

Kenneth Cole

Yes ideas are important and continue to have a place and comfort continues to be important and it doesn’t go away. Pretty sexy shoes are finding their way back into the market and but I think we’re realistic, I think we understand where the market is going and I think we get that and in return execute it within the confines of the brand dimension that exist.

Heather Boksen – Sidotti & Company

With regards to the guidance for the second quarter you said if the aging is good and the wholesale inventories were down 11% at the end of the quarter to get to the [loss] you’re looking for implies and you’ve kind of said it, reduced margins, is that just a factor of increased markdown allowances, is there too much inventory in the channel, because it looks like in terms of your own inventory those are in line.

David Edelman

The guidance contemplates two factors that are bringing down our margins. One is the increased markdowns and allowances and also with less replenishment business which is usually full margin and it doesn’t require support that business is shrinking. But its also as Kenneth mentioned earlier we have some cost pressures that we’re unable to do anything about in the Q2 but we’re dealing with as we go further out for Q3 and Q4 relating to freight and some labor charges.

Operator

Ladies and gentlemen this concludes our Q&A session. I would like to turn the call over the Mr. Kenneth Cole for closing remarks.

Kenneth Cole

I want to thank our shareholders and our staff, our management team again for their efforts above and beyond efforts and dedication to this commitment. There are certain opportunities we intend to avail ourselves and we are confident we will deliver more significant good turns in the not to distant future. Thank you very much.

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Source: Kenneth Cole Productions, Inc. F1Q08 (Qtr End 03/31/08) Earnings Call Transcript
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