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True Religion Apparel, Inc. (NASDAQ:TRLG)

Q4 2007 Earnings Call Transcript

April 29, 2008 4:30 pm ET

Executives

Andrew Greenebaum – IR, ICR Inc.

Jeff Lubell – CEO and Chairman

Pete Collins – CFO

Michael Buckley – President

Analysts

Eric Beder – Brean Murray

Karen Short – Friedman Billings Ramsey

Jeff Mintz – Wedbush

Ronald Bookbinder – Global Hunter

Jody Kane – Sidoti & Co.

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the True Religion Apparel, Inc. 2008 first quarter financial results conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be opened for question. (Operator instructions) This conference call is being recorded today, Tuesday, April 29 of 2008. I would now like to turn the conference over to Andrew Greenebaum of ICR. Please go ahead, sir.

Andrew Greenebaum

Good afternoon, everyone, and thank you for joining us today to discuss True Religion Apparel's fourth quarter 2007 year-end financial results. For the purposes of today's call the company will be restricting its comments to its fourth-quarter and full-year 2007 performance. The company will update the investment community on its Q1 2008 financial results, 2008 guidance, and business initiatives for 2008 concurrent with its Q1 2008 earnings release currently scheduled for next Thursday, May 8, 2008.

On the call today are Jeff Lubell, True Religion's Chairman and Chief Executive Officer, Michael Buckley, the company's President, and Pete Collins, the company's Chief Financial Officer.

By now, everyone should have had the access to the fourth quarter and fiscal 2007 earnings release, which went out today at approximately 4:00 pm Eastern Time. If you have not received the release, it is available on the Investor Relations portion of True Religion's website at www.truereligionbrandjeans.com, by checking on the Investor Relations tab. This call is being webcast and the replay will be available and archived on the company's website.

Please note that all the information discussed on the call today is covered under the Safe Harbor provision of the Private Securities Litigation Reform Act. We caution listeners that during this call True Religion management will be making forward-looking statements. Actual results could differ materially from those stated or implied by our forward-looking statements as to risk and uncertainties associated with the company's business. These forward-looking statements are qualified in their entirety by the cautionary statements contained in True Religion's SEC filings, including the Annual Report filing on Form 10-K, and the quarterly report on Form 10-Q. The content of this conference call contains time-sensitive information, which is accurate only of the date of this live broadcast, April 29, 2008. True Religion undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call.

With that said, it is my pleasure to turn the call over the Jeff Lubell. Jeff?

Jeff Lubell

Thanks, Andrew, and good afternoon everyone and thank you for joining us today as we discuss our 2007 fourth-quarter and year-end financial results. The format of today's call will include my brief business overview and highlights for the fourth quarter and full year. Pete will follow with a thorough discussion of our financial restatement, as well as provide additional detail on our fourth quarter and year-end financial results. Michael will then provide an update on our business operations before opening the call up to your questions.

2007 was a transformational year for True Religion, characterized by an evolving distribution strategy, an expanding collection of premium denim and denim-related sportswear products, and accelerated growth in revenue and profitability. We are extremely pleased with our fourth-quarter and full-year 2007 results. We achieved record-breaking sales in the fourth quarter with year-over-year sales up 73.5% to $52.7 million, due to the continued growth of the brand, particularly in our premium wholesale and consumer direct segments.

Reflecting the strength of our growth in consumer direct business, our fourth-quarter gross margins expanded to 57.2% from 54.6% in the prior-year period. For the year, we recorded net sales of $173.3 million, up 23.3% from 2006, and our gross margins expanded over 360 basis points to 57% from 53.4% in 2006.

We continue to make significant progress on our goals to diversify our distribution, introducing new and innovative products, and developing more global points of presence to further establish True Religion as a global aspirational brand. We opened up 11 new stores in 2007, bringing our total branded retail store base in 2007 to 15, ahead of our initial plan. As a group, these stores delivered top tier operating margins in excess of 40%. The stores opened in 2007 were located in premier shopping centers with strong consumer demographics, excellent traffic trends, and complementary retail partners.

For the year, our consumer direct segment represented 16.9% of net sales, compared to 3.9% in 2006. In 2008, we continued to achieve the growth in our stores base with at least 35 branded retail stores. We expect that our consumer direct net sales will exceed 27% of total net sales in 2008.

As our consumer direct business becomes more significant as a percentage of our total sales, we expect to further expand our gross margin. We also generated strong growth in our domestic wholesale business with year-over-year increases in net sales of 62.4% and 24.9% in the fourth quarter and second half of 2007, respectively, led by the strength of our 2007 Fall and Holiday collections. Our 2007 Fall and Holiday collections focused on a wide array of authentic denim, washes from very clean to very distressed vintage looks. We introduced new and innovative styles, fits and washes, new styling details, hardwares and trims. We also further differentiated ourselves from other denim-based brands by offering additional embellishments, such as leather logos, diamond-like crystals, and painted logo pockets, new design stitching concepts, as well as our Big-T stitch and our patented Super-T stitch in new and flattering fits in both our men's and women's denim collections.

With our women's denim collection, the notable highlights included the Disco collection, which is a denim jean encrusted with diamond-like crystals on both the tack buttons and the rivets, was an immediate hit and sold out almost overnight when introduced to our consumers and retailers during our Holiday 2007 collection. We further expanded our Disco collection in our Spring 2008 product offering, also into Fall 2008.

The foil painted pocket jean, which includes the traditional True Religion logo on the front and back pockets in various metallic colored paint.

The Rock Star collection, which we launched under our Seamless Denim Group, utilizes a four-way stretch fabric by INVISTA, that looks like a jean, yet fits like a legging, with pockets, waistband and front closing only top stitched. This jean fits like a second skin.

Within our men's denim collection, notable highlights included the Heritage Group, which is our workwear-inspired denim group, introduced in our Fall 2007 collection, and our big stitch – Big-T and the patented Super-T stitch design, which, with two stitches per inch, is bold, detailing design, extremely distinguishable as uniquely True Religion. The Super-T has quickly become a staple of our men's denim line and the styles designed using the Super Big-T stitch were some of the best sellers in 2007.

