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Executives

Marie Hirsch – Director of IR

Daniel Griesemer – President and CEO

Tim Martin – SVP and CFO

Georgia Shonk-Simmons – President and Chief Merchandising Officer

Analysts

Michelle Tan – Goldman Sachs

Jennifer Black – Jennifer Black & Associates

Jeff Black – Lehman Brothers

Chris Kim – JP Morgan

Barbara Wyckoff – Buckingham Research Group

Liz Pierce – Roth Capital Partners

Crystal Kallik – D.A. Davidson

Mark Montagna – C.L. King & Associates

Margaret Whitfield – Sterne Agee

Coldwater Creek Inc. (CWTR) Q2 2008 Earnings Call Transcript August 27, 2008 4:45 PM ET

Operator

Welcome to the Coldwater Creek second quarter 2008 investor conference call. Today's call is being recorded. With us today we have Mr. Dan Griesemer, President and Chief Executive Officer; Ms. Georgia Shonk-Simmons, President and Chief Merchandising Officer; Mr. Tim Martin, Senior Vice President and Chief Financial Officer; and Ms. Marie Hirsch, Director of Investor Relations. Ms. Hirsch; please go ahead.

Marie Hirsch

Thank you, Trisha. Good afternoon and welcome to Coldwater Creek's fiscal 2008 second quarter conference call. We'll begin with a few formal comments from management and then open up the lines for your questions.

During the course of today's conference call, we may make forward-looking statements regarding future events or performance of the company including forward-looking statements and projections about our operational results, business initiatives, growth opportunities, and prospects.

We want to emphasize that any projection involves judgment and that individual judgments may vary. Any projections we make today are based on information available to us now, which is subject to change as the quarter progresses. Actual results may differ substantially from what we say today and no one should assume later in the quarter that the comments we provide today are still valid. Moreover, we are not undertaking any obligations to provide updates in the future.

The documents the company files from time-to-time with the Securities and Exchange Commission, including our most recent Form 10-K and Form 10-Q contain and identify important factors including the risks and uncertainties described under the “Risk Factors” that could cause actual results to differ materially from those contained in any forward-looking statements.

A replay and the transcript of the call will be made available in the Investor Relations section of the company's Web site at coldwatercreek.com.

And now I'd like to introduce Daniel Griesemer, President and Chief Executive Officer.

Daniel Griesemer

Thank you, Marie. Good afternoon everyone and thank you for joining us today as we discuss our results for the second quarter fiscal 2008. During today’s call I'll provide you with an update on our business and strategic initiatives we’ve been executing for the past six months, in particular, our new merchandizing strategy as well as discuss we'd like to add for the Coldwater Creek brand for the balance of the fiscal year.

Tim will then take you review our second quarter financial performance in more detail, and Georgia will provide a more comprehensive update on our merchandising including a discussion of our fall product that hit the stores on August 15th. I would like a few closing remarks before we open up the call to take your questions.

Over the past six months, the entire Coldwater Creek organization has done a tremendous amount of work in every aspect of the business to position our company for long-term growth and profitability. Although we are still in the early stages I'm pleased to report that we're beginning to see financial confirmation of the hard work that's been going on behind the scene to improve our product and our customer experience, right size our resources and control our expenses.

Despite a difficult macro environment we exceeded the high-end of the revised guidance we provided in the mid-July. Our second quarter sales were $241 million with earnings per share of $0.03 compared favorably to our guidance of sales of $235 million to $240 million and earnings per share of breakeven to $0.02.

It is important to note that our results also include a $0.01 per share non-cash charge related to the impairment of certain Coldwater Creek day spa location, which I will discuss in a moment.

Our better than anticipated performance is a result of improvements across every division of the company as we continue to make progress on our strategic key initiatives and successfully manage, controllable parts of our business.

While we remain confident in the execution of our strategy, in the second quarter, customer traffic remained exceptionally challenging. Traffic was down in the low to mid teens that we saw better conversion rates and reduced clearance activity. As a result, we did see sequential improvement in same-store sales which were down 13.7% compared to down 19% in the first quarter.

We still have a long way to go. However, I'm confident in our execution and our ability to restore our brand's unique heritage. We made significant progress on managing our inventory to improve margins and return to full-price selling while editing our assortments to reflect the more cohesive product and brand point of view.

We ended the quarter with inventories per square foot down 24% year-over-year. It's clean and it's current, and we are well-positioned from an inventory standpoint as we enter the important fall and holiday season.

During the second quarter we also continued to align inventories and style counts for demand with approximately a 21% reduction in styles and colors. We remain on track to reduce our style counts by at least 20% in the second half of 2008. Based on more in-depth customer research we are learning what products our customers want, the best quality and construction and most compelling price points and how to present, and market the product.

We are focused on providing fashionable high quality and appropriately priced additions to our wardrobe. This includes a particular focus on our pants, jackets, wovens and knit tops businesses. The majority of these products changes are manifested in the fall collection which rolled out to stores on August 15th.

Georgia will address both the product and the new store layout in more detail. But we believe the new collection and this new shop concept will improve the customer experience and enable us to better help build outfits and find unique items to enhance our existing Coldwater Creek wardrobe.

Even that we do not care to back-to-school shopper our fall season officially begins after Labor Day. Although we won't have a true sense of the demand until mid-September we are very pleased with both the look and feel of our fall merchandize, and the new store layout based on lifestyle shops.

As we indicated previously, we continue to be more strategic with regards to our promotional cadence and are beginning to restore our regular price heritage. During the second quarter, transactions carrying a promotional discount significantly decreased to approximately 15% of transaction in the second quarter 2008 from approximately 44% in the second quarter of 2007.

While we intend to continue to reduce discounting activity, we still plan to offer limited, more focused promotions and strategic advertising placements. In fact, as planned, our fall coupons offering $25 off for a purchase of $100 or more, if selected September publication in home and our new stand in the early to mid-August.

We are also making intelligent marketing investments such as refining our catalogue circulation to be more cost effective while still driving our top-line. We decreased our catalogue circulation by approximately 34% and the number of pages by 36% in the quarter. We remain on track to reduce our total circulation to 93 million in 2008 from 128 million in 2007.

Finally, we continue to prudently manage our growth and capital. We have a very strong cash position, ending the quarter with $89 million in cash. As we said in the past, we believe that the best use of our capital is to continue to carefully grow our store base. 40 to 45 new stores planned this year, and approximately 40 stores a year in future years.

Maintenance decision to continue with our store opening base based on what is best for our company in the long-term. At a time when many retailers have stopped store growth, and some are even closing stores, we are being offered great locations and extremely advantageous economics, favorable tenant allowances in top gear centers.

Turning to the Coldwater Creek spas we have made a decision not to pursue any further expansion of this concept. We will however, continue to operate the existing nine spas focusing on profitability in the overall Coldwater Creek brand experience. As such, we founded necessary to take a pretax $1.5 million non-cash impairment charge related to a few Coldwater Creek day spa location.

I'm proud of our accomplishments in the first half of the year as we strengthened our underlying business fundamentals, establish a more efficient expense structure and most importantly, improved our product and store experience.

However, looking towards the back half of 2008, we are facing strong headwinds with continued deterioration in the macro environment. Retail traffic is extraordinarily challenging and we see no external stimulus to improve our customers’ willingness to shop and spend in the short-term. That being said, we are keenly focused on executing our strategic initiatives and navigating the current environment.

With that I’d now like to turn the call over to Tim to discuss our results in more detail. Tim?

Tim Martin

Thanks, Dan. Looking at our second quarter results, net income for the three months period ended August 2, 2008, was $3.1 million or $0.03 per share, compared with net income of $8.7 million or $0.09 per share for the same period a year ago.

As Dan mentioned earlier, we have decided not to continue the expansion of spa concept. After an in-depth review of each spa location, we found it necessary to take a non-cash impairment charge to reduce the carrying values of a few Coldwater Creek day spa location; we estimated fair value of the respective assets. This non-cash charge is $1.5 million of pretax or $0.01 per share after tax.

Consolidated net sales in the second quarter decreased 4.8% to $241.4 million from $253.5 million in the second quarter of 2007, primarily a result of the decrease in retail stores traffic and lower direct channel sales.

Net sales from the retail segment which includes our premium retail stores, outlet stores and day spa locations, were up 6.6% for the second quarter to $189.4 million, compared to $177.7 million in the second quarter of 2007.

Retail segment net sales represented 78.4% of the company’s total net sales in the second quarter compared with 70.1% in the second quarter of 2007. The company opened seven retail stores during the quarter for a total of 322 premium retail stores in operation at the end of the period, which compared with 260 premium retail stores at the end of the second quarter last year.

Comparable store sales decreased 13.7% for the second quarter compared with 6% increase in the prior year period. Comp store traffic was down roughly in line with comp store sales as well as our comp store conversion rate was up approximately 100 basis points.

Direct segment net sales decreased 31.3% to $52.1 million in the quarter from $75.8 million in the second quarter of 2007.

Direct segment net sales represented approximately 21.6% of the company's total net sales in the quarter compared with 29.9% in the second quarter of 2007.

Gross profit for the quarter was $95.6 million or 39.6% of net sales compared with $110.2 million or 43.5% of net sales in the second quarter of 2007. The decrease in gross profit rate was primarily due to deleveraging of occupancy costs due to the lower same-store sales.

Selling, general and administrative expenses for the second quarter were $88.5 million or 36.6% of net sales, compared with $98.1 million or 38.7% of net sales for the 2007 second quarter. The decrease in SG&A expense of approximately $9.6 million was driven primarily by reduced marketing spend and other cost savings initiatives.

Our operating income for the second quarter was $5.7 million, compared with operating income of $12 million in the second quarter of 2007.

Now, turning briefly to our six-month results, net sales for the first half of fiscal 2008 were $512.5 million versus $534.8 million in the same period last year. Net loss for the first six months was $6.1 million, or $0.07 per share, compared with net income of $20.7 million, or $0.22 per share in the first half of 2007.

Once again, the effectiveness of our business model allowed us to end the quarter with premium retail inventory including the distribution center, down 24% per square foot in the second quarter last year. Approximately, 200 basis points of decrease is due to a shift in the receipt timing versus the prior year.

Total inventory decreased 17.3% to $127.1 million compared to $153.6 million at the end of the second quarter 2007. This decrease is significant given the additional 62 premium retail stores or 26.5% premium retail stores square footage growth over the same period.

CapEx for the quarter totaled $18.5 million primarily related to new store construction and information technology. Depreciation and amortization for the quarter was approximately $14.8 million.

Cash flow from operations was $30 million in the quarter versus $4.8 million in the second quarter last year. We continue to expect to end the year with higher cash balance then we began the year as we continue to prudently manage our capital and investments.

At the end of the quarter, the company continues to have no borrowings on its bank facility and cash of $89.2 million, up from $62.5 million at the end of the fiscal year.

As we discussed in the previous quarters we remain very confident about our liquidity position, ample cash balances and our ability to fund both our operations and current growth plans without the need for any borrowings.

Turning to guidance for the balance of the year, we are reiterating our guidance for the third and fourth quarter at this time. However, we are incorporating the better than expected results from the second quarter to our full year guidance.

We now expect full year sales of $1.1 billion to $1.15 billion and a full year loss of $0.01 per share to earnings of $0.10 per share.

Now, with that I’d turn the call over to Georgia.

Georgia Shonk-Simmons

Thank you, Tim. Good afternoon, everyone. As previously discussed we are intensely focused on our product, its design and development and the merchandising process to enhance the total brand experience. We have been working on improving our products for the past year. Our fall collection that hit the stores on August 15th is the first collection that manifests all the work of our design and merchandising team.

Over the past several months we work to bring back the uniqueness and the magic to our product, and restore promotional connection with our merchandize and brand experience. We did this by ensuring our efforts to reflect our brand heritage which is in the ease and casualness of how she feels while looking great in our unique apparel.

We know from our access to customer research, our customers looking for clothing, and accessories, but a casual carefree and make her feel beautiful while instilling confidence. At the same time, quality, comfort, and fit are extremely important to her and we make sure that everything we design has all of these attributes.

In our new collections we brought back the wow factor, attached into her emotionally. We have moved away from too many basics in our product mix. We have said in the past, that we are committed to bringing the company back to full-price heritage.

We have scaled back our promotional activity and focused our merchandising team on a product mix that answers our fashion needs, surrounded with great, updated key items. We offer her compelling opening price points as we are managing the pricing pyramid.

We will continue to update her wardrobe to color, new fabrics, exclusive prints, while providing her with fashion that she does not already have in her closet. We know she comes to us for any jacket, a variety of pants, key layering pieces and other must-have.

We remain committed to our customer and providing her with the styles that are comfortable, versatile, and functional and certainly relevant to her lifestyle. As we have said, our summer collections did not reflect the full-price improvement that we did have several categories that resonated well with our customers. She continued to favor our crop pants, our fashion knit-tops, T-shirts, and various (inaudible) tanks for layering.

As both Dan and Tim highlighted, we also significantly reduced our inventory per square foot this quarter. At the end of the quarter, our style and color count was down 21%. This reflects the progress we are making with our goal to reduce our style count by 20% this year, by eliminating and profitable SKU and continuing to improve our business by narrowing our assortment to create collections that is far more relevant to her.

The results of all these efforts to improve the merchandize can be summarized in the following seven points.

Our product is unique from distinct brand point of view. We have made larger investments in key fashion and must-have items and bought these in deeper depth. We have right-sized our inventory in line with the business climate.

We have improved our quality across our collections by focusing on new fabrics and fits. We have improved our presentation through our new lifestyle shop concept. Pricing for our fall collection is balanced with well-priced value items and appropriately priced higher end fashion products.

And lastly, we are using customer input in our decision-making during the entire process. An example of an item that manifests the effects of these initiatives is our Coldwater Creek (inaudible) shawl. This (inaudible) shawl is a great quality. It's a versatile piece that works well with the entire point of view of the collection. We have made this in a variety of fall colors and are offering it at an extremely compelling price points. To-date, we have seen excellent customer response.

As mentioned earlier, our fall collection has benefited from the use of customer research, as we are listening to her needs and providing fashion items that she can update her wardrobe. Additionally, to ensure that we have the right product in our stores, we are going forward with a more integrated testing program. We believe these two key product initiatives will help us to continue to refine our product assortment.

In terms of what we are seeing in our stores now with our fall collection and what you will be seeing in the future, the merchandize and shopping experience is based on lifestyle shop. In addition to improving our product, we are also committed to enhancing her shopping experience with us.

Our new store layout is based on the idea of creating destination shopping for the customers and is organized to help her find the products that best suit her needs. It not only will be easier for her to shop but also for her sales associates to assist her.

Each of the four lifestyle shops will be self-contained. They will each have the apparel items and appropriate accessories of each season for a particular shop. Our shop concepts allow our stores to be more organized while still being a fun eclectic place to shop.

Let me start with our extremely important denim shop. We know one of the key items our customers are looking for is denim that is well-fitting, and comfortable. So we have created a denim shop that includes everything that goes with your jeans.

Fashion jackets, wow pieces, along with layering and other things that match and work with her denim look. We have an assortment of denim fits that are flattering, slimming, and includes stretch to make them comfortable.

Next our casual shop houses our twill bottoms and other casual pants, surrounded by novel jackets that can be dressed up or dressed down. As well as our new moleskin two way stretch pants and fantastic colors. Our ready-to-wear shop includes a more dressed up approach. It is knit-based, but we have also mixed in key wovens and dress pants.

The products in our ready-to-wear shop is a bit dressier but appropriate for work and still remains comfortable with relaxed fits and features. We offer beautiful prints it also houses our most successful dress pant, the Holly fit.

Lastly, our playwear shop. Here, she can find clothes that are really easy to wear and perfect for her casual daily activities. It is important to note this is not Yoga wear or exercise clothes, this shop is more knit based also, but also includes some active fun woven, jackets, and pants.

In the center of our stores we will have the must-have and fashion trends at the moment. We will begin giving her some ideas of ways to cross-merchandize across all of the shops. We are excited about our new lifestyle concept. Because it showcases our kind of a merchandize and improves our customer experience.

Although it is still very early we believe that we are on the right track to maximizing our brand potential. We believe we've taken the right steps with our fall collection and our new store layout to improve her emotional connection with Coldwater Creek and keep bringing her back to our stores. We are looking forward to getting into September, our true fall selling season, and receiving feedback about our merchandise initiatives.

I personally look forward to updating you on the results next time, and discussing our product with Holiday.

With that I'd like to turn the call back over to Dan Griesemer.

Daniel Griesemer

Thanks, Georgia. In summary, we are very pleased with our teams’ execution in the first half of 2008. We continue to effectively execute on our key strategic initiatives to improve our product and our customer experience.

I spent the last week visiting stores nationwide to see the results of the efforts and came away extremely proud of everyone at Coldwater Creek and what we have accomplished. The stores look great. I was particularly impressed with the attention to detail from the fall collection to the new store layout to the training and product knowledge of the sales associate.

And fortunately, all of these positive changes are coming at a time when the macro environment is extraordinarily challenging. And we have not yet had the opportunity to see them translate into a result. While we maintain cautious outlook for the remainder of 2008 we are confident and encouraged that we are well positioned for the future and our superior product and excellent customer service compel her to shop at Coldwater Creek.

With that I’d now like to turn it over to Tricia for your questions. Tricia?

Question-and-Answer Session

Operator

(Operator instructions) And we will go first to Michelle Tan with Goldman Sachs. Ms. Tan, your line is open.

Michelle Tan – Goldman Sachs

Hi, sorry about that. Love the mute button. So I just had a couple of questions. I guess the first one will be any update you can give us as you've seen the August product hit on how business has been tracking so far month to-date?

Daniel Griesemer

We've said that we see a very challenging macro environment and I think you've heard it from a lot of our peers, lot of other retailers that the current environment is very challenging. We really need to see and get into September is when our natural selling season is. We don't have a back-to-school customer. She really turns to fall – updating her fall wardrobe in September. It's always been that way. But we are very pleased at the way our product looks, the way the stores look, how we differentiated ourselves from the field out there, and we need to really get into September to see it.

Michelle Tan – Goldman Sachs

Okay, great. Any product call outs I guess even if it's too early to look at the overall trend for August?

Georgia Shonk-Simmons

Yes, I would say, Michelle, that what we're seeing is prints, prints, prints. Our print jackets, our print T-shirts, prints are really resonating with her along with again, our lighter weight Holly fit pants.

Michelle Tan – Goldman Sachs

And then in terms of regional performance, anything there to highlight, we've heard about obviously, the challenges in Florida, are you seeing any change, any trend, as you look at the business on a regional basis so at least maybe getting less negative in certain parts of the country?

Daniel Griesemer

No, I would say there is – I've seen a slightly better performance out of the Midwest, but I would step back and say a 50,000 feet, it's a national view relatively consistent across all regions.

Michelle Tan – Goldman Sachs

Great. And then on the direct business, and the decline that you saw there, was it within – obviously you hit your sales guidance. Was the decline within the realm of your expectations and then any kind of color you can give us on web traffic versus conversion?

Daniel Griesemer

The direct business delivered what we anticipated it would deliver largely due to reduced catalog circulation, reduced promotions and reduced disposition activity. That's really the key there. That's what the story and take away is on the direct business.

Michelle Tan – Goldman Sachs

So was it – if you can – is there anything you can share in terms of conversion versus web traffic?

Daniel Griesemer

No. I don't think so at this point. It's nothing material. It's really as we expected it would actually give.

Michelle Tan – Goldman Sachs

And the follow-up is the more – wouldn't that have when is it just – alright – I was just going to say with less catalogs is it just less people think of the site and go there or is it also less product features so lower conversion?

Daniel Griesemer

We know that our catalogs drive a lot of the traffic to our Web site – it was not the right time to invest in catalog, spend at that time we're appropriately investing in into the – into when she naturally buys and those are the books that we're dropping right now. That's the largest impact of what's going on there.

Michelle Tan – Goldman Sachs

And then is there lumpiness with the catalog plans going forward? Is it kind of a consistent reduction each quarter what you've done so – in 2Q, as you look at the plans through the fall and Holiday?

Georgia Shonk-Simmons

The second half of the year we'll, we'll continue lowering our circulation; will be down approximately 30%. And that's for Q3 and Q4 combined.

Michelle Tan – Goldman Sachs

Great. Thank you very much. And good luck.

Georgia Shonk-Simmons

Thank you.

Michelle Tan – Goldman Sachs

Thank you.

Operator

We'll go next to Jennifer Black, Jennifer Black & Associates.

