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Cache Inc. (NASDAQ:CACH)

F2Q08 Earnings Call

July 24, 2008 9:00 am ET

Executives

Allison C. Malkin – Senior Managing Director, ICR

Thomas Reinckens – Chairman, Chief Executive Officer and President

Margaret Feeney – Executive Vice President and Chief Financial Officer

Analysts

Margaret Whitfield - Sterne, Agee & Leach

Robin Murchison - SunTrust Robinson Humphrey

Neely Tamminga – Piper Jaffray

Liz Dunn - Thomas Weisel Partners

Eric Beder – Brean Murray, Carret & Co.

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

Elizabeth Pierce – Roth Capital Partners, LLC.

Mark Montagna – C. L. King & Associates, Inc.

Harry Ikenson - Ikenson Research and Consulting

Operator

Welcome to the Cache Inc. second quarter fiscal 2008 results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Allison Malkin of ICR.

Allison C. Malkin

Today's conference call includes comments concerning Cache’s business outlook and contains forward-looking statements. These particular forward-looking statements and all other statements that may be made on this call that are not based on historical fact are subject to risk and uncertainties. Actual results may differ materially.

The fiscal information concerning a number of factors that can cause actual results to differ materially from the information that will be discussed is available in Cache's filings with the SEC including Cache's report on form 10-K for the fiscal year ended December 29, 2007. For those of you who wish to participate on this conference call via the webcast, please go to www.cache.com, click on ‘Investor Relations’ and then on ‘Presentation’.

And now, I'd like to turn the call over to Tom Reinckens, Cache's Chairman and CEO.

Thomas Reinckens

Here with me today are Maggie Feeney, our Executive Vice President and Chief Financial Officer; Ashok Gandhi, our Vice President of Finance; and Victor Coster, our Treasurer and Secretary.

For today's call, I will begin by providing an overview of our second quarter results and update on our progress towards achieving the priorities we set at the beginning of the year. Then Maggie will review our financial highlights, and I will provide closing comments and turn the call over to the operator to conduct the question-and-answer portion of the call.

We are pleased to report better than expected second quarter results. Net sales rose 4.1% with comparable store sales up 3%. As anticipated, comp store sales accelerated in May and June as sportswear became a larger percentage of our mix. This positive trend has continued in July.

Earnings of $0.16 were $0.01 ahead of the recently raised guidance we provided on July 8. We attribute our strength in a difficult consumer spending environment to the success of our key priorities which we believe position us to increase market share and over time attain our mission 500 sales goals and double-digit operating margin targets.

Briefly, reviewing these priorities first to maximize the potential of the AVD acquisition, consumers are responding very favorably to our cohesive assortment and collection dressing which has been made possible through the design and sourcing talent that we acquired along with the acquisition. In sportswear, our offerings are now appropriate for more of our customers lifestyle needs which is driving traffic, UPP and shopping frequency. We've also seen a benefit to our dress and accessory assortment with encouraging results.

In addition, in 2008 we have now begun to shift a larger portion of our on-order inventory purchases to lower cost, overseas factories. We are pleased with the innovative fabric and quality from our overseas partners. This effort is also allowing us to offset higher labor costs in the U.S. We will however, continue to utilize domestic manufacturing partners for speed to market but at levels less than a year ago.

Second, to implement a good, better, best pricing strategy we rolled out this strategy to our stores during the spring with great results. We now have competitive pricing which is common in our signage and marketing and this is resonating with consumers. UPP's are up. We are confident this initiative will drive sales per square foot to our mission 500 goal.

Third, to maintain discipline in expense and inventory management expenses were well controlled despite incurring incremental expense due to the AVD acquisition. Average inventory at cost on a per store basis for finished goods was down 17% from the same period a year ago.

Fourth, to improve compability by closing underproductive stores and selectively opening new stores as we mentioned last quarter, we identified approximately 14 underperforming stores for closure, mainly our Cache Luxe location. We will continue to carry the last Cache Luxe brand in our ongoing Cache stores and believe our company will benefit as we focus exclusively on Cache.

As it relates to new stores during the quarter, we opened five stores, closed two locations, ending the period with 297 stores. For the second half of the year, we remain on track to open approximately eight new stores and close approximately 13 locations. For the year, we expect to open approximately 16 new stores and close about 21 locations ending the year with approximately 292 locations and 590,000 square feet in operation.

Fifth, to provide consumers with effective marketing our latest catalogue and mail orders have achieved strong results following the testing of several types of events last year. We are also pleased with our Cache Accents program, which is our program designed to grow customer loyalty. To date, we have signed up over 470,000 customers and expect this initiative to continue to gain traction with consumers this year. In addition over 15,000 customers have signed up for our co-branded Cache Visa card.

We also ended the quarter in a strong financial position. Cash and marketable securities