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Charming Shoppes, Inc. (NASDAQ:CHRS)

F2Q09 Earnings Call

August 27, 2008 9:15 am ET

Executives

Gayle M. Coolick - Vice President, Investor Relations

Alan Rosskamm - Chairman, Interim Chief Executive Officer

Eric M. Specter - Chief Financial Officer, Executive Vice President

[Steven Wichner] - Senior Vice President of Finance

Analysts

Christopher Kim - J.P. Morgan

Scott Krasik - C.L. King & Associates, Inc.

[Sabino Battia - Bosco Capital]

[Ildiko Hilber - Waterstone Capital]

Margot Murtaugh - Snyder Capital Management

Lizabeth Dunn - Thomas Weisel Partners

[Garrett Rubin] - CRT Capital

Operator

Welcome to the Charming Shoppes second quarter 2009 earnings conference call. (Operator Instructions) With us today are Alan Rosskamm, Chairman of the Board of Directors and Interim CEO for Charming Shoppes, Eric Specter, CFO and Executive Vice President, Steven Wichner, Senior Vice President of Finance, and Gayle Coolick, Vice President of Investor Relations.

I’ll now turn the call over to the host of this call, Gayle Coolick.

Gayle M. Coolick

Today’s discussion will contain certain forward-looking statements concerning the company’s operations, performance and financial condition including sales, expenses, gross margins, capital expenditures, earnings per share, store openings and closings, and other matters. Such forward-looking statements are subject to various risks and uncertainties that can cause actual results to differ materially from those indicated. Information regarding risks and uncertainties are detailed in the company’s filings with the Securities and Exchange Commission including the company’s annual report on Form 10K for the fiscal year ended February 2, 2008. Our complete Safe Harbor statement and today’s prepared remarks are available at www.charmingshoppes.com. Our quarterly income statements along with our balance sheet and cash flow statements are provided with today’s press release.

I’d like to turn the call over to Alan Rosskamm, our Chairman of the Board and Interim CEO, who would like to make a few opening remarks about our business and the initiatives we have been executing upon over the last few months.

Alan Rosskamm

I know many of you would like an update as to what our priorities and actions have been since my appointment as Interim CEO. If I had to summarize it in just a few bullet points, I would have to say that our priorities are: (1) to refocus the company’s energies on its core brands and on serving our plus size customers, and (2) to simplify the business by editing out on-core assets, by eliminating unproductive inventory, by streamlining the organization, and by walking away from unprofitable sales.

I think you all know that earlier this week we signed an agreement for the sale of our non-core Misses apparel catalog titles to Orchard Brands. Not only were these businesses a distraction from our core brands, they were losing money. So the completion of this transaction will be immediately accretive to earnings.

We also said we would explore the sale of our Figi’s catalog business. Unlike the Misses apparel catalogs, Figi’s has been consistently profitable and generates substantial cash flow. However, cheese and food gifts are not related to our core business or our core competencies so we are willing to sell Figi’s provided we can obtain full value.

Among our biggest issues at Charming Shoppes has been the revolving door leadership we have had at the brand level. As a result of having multiple leaders in each brand over the last several years, each of whom has had their own point of view, we find that we lack brand clarity and have failed to maintain a clear definition of the core customer for each brand. Going forward we are committed to recruiting strong and experienced brand presidents. Our objective will be to empower each brand leader to fully own the relationship with their customers. At the same time through shared support services and expertise, we hope to capture the full synergies of being a multi-brand retailer all focused on the plus size apparel customer.

Speaking of experienced empowered brand leaders, in July we brought on [Brian Wolf] to lead our flagship brand, Lane Bryant. Brian has been warmly embraced by the Lane Bryant team. He has already embarked on a series of enhancements to our marketing and store presentation plans for this fall in order to emphasize our wear to work offerings. We would also expect the influence of his fashion merchandising strategies to be visible in our floor sets for late spring 2009 and are optimistic about his ability to restore Lane Bryant’s appeal as a premier fashion apparel resource.

I know you are also interested in the progress we are making with our search for both a permanent CEO and brand leaders for our Fashion Bug and Catherines divisions. We are a big further along with our search for our brand leaders as we had initiated these searches early in the year. We have identified a number of strong candidates and I feel confident about the progress that the search is making. As far as our search for a permanent CEO, the search committee of our Board has hired a search consultant and initial screening and candidate interviews have begun. In any search process, anticipating the timeline is difficult but we are committed to bringing the right leadership to this company.