We entered 2007 with product diversification as a top priority, particularly on the non-denim side. Today, we are a global aspirational brand that maintains a strong denim foundation. Our roots lie in denim and we will continue to update and innovate our denim collections and our sportswear collections to appeal to our True Religion customers, while reaching out to new customers. The philosophy of providing well-fitting, comfortable, and distinctive products has since carried into our denim-related sportswear collection.

Our 2007 Fall and Holiday sportswear collections included a variety of solid and screen printed short sleeved tee shirts and long-sleeve tee shirts, polos, V-necks, fleece – and outerwear, track pants, sweater knits, hoodies, shorts, mini-skirts, and western-inspired woven shirts in various looks, both printed and solid.

We continue to expand our sportswear product with our Spring/Summer 2008 sportswear collections. Our Spring and Summer 2008 collection was the broadest in the company's history, building upon our 2007 Fall and Holiday collections with a variety of denim and sportswear in a huge range of colors in unique vintage finishes and fits. We updated our existing classic looks, offered product in a myriad of colors, and with a large variety of screen printed graphics in logo-driven, as well as non-logo driven.

As part of our product diversification strategy, we expanded into our four new product categories, including headwear, footwear, handbags and swimwear through licensing agreements. As the chief merchant, I am intimately involved in the design process for every piece that we or our licensees create to ensure our licensed products echo the True Religion design sentiment and reveal a sense of unity throughout our entire collection.

Our 2008 Spring and Summer collections featured our licensed handbags and swimwear and the response has been terrific. Our swimwear collection is very distinct, with swimwear characterized by bold prints, bright colors, and inventive fabrics, crochets in solid and arm-bracing [ph] cotton, washable leathers and suede, stretch velour, indigo French terries [ph] with Lycra, just to name a few.

Our bathing suits are accompanied by bright cover-ups for women's and a unique design innovated board short collection for men. We also introduced our full line of handbags offered in a wide range of colors and SKUs and high quality fabrics, which also includes small leather goods, clutches in a multitude of different sizes.

Our quality and construction were a huge success with some bags incorporating python and leather and serape-type fabrics, yet remaining at attainable price points for the True Religion customer.

Additionally, in 2007, we continued to make progress in increasing awareness of the True Religion brand worldwide. In the fourth quarter, international net sales increased 21.3% over the fourth quarter of 2006, and for the year, excluding Japan and the UK, international wholesale sales increased 11.5% over 2006. Michael will provide additional information on our international strategy in his remarks on today's call.

In summary, we couldn't be more pleased with the way we finished the year, particularly in light of the overall consumer environment. Our fourth quarter results reflect strong brand momentum across both our wholesale and retail businesses. We attribute our strong performance to our continued ability to provide consumers with a comprehensive portfolio of innovative, fashion-forward denim and sportswear products supported by our multi-segmented distribution model. We are especially pleased to report that our strong momentum has carried over into the first quarter of 2008, which we look forward to updating you on the next earnings call.

Looking to 2008 and beyond, I remain confident in the long-term prospects for the business and the strength of the team leading it. From a design, operational, financial, and overall cohesiveness perspective this team has never been stronger. Michael Buckley, our President, joined True Religion in the second quarter of 2006 from Ben Sherman for over a five-year period and, previously, Diesel, for a period of over five years. Michael's background in helping growing international power brands will continue to be a tremendous resource as we further establish True Religion as a globally recognized brand.

Pete Collins, our Chief Financial Officer, joined the team in the first quarter of 2007 and brings over 16 years of public accounting experience, as well as five years with Nordstrom's and Albertson's. Pete has been a remarkable asset to our financial team, instilling a strong sense of structure within our finance organization, identifying and implementing process and improvements to ensure timely financial reporting and tight financial controls on a go-forward basis. Pete has brought in several key hires aimed at raising the overall capabilities of the department and has also brought in more qualified legal, finance, accounting, and tax advisors. Importantly, Pete led the restatement process, ensuring we work to complete this matter in a complete and timely fashion as possible. We are confident that the proactive changes throughout the finance organization vastly improve our controls and reporting process and place us in line with public company requirements on a go-forward basis.

As a team, Michael, Pete, and myself bring a collective approach to managing and growing the business. We are equally committed to driving the business forward and we will continue to provide transparency and visibility into our progress through ongoing communications with our shareholders and the investment community. In addition to senior management, we have a terrific bench strength across our organization. We have continued to build our infrastructure within our retail, finance, and production teams to support our growth. We continue to invest in talented, experienced personnel to drive our ongoing growth and keep momentum strong.

That concludes my remarks. I will now turn the call over to Pete to review our restatements, as well as our financial results for the fourth quarter and full year. Pete?

Pete Collins

Thanks, Jeff, and good afternoon, everyone. As I'm sure many of you are aware, we announced on our third quarter call that we would need to restate our previously issued consolidated financial statements for the fiscal years ended December 31, 2005 and 2006, including the quarters therein, and the quarter ended March 31, 2007, and the quarter ended June 30, 2007, due to certain accounting errors.

The restatements center on three main areas – income taxes, restricted stock compensation, and accounting for stock options. With respect to income taxes, our prior financial statements did not recognize that our executive cash bonus and restricted stock award programs were not performance-based, as defined by the tax code. The tax code does not allow compensation over $1 million earned by the company's highest paid executives to be deducted, unless the company's stockholders and Board have approved the programs in advance. We did not meet these requirements in prior years, so we should have limited the deductions to $1 million per executive per year when we computed our annual tax expense. We have recomputed our tax expense to recognize these limitations, and have recorded additional income tax expense of $1.5 million for 2007, $1.1 million for 2006, approximately $600,000 for 2005, and approximately $100,000 for 2004.