Jennifer Black – Jennifer Black & Associates

Good afternoon. I think all my questions [ph] have been answered except for one. Are you going to stay at 50% direct sourcing and can you speak to your raw material cost over the next year? Thanks.

Georgia Shonk-Simmons

We're – right now for this year we are on track to hit that 60% number. And so we will be doing that. And we will be keeping there probably for the next year, year and a half. Along with that we have upgraded all our fabrics. So in upgrading our fabrics we have seen again some higher fabric costs. But this is a planned upgrade in doing our fabrics in our fit and really have been gaining a real big positive what the customers seeing, feeling and touching.

Jennifer Black – Jennifer Black & Associates

Will you have to raise your price points? I mean with raw material prices going up and then you're buying better quality fabrics?

Daniel Griesemer

No. The real story there is – we've talked about this little bit before, Jennifer, that it's not about IMU as much as it is about net margin and about balancing our pricing offering. And so we are upgrading quality across the board. Everybody is seeing some increased prices as a result of energy, the effect of energy prices or labor in China, those things, those are kind of level-playing field. We're going to have a flat product offering from a price standpoint, but what you will see is greater diversity. So the things that we can really get paid for the high fashion, really high-end things that deserve the price we will charge for it. And she has demonstrated the willingness to spend it. Conversely, the things that we want to be very well priced for. And we are famous for and becoming more advantage famous for all the time. We will charge the right price for that but the mix will be similar pricing.

Jennifer Black – Jennifer Black & Associates

Great. Are you in a position to achieve sales?

Daniel Griesemer

Absolutely.

Jennifer Black – Jennifer Black & Associates

If you have a hot item line, because I don't know what your lead times, I guess it's very strong category to category.

Georgia Shonk-Simmons

It does vary from category to category. But on the key fashion item that we believed in, we also have backup piece goods, and a backup piece goods is in grayish so we can dye it very quickly and what we need and get it here.

Jennifer Black – Jennifer Black & Associates

That's very helpful. Thank you. And good luck.

Georgia Shonk-Simmons

Thank you.

Operator

We'll go next to Jeff Black with Lehman Brothers.

Jeff Black – Lehman Brothers

Hey, thanks. Nice job on executing the plan, guys.

Georgia Shonk-Simmons

Thank you.

Jeff Black – Lehman Brothers

Dan, on the promo side you gave some numbers that you have 44% of the SKUs and the former promotion—

Daniel Griesemer

Transactions last year and 15% this year with carrying a discount.

Jeff Black – Lehman Brothers

And just for comparative purposes, do you have those numbers or can you share them what that for 3Q and 4Q last year?

Daniel Griesemer

No, we'll be sharing that as we share results for the quarter. But if you remember what we ran into last year in the third and fourth quarters, inventory levels that were higher and assortment levels that were broader than we needed relative to the business climate, we had fairly heavy promotional activity and then layered on top of that additional promotional activity, so we are up against pretty heavy promotional discounting throughout really the – whole rest of the year and we are doing what we did in the first quarter, and second quarter which is really reducing that significantly.

Jeff Black – Lehman Brothers

Just a follow-up on the cost side. What portion of the SG&A savings were reduced, is that the vast majority and on the cost saving initiatives what are you working on there and how does this move forward into '09? Are there buckets of cost you can continue to take out price?

Daniel Griesemer

I will give the overall reductions are result of lower spend and will continue to be a result of lower spend. We said on a number of calls and we are going to continue to say the same thing. We're looking at everything possible to rationalize our spend to make sure that we are appropriately investing with the right level of return from everything that we invest in the bags, boxes, labor, we have a pretty rigorous program and I'm quite proud of how Coldwater and Coldwater's employees are doing and focusing on making sure those investment decisions are done wisely and prudently as we move forward in this environment.

Jeff Black – Lehman Brothers

Is it just too early to invest in spend to generate some traffic in your view we're going to see catalogs down 30% what are your thoughts on what we might see, a reversal of that trend?

Daniel Griesemer

I'm looking at this business in this environment right now. And I was out in stores and I have been talking to a lot of people, but really, you go out into stores and you will see what other retailers are doing in this environment. And I think it's the wrong thing to do for any for the integrity of any brand long-term, but it's also wrong thing to do for the short-term, returns in this environment to be investing heavily in marketing efforts, or discounting, simply would backfire and create an erosion of the overall results. We are still mailing almost 93 million catalogs this year. We still have lot of books that are going to be in the mail very regularly, representing this incredible product that we have to show and so we are not backing off of that. What we did and we said we were going to do this is that we are being more prudent with both page count and overall circulation to get the most and highest efficiency out of those. So, we are still mailing – I can't say who but I don't know many other apparel retailers that are, especially retailers that are mailing as many catalogs as we are. We are just doing it efficiently and to go beyond that, I don't think it would be a prudent return at this point.

Jeff Black – Lehman Brothers

Great. Got it. Fair enough, and good luck.

Georgia Shonk-Simmons

Thank you.

Daniel Griesemer

Thanks, Jeff.

Operator

We'll go next to Chris Kim with JP Morgan.

Chris Kim – JP Morgan

Just more on the expense side of the equation. You guys have done pretty good job in controlling expenses here. How should we be looking at the declines on a dollar basis in the back half of the year, I mean we have seen accelerating declines in the first and second quarters so, any color on the back half

Daniel Griesemer

I think we should stick with the guidance we've given that we expect SG&A dollars to be flat with the prior year in both Q3 and Q4. We will be opportunistic when necessary if we have cost savings that come to fruition in advance of our program. We may choose to invest those in other ideas or other programs but I'm sticking with the guidance that we have in the back half of the year of flat SG&A with prior year.

Chris Kim – JP Morgan

And then how much of the decline in the second quarter is a function of lower marketing spend?

Daniel Griesemer

It's a combination of both marketing spend and other cost savings initiatives. If you were to look at in an absolute dollar basis versus the prior year, it's a little bit more marketing in other areas but that's a larger dollar spend. So at the end of the day though it's pretty much represented across every category, and every aspect of how we're looking at the business from a cost savings perspective.

Chris Kim – JP Morgan

And then on the gross margins side – I apologize, if I missed it, but did you guys talk about the merchandize margins and the basis point trend you are seeing there?

Daniel Griesemer

No. We do not, we don't disclose that separately.

Chris Kim – JP Morgan

But I mean, up, down and directionally even?

Daniel Griesemer

We haven't given any color on that. And at this time, we are not going to, but I will say that the decrease versus the prior year is almost entirely due to deleveraging of occupancy costs.

Chris Kim – JP Morgan

And then finally, just on the segment margins, do we have to wait for the Q before we get any kind of color on the segment?

Daniel Griesemer

We won't really discuss individual segment operating margins on the call. And honestly, as a business don't run the business with an eye towards that. We are quite agnostic as to what channel she shops with us and run the business in a holistic basis.

Chris Kim – JP Morgan

Okay. Great. Helpful. Thanks very much, guys and best of luck with fall.

Daniel Griesemer

Thank you.

Georgia Shonk-Simmons

Thank you.

Operator

We'll go next to Barbara Wyckoff with Buckingham Research Group.

Barbara Wyckoff – Buckingham Research Group

Hi, everyone. The stores do look better. I agree.

Daniel Griesemer

Thank you.

Barbara Wyckoff – Buckingham Research Group

Can you talk about your historical top to bottom ratio? Do you see it changing given all the emphasis on jackets, and what not? And then has there been any stand-out colors or sort of print direction this fall so far?

Georgia Shonk-Simmons

The top to bottom ratio it really is running about the same as it always have historically. Because again, I think that how we have managed our retail with opening price point and that happened across every category. I will say that the colors that we're seeing early happen to be bright, so our brighter prints and our jackets along with neutral. There are neutrals we've taken on a very big light colored natural that have taken on a really important part along with the bright

Barbara Wyckoff – Buckingham Research Group

Thanks so much.

Daniel Griesemer

Thank you.

Operator

We'll go next to Liz Pierce, Roth Capital Partners.

Liz Pierce – Roth Capital Partners

Thanks. And nice job you guys on managing in such a tough environment. Did you give inventory guidance for the back half of the year, if you did I missed it, I am sorry?

Daniel Griesemer

We have not changed our guidance for the back half of the year. We said we expect to be down approximately 50% per square foot by the end of the year.

Liz Pierce – Roth Capital Partners

And then as Jennifer said, you can change if you need to on some of those–?

Daniel Griesemer

Correct. The beauty of being in this position is clean and as current as we are that we are not burdened with trying to liquidate historical inventory position. We can focus on the current business and react to what we need to.

Liz Pierce – Roth Capital Partners

I was curious if you step back to last year, when the business started to deteriorate, and understanding that your customer probably doesn't step up and shop until after Labor Day, but are there things, are their variances in differences that you're seeing going into that period now that make you feel really validate these changes?

Georgia Shonk-Simmons

I definitely think that if I look at last year's assortment we really had way too many basics. We didn't have a large enough print assortment and certainly not the decorated T-shirt business that we have this year. So, all of those are new pieces that have been added that she is really liking and that part is really working for her. So I think it's a more fashion ad.

Liz Pierce – Roth Capital Partners

So really you're seeing call outs, even though this is not like peak shopping for her yet?

Daniel Griesemer

I was out in stores, I talked to a lot of our customers, I talked to a lot of our staff, you heard in the tone in the call that we're very pleased with the look and feel of our fall collection, the way our stores look, that comes from customer feedback from some underlying fundamental metrics that we watch to use the business, we feel very, very good about the product that we are offering and the significant improvements that's been executed here. It's obviously the challenge, it's a challenging environment.

Liz Pierce – Roth Capital Partners

And in terms of the different lifestyles, did the August 15th floor set fully reflect that – I wasn't quite sure.

Daniel Griesemer

Yes. The shop concept is set in stores, I encourage you to go and look at it, and you will see the shop concepts that Georgia detailed that began on August 15th.

Liz Pierce – Roth Capital Partners

Maybe – alright. I mean we have and then maybe wasn't as clear on the few instances. And then the other question I had on the couponing I know that you talked about having a shorter duration on the coupons that the expiration, just an update on that?

Daniel Griesemer

That's consistent with what we have been talking about all year along that as part of restoring the company's regular price heritage. We still will have promotions. I think it's necessary in order to remain competitive and create a compelling experience and engage our customers but we want to make sure that we manage those prudently. And that requires being very smart about when you expire certain coupons and making sure you don't overlap on discounts and that we have taken a pretty judicious approach with regards to that.

Liz Pierce – Roth Capital Partners

And then finally on the 52 million that was the direct, can you break that down between catalog and internet?

Tim Martin

Sure. I will give you some color. Internet is approximately 76% of the business; catalog is around 24% of the business. Last year it was around 72% internet, and 28% catalog.

Liz Pierce – Roth Capital Partners

That's helpful. Thank you and good luck to you, guys.

Tim Martin

Thank you.

Operator

We will go next to Crystal Kallik with D.A. Davidson

Crystal Kallik – D.A. Davidson

Good afternoon, everyone. And also congratulations on managing in a wild environment right now. I wanted to ask a follow-on on the direct business. It obviously sounds like it came in right where you were expecting and you were talking about total circulation decrease in the second half. So is it safe to assume a fairly similar trend when we were modeling direct business for the second half?

Daniel Griesemer

Yes, the direct business is following what's going on with – what we have said about the whole business we are not pleased with the negative 13.7 comp, but it is an improvement and it's what we expected to deliver based on all of the fundamental changes that are happening the direct business is tracking the total business.

Crystal Kallik – D.A. Davidson

So should we – as far as the circulation decline, it sounds like it will follow pretty closely, is there any disparity between circulation in Q3 versus Q4, when we look at modeling the direct business?

Daniel Griesemer

No, they are both basically down 30% as Georgia had said, but you got to remember we do not own the kind of disposition and mark down in clearance inventory that we have owned historically. That has a pretty big effect particularly on the web business because we got a permanent online outlet site there, and it's all part of the plan in restoring this company's integrity and brand integrity and regular price heritage to not carry those kind of inventories that you are seeing net effecting the direct business as well.

Crystal Kallik – D.A. Davidson

Great. And then I'm not sure if this is Dan or Tim or combination, but as you shift over to the lifestyle shop, how does that affect your store operating cost? Are you able to bring down the number of hours in the stores as that becomes a more organized way to run the business or how do you look at that

Daniel Griesemer

We are very pleased with the way the stores have responded and it's a feedback from them in both metrics that in anecdotally is that this is really working for them. We house in each shop a key pant or bottom or couple of key pants styles in each one, all of the colors, all of the sizes are right there in one place to replenish the stores makes a whole lot of sense, operationally, and managing both the salary and wages, the field has done a great job in this challenging environment, but particularly, as we flip the floor and set this new product, I'm just real proud of what they have done there.

Crystal Kallik – D.A. Davidson

Good to hear. And then finally, just one question for Georgia, when does the lamb swing coat hit the stores?

Georgia Shonk-Simmons

You're talking about the long duster?

Crystal Kallik – D.A. Davidson

No, the shorter one that you had in the back in shelf.

Daniel Griesemer

The shorter one will hit the stores – really that will be Holiday one.

Crystal Kallik – D.A. Davidson

Thanks so much, guys. Good luck.

Operator

And we will go next to Mark Montagna, C.L. King & Associates.

Mark Montagna – C.L. King & Associates

Hi. Few questions. Georgia, you talked about emphasizing fashion, much more southern basics. Can you put that in perspective say, what percent of merchandize is fashion for this year's second half? And specifically, third quarter versus last year?

Georgia Shonk-Simmons

I would say that as I look at it – if I look at the top 30 items, that were running I would say that probably 30% of those are more fashionable than prior years. And absolutely the key metric for us.

Mark Montagna – C.L. King & Associates

Alright. And then the metric you were using in terms of the percentage of transactions, that were promotional in the second quarter, can you remind us what that number was in the first quarter of this year and also for last year in the first quarter?

Daniel Griesemer

I have to get – we will get back to you on that, Mark. It was a significant reduction in the first quarter as well. But we're going to have to get back with the exact numbers. Sorry.

Mark Montagna – C.L. King & Associates

And then actually last question just dealing with marketing spend. I've in my notes that you're expecting to have it down about $33 million this year. Is that still what your target is for this year?

Daniel Griesemer

Yes.

Georgia Shonk-Simmons

Yes.

Mark Montagna – C.L. King & Associates

All right. That's all I have. Thanks.

Georgia Shonk-Simmons

Thank you.

Daniel Griesemer

Thank you.

Operator

We have a follow-up question from Michelle Tan, Goldman Sachs.

Michelle Tan – Goldman Sachs

Great. Thank you. So – I just had few quick follow-ups actually. Just looking at the merchandize margins, the metrics where you're looking at doing fewer sales on coupon and promotion, as a percentage of the mix, what's the offset for that that prevents the merchandize margin from going up? Is it deeper discounts on the clearance or – ?

Daniel Griesemer

No. The strategy is to get your inventories in line with the overall business climate so that you don't have the over – the inventory overhang, make your product unique and compelling on the best – best and most compelling styles in-depth and then appropriately promote not to the degree that we did historically and the goal is for product margins to go up.

Michelle Tan – Goldman Sachs

No, no, I understand. But I mean in the quarter, I think you did say that there was less product sold on promotion, right versus last year so, in this quarter, what is the offset is my question?

Daniel Griesemer

In Q2 the offset would have been getting our inventories in line where we thought business was trending and being clean and clean – clean and ready for the fall merchandize delivery. So –

Michelle Tan – Goldman Sachs

So the clearance season is right. Thank you. And then I guess my other question is a little bit – obviously there's been a huge change in the business model since early 2000, but I guess some of the strategy is that your kind of weathering the difficult environment or similar in terms of paring back on, the inventory paring back on the investment in the circular and cutting costs which back then did certainly help protect the operating margin. I guess my question is what is it the different in the strategy this time around from what you did back then? And where – at what point do we expect to see the gross margin piece of things get better because I guess in early 2000 the gross margins declined for a few years, I guess. What is it about the strategy that different this time it gives you the comfort that you will start to see that recovery?

Daniel Griesemer

We probably in order for you to fully understand, Michelle, we should probably spend some time offline and I would encourage, Tim, to do that I will certainly make myself available, but the high level answer to this question is that what we have going on in this company right now is to focus on product, and the customer experience. Historically, we drove the business – and quite effectively for many years on a market share strategy. And as we are doing that your opening stores that 60 stores to 65 stores a year you were funding, advertising, investments to attract broad-based new customers to brand, and you were discounting to promote transactional activity. And that all works in an uptrending healthy macro environment that's great. If the rules of the game change which is what has gone on and it's a very challenging environment out there what we have to rely on is the uniqueness and attractiveness of our merchandize first, and a great compelling experience in our stores and other channels. So the big difference is those are the two things we're really paying attention to. We're rightsizing the resources, we're getting – the inventory in line we have done all that, we've now delivered a product assortment that I'm extremely proud of and very encouraged by, because it reflects the things that we've been working on for month. So it is a dramatic difference in the way we've been running the business historically.

Michelle Tan – Goldman Sachs

Very helpful. Thank you very much.

Daniel Griesemer

Thank you.

Operator

We'll go next to Chris Kim, JP Morgan.

Chris Kim – JP Morgan

Hi. Thanks. Just a quick follow-up. Outside of the write-downs at the spa business, what was the impact to EPS?

Tim Martin

Slightly less than $0.01 per share.

Chris Kim – JP Morgan

That's all I got. Thank you.

Operator

And our next question is Margaret Whitfield with Sterne.

Margaret Whitfield – Sterne Agee

Yes. I was following up on the spa as well. What do you expect the loss might be from the spas for the year and how long did the leases run for the stores that the spas will remain open and what will happen upon lease renewal?

Tim Martin

The expectation of the spa hasn't changed from an operating earnings perspective. We said and we continue to say it will be slightly less than one penny per share for each quarter in 2008. The leases on the spas are ten year lives and at this point in time we have no decisions made, it's still quite early to determine other any renewal on any of the spas.

Margaret Whitfield – Sterne Agee

And for Georgia, in my store, they told me there were eight shops they mentioned something called Navajo, something called ICAT [ph], as well as the ones that you mentioned. Wondered if you're planning on any changes to the shops depending upon consumer interest for the Q4? Or is there any new shop additions?

Georgia Shonk-Simmons

No. I think that what the sales associates were talking about is that within each shop, we have some different fashion stories that are cohesive. So, one of the shops is focused on more ICAT and one of the shops is focused again on some interesting looking Navajo blanket patterns, but they are all living in the same shop. That makes sense?

Margaret Whitfield – Sterne Agee

And the changes in the fourth quarter any new shops coming on or tweaks depending on demand?

Georgia Shonk-Simmons

No. I think what you – the thing you will see in the fourth quarter is that we will maintain all our shops and then down the center of the store when we get to December, we will turn that into get.

Margaret Whitfield – Sterne Agee

Okay. So more giftables than a year ago?

Georgia Shonk-Simmons

Different giftables than a year ago.

Margaret Whitfield – Sterne Agee

Can you elaborate? I think you had sleepwear last year for the first time?

Georgia Shonk-Simmons

I think we will get and we will give you much more data about Holiday on the next call. But we are excited about our gift assortment.

Margaret Whitfield – Sterne Agee

Okay. Thank you. And good luck.

Georgia Shonk-Simmons

Thank you.

Operator

And our next question is from Liz Pierce, Roth Capital Partners.

Liz Pierce – Roth Capital Partners

Hi. Tim, could you just on the tax rate what should we be using for the rest of the year? Looks like it spiked up a bit.

Tim Martin

Yes. It spikes up a bit. I think if you look at a full year rate, somewhere around the 39%, 40% range, you probably in the best place you could be. As we sort of go back and forth amongst our projections for a full year, effective rate you're going to see some anomalies in a quarterly rate.

Liz Pierce – Roth Capital Partners

So for the second half we should go back to that 39%?

Tim Martin

That will be fine. Somewhere in that range.

Liz Pierce – Roth Capital Partners

All right. Thanks.

Daniel Griesemer

Tricia, I think we have time for just one more question.

Operator

Actually, there are no further questions at this time. Mr. Griesemer, I'll go ahead and turn the conference back over to you for any additional or closing remarks.

Daniel Griesemer

Perfect timing. Okay, well, I'm really proud of everybody at Coldwater Creek and I'm very pleased and encouraged by the fall merchandise and the look and feel of our stores, and I really look forward to updating all of you in November. So thanks for joining us today. Bye-bye.

Operator

That does conclude today's conference. Thank you for your participation. You may now disconnect at this time.

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Source: Coldwater Creek Inc. Q2 2008 Earnings Call Transcript
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