An immediate objective in all of our brands is to sell through our remaining spring inventories and to adjust our inventory commitments so that we will also be able to effectively sell through our fall merchandise in this very difficult retail environment. In the recent past, in order to achieve sell throughs we have resorted to overlapping promotions with multiple couponing and as a result we generated sales at disappointing margins. As we make commitments for the spring season we will plan our purchases and our promotion schedule in such a way that we retain open to buy to react to sales and can improve gross margins.

Notwithstanding our difficulties we have made progress on a number of initiatives that have contributed to the generation of significant free cash flow here to date. We are committed to managing our inventories tightly and plan to end the fiscal year with lower levels of inventory. We have begun to realize decreases in overall SG&A expenses through our focused attention on expense management and we believe additional savings opportunities exist. We have closed 78 of the 150 underperforming stores identified for closure during this fiscal year which is expected to contribute to improvements in our operating performance in future periods. Also, the relocation of our Catherines’ home office operations to Bensalem was completed successfully and on schedule during the first quarter, and during the second quarter we completed the sale of our Memphis, Tennessee distribution center which provided $5 million in cash proceeds.

As we look to the second half we anticipate continued challenges in this difficult environment. While we expect sales and earnings will be depressed we hope to finish the year as a leaner, more focused organization ready for a turnaround in fiscal 2010.

In closing, I want to assure you of my confidence in our ability to improve this business. There is a dedicated and talented team here and they have truly rolled up their sleeves and are working diligently to address the company’s issues. There is real underlying strength in our brands and we have a strong balance sheet that gives us the time to do the things we need to do. Personally, my goal in my role as Interim CEO is to deliver a healthier company than I found just a few weeks ago.

Thank you. And at this time I’ll return the call to Gayle to provide an overview of our operating results for the quarter and some guidance for the second half.

Gayle M. Coolick

As a reminder, our quarterly results for the current and prior year periods exclude the income statement impact of our non-core Misses apparel catalog titles as we’ve designated them as a discontinued operation pending their sale to Orchard Brands. As you review our financial statements, please keep in mind that both this year’s and last year’s financial statements have been adjusted to reflect the effect of the discontinued operation.

For the 13 weeks ended August 2, 2008 we reported a loss from continuing operations of $3.7 million or $0.03 per diluted share. This compares to income from continuing operations of $20.9 million or $0.16 per diluted share for the 13 weeks ended August 4, 2007. For the second quarter ended August 2, 2008 income from continuing operations includes after-tax charges of $5.8 million or $0.05 per diluted share related to the severance agreement between Charming Shoppes and its former CEO, and $3.5 million or $0.03 per diluted share related to previously announced consolidation and streamlining initiatives. Without consideration to the charges related to the severance agreement with our former CEO, our performance met our operating expectations for the quarter.

Net sales from continuing operations for the 13 weeks ended August 2, 2008 decreased 7% to $648.6 million compared to net sales from continuing operations of $694.4 million for the 13 weeks ended August 4, 2007. Net sales for our retail stores segment were $622 million during the 13 weeks ended August 2, 2008 a decrease of 9% compared to $685.1 million during the 13 weeks ended August 4, 2007.

Consolidated comparable store sales for our retail stores segment decreased 10% during the 13 weeks ended August 2, 2008 compared to a decrease of 3% in comparable store sales during the 13 weeks ended August 4, 2007. The change in net sales year-over-year was impacted by an increase in e-commerce sales more than offset by decreases related to the closing of 87 stores and decreases in comparable store sales. Comparable store sales data by core brand are detailed in our press release and on our corporate website.

Net sales from continuing operations for our direct to consumer segment were $22.5 million during the 13 weeks ended August 2, 2008 compared to $4.2 million during the 13 weeks ended August 4, 2007. The year-over-year difference is primarily related to the addition of sales volume from our new Lane Bryan Woman catalog which was launched during the fourth quarter of last fiscal year and is currently in start-up mode.

Consolidated gross margin from continuing operations for the quarter was 26.9%, a 320 basis point decrease compared to 30.1% in the year ago period. The consolidated merchandise margin decreased by 140 basis points and consolidated buying and occupancy expenses as a percent of sales increased by 60 basis points compared to a year ago. Consolidated catalog advertising expense increased by 120 basis points related to the launch of the Lane Bryant Woman catalog.

For the retail store segment the gross margin declined by 330 basis points for the quarter primarily related to negative leverage of occupancy expense on declining sales as well as decreases in the merchandise margin related to a higher level of promotional activity in order to ensure the appropriate clearance of seasonal merchandise. The gross margin from continuing operations for the direct to consumer segment declined related to higher catalog advertising expenses as we continue to invest in customer acquisition during the start-up year of the Lane Bryant Woman catalog.

Consolidated SG&A expenses from continuing operations represented 25.4% of sales for the quarter consistent with the year ago period. Administrative expenses as a percent of total sales improved by 30 basis points and selling expenses as a percent of total sales increased by 40 basis points. On a dollar basis SG&A expenses decreased versus a year ago related to our expense control initiatives as well as the closing of underperforming stores. We were pleased to be able to maintain our SG&A ratio to sales despite disappointing sales performance.

For the 26 weeks ended August 2, 2008 we reported a loss from continuing operations of $3.1 million or $0.03 per diluted share. This compares to income from continuing operations of $47.4 million or $0.36 per diluted share for the 26 weeks ended August 4, 2007. For the first half ended August 2, 2008 income from continuing operations includes after-tax charges of $5.8 million or $0.05 per diluted share related to the severance agreement between Charming Shoppes and its former CEO, $5.8 million or $0.05 per diluted share related to previously announced consolidation and streamlining initiatives, and $3.7 million or $0.03 per share for advisory and legal fees arising out of the proxy contest which was settled on May 8, 2008.

Net sales from continuing operations for the 26 weeks ended August 2, 2008 decreased 7% to $1.29 billion compared to net sales from continuing operations of $1.391 billion for the 26 weeks ended August 4, 2007. Net sales for our retail store segment were $1.235 billion during the 26 weeks ended August 2, 2008 a decrease of 10% compared to $1.371 billion during the 26 weeks ended August 4, 2007. Consolidated comparable store sales for our retail store segment decreased 11% during the 26 weeks ended August 2, 2008 compared to a decrease of 2% in comparable store sales during the 26 weeks ended August 4, 2007. The change in net sales year-over-year was impacted by an increase in e-commerce sales more than offset by decreases related to the closing of 87 stores and decreases in comparable store sales. Net sales from continuing operations for our direct to consumer segment were $49.5 million during the 26 weeks ended August 2, 2008 compared to $14.6 million during the 26 weeks ended August 4, 2007. The year-over-year increase is primarily related to the addition of sales volumes from our new Lane Bryant Woman catalog which was launched during the fourth quarter of last fiscal year.

Consolidated gross margin from continuing operations for the first half was 28.6%, a 250 basis point decrease compared to 31.1% in the year ago period. The consolidating merchandise margin was consistent with a year ago and consolidated buying and occupancy expenses as a percent of total sales increased by 120 basis points compared to a year ago related to negative leverage of occupancy expense on declining sales. Consolidated catalog advertising expense increased by 130 basis points related to the launch of the Lane Bryant Woman catalog. For the retail store segment the gross margin declined by 250 basis points for the half primarily related to negative leverage of occupancy expense on declining sales and to a lesser extent decreases in the merchandise margin related to a higher level of promotional activity in order to ensure the appropriate clearance of seasonal merchandise. The gross margin from continuing operations for the direct to consumer segment declined related to higher catalog advertising expenses as we continue to invest in customer acquisitions during the start-up year of the Lane Bryant Woman catalog.

Consolidated SG&A expenses from continuing operations represented 27.3% of sales for the first half compared to 25.6% in the year ago period. Administrative expenses as a percent of total sales increased by 70 basis points and selling expenses increased by 100 basis points both related to negative expense leverage on lower sales.

Our balance sheet and our cash flow statement are included with today’s earnings press release and are subject to adjustment pending our completion of the filing of our 10Q. Total cash, cash equivalents and available for sale securities were approximately $138 million at the end of the period compared to $75 million at February 2, 2008. We continue to maintain a healthy cash balance, strong liquidity, and a committed revolving line of credit. Our long-term debt at the end of the quarter was $316 million and primarily related to our $275 million convertible debt due 2014.

Total inventory for continuing operations at the end of the period was approximately $337 million compared to $341 million a year ago, a decrease of 1%. On a same store basis year-over-year inventories decreased by 6%. Without the inclusion of inventory from the Lane Bryan Woman catalog which launched in November 07, total inventories decreased 6% year-over-year.

Capital expenditures were approximately $16 million for the quarter, a decrease of 57% compared to $37 million in the year ago quarter. Depreciation and amortization for the quarter was approximately $23 million. The company generated free cash flow of approximately $74 million year to date. On our corporate website www.charmingshoppes.com we have posted a GAAP to non-GAAP reconciliation defining our calculation of free cash flow.

We have an outlook for our third fiscal quarter and our fourth fiscal quarter. Given the continuing uncertain economic climate and our expectations for continuing weak traffic trends, we continue our conservative approach in planning for the third quarter of fiscal year 2009. As a result we will maintain lean inventories and carefully control operating expenses in an effort to continue to generate positive free cash flow.

For the three month period ending November 1, 2008 we have projected diluted loss per share from continuing operations in the range of $0.11 to $0.09 compared to diluted loss per share from continuing operations of $0.01 for the corresponding period ended November 3, 2007. This projection includes pre-tax charges of $2 million which is $1.3 million after-tax or $0.01 per diluted share related to previously announced streamlining initiatives. Our projection for the third quarter assumes net sales from continuing operations in the range of $560 million to $570 million compared to net sales from continuing operations of $599.7 million for the period ended November 3, 2007. Our projection assumes high single digit percent decreases in consolidated comparable store sales for the company’s retail store segment compared to an 8% decrease in consolidated comparable store sales in the prior year.

For the three month period ending January 31, 2009 we anticipate narrowing our diluted loss per share from continuing operations as compared to the corresponding period ended February 2, 2008. In the fourth quarter of the previous year the company reported a loss from continuing operations before extraordinary item of $0.19 excluding a charge of $0.84 related to the impairment of goodwill and trademarks. Please see our GAAP to non-GAAP reconciliation in today’s press release and on our corporate website.

This completes our prepared remarks. I’ll now turn the call over to our conference call administrator LaTonya for our Q&A session with Alan Rosskamm, Chairman and Interim CEO, Eric Specter, Executive Vice President and Chief Financial Officer, and Steve Wichner, Senior Vice President of Finance.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Christopher Kim - J.P. Morgan.

Christopher Kim - J.P. Morgan

Could you talk a little more about the further wind down of the Crosstown Traders operations? What exactly is involved in the sale here? What assets, headquarters, DC, call center, etc.? And can you talk a little more about the timing of this transitional services agreement?

Eric M. Specter

Again I’ll refer everyone to the release we made Monday evening, but let me give a little more color to the questions you’ve asked. The business was sold, meaning the Missy apparel catalogs as we outlined. There are eight catalogs in total that make up that group. All of the inventory, the trademarks, the customer lists and so on were part of that transaction; substantially all the assets of the business. We continue to retain and run out of Tucson our Lane Bryant Woman catalog as well as our websites, our headquarter to be. They’re run out of the Tucson facility meaning all of our retail websites along with a stand-alone website www.shoetrader.com that we’ve retained as part of this acquisition back in 2005.

As far as the transitional service arrangements as we outlined in the release Monday evening we will retain what we call the infrastructure assets which are part of our whole shared service group, meaning the DCs, the distribution centers which there are two primary ones; one in Wilmington, North Carolina as well as one in Tucson that is connected to the home office. Those facilities will remain with us. They are leased facilities; they’re not owned. We also will be providing IT services through the transition period.

The transitional periods burn off at various time periods over the next 12 months but none of them go beyond a 12-month period. So we will wrap up all of these transitional services that we’ll be providing to Orchard Brands for a period not to exceed a year from closing. So they’ll all be completed the end of next September.

Christopher Kim - J.P. Morgan

Also regarding the Figi’s part of the business, I have in my notes that it generates about $100 million in revs. Can you give us any additional color on operating margin or EBITDA, trailing 12 or historical levels?

Eric M. Specter

Let me just clarify the sales run rate. If you look at an SEC reporting sales number which includes other revenue like shipping and handling, your $100 million is right. If you want to look at just their net sales from selling product, it’s approximately $90 million. So as a run rate of $90 million in sales. Of course again for the benefit of everyone on the call, substantially of its business and all of its profit are in the fourth quarter and more specifically in the period that starts in November and runs about seven or eight weeks through Christmas is where the majority of those sales and all of its earnings are recorded.

It runs very healthy margins, all in on an allocated basis. The catalog industry and the food and gift industry runs very healthy margins. It runs high single digit to low double digit type of EBIT margins. As we’ve outlined in the release again Monday evening, we’re exploring the sale. We would expect a very healthy auction on this business. It’s been profitable. It’s been very consistent. We mentioned it was the one business last year, with all the issues we had during our holiday season with apparel, the Figi’s food and gift business hit all its key metrics, sales margins, operating margins, EBITDA margins, and we feel we’ve got a very good plan in place to build on that for this current holiday season.

Operator

Our next question comes from Analyst for Scott Krasik - C.L. King & Associates, Inc.

Analyst for Scott Krasik - C.L. King & Associates, Inc.

Can you remind us when the next credit card securitization will occur?

Eric M. Specter

Yes. Again this is all outlined in our 10K. We do have a securitization that comes up in May 2009. It is much smaller than the one we did this past October which again for everyone on the call we raised $320 million through a 144A type transaction in the credit markets. And this one will be sized somewhere slightly below $200 million so it’s a much smaller offering. We are starting already the process to begin discussions on that transaction but as far as when it comes up, it’s into the second quarter of next year.

Analyst for Scott Krasik - C.L. King & Associates, Inc.

What’s the state of the asset back security market right now?

Eric M. Specter

Of course all the credit markets are difficult. I will point to the fact that we raised and did a $320 million securitization in one of the worst periods last October coming off the heels of the initial meltdown last summer and we are confident. We have a name that’s been out there. We’ve been securitizing for almost 20 years. More importantly, our credit portfolio is extremely healthy and profitable. We have very significant net excess spreads. The difference between the yields on the file and our funding and write-offs, and although we are experiencing some increases in charge-offs year-over-year as we outlined in our first quarter call, they are well within plan and actually lower than planned and significantly lower than a normalized run rate that we were seeing in any five-year periods that you want to pick into the 90s and early part of the decade. So we’re continuing to run very healthy net excess spreads. It remains very profitable. It made its plan the second quarter so those are a lot of the things that the asset back investors will look for as they start to look at a transaction later this year or early next year.

Analyst for Scott Krasik - C.L. King & Associates, Inc.

What happens if you can’t complete it?

Eric M. Specter

We have alternative and what I’ll call backstop liquidity programs in place with our credit card securitization lenders. Banks that provide in the securitization and the asset back credit card world are called conduit financings that typically are out there for 365 day periods. One of the reasons we like to tap the markets is to be able to get much greater liquidity in terms of three or five year. The one we did in October for example was five years of liquidity. So that would be one alternative we would look at. Again, this being a much smaller transaction than the one we did this past October, it gives us a lot more flexibility with our securitization lenders. So that would be the alternative.

I should remind everyone that unlike conventional corporate debt that when we say we need to do a securitization in May 09, that just starts an amortization event that goes on for a six to seven to eight month period. So it’s not as if $200 million comes due and payable in May 2009. There is a lot more flexibility than in a conventional refinancing where obviously you need to pay off the full principal amount at the due date.

Again, these are all the alternatives and things that we’ve been doing in the past securitizations and we feel at least at this time confident that we will be able to complete this transaction in the early part of 09.

Analyst for Scott Krasik - C.L. King & Associates, Inc.

Has there been a final determination on the accounting rules surrounding net share settle structure converts?

Eric M. Specter

Yes, there is. The Accounting Standards Board has made a decision. We’re still waiting for the actual standard to come out but they have commented on it. You’ll see in our 10Q that we have put some verbiage in relative to the impact of recent accounting pronouncements. This will not affect this fiscal year but if this standard is issued as it’s expected to be here this fall, we will have to comply and it will affect the accounting for the convertible notes that we issued this last year ago April.

Operator

Our next question comes from [Sabino Battia - Bosco Capital].

[Sabino Battia - Bosco Capital]

I have three quick questions. One, the Misses apparel catalog business that you sold, I just wanted to know, do you guys have any kind of profit-sharing linked to this business or is it just a clean sale and that’s about it? The second question is that the credit card receivables business that you guys sold, is there any kind of liability that’s still linked to Charming Shoppes or once again it’s just a clean sale? And the third question is, as far as uses of liquidity/cash are concerned, what are your priorities? Has anything changed on that end? Just some color. Any color.

Eric M. Specter

As far as the first two questions, it is a clean transaction. There are no other agreements associated with the sales so at closing we’ll receive the $35 million of proceeds from the Orchard Brands group and our only obligations are under providing the transitional services as I spoke to Chris a few minutes ago.

The credit card receivables likewise this is a straight-forward transaction. We’re expecting to close this sometime during the second half of this year before the end of our fiscal year and at that point we will be receiving 100% of the value for those receivables from ADS and they will write us a check for approximately $40 million. Of course that number could move a little bit depending on the size of the receivable portfolio at the time we would close that transaction, but there will be no residual liabilities associated with that. Once that transaction’s completed ADS will own the file and operate the file under an arrangement they’ve reached with Orchard Brands. Once we get the closing of that transaction, we receive the full amount of the proceeds for that file and we will go ahead and pay off our securitization indebtedness which is luckily 80% of that number and we will generate cash of $8 million or $9 million from that transaction that in a sense shows up on our balance sheet under current assets of credit card certificates. So we will monetize $8 million or $9 million of cash from this transaction when it closes.

As far as use of proceeds, nothing’s changed. We’re in a very difficult retail climate at this stage so there are no alternative plans other than to increase our liquidity, financial flexibility and at this point our intentions are to strengthen the balance sheet further.

[Sabino Battia - Bosco Capital]

One other thing. The $375 million credit facility, what’s outstanding on that?

Eric M. Specter

It’s undrawn upon.

Operator

Our next question comes from [Ildiko Hilber - Waterstone Capital].

[Ildiko Hilber - Waterstone Capital]

Following up on the last question, if nothing’s drawn on the bank line, how much is available currently?

Eric M. Specter

Based on the borrowing base formula, and of course we’re at a low point in inventory at the end of July, there’s approximately $300 million of available liquidity at this stage against the $375 million line.

[Ildiko Hilber - Waterstone Capital]

Will the sale of the catalogs that you’ve just entered into affect the bank line at all?

Eric M. Specter

It will reduce the availability based on the removal of the inventory from that business.

[Ildiko Hilber - Waterstone Capital]

Any rough estimate? Is it $50 million, $20 million, $100 million?

Eric M. Specter

Again it changes obviously because the working capital will change month to month, but on an average basis it’s around $50 million of availability would be reduced.

[Ildiko Hilber - Waterstone Capital]

Can you remind me? I didn’t catch what the amount of the transaction was that’s going to be amortizing starting in May of 09? You said it’s not due right away.

Eric M. Specter

That’s a $180 million transaction we did in 2004.

[Ildiko Hilber - Waterstone Capital]

Do you think you’d look to refinance the whole amount or with the sale of those catalogs, does that amount change?

Eric M. Specter

No, the receivables for Crosstown that was financed through as I mentioned to Chris a little bit earlier here today through our bank conduit facilities. So part of the alternatives to refinance the $180 million in the markets next spring would be that we’re free up $40 million of liquidity from our banks to be potentially used to support this transaction. So none of the $40 million was part of the 2004 to fund receivables in our core retail credit card portfolios of Catherines, Fashion Bug and Lane Bryant.

[Ildiko Hilber - Waterstone Capital]

Correct me if I’m wrong, are you guys exploring the sale of your credit card business?

Eric M. Specter

No, we are not.

[Ildiko Hilber - Waterstone Capital]

One of the things I was thinking about as you guys were talking about how you’ve lost focus at the brand level because there’s been so much turnover. It just appears that it’s going to be difficult to get a key person in there until you get the CEO spot filled. Can you talk a little bit more about how you’re going to orchestrate the timing of that to facilitate getting good people in the door?

Alan Rosskamm

We were certainly successful in recruiting Brian Wolf who was a seasoned retailer, former CEO of a public company Cache. Brian came in and was aware just at the time that our CEO resigned and his attitude was that he knew what the job was that he needed to do at Lane Bryant; he was excited about the challenge; and he embraced the opportunity. So Brian would be an example of a seasoned experienced leader who was not deterred by the fact that he didn’t know who his ultimate boss would be. We acknowledge and we’ve had some interesting and candid conversations with candidates that it is a little bit unusual and maybe a little bit unsettling to consider committing to a position. In the ideal world we would fill the corporate CEO position first. But because the brand leader interview process had a significant head start, it is at least possible that we will proceed in filling one or both of those roles before the corporate CEO position is filled, obviously with a person that is similarly self confident and willing to embrace the challenge of the particular brand they would be leading.

[Ildiko Hilber - Waterstone Capital]

How long again do you think that the CEO search is going to be going on?

Alan Rosskamm

That’s almost impossible to predict. We might get lucky and fill the position very quickly which would be great. What we don’t do is rush the process. We have a high sense of urgency but we’ll take the sufficient time to find the right candidate.

[Ildiko Hilber - Waterstone Capital]

As far as options for the overall company, are multiple options being explored? It is a tough environment to get a CEO in the door and I do know the word out there is it’s tough going to find good candidates.

Alan Rosskamm

My own opinion is that Charming Shoppes is truly a fantastic business opportunity. There’s no question that we haven’t done some things correctly, that the stock price is depressed, but there is tremendous core strength in our brands, there is a balance sheet and liquidity that’s strong enough to allow the company to take the steps it needs to correct its situation, and there’s a chance here for somebody to come in and be a hero and create tremendous shareholder value.

Operator

Our next question comes from Margot Murtaugh - Snyder Capital Management.

Margot Murtaugh - Snyder Capital Management

If we’re expecting a larger loss in the third quarter, what goes into that thinking? Why is it a larger loss? Is it more merchandise markdowns?

Eric M. Specter

What has been clearly disappointing even though we delivered the second quarter earnings forecast, it clearly was not due to improvements in our trends in sales. We ran a 10% drop. Although there was a slight improvement against the run rate of first quarter, we expected to be better than that. We are seeing very good now as we kick in a lot of the expense reduction initiatives and really the second quarter was delivered on the heels of being able to not see negative leverage on the SG&A ratio. We’ve been working hard to reduce our cost structure. As we now look forward here to this third quarter the trends of the business here in the second quarter being down 10%; traffic trends continue, although they’re stabilizing at these lower levels, they are still double digit drops in traffic from a year ago; we’re not seeing any improvement in those trends although we are working across all the brands and the marketing executives and associates to look for ways to attract and drive our consumers into the store. But we’re in a challenging environment as you well know. Our consumer being more moderate and of course from the Fashion Bug brand I would characterize it as low moderate, these are consumers that really have lost their entire financial flexibility at the moment relative to what’s going on in the economy, and they are just not buying at the rate that they were buying a year ago. Most of what caused a lot of the drops in comps second quarter of the seasonal spring product was the fact that demand for core casual sportswear, whether it’s Capri pants, knit tops, slogans, just was nowhere near the rate of demand that we’ve seen in prior seasons. And at this point we’re just not going to step out and say that things are going to turn here in the fall. So we’ve modeled high single digit drops. Of course in our seasonal sales curve, third quarter is not over the years a strong quarter fort the company so we have a seasonal curve that our total sales dropped down in the third quarter primarily because as a moderate provider of apparel to women that are 30 to 50 years old, August is not an important month from a standpoint of the back-to-school season. We have very little merchandise that would target a junior customer with the exception of a small department at Fashion Bug. So we’re relying on getting those sales as we move into the core part of the season of September and October. That makes it a short season for third quarter and that’s the reason our sales generally come down between second and third quarter and that puts a lot of pressure on our operating earnings model.

Margot Murtaugh - Snyder Capital Management

Did you break out the operating income or loss from the divisions retail versus catalog?

Eric M. Specter

We will have that completed as we have been the last several quarters and that will be in our 10Q which we will be filing by the end of next week.

Margot Murtaugh - Snyder Capital Management

Any comments on the progress of the Lane Bryant catalog and its prospects?

Eric M. Specter

I will comment that again that continued to perform as planned. In fact a little bit better than planned on the sales line second quarter. As I mentioned first quarter, we are still in a very aggressive customer acquisition mode as we build that business quarter-over-quarter and we are now up to just south of 500,000 customers in a very short period of time here from November through July. So we’re very pleased with the metrics that we’re seeing in that catalog. Because of the heavy customer acquisition and the accounting for that, it flows through catalog expenses and up into our margin. We’re still running a loss in that business but the losses are starting to subside from where they were from the previous quarter and first quarter and fourth quarter, and we would anticipate as I said at the first quarter call that beginning in the fourth quarter it will start to level out and be around a break-even business starting in the fourth quarter going forward.

Margot Murtaugh - Snyder Capital Management

Are there any other asset sales contemplated besides Figi’s? Any other little things?

Eric M. Specter

The only other thing that we’re actively and is in process, and again this is nothing new, but we’re still pursuing and working with a number of the lenders and institutions on a sale lease-back transaction of a couple of our more significant owned properties, distribution and office. And that is a process that we’re in and is in progress and we’ll have more to say about that later in the year.

Margot Murtaugh - Snyder Capital Management

Are the losses from the stores that are going to be closed still in the continuing earnings?

Eric M. Specter

Yes. Until they are closed, they run through continuing operations.

Margot Murtaugh - Snyder Capital Management

Any estimate of how much that is?

Eric M. Specter

When we announced the closing program in January, once we complete it there is a roughly $5 million to $6 million improvement in terms of those losses. Of course that’s an annualized number that we won’t fully realize until 2009. We are right on schedule. Over half the stores are closed as we closed the second quarter and we are right on schedule to complete that closing program by the end of the fiscal year; all 150 will be closed by the end of January.

Margot Murtaugh - Snyder Capital Management

You still feel comfortable that that is the number that should be closed or do you think that maybe more should be closed given the tough environment?

Eric M. Specter

This is an ongoing analysis. Clearly at the point in January when we did this review as we commented at the year-end call, we were comfortable with the numbers and if the number needed to be higher it would have been. We are in a depressed climate and we are monitoring and analyzing as we speak but at this time there’s nothing further to say about additional closings. No plans for that.

Operator

Our next question comes from Lizabeth Dunn - Thomas Weisel Partners.

Lizabeth Dunn - Thomas Weisel Partners

My question relates to the Lane Bryant business. What are Brian’s key strategies to turn that business around and what’s the timeframe in order to execute a turn? I also wanted to know just an update on the sourcing environment? I know you had some specific working initiatives underway but also a lot of other retailers are talking about cross pressure coming out of China, so how do you feel about that? And the final questions, where do you think the operating margin for the core business which you’re trying to get back to, where can those go over time?

Alan Rosskamm

My first response on Brian’s behalf is we need to give him a little bit of time but he’s jumped in with both feet and has a lot of energy and enthusiasm for the business and the opportunity that he sees. At a high level he feels that Lane Bryant has become too promotional and that the fashion component which is there and which can be further enhanced needs to speak for itself and we need to be proud of and featuring our fashions and our sales promotion although we will continue to be promotional in this environment needs to feature product and not only price. The wear to work opportunities he feels are very strong for the Lane Bryant customer, and he believes we’ve got additional sourcing opportunities. Overall, I think again he’s enthusiastic about the core strength of the brand. We need to clarify our positioning as a true fashion resource for our customer base.

Lizabeth Dunn - Thomas Weisel Partners

And on the sourcing environment Eric?

Eric M. Specter

Liz, the sourcing environment as you’ve mentioned, we are seeing pressure on prices. Raw material prices which can make up 60% to 65% of the cost of a garment are under some pressure because of oil prices and other commodity prices.

Alan Rosskamm

And labor prices.

Eric M. Specter

The labor, we do a substantial amount of our direct business out of China although we had attended because of our presence over there for now 20 some years have expanded with the quota system now in effect eliminated, we’re doing a fair amount of business in countries like Indonesia, Bangladesh, Vietnam and we’re doing that to be able to offset some of the rising prices that we’re seeing in what I would call the Tier 1 or some of the high Tier 2 countries. But the China situation we’re trying to hold our costs by looking at efficiencies and other parts of the cost structure: Supply chain, shipping, and so on. But clearly the pressure is on both the labor front in terms of the wages the employees are getting out of these factories as well as the raw materials and on the same token we’re trying to hold initial markups. There are some minor price increases that will show up on the ticketed price to accommodate this, but we’re talking single dollar increases; nothing substantial. And as I mentioned, we’re using our network and offices there to shift where we can to offset some of the increases that we’re seeing particularly in China.

I should make the comment that one of the other things that hurt us, put all that in place, the dollar other than Hong Kong where the dollar’s completely pegged to the Hong Kong dollar to the US dollar, the dollar now reversing its two-year long devaluation will help us because in countries like India and Bangladesh where it wasn’t pegged, that put a lot of pressure on the factories and the exporters that we’re relying on to produce and ship. So there’ll be some relief there if the dollar continues its trend right now which is if you want to believe the economists is going to get stronger here over the next six to 12 months. So that will be some offset but overall we’re experiencing what every other retailer’s experiencing and we’re working through it.

On the operating margin, longer term and again we’re in a turnaround state for the company. Clearly as Alan outlined at the top of this meeting there’s a sense of urgency, a focus by this organization to put in the core brands. We got a little bit of a headwind so even as we improve our product offerings, we improve our execution, we reduce our cost structure, we are in a difficult economic environment but that said, it will turn. And when it does we’ll be well positioned as we did in the earlier part of this decade to start to realize the power of these brands and the power of this business to generate much higher operating margins. Obviously what we’re experiencing here in the last four or five or six quarters and there’s nothing structural that is in our way to have these businesses in the high single digit EBIT, operating margins 7% or 8% is what I would call a medium term goal for us. Whether we can get beyond that longer term, there’s still things that need to be done but we’re taking it one step at a time and we’d like to shoot for something material that would really be appreciably of value to our shareholders in terms of stock valuation. And again that’s what we’re striving for at this stage.

Operator

Our next question comes from [Garrett Rubin] - CRT Capital.

[Garrett Rubin] - CRT Capital

Most of my questions have been answered, but I do have one. Can you offer any specifics on bad debt for the credit card business this quarter?

Eric M. Specter

As I think I may have commented, the credit profitability for the quarter was on plan. The actual bad debt or charge-offs are up over the corresponding period of a year ago but if we look at it relative to the first quarter, we did not see any kind of appreciable increase. So they’re stabilized but at a higher rate than a year ago. I do want to mention the fact that the last few years of 06 and 07 particularly following the bankruptcy reform, we saw as all credit card operators whether they were retailers or bank cards saw very abnormal low charge-off rates for a period of a couple years. So even though they’re up over a year ago, they’re well within plan and if I look at any kind of five to 10 year average, they’re well below the run rates of any of those five and 10 year averages. We’re running right now as healthy net excess spreads as we’ve had over the last 10 years.

Operator

I would like to turn the call back over to management for closing comments.

Gayle M. Coolick

Thanks everyone for being with us today. We’re available by phone today if you have follow up questions and please be in touch if you do. Have a great day everyone.

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Source: Charming Shoppes, Inc. F2Q09 (Qtr End 08/02/08) Earnings Call Transcript
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