To correct these errors, we will pay additional income taxes of approximately $6 million for the period 2004 through 2007, which is reflected in our balance sheet as of December 31, 2007. This amount includes the $3.3 million in additional income taxes resulting from the greater amount of compensation recorded in 2004 through 2007 that was not fully deductible. In addition, we have increased our income taxes payable by $2.7 million to recognize that tax deductions taken in prior years should have been limited. The benefit of these deductions was originally recorded as an increase to equity, so the restatement will result in a decrease in equity by a corresponding amount.

Turning to restricted stock compensation, we had previously determined and identified on our third quarter call that the company did not record enough compensation expense in 2006 for the January 2006 restricted stock award. At that time, the company reported that it had incorrectly booked approximately $1.2 million of stock-based compensation in the first quarter of 2007, when the error was initially identified, versus in 2006. As such, we have shifted this $1.2 million of compensation from 2007 back into 2006.

In the review work performed since November, the company identified an additional $1.2 million of compensation expense that was incorrectly booked in January 2007 because the actual grants had occurred in December of 2006. To correct this error, we shifted an additional $1.2 million of pre-tax compensation from 2007 back to 2006.

On the stock options front, we analyzed the accounting for all stock options grants since the company's inception. We found that the accounting was not correct in certain situations. We have recorded additional pre-tax compensation expense of approximately $300,000 in 2007, $400,000 in 2006, approximately $300,000 in 2005 and approximately $400,000 in 2004 to correct these errors.

In addition to these restatement adjustments identified, we have corrected other immaterial errors in our prior period financial statements, and have reclassified some transactions within the 2006 and 2005 income statements. We have a separate footnote in the amended 2006 10-K and the amended first and second quarter of 2007 10-Qs, which explain our adjustments and reclassifications.

In connection with the identification of these accounting errors leading to the restatement of our prior period financial statements and a comprehensive evaluation of the effectiveness of the design and operations of our disclosure controls and procedures, we will report that we have identified material weaknesses in the company's internal control over financial reporting as of December 31, 2007 in income taxes, stock-based compensation, and the financial close and reporting process.

We have taken a number of actions over the past year to correct these weaknesses, including strengthening our finance and accounting teams and engaging new legal counsel and tax advisors. We are intently focused on improving our internal controls over financial reporting and intend to remedy identified internal control weaknesses throughout 2008.

Turning now to our results for the fourth quarter and the year ended December 31, 2007, net sales for the quarter increased 73.5% to $52.7 million versus $30.4 million in the fourth quarter of 2006. Consumer direct sales, which include both our branded retail sales and our e-commerce, increased 265.8% during the fourth quarter to $11.5 million from $3.1 million in the fourth quarter of 2006. The growth is largely attributable to the expansion of our retail stores, which totaled 15 at the end of 2007, compared to four at the end of 2006.

U.S. wholesale sales for the quarter increased 62.4% to $31.8 million versus $19.6 million in 2006, led by the continued acceptance of our men's product lines, the introduction of new denim and sportswear offerings in the second half of 2007, and continued growth within our premium boutique accounts.

International wholesale sales for the fourth quarter increased 21.3% to $9.2 million versus $7.6 million in the same period of 2006 as we began to experience benefits from our planned restructuring at the key international markets in Japan and the United Kingdom.

Fourth quarter net sales included approximately $200,000 of licensing revenue. Gross profit in the fourth quarter grew 81.8% to $30.1 million, or 57.2% of net sales, from $16.6 million, or 54.6% of net sales in the fourth quarter of 2006. The 260 basis point improvement in gross margin was primarily a result of our higher margin consumer direct business generating a larger share of our total net sales.

Our selling, general, and administrative expenses increased 42.1% to $15.4 million in the quarter, from $10.8 million in the prior-year period, primarily due to the growth in our consumer direct business and incremental investment in our infrastructure as we look to support our long term growth plan. Our fourth quarter SG&A includes $2.4 million of incremental operating costs for the expansion of the consumer direct business. This incremental increase can largely be attributed to additional occupancy costs, sales personnel, and store management associated with our retail store growth. As a percentage of sales, SG&A decreased to 29.2% from 35.7%, as we were better able to leverage our overhead expenses due to our net sales increase.

Operating margin for the fourth quarter increased over 900 basis points to 27.9%, from 18.9% in the prior-year period, primarily due to higher sales and stronger margins generated in our consumer direct business.

Our effective tax rate in the 2007 fourth quarter was 41%. Net income for the 2007 fourth quarter was $8.9 million, or $0.37 per diluted share based on weighted average shares outstanding of 24 million shares, compared to net income of $4.1 million, or $0.18 per diluted share on a weighted average share count of 23.6 million in the fourth quarter of 2006.

On a non-GAAP basis, adjusted net income for the fourth quarter of 2007 was $9.4 million, or $0.40 per diluted share based on a 23.6 million weighted average share count. Our non-GAAP adjusted earnings per share excluded $395,000 of additional income taxes resulting from compensation recorded in the fourth quarter of 2007 that was not deductible and reflects a reduced weighted average share count.

Our weighted average share count for the fourth quarter and full year of 2007 exceeded the share count used when we previously reiterated our full year 2007 guidance by approximately 300,000 shares. This is due to a change in the anticipated future tax treatment of vested stock options, which we identified in the review of our accounting for stock options as part of the overall restatement project.

Turning to our 2007 full year results, net sales for the period increased 23.3% to $173.3 million versus $140.5 million in the same period last year. Net sales in the consumer direct segment increased 430.8% to $29.3 million, compared to $5.5 million in 2006. U.S. wholesale net sales increased 14.6% to $111.4 million, compared with $97.2 million in 2006.

International wholesale net sales decreased 15.8% to $31.7 million versus $37.7 million in 2006. Net sales in 2007 from licensing revenues were approximately $900,000.

Turning now to net sales by the three classifications of our business, in 2007 59% of our net sales came from women's merchandise, 37% from men's, and 4% from kids. Our average sales price for women's products in our full price retail stores was $213 in 2007, for men's products, it was $217, and for kids' products, it was $96.

Gross profit for the full year 2007 was $98.8 million, or 57% of net sales, compared with $75.0 million, or 53.4% of net sales in 2006. Gross margin was positively impacted by segment mix shift reflecting increased penetration of our higher margin consumer direct sales. Gross margin by segment for the full year is as follows. Consumer direct was at 76.7%, U.S. wholesale at 53.9%, and international wholesale at 48.8%.

Selling, general, and administration expenses for the year increased 29.1% to $51.7 million, from $40.0 million in 2006, driven primarily by an increase in the number of our retail stores, the expansion of our design team, a larger distribution center, and the buildup of administrative functions to support our accelerated growth profile. Our full year 2007 SG&A includes $8.2 million of incremental operating costs for the continued expansion of our consumer direct business.

Also, during 2007, we incurred severance and recruiting costs of $2.4 million related to the replacement of two executives in 2007 and a charge of approximately $300,000 related to the termination of the strategic review with Goldman Sachs. Our 2006 SG&A included a $2.1 million litigation settlement cost.

Operating margins for the year increased to 27.2% from 24.9% in 2006, led by the growth in our consumer direct segment. Our tax rate for the full year of 2007 was 43.1%, which exceeded the midpoint of our previous estimate of 38% to 39% by more than 450 basis points. This impacts our 2007 net income by approximately $2.3 million. The greater than anticipated tax rate is largely due to the greater amount of compensation recorded in 2007 that was not fully deductible as discussed in my prior remarks. In addition, we incurred approximately $800,000 of incremental taxes related to miscellaneous adjustments, which also caused our income tax rate to be higher than expected.

Net income for 2007 was $27.8 million, or $1.16 per diluted share based on weighted average shares outstanding of 23.9 million, compared to net income for 2006 of $21.7 million, or $0.92 per diluted share based on weighted average shares outstanding of 23.6 million.

On a non-GAAP basis, adjusted net income for the year was $30.5 million, or $1.29 per diluted share based on a 23.6 million weighted average shares outstanding count. Our non-GAAP adjusted EPS excludes the severance and recruiting costs related to the replacement of two former executives, the termination of the strategic review with Goldman Sachs, the previously mentioned restatement items impacting our 2007 financial results, the unanticipated change in our 2007 effective tax rate, and the increase in our weighted average shares outstanding by approximately 300,000 shares, as previously mentioned.

Turning to our balance sheet at December 31, 2007, the company had approximately $44.2 million in cash, cash equivalents, and marketable securities. Accounts receivable, including receivable from factor, totaled $27.9 million, compared with $16.0 million at December 31, 2006. This increase comes primarily from the increase in our U.S. wholesale sales in the fourth quarter of 2007 versus 2006, as well as a change in wholesale sales patterns in the quarter leading up to the two measurement dates.

Inventory totaled $20.8 million at December 31, 2007, versus $9.3 million at December 31, 2006. This year-over-year increase is a result of the expansion of our wholesale inventory to support the first quarter order book, as well as the increase in our store count, and the expansion of our consumer direct business. As we've mentioned in prior quarters, we continue to carry no debt on our balance sheet as of December 31, 2007.

Now, I'd like to make some remarks as it relates to our 2008 guidance that we provided back in January. As mentioned, we will provide a full update to our 2008 guidance with you on our Q1 2008 conference call on May 8. However, we feel it is important to mention a couple of items that are meaningful to our 2008 quarterly results. This past January, our compensation committee awarded restricted stock to our management team. We estimate that our annual stock-based compensation expense for 2008 will be approximately $10 million. 40% of these costs will be recognized in the first quarter of 2008. The remaining 60% will be recognized ratably over the second through fourth quarters of 2008.

Also, we are ahead of plan on the timing of our branded retail store openings. While we continue to be pleased with our ability to continue our retail expansion, we have incurred incremental pre-opening costs in the first half of 2008. Michael will provide additional detail on our store openings to date, and how this will impact our first quarter results shortly.

Now, I'd like to turn the call over to Michael to discuss our strategic business initiatives. Michael?

Michael Buckley

Thanks, Pete. Good afternoon, everyone. We had a record breaking quarter, the biggest quarter in our history. Our fourth quarter sales reflect solid growth across each of our business segments. This broad based sales momentum demonstrates the success of our multi-segment distribution model as we continue to expand our points of presence to meet the growing demand for True Religion branded products.

As Jeff mentioned, we are pleased to report that the strong sales momentum we spoke of back in January carried over through the first quarter of 2008. We continue to see strong sell-through within our key premium department store accounts and within our own branded retail stores. While we cannot provide specific insight into the sell-through within our premium boutiques, reorder levels remain strong.

With respect to our wholesale business, our total initial wholesale bookings of our Spring 2008 collection, which includes U.S. and international wholesale bookings, were up more than 40% based on our year-end order book as measured each year. The strength of our order book as measured at March 31, 2008 versus 2007, continues to exceed our expectations, indicating that our products continue to be well received by buyers. We have good visibility of the domestic and international wholesale order books for the second and third quarters and will update you on May 8.

Turning to the specific results within our business segments, for the year, we experienced 23% sales growth over 2006 with approximately 82% of the business coming from wholesale, comprised of 64% domestic, and 18% international, 17% coming from consumer direct segment and approximately 1% coming from our licensing segment. Long term, we expect our sales mix to be approximately 45% wholesale, 45% consumer direct, and 10% licensing. Our U.S. wholesale business increased 62.4% and 24.9% in the fourth quarter and second half of 2007, respectively, driven by the strength of our Fall and Holiday 2007 collections.

Despite challenging retail environment that Jeff alluded to, our sales per door continued to rise. As I mentioned, True Religion continues to be a top performer among denim-based brands in terms of sales volume and sell-through within our key premium department store accounts and specialty boutiques.

Turning to our international wholesale business, sales increased 21.3% in the fourth quarter of 2007. For the year, international wholesale sales declined 15.8%, reflecting the planned restructuring of the UK and Japan markets. For the year, excluding Japan and the UK, international wholesale sales increased 11.5% over 2006. Our full year international sales results were adversely impacted by the planned termination of our distribution agreement with our former UK distributor. As a result, sales within the UK for the first and second quarter of 2007 were halted, as we transitioned to a new distributor in the third quarter of 2007. We are very pleased with our current UK distributor and are confident that the transition better positions True Religion for future growth in the region.

With respect to Japan, while we do not break out revenue contribution for the region, as expected, we experienced negative comps over 2006. This was the result of a strategic decision on our part to significantly reduce sales to our Japanese distributor to maintain brand equity, which we implemented in the latter half of 2006. We are currently distributed through approximately 250 to 350 wholesale doors, and we are working closely with our Japanese team to ensure that the True Religion brand is properly positioned within the marketplace. Despite our 2007 performance within the region, we continue to see significant opportunities to grow our business.

The True Religion brand has been the number one U.S.-based premium denim brand since we launched in the region in 2003. We are very pleased to report that we have hired a country manager for Japan that will reside in Japan and be responsible for distribution and retail relationships to help us fully develop the region in a manner that is appropriate for a premium brand. We expect to announce positive news on this front very shortly. Part of building our presence within the Japanese marketplace will be establishing a vertical retail presence through free-standing branded retail stores and shop-in-shop concessions. We currently estimate that the Japanese market can support approximately 15 to 20 retail stores and approximately 20 to 25 shop-in-shop concessions.

With respect to other international markets, we continue to explore opportunities to drive long term growth. We currently have 15 distributors covering 50 countries and spanning six continents to help drive our international wholesale business. Subsequent to the quarter, we announced our new Israeli distribution agreement with Positive Ltd., expanding our presence within the Middle East. We continue to evaluate potential franchisee relationships of our retail stores in select markets, including Mexico, Hong Kong, China, and Dubai. Additionally, we are exploring additional alliances with new distributors and partnerships in new markets, including Turkey, India, and Russia, to name a few.

Turning now to our consumer direct business, net sales increased by 265.8% in the fourth quarter, and by 430.8% in 2007, driven mainly by the increase in our branded store retail count from four stores to 15 stores in 2007. We ended 2007 with 13 full-price stores and two outlet stores. Going forward, we are targeting three to four full- price stores per outlet store. As a class, our stores deliver industry-leading metrics. For the full year 2007, average sales per square foot on an annualized basis were approximately $1,500.

Gross margins were approximately 78.1% in the fourth quarter and 77.1% for the year. Four-wall operating margins were in excess of 47% in the fourth quarter and 45% for the full year 2007. After accounting for retail corporate overhead costs, the consumer direct business delivered a 43.5%, and a 40.8% operating margin for the fourth quarter and full year, respectively. As we continue to grow our consumer direct business towards our goal of 45% of net sales, we expect this business to further accelerate our future revenue growth and profitability.

Our branded stores are located in some of the most sought after, premier retail locations, both freestanding, as well as mall-based. In the fourth quarter we opened two stores, including the Miracle Mile Shop and Fashion Show Mall in Las Vegas. The location of these stores represent the brand well and serve to increase our brand awareness as they generate strong foot traffic and are positioned among other premium and luxury goods retailers. In addition to being a key driver of future growth and revenue and profitability, branded retail supports our ongoing product diversification strategy as it allows us to showcase the entire breadth of our merchandise offering in a controlled environment, as well as provides an opportunity to educate consumers and retailers on our product line. Our branded retail stores are incremental to our wholesale business, as they serve to increase overall brand awareness and allow us to communicate directly with the consumer to better understand their needs.

As we have stated previously, we plan to open at least 20 branded retail stores in 2008, bringing our total branded retail store base to at least 35 stores by year end. At the time of this call, we have 22 stores opened, of which 17 are full price, and 5 of which are outlet stores. In the first quarter, we opened three new stores, including Rio Grande Premium Outlets, Beachwood Place, and Houston Premium Outlets. Thus far in the second quarter, we have opened four stores, including San Francisco Centre, St. John's Town Center, Williamsburg Premium Outlets, and Pentagon City.

In evaluating the U.S. market opportunity for our branded retail stores, at this time we see potential for approximately 110 full price locations and approximately 20 outlet locations. We continue to believe that we have the opportunity to select from some of the most premier A shopping destination around the country for new store locations. Additionally, we will continue to evaluate B locations that we believe will support the growth of the brand without compromising the brand.

As our consumer direct strategy continues to grow in magnitude as a percentage of our overall business, we think it's important to briefly review our new store budgeting process. We carefully evaluate the demographics, population, income levels, and co-tenants, among other criteria, for each of our new branded retail stores. As such, each new store's budget, from a revenue and expense perspective, are independent of one another.

We are commonly asked if we expect average sales per square foot for our new stores to be in line with our historical average sales per square foot of $1,500. However, it is important to recognize we do not budget our new stores from a top-line perspective. Given the unique characteristics of each individual store location and our ability to negotiate store costs, such as occupancy, we budget our new stores using an operating margin hurdle rate of 35% plus. Additionally, from the time we take possession of the store to the time we open our doors, approximately three to four months, we incur pre-opening costs, including rental cost, salaries, utilities and training, of approximately $175,000 per store.

For the first quarter of 2008, we have pre-opening expenses for 10 weighted-average new stores. This accounts for the three stores opened in the first quarter, four stores opened to date in the second quarter, and the remainder opening in the balance of the second quarter and early third quarter. The total cost of capital associated with the build-out of the new stores is approximately $500,000 to $600,000, plus inventory of approximately $150,000 to $250,000.

Turning now to our licensing strategy. In our debut year, licensing revenue generated approximately $900,000 in fees, driven by the strength of our licensed products, including footwear, headwear, handbags, and swimwear. We ended the year with six licenses signed, including our fragrance license, and we are looking to add additional categories, such as sunglasses and eyewear, intimate apparel and underwear, loungewear, watches, and others. We continue to expect to have 10 to 12 licenses by the end of 2009. Our licensing strategy continues to be a core component of our growth strategy and it provides the opportunity to diversify our product mix with minimal infrastructure build into a broader collection, key to establishing True Religion as a global aspirational brand.

That concludes my remarks. We would now like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, at this time, we will begin the question-and-answer session. (Operator instructions) And our first question comes from the line of Eric Beder with Brean Murray. Please go ahead.

Eric Beder – Brean Murray

Good afternoon. Congratulations, guys.

Jeff Lubell

Thanks, Eric.

Michael Buckley

Thanks, Eric.

Eric Beder – Brean Murray

Just a few housekeeping questions. When did Pentagon City store open? And what should we think about in terms of – you've changed the share counts around, what should we think about in terms of share counts for '08?

Michael Buckley

Well, I'll answer the Pentagon City one. That store opened less than a week ago.

Pete Collins

And then on the share count, Eric, we are going to be giving the updated guidance for the– for 2008 next week, but the 300,000 shares we talked about on this call were not included in the guidance that we had originally discussed back in January. So, that's incremental to what we had shared. So, it's probably in the neighborhood of closer to 24.3 million versus what you had seen before.

Eric Beder – Brean Murray

Okay. I don't know if I caught this. What was the percentage of denim, non-denim for Q4 and for '07?

Michael Buckley

I don't think we broke it out.

Pete Collins

Yes, we didn't provide that. The goals are still the same as far as 60% denim and 40% to 50% sportswear, but we didn't provide that specific information for Q4.

Michael Buckley

And even within our own retail stores, some of our best sellers now are on the denim-related sportswear side, some of the new tee shirts and solids and some of the new graphics. The fleece hoodies continue to sell through well and recently some of the solid and paisley western shirts, both men's and women's, have hit and they're on our top seller list within our own retail.

Eric Beder – Brean Murray

Okay. Just two other quick ones. In terms of non-denim in your wholesale channel, we've started seeing more of it. How has- – have you been pleased with kind of the level you are seeing that kind of flow in? And, I guess the other thing is, what are the major trends you guys are seeing in terms of denim this year?

Michael Buckley

Well, let me answer the question on the wholesale side. I mean, clearly it's not the representation that we put in our own stores, but typical of the wholesale customer, they're going to slowly test it and they'll continue to expand on it. And quite frankly you are having more of our own stores out there where they can go into the store and see how we're doing with it, makes it easier for our sales team to sell on the wholesale side. In terms of denim trends, you want to–? You want to run with that one?

Pete Collins

I think on the overall denim trends, I think the one thing I'd share with you, Eric, is some of the comments we've been seeing from Nordstrom in particular that premium denim is doing very well within their shop. So, that's really the kind of the overarching theme is that premium denim, even in this environment, is doing well for the category.

Eric Beder – Brean Murray

Great. Congratulations. And we'll hear you in a few weeks.

Jeff Lubell

Thank you, Eric.

Operator

Thank you. Our next question comes from the line of Karen Short with Friedman Billings Ramsey. Please go ahead.

Karen Short – Friedman Billings Ramsey

Hey, everyone.

Jeff Lubell

Hi, Karen.

Karen Short – Friedman Billings Ramsey

Good quarter.

Jeff Lubell

Thank you.

Karen Short – Friedman Billings Ramsey

Just a couple also housekeeping questions. I guess the first question is, you gave your comments on the restricted stock component of corporate expenses for '08, but I just want to be clear, you're still at $18 million in total corporate expenses for '08 given – it seems like the restricted stock component was a little higher than I would have expected it to be for the year?

Pete Collins

Well, Karen, the guidance that we've given for the year is at the sales line and at the margin line, by segment, the gross margin line by segment, and then at the pre-tax income line. So, that's really the guidance that we've provided, as well as the EPS range. So, that's what we've done and that's what we're staying with. We will have an update when we release our Q1 numbers next Thursday. But at this point, we haven't commented on specific numbers as it relates to the overhead or SG&A.

Karen Short – Friedman Billings Ramsey

Right. But within corporate, the $18 million guidance that you've given, that included the $10 million of restricted stock expense?

Pete Collins

The expense that we have for restricted stock is in line with what the guidance was that we provided. When we issued the guidance in January, we had already had that Board meeting and already knew what the expense was going to be.

Karen Short – Friedman Billings Ramsey

Okay. And then, I'm wondering if you could actually just talk a little bit about your tax rate beyond '08, I mean, is – where – do you see that normalizing beyond '08?

Pete Collins

Yes, I think that from just a statutory rate perspective, with where our operations are, we are starting at pretty much of a 40.8% type of a tax rate. There are some credits that are available to us because of our – because of the fact that we manufacture our denim here in the U.S. that will help bring that down. And then there are other things that we can do to try and minimize our taxes and plan to take advantage of opportunities out there. But, at this point we haven't given specific guidance. But I'd say 40.8% would be a top line ETR going forward. And we are going to – now that we get some of these things behind us, have some time to invest in looking to see what we can do to continue to bring that down.

Karen Short – Friedman Billings Ramsey

Okay. Also, just for modeling purposes, I'm wondering, would you – do you guys have gross margins by division for the fourth quarter available?

Pete Collins

Yes, I think we – my comments – they were in my comments. Let me flip back to the–

Karen Short – Friedman Billings Ramsey

For the quarter, though. Do you – I'm sorry, I didn't catch that if you gave it.

Pete Collins

That's all right. Let me just flip back my comments. No, you're right. I talked about it for the year. For the quarter, the gross margin in U.S. wholesale was 52.8%. And international wholesale was 45.7%. And in the consumer direct segment, it was 77.6%.

Karen Short – Friedman Billings Ramsey

Okay. Thanks. And then I guess just last comment, I mean I guess there's so much noise out there with the consumer kind of derailing and weakness from every possible channel of retail. Can you – you guys seem to be still holding up pretty well. Can you just give some directional comments on what you are seeing out there in the environment?

Michael Buckley

Well I mean, Karen, our business continues to be strong. Some of my prepared remarks talked about how our order book at the end of March is still strong and still ahead of what our initial plans were. I think the one thing that people have to realize with True Religion is we are still a very young brand and very underpenetrated, sort of still in our infancy. So, we would imagine if the macro was better, we would probably be doing even better than we are.

Karen Short – Friedman Billings Ramsey

Okay. Great. Thanks a lot.

Michael Buckley

Thanks, Karen.

Operator

Thank you. Your next question comes from the line of Jeff Mintz with Wedbush. Please go ahead.

Jeff Mintz – Wedbush

Thanks. A couple of questions, Pete. Can you talk a little bit about inventory? I mean, it looks like it's up significantly year-over-year. Obviously, some of that is for the stores. So, could you talk – just talk about what inventory is in the stores and what is more at wholesale inventory levels?

Pete Collins

Well, Jeff, the inventory, if you look at it sequentially, I believe it is very much in line from Q3 to Q4. And really the investment in inventory is a function of the growth in the order book, so we've got more denim styles that we are offering now. So, we are carrying inventory for that. We've got expansion of the product line as it relates to all the sportswear we are carrying. And then the – just the overall growth in the order book necessitates increased inventory. And then the final thing is that, from a store perspective, we are probably carrying in the neighborhood of $4 million to $5 million of inventory to support our retail stores, plus the e-commerce business on top of that. So, the inventory numbers are something that we are very comfortable with. We are not seeing any problems as far as markdowns or anything like that. We continue to have a good solid channel for off- price, being our own outlet stores. And we feel good about the inventory position, both at the end of the year, as well as where we sit today.

Jeff Mintz – Wedbush

Do you have an inventory per square foot number for your own retail stores?

Pete Collins

I don't have that off the top of my head. I mean, we could provide that information as of Q1, on our call next week. But I don't have that today.

Jeff Mintz – Wedbush

Okay.

Michael Buckley

We gave some color in terms of the initial inventory investment of around $150,000, which is really more for a full price store, and up to $250,000 for some of our larger stores, and some of the outlet stores as well.

Jeff Mintz – Wedbush

Okay. So, that's a pretty good assumption, even for a store that's kind of continuing in that range per store?

Michael Buckley

Yes.

Jeff Mintz – Wedbush

Okay. Great. Thanks. And then, Pete, on SG&A, I noticed that you didn't break out the categories that you had broken out previously, in previous quarters. And I'm wondering if that's something that will be in the K that's supposed to come out tomorrow.

Pete Collins

Well, the K has the – it's got the SG&A broken down between wholesale and the general and administrative section, as well as in consumer direct. What we found, Jeff, as we were looking at the – as part of this whole restatement process and looking at the classification of expenses, one of the things that we found was that the classification of SG&A expenses between U.S. wholesale and international wholesale was pretty arbitrary. And I know that I'd been getting a lot of questions from various people about trying to explain what's in selling and shipping versus general and administrative. So, we kind of stepped back and looked at the overall SG&A categories and broke them down into those three that I mentioned – wholesale, consumer direct, and G&A. And we've got a description of what's behind each of those in our 10-K in the MD&A and hopefully there's plenty of visibility for you when you see that tomorrow.

Jeff Mintz – Wedbush

Okay. Great. I'll definitely take a look at it.

Pete Collins

I think it's going to be – going forward I mean I know it's a bit of a transition for people like you, but hopefully it'll be a better way for all of us to be able to communicate with each other and be more clear as to what things mean going forward.

Jeff Mintz – Wedbush

Okay. Great. And then, Michael, just a quick question on the women's business. It looks like for the full year of '07, the women's business was up around 13% or a little more than 13%. And I'm kind of wondering, what do you see – and not really looking for guidance, but just kind of what do you see with that business? Was that mostly coming from slowdowns in Japan and the UK? Or is there something with the women's business that it's reached a level of maturity that we are past kind of a hyper growth phase?

Michael Buckley

No. I mean, the women's business to us is completely back on track in terms of sales performance and product. We've said on previous calls – the first half of last year, we didn't invent or reinvent the product the way we should have. In the U.S. the business, the women's business, was up 52% in the fourth quarter over the fourth quarter of '06. So, some of the new styles that we're doing – the Disco group, with the diamond-like crystals, the women's Super-T, the jeans that we've done with the gold foil pocket, as well as the seamless jean, the Rock Star – are really, really accelerating the women's business.

Jeff Mintz – Wedbush

Okay. Great. Thanks very much and look forward to next week.

Michael Buckley

Thank you, Jeff.

Operator

Thank you. Your next question comes from the line of Ronald Bookbinder with Global Hunter. Please go ahead.

Ronald Bookbinder – Global Hunter

Good afternoon and congratulations.

Jeff Lubell

Thank you, Ron.

Pete Collins

Hey Ron.

Michael Buckley

Thanks Ron.

Ronald Bookbinder – Global Hunter

I know it's still very early in the life of your company to talk about comps, but you had like four stores in 2006, 15 at the end of 2007. Do you care to comment about comps yet?

Michael Buckley

Well, I mean we are not going to start to release comps on a formal basis, I mean not at least until we have a – or potentially until we have a large enough base of stores. But we do – for the existing stores, we do budget or we did budget them up versus last year. And we are exceeding our budgeted numbers. So, we are happy with how the existing stores are performing.

Ronald Bookbinder – Global Hunter

Switching over to AURs, in your wholesale line, you talked about the AURs at the – at your retail stores. But, I continue to see more and more of the higher ticket Super-T out there at significantly higher price points than your basic 172 jean. Where do you see that going? You still don't see any pushback on that despite the environment?

Michael Buckley

Not at all. I mean, I think as we continue to offer unique innovative products, we haven't seen any price resistance.

Ronald Bookbinder – Global Hunter

So, it's still just like Jeff always says, it's all about the product?

Michael Buckley

It's all about the product.

Ronald Bookbinder – Global Hunter

Switching to international, you talked about Japan and UK, that you made some changes there. Do you think they're ready for growth in 2008?

Michael Buckley

In terms of UK and Japan?

Ronald Bookbinder – Global Hunter

Yes.

Michael Buckley

Well, certainly in terms of the UK. I mean, Japan, we are in a process now of putting together a three-year business plan, which includes growing the wholesale side, as well as growing the retail side. So, we have to put together that plan, determine what investment it's going to require from us, and really agree that before we can really see what the rest of the year is going to look like.

Ronald Bookbinder – Global Hunter

And when looking at the possibility of international stores, when do you see the first possible international store? And would it be more in Japan or the UK or–?

Michael Buckley

Well, I think that – I mean our plan is to – the first international store outside the U.S. that we would handle ourselves would be in Japan, and hopefully before the end of this year. And then the next market that we – obviously there's some franchise opportunities, but other markets that we might run the stores ourselves would be in Europe.

Ronald Bookbinder – Global Hunter

Okay. Now, you sell in dollars, so you don't get the benefit of currency translation. But the price of your product as the dollar drops in value should be dropping overseas. Is the wholesaler, the middleman, the distributor, are they moving the price of the product down or are they capturing that extra margin?

Michael Buckley

Well, it's an exercise that we are looking at now because our gut instinct is that they are taking more profit and they are not lowering the prices. So, once we complete our analysis, distributor by distributor, of where the product is being wholesaled and retailed, we might make some decisions based on where the dollar is to take more advantages for ourselves.

Ronald Bookbinder – Global Hunter

Okay. Thanks.

Michael Buckley

Thanks, Ron.

Operator

Thank you. (Operator instructions) And our next question comes from the line of Jody Kane with Sidoti & Co. Please go ahead.

Jody Kane – Sidoti & Co.

Hi, thanks. Can you talk about the rest of Europe, kind of excluding the UK, how the rest of Europe's doing and your expectations for the next couple of quarters there?

Michael Buckley

Well, I mean it’s across the board, I mean we mentioned how our order book is both domestically and internationally. I mean, the brand continues to gain momentum internationally as well, in particular in Europe. So, I mean, we don't break out country by country, but we are pleased with what we are seeing in terms of sales and forward bookings.

Jody Kane – Sidoti & Co.

Alright. And then, in terms of the non-denim performance this holiday season, how did that affect the purchases by the retailers? How that sort of business did and how they changed their view on the non-denim product?

Michael Buckley

Well, I mean on the wholesale side, we still had very little non-denim product in the channel, even in the fourth quarter. So, there's a little bit more there now. I think, if you remember from the project show in August of last year, there was a much better representation of the non-denim product, but that was product that really hits in the spring. So, hopefully, as that product hits the marketplace – and we are already seeing the success of that product within our own retail. So, as we see that success in the wholesale side, hopefully that will lead them to buy more of that in the quarters going forward.

Jody Kane – Sidoti & Co.

All right. And then, can you talk a little bit about the denim trends, in terms of color, cleanliness and where you guys are in terms of those trends?

Michael Buckley

Well, I mean I think our perspective is we don't follow the trends, so they are not that meaningful to us. We do what we think is right. We have come up with a lot of innovative products across men's, women's, and kid's here, certainly since we have added to the design team over the last year. So, we design what we think is right for the marketplace and we are seeing great success in what we are selling in on now.

Jody Kane – Sidoti & Co.

All right. And then, Pete, just a final question, just on the guidance. So, the things that have changed since you first provided guidance are a higher tax rate and a higher share count, but the same stock compensation.

Pete Collins

No, the tax rate – the tax rate has not changed from the guidance, Jody. The stock compensation, you are right, is not changed. The only thing that's changed is the additional shares from a weighted average share perspective and that's due to the treatment of stock options that are vested, but unexercised at this point.

Jody Kane – Sidoti & Co.

Okay. And, Michael did say, though, that the order book is above what you were expecting, which is also different from when you first provided the guidance.

Michael Buckley

Well, no. We provided guidance, we had visibility into the first quarter and what we are saying now is that the order book, at the end of March, is above what our initial expectations were.

Jody Kane – Sidoti & Co.

All right. Great. Thank you very much.

Pete Collins

All right, Jody.

Operator

Thank you. Our last question is a follow-up from the line of Karen Short with Friedman, Billings, Ramsey. Please go ahead.

Karen Short – Friedman Billings Ramsey

Hey, thanks for taking my question. Just a quick follow-up on your cash balance. Obviously, you guys are very comfortably positioned. I'm just wondering if you had any further discussions or thoughts on share repurchases.

Pete Collins

Well, we evaluate our liquidity and want to make sure that we are enhancing the long term value for our shareholders. So, it's something that we have discussions on. We don't have a current authorization and don't have a current program in place, but it is something that does get discussed. So, that's- – there's really nothing to say more than that, Karen.

Karen Short – Friedman Billings Ramsey

Okay. Okay, thanks.

Pete Collins

Yes, thanks.

Operator

Thank you. Management, at this time, we'll turn it back to you for closing comments.

Andrew Greenebaum

Okay. Thank you all again for participating in our call today. We greatly appreciate your continued support and interest in True Religion. We look forward to speaking to you again and updating you on our 2008 progress to date next Thursday, May 8. That concludes our call today and we thank you again for your attention.

Operator

Thank you. Ladies and gentlemen, that will conclude today's teleconference. We do thank you again for your participation and thank you for using the conferencing center. At this time you may disconnect.

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Source: True Religion Apparel, Inc. Q4 2007 Earnings Call Transcript

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