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Kenneth Cole Productions, Inc. (NYSE:KCP)

Q2 2008 Earnings Call

August 5, 2008 4:30 pm ET

Executives

James R. Palczynski - Principal, Integrated Corporate Relations, Inc.

Kenneth D. Cole - Chairman and Chief Creative Officer

Jill Granoff - Chief Executive Officer

David P. Edelman - Chief Financial Officer

Analysts

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

Jeff Van Sinderen - B. Riley & Company, Inc.

Sam Poser - Sam of Sterne, Agee & Leach

Operator

Welcome to the Kenneth Cole quarter two 2008 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, James Palczynski from ICR.

James R. Palczynski

I’d just like to before we get started remind you of the company’s Safe Harbor language. The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results might differ materially from those projected in such statements due to a number of risks and uncertainties including, but not limited to, demand and competition for the company’s products, the ability to enter into new product license agreements or to renew or replace existing product license agreements, changes in consumer preferences or fashion trends, delays in anticipated store openings and changes in the company’s relationships with retailers, licensees, vendors and other resources.

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

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

Kenneth D. Cole

With me on the call today are Jill Granoff, our Chief Executive Officer, and David Edelman, our Chief Financial Officer. We’d like to accomplish three things on the call today. First, Jill and I are going to give you an overview of our strategic review process and our key findings thus far. Second, David will walk you through the results for the quarter and our guidance for the upcoming quarter and third we’ll share the specifics of what we are doing to improve financial performance for the back half of the year.

As we mentioned on our last call we are conducting an in depth review of our business in order to develop a clear and compelling three-year strategy to increase sales and drive improved returns for shareholders. Jill and I are working extremely well together and are enthusiastic about the company’s growth opportunities. Our process is affirming some core realities about the business. Kenneth Cole is a well recognized contemporary lifestyle brand that is under penetrated on a global basis. The brand has opportunities to grow by gender, by category, by geography and by channel of distribution.

Number two our operations can become significantly more profitable, we can capture economies of scale, streamline our infrastructure and improve margins in a variety of ways. Finally we have the financial resources to achieve our objectives. Our balance sheet as you may know is very strong and provides us with the flexibility to pursue any appropriate strategic path.

We appreciate the patience our shareholders are exercising. We believe it will be rewarded and that we will emerge as a well diversified, very profitable global lifestyle business. As we move forward over the next few months we will remain focused on identifying and maximizing our various opportunities. Before I turn it over to Jill to talk about our strategic review, I’d like to say that while we met our guidance for the quarter and beat consensus estimates we are not pleased or satisfied with the results. They’re unacceptable. Yes, the environment is challenging but it is not the root cause of the problems. We can do better and we will do better.

With Jill on board I will now distort my time and attention to ensuring we have the best product which as you know is the key driver of performance. I’d now like to turn the call over to Jill so she can share the actions we are taking through the strategic review process to better position our company for the long term.

Jill Granoff

During my first 100 days we have been intently focused on gaining a deeper understanding of our business strengths and opportunities. The insights have reinforced one of my core beliefs, namely that the hallmark of a great brand is compelling product, inspirational marketing and an engaging customer experience at point of sale. I will share our thoughts on each of these brand pillars in a minute but to set the stage you should know that Kenneth and I are committed to continuing to evolve our brand position, improving our merchandise assortment in terms of style, quality and fit, enhancing our already impactful marketing with an increased emphasis on fashion product and elevating the quality of our distribution to reinforce our position as an aspirational lifestyle brand. As we make progress in these areas we can unlock the true power of the Kenneth Cole brand and create value in our business for our consumers and most importantly for our shareholders.

Let me know describe briefly the process so far and then I’ll share some of our key observations. You know in my first week at Kenneth Cole Productions we held two town hall meetings with all of the KCP associates and then we distributed an online survey. We received an excellent response, over 70%, which generally showed that this organization understands well the challenges we face and has good ideas on how to overcome them. Culturally it was very important to let each associate know that their voice would be heard and that everyone can make a difference. I think these meetings reinforced the importance of teamwork and collaboration in building a winning performance driven culture.

We then conducted what I refer to as deep dives with each functional and business area. These deep dives included a very granular analysis of performance, extensive product line reviews, visual displays of marketing and merchandising programs and discussions on operational capabilities. In addition to working with Kenneth on this process I have spent a lot of time in the field with the management team in order to see our brand as the customer sees it. In the past few months we have conducted market tours throughout the country and I’ve personally visited roughly 25 of our retail locations. In addition we walked the floors of numerous department stores and other specialty retailers to get a broad understanding of the brand experience across channels as well as the competitive landscape.

We’ve also spent a significant amount of time with many of our key partners outside the business. I have been wonderfully impressed with the quality, talent and commitment of our licensees and wholesale partners. We’ve also received valuable input from a variety of consultants, industry advisors, fashion media and editors, shareholders and analysts on topics such as branding our products, marketing, merchandising our store experience and of course our business performance. People have been very generous with their time and candid with their input. Kenneth and I are extremely grateful for this.

Finally and perhaps most important we commissioned and completed a meaningful consumer research initiative among 1,100 men and women aged 18 to 44 with household incomes above $50,000. We received their input on Kenneth Cole brand awareness, brands perceptions and purchase and usage behaviors across brands, channels and product categories. We are pleased to confirm that the Kenneth Cole brand has a very high level of awareness, strong brand equity and positive perceptions. The research also showed us clearly where we have opportunities to leverage this. I’ll talk in a few moments about how we are using this information to improve our business near term.

Now you’re probably ready to hear about the learnings. Well, I have grouped our findings into four major buckets, brand positioning, product, marketing and distribution. The first and most important area we focused on was brand positioning. In each of our internal and external meetings we asked the question what does the Kenneth Cole brand mean to you? The research showed us that many people still think of us as a footwear company. Footwear will always be our heritage and foundation but the business has already transcended these roots. While we report roughly $500 million in sales on our books we generate approximately $1.5 billion in sales at the cash register when you gross up licensee sales and wholesale shipments. Interestingly apparel sales are equal to our footwear sales and accessories is our largest category overall including watches, jewelry, fragrance, sunglasses, handbags, luggage and small leather goods. There are many opportunities to further raise our brand awareness outside of footwear to further define the Kenneth Cole lifestyle and create growth.

Next I want to share our findings about product. When questioned about wear occasions consumers view us primarily as a dress up brand for work or evening. While this is a good position to hold in terms of how the brand is viewed we have been missing the casual side of the consumer’s lifestyle and we believe this has cost us market share. We are adding significant new brand appropriate assortments of core basics, casual items and seasonless product to address this and to round out our assortment beginning this fall. As we stated product is the most important aspect of any company in this business and our organization is very fortunate to have Kenneth’s guidance and renewed focus on the product lines. The product is always at its best when he is deeply involved in design and the whole organization is very excited to have that back.

In addition to design we have a big opportunity to get the right product in the right stores at the right time. For example offering boots year round in cooler climates and sandals year round in warmer climates and ensuring we have ample supply of large sizes in certain regions and smaller sizes in others. We will look at opportunities to optimize our merchandise planning and allocation to increase product sell through and minimize markdowns.

Moving on to marketing, we know that marketing is one of our core strengths. Our marketing has built tremendous brand awareness with over 80% of customers aware of the Kenneth Cole brand. Our campaigns have broken through the cluttered landscape of fashion advertising. Consumers know us best for our focus on important social issues. This has given us a unique and distinctive voice. We now need our marketing to generate the same kind of recognition and awareness for our fashions. Kenneth Cole is a brand that represents a fashionable, youthful aspirational lifestyle. We need to keep the edge that we’ve cultivated and more so than before design our campaigns to get consumers into the stores and ringing the register.

Next, I’ll talk about distribution. Of all the things we’ve grappled with over the past 100 days the need to rethink our approach to distribution is the biggest. Put simply, our goal is to focus on a higher quality of distribution. With better product and marketing we know that we can reduce our off price distribution and increase our penetration in existing doors so that volume remains good and margins improve. We have a complex business model in part because we have been pursuing too many small initiatives that are not driving enough growth. We need to become more focused on fewer things that matter more and we need to share our own future. We believe that our consumer direct business can be a powerful tool for us in this regard. Our retail stores are the face of the brand. They allow us to cross merchandise product category, create visually compelling merchandising, control pricing and provide direct interaction with the consumer. This in turn enables us to establish an emotional connection and a personal relationship with the customer. Great retail stores will enhance the brand and in turn our other channels of distribution.

We are very pleased with the progress in our company stores where we continue to have positive comps, above average productivity and double digit four wall profitability. By the way our company stores are our outlet stores. We are also pleased with our Internet business which should double in volume this year albeit off of a relatively small base. Our biggest improvement opportunity is in our full price retail stores. At an average of $2 million in sales per store the consumer demand is good. The major issue is that our stores are too big which causes low productivity and negative profitability. We are now in the process of structuring a five to six store test with footprints in the range of 3,000 to 3,500 square feet versus the average today of close to 5,000. These stores will offer a full complement of product with improved assortments and visual presentation. They will also have reduced selling and operating costs. We are targeting a combination of street and mall stores in a diverse range of geographic locations so that the results of the test will give us confidence to deploy additional capital.

Now I’d like to spend a minute on licensing and international. These are both important contributors to profitability. Additionally our licensed businesses have extended the reach of the Kenneth Cole brand on a global basis. While we do not anticipate adding any new licensed categories in the near future we do believe there are growth opportunities with many of our existing license partners. The key to success is to leverage our licensee partners’ expertise in product design, development and sourcing while maintaining a close partnership to ensure that brand image, positioning, pricing and distribution are consistent across product categories. We also see growth potential in international markets and this is probably one of our biggest longer term opportunities. International is just over 10% of our total sales at retail but it is one of our fastest growing segments. Today we are in 66 different countries with 67 retail stores so clearly we can be deeper in each and every market. We expect to share more detail on this initiative when we present the full scope of our three-year plan.

I have shared my thoughts on the brand, our products, marketing and distribution. We are in the process of developing a three-year plan to build upon these key learnings and to realize the full potential of the Kenneth Cole brand. Of course we all know that the ultimate key to success is the ability to execute these strategies effectively and that all comes down to having the best talent and the appropriate capabilities. While we are still in the process of defining our organizational structure and staffing needs I did want to point out a few key management changes.

First as you may know last week we announced the appointment of Kristen Dykstra as Senior Vice President and Chief Marketing Officer. Kristen comes to us from BCBG where she was instrumental in helping grow the BCBG brand from $250 million to well over $1 billion over the past 10 years. Second we have announced the promotion of Jeff Cohen to President of Consumer Direct. Jeff was previously head of our company stores business and did an outstanding job of turning that business. We are now looking forward to his leadership in the full price stores as well.

Before turning it over to David to discuss our second quarter results I’d like to make a few quick comments on our financial performance. We are in a challenging economic environment. I’m glad we’ve been able to maintain our overall sales level in the difficult climate but clearly it is our goal to drive incremental growth. Equally important it is our goal to generate increased profit flow through by improving margins and reducing SG&A expenses as a percent of sales. These will be key areas of focus over the next several months. There are some quick fix items we are working on for the second half which I’ll share with you in a moment and some longer term opportunities to improve margin including building a more effective sourcing organization. But the key to delivering higher sales margins and profits on a sustainable basis is as I’ve already described to strengthen our brand position through great quality product, innovative and aspirational marketing and brand enhancing distribution.

I’d like David to now go through the numbers for the quarter and our guidance for the next quarter so you have a backdrop for these initiatives.

David P. Edelman

Let me now take you through some of the important financial details of our second quarter results. Consolidated net revenues for the second quarter were $111.2 million down 6.6% compared to $118.9 million in the year ago quarter driven nearly entirely by softness in our wholesale business. Wholesale sales for the quarter including sportswear were $57.9 million versus $67.1 million in the year ago period. Higher levels of sales dilution, poor results from the department store channel and a generally sluggish environment were the primary drivers behind the decline. While footwear was down across most of divisions we did experience high single digit growth in handbags and we are pleased that our wholesale backlog as of this morning is up 3.5% albeit with most of the improvement weighted towards the end of the third quarter and early in the fourth quarter.

Consumer direct sales rose 4.2% to $43 million versus $41.2 million in the year ago quarter. Comp store sales for the quarter were up 1.3% based on continued positive comps in our company stores and an improving trend in our full price stores. Year-to-date we have achieved positive comp store sales of 2.3% showing we can improve regardless of the environment. Licensing and royalty income in the quarter was $10.3 million versus $10.6 million in the year ago quarter. This slight decrease in our royalty revenue is due to the re-acquisition of our men’s sportswear license partially offset by increases in existing licensees and the launch of Le Tigre at JCP, Penney’s.

Gross profit margin in the second quarter was 41.4% versus 44.3% in the year ago quarter again reflecting the highly promotional environment. Total operating expenses were $49.1 million versus $48.9 million last year. The increase in operating expenses was due to additional costs for new business initiatives for men’s sportswear and Le Tigre and were partially offset by other cost savings throughout the company. However SG&A as a percent of revenues rose to 44.2% versus 41.1% due primarily to the de-leveraging in wholesale. We are extremely focused on right sizing our expenses while investing in our future growth drivers. Interest income in the quarter declined to $354,000 from $1.6 million in the year ago quarter. This reflects lower interest rates between Treasury invested in vehicles and the money market rates earned in the year ago period. The net loss for the quarter was $2.1 million compared to a net gain of $3.3 million last year. On a per share basis the loss was $0.11 per share in line with our recent guidance.

Turning to the balance sheet, cash and equivalents at the end of the quarter declined $36 million t $72 million versus $108 million at the end of the same quarter last year. Please bear in mind that we have used approximately $54 million in our share back program and our acquisition of Le Tigre, $39 million to buy back approximately 2.3 million shares and $15.5 million for the purchase of the Le Tigre business. Since the close of the second quarter we’ve also purchased an additional 337,000 shares leaving us with approximately 3.1 million shares available for repurchase under prior authorizations by the company’s Board of Directors.

Inventories at the close of the quarter were very clean. While total inventory was down about 1% our wholesale footwear and handbag inventories were down approximately 22%. Total inventories include new men’s sportswear inventory, a business which we did not have last year and a ramp up to support planned increases in our outlet stores. Capital expenditures for the quarter were $1.7 million primarily for new store openings. Capital expenditures for the six months were $2.8 million.

With respect to guidance for the third quarter we expect revenues to be between $125 million and $130 million. We expect total expenses to be down slightly, however this improvement will not fully offset the projected contraction in gross margin rates which we expect to land at similar levels in Q2 due to the continuing difficult and promotional environment. We also project about a $0.04 impact for lower interest income. Accordingly we expect earnings per share to be in the $0.07 to $0.09 range.

Thank you and I’ll now turn the call back to Jill so she can share some of the actions we are taking to improve performance in the back half of the year

Jill Granoff

As I said before we are in the process of developing a long-term strategy to realize the full potential of our business and we will share that with you in the near future. We are hoping to have highlights on our next call. At the same time we also know that we need to make improvements now. With respect to the plan for the second half we are making some immediate adjustments to our business to bolster profitability and sales performance. Within consumer direct we will take action to accelerate the improvement we are seeing. As David mentioned our outlet business was strong and continues to post same store sales increases. These stores are generating good levels of operating cash. We are planning to open four more new outlet stores by the end of this year which would bring our total to 52. We believe we can continue to make margin gains in this business as well.

Our Internet business is also performing well. We’ve recently re-launched our web platform with GFI, one of the best partners in Internet retailing. The new site is commerce focused where previously we were focused more on marketing and as I mentioned earlier we expect volume to double this year. Our full price stores are also continuing to improve. As you know we closed seven stores and downsized one since this time last year. In our remaining 43 stores we have some good merchandising initiatives to drive volume in the second half including higher levels of density, more seasonless product and our first holiday gifting program. We’re also creating window displays that we believe will help drive traffic and we’ve installed traffic counters which went live in July to help us improve conversion ratios and ensure our labor costs are optimized.

Moving onto licensing, we are generally pleased with how our licensees are performing at the moment. We have worked closely with our partners to maximize our opportunity for fall and holiday. Of particular note we expect to make great strides with Le Tigre which launched this quarter with JCPenney and we are also projecting continued strong momentum in women’s apparel and in outerwear.

Wholesale is currently our biggest challenge. We are doing a number of things to create better performance in the second half. We have rationalized our product mix to focus on proven performing items we have an increased number of replenishment styles and have made some infusions based on learnings from test and react initiatives. We will leverage our top doors with targeted marketing programs, improved signage and in store events. We’re also watching expenses and inventory very closely. Within wholesale we are working hard to improve the men’s sportswear business. The market is now clean of slow moving deeply discounted products from PDI. We’ve adjusted our fit to address a wider range of consumers, we are reducing the percent of fashion items in favor of basic brand right sportswear products and we will have a stronger denim program which based upon early tests should perform well and help results quickly.

Finally we are very excited about Kenneth’s personal support for the brand especially in honor of our 25th Anniversary. Kenneth has recently completed and is in the process of publishing a book on volunteerism with 86 personal [inaudible] from noted individuals including President Bill Clinton, Robert Redford, Lance Armstrong and Mia Farrow. The book features stories on how ordinary people can do extraordinary things to improve society, the environment and individual well being. The Kenneth Cole brand has always stood out for its social consciousness and this book on awareness spelled AWEARNESS reinforces our authentic position to make a difference in the world. Kenneth will be doing a lot of national media and will host several in store events to promote this new book. We believe this will drive additional traffic to our stores.

In addition our holiday campaign will revolve in part around the gift of giving. We will give each of our store customers who make a purchase above a certain dollar level a gift card to be donated to the charity of their choice. This of course will tie into a national and local advertising campaign and unique gifting items in our own retail stores to drive improved sales performance.

In conclusion Kenneth and I recognize the hard facts regarding our performance over the last several years. Our sales have been flat, our operating profit margin has eroded and our shareholders have not seen an acceptable level of return. While there is definitely a challenging road in front of us and a lot of work to do it is clear that this company has some incredible strengths that we will leverage as we move forward. We have strong and positive brand awareness, a committed and involved brand founder who is a living iconic fashion designer and brand ambassador, we have a true lifestyle assortment, a global growth opportunity in many categories and an exceptionally strong balance sheet. We can and will leverage our strengths to improve our performance. We’ll make some short term gains in the second half but more importantly we’ll position the business for long term improvement. There are no sacred cows in defining the path to profitability. Kenneth and I are committed to building a global retail driven lifestyle brand and delivering increased shareholder value.

Kenneth D. Cole

Before we finish I would like to just once again reiterate that while I’m not satisfied with our results we continue to make progress and we believe we have significant near and long term opportunities to improve our performance across all classifications and points of distribution.

I’d like to congratulate Jill on her efforts and contribution in a relatively short period of time as well as our energized management team and the entire organization for their hard work and dedication. Further I’d like to thank our customers and partners for their loyalty and our shareholders for their continued support.

Thank you. Now we’d like to open this up for questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question will come from Scott Krasik – C.L. King & Associates, Inc.

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

First question, Jill, the last three, four, five years your SG&A has really grown significantly, $40+ million. Is it too early to get a sense of where that really went to and how you right size that? Can we see meaningful declines in SG&A over the next few years?

Kenneth D. Cole

Scott, we’re looking at all discretionary spending and we’re looking at all expense items as they relate to each channel. In the last 12 months we’ve reduced corporate headcount, we’re taking a careful look at discretionary items such as trade shows and travel, we’re asking all departments to reduce costs where appropriate, we’re creating some leverage in the consumer direct channel, we’re looking at our largest single expense item which is rent and we are looking to drive down our costs.

Jill Granoff

I would just add to that, that rent is a big item for us as well that we’re looking at. I think we mentioned earlier that our stores are large and we can drive greater levels of productivity by right sizing our stores. So we are taking steps in that regard. Another thing we are doing is we are looking to re-deploy and rationalize our resources behind highest level growth opportunities. Our business today is overly complex and we will be looking at opportunities to simplify the business and really focus our resources behind those opportunities that can yield the greatest returns.

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

What does that mean? Is that less brands or less layers? What are you getting at there?

Kenneth D. Cole

I think Scott that we’re going to not respond to that yet. This needs to be totally thought out and articulated appropriately. We’re not quite prepared to do that but we are committed to make this a more focused business model and we hope to have a clear strategy to lead for you sooner rather than later.

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

The positive wholesale backlog for Q3, Q4 deliveries is certainly encouraging. It’s getting much tougher for the department stores, it’s harder to get reorders. How are you keeping the share that you are and actually potentially growing the business a little bit?

Kenneth D. Cole

The wholesale business model is a tough one in this marketplace. I’m not comfortable attributing our less than stellar results to environmental circumstances but the reality is, and I do believe if we get the product right, we’ll do well despite environmental circumstances. That said, it is difficult out there and we’re trying to run a winner business, we’re trying to respond quicker and more effectively to opportunities as well as liabilities and you’ll see a more productive business entity as we go forward and that’s very much what we’re focused on.

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

Are you maybe keeping some market share in footwear because you have a successful handbag business and you have a successful accessories business through your licensees? Is that keeping you there?

Kenneth D. Cole

I’m not so sure our percentage of the pie has gotten any smaller. The pie has gotten smaller. But I still believe that that said there’s certain cuts to get to the product we need to re-energize and focus on and we missed on the transition from we had these Reaction footwear product in both men’s and women’s that we missed it, we owned it, we transitioned too late and/or too early. It set us back a little back. I think we’ll be a little bit smarter going forward and we’re in an environment, a declining environment so we’re more focused on that as well.

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

David, can you give us a little more detail behind Le Tigre, the timing of the launch, what your expectations are? I know that’s one of several brands that JCPenney’s is focused on.

David P. Edelman

Scott, we generally don’t break out the financial parts of that but we launched Le Tigre during the second quarter and it performed well but it’s only been out there for a couple of months and we just recently launched our second classification, young men’s and I heard that was received very well as well.

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

The first one was what, young women’s?

David P. Edelman

Yes.

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

And then footwear?

Kenneth D. Cole

We have a small assortment of footwear that’s going in there as well as we speak as well as some handbags.

Operator

Your next question comes from Jeff Van Sinderen - B. Riley & Company, Inc.

Jeff Van Sinderen - B. Riley & Company, Inc.

I wonder if you can give us a little bit more color on what’s going on with the men’s sportswear business, how that’s been evolving and what we should expect going forward there in terms of changes?

Jill Granoff

Men’s sportswear is a very important classification for us. You always have some bumps during a transition period from a licensed category to bringing it in house particularly in this challenging environment but we continue to believe this can be a sizable and profitable business. We have already taken steps this fall as I alluded to earlier in terms of the assortment and the fit to make the collection better, really based on customer feedback. Also this is an important classification for us, an important initiative for us as we build our retail and our international business.

Jeff Van Sinderen - B. Riley & Company, Inc.

I think in your prepared comments you talked about some near term opportunities that you’re focusing on. I wonder if you can share some of those with us and then how you’re approaching that?

Jill Granoff

I think as we said just to repeat if you look at consumer direct, our outlets are doing well, we’re going to open four more stores, that should drive improved top line sales performance and we also believe we have an opportunity to improve margin. Our Internet business we’ve just re-launched with GSI, we expect it to double in volume this year so that should help our back half performance. We just launched with GSI in July and on the full price store side we have done store-by-store visits to really look at the assortment, to look at how we’re using space, to improve density. We’re already seeing improved results, retail is detail and we’re taking those steps. We’re looking at payroll to see where we can reduce our payroll and we’ve introduced a holiday gifting program and marketing behind it to drive traffic. We’ve talked about what we’re doing in wholesale with increased replenishment skews and with some seasonless items and with some infusions and we’ve talked about what we’re doing in sportswear.

So we’ve looked at the business and we’ve worked with our licensee partners as well to see where we can drive improved performance. We’ve gone through segment-by-segment, category-by-category to see how we can improve performance and we will also keep a very careful watch on both expenses and on inventory.

Jeff Van Sinderen - B. Riley & Company, Inc.

In terms of your full price retail stores, you said that the trends are starting to improve there. should we think that they’re still running negative comps or show should we think about that? Also maybe you can just touch on how you’re approaching right sizing the store closures, things of that nature for the full price stores?

Jill Granoff

We don’t report out our comps by segment within consumer direct but we are seeing improving trends so I would say that we’re very pleased with the results in our full price stores just by making some of the tweaks that I’ve discussed really on a store-by-store basis both in mix and in density.

Kenneth D. Cole

Some are by the way the other shorter term things, too that Jill kind of alluded to but you’re going to see a little bit more core product in all classifications. I think our sourcing is getting a little bit better going forward so hopefully you’ll feel that in the margins and also there’s a gifting initiative which is significant and it could be significant. We haven’t done this before and it’s all incremental business that you’ll see contribute to our fourth quarter business.

Jill Granoff

I just want to build on the question that you asked about how we’re right sizing some of our stores, you know this company has amazing, amazing real estate. We’re in great locations, some of the best malls and streets in America. I think the stores are just too big but the locations are very desirable. So again we have done a store-by-store review and on our next call I’ll be happy to share with you where we are right sizing our stores, increasing, downsizing, whatever it may be but in several of our stores we can actually go back to the landlord, reduce the space and there are very interested tenants in taking adjacent real estate and because we have sufficient frontage with most of our stores and also attractive rents in many cases the landlord is happy to help us out in this regard. So that’s what we’re doing.

Kenneth D. Cole

We told you guys on the last call about Philadelphia which is a good example. That store is literally half the size that it was and it’s operating at 90+% of the volume at half the size with 80% of the inventory.

Jill Granoff

What’s interesting is a lot of our stores were small, they were very productive and very profitable. We went to bigger stores, but the sales didn’t double or grow even beyond to cover the increased costs of the build out of the rent and I’m sure you’ve seen that again and again in retail. We’re really looking now at what is the right size box, we’re going to do this test and the we’ll really map out a very clear full price retail strategy moving forward.

Jeff Van Sinderen - B. Riley & Company, Inc.

Is it too early at this point to talk about some of the things you’re focusing on for international initiatives as you see that as an area that’s under penetrated or is there anything else to talk about there to give us any more clarity on that?

Jill Granoff

Yes and yes.

Kenneth D. Cole

[Inaudible] to know the international contribution to our results is a fraction of what it is for our competitors. So the opportunity is significant, the brand we have come to learn it has awareness and viability in markets we didn’t believe it did and we’re contemplating studying the options and our alternatives and we will be getting back to you.

Operator

Your next question comes from Sam Poser - Sam of Sterne, Agee & Leach.

Sam Poser - Sam of Sterne, Agee & Leach

David, can you give us within the guidance what the gross margin in SG&A assumptions are?

David P. Edelman

For SG&A we’re actually thinking that some of the cost cutting measures we’ve taken over the last few quarters will kick in and our expenses are going to be down year-over-year and as a percentage of revenue. In terms of gross margin we feel that the wholesale business is still going to remain under pressure and will be similar to what we’re experiencing Q2 and we’re hoping to have some of that turn around towards the back part of the year.

Sam Poser - Sam of Sterne, Agee & Leach

So basically at around that 41% rate?

David P. Edelman

For gross margins?

Sam Poser - Sam of Sterne, Agee & Leach

Yes.

David P. Edelman

Yes.

Sam Poser - Sam of Sterne, Agee & Leach

One of the things, Jill, that you said in your prepared remarks was discussing the brand positioning. By making the moves that you’re making now to open more outlet stores and as you say fixing the sportswear brand and adding casual product now, how does that match up against fixing the brand positioning when you haven’t publicly stated the three year plan? I understand what I’m saying. How do you know where you’re going as you do these, I don’t know if their band-aids or how to even think about it?

Kenneth D. Cole

Right now we think casual is kind of casual kind of within the parameters of the brand and it’s Kenneth Cole Casual, it’s not casual as you know casual but it’s just re-apportioning our assortments and a little less dressed up, a little bit it’s casual wear to work rather than dress up wear to work. It’s still in the spirit of this brand and these are short term fixes and they’re not long term, they’re just immediate sorts of things that we need to do and a more clear longer term strategy as it’s addressed will probably accomplish we believe elements of what we’re doing now. I don’t know if that’s clear to you, Sam.

Sam Poser - Sam of Sterne, Agee & Leach

It is. I guess the issue is when you launched the apparel, the sportswear under your own brand, you had other things going on. I’ll bluntly ask how much of this is basically protecting shelf space at the department stores versus really positioning the brand?

Kenneth D. Cole

There’s nothing we’re doing short term we think that’s going to get in the way of our long term ideas which we anticipate them. Much of what we’re doing anyways is focused on our own stores, it’s not really about third party distribution and the plan you’re going to hear is a three year comprehensive brand strategy and it’s bigger than these initiatives that we’re dealing with right now to address our immediate needs.

Sam Poser - Sam of Sterne, Agee & Leach

But if the wholesale gross margins are going to remain under pressure, David, can you discuss why that is? Is it a top line issue or is it having to answer up for markdowns?

David P. Edelman

No I think the gross margin is under pressure because of two things, one we’re in a difficult department store channel environment right now and then our dilution is up higher than it has historically been and the second thing is we are experiencing some rising costs particularly out of China and our sourcing sites. We’re losing a couple of points on our IMEs.

Sam Poser - Sam of Sterne, Agee & Leach

How is that being corrected for 2009?

David P. Edelman

In what regard?

Sam Poser - Sam of Sterne, Agee & Leach

The initial markups. Are you raising prices? How are you looking ahead for that?

Kenneth D. Cole

Sam, I think what we’re going to do is we’ll address a comprehensive strategy on our next call and we’ll deal with all that then.

Jill Granoff

I think as we mentioned also we are looking to put together a more comprehensive sourcing strategy, sourcing team, etc., and we’re looking at countries we produce and we’re looking at a lot of our partners over there and we will come back to you with more information on sourcing as we unveil a three-year strategy. It is a core element.

Operator

That does conclude the question-and-answer session.

Kenneth D. Cole

Again I just want to thank our shareholders, thank you for your support and your patience and I think it will pay off over time. I can’t thank the organization enough for staying focused and helping us through this period of change and opportunity. Thank you very much.

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Source: Kenneth Cole Productions, Inc. Q2 2008 Earnings Call Transcript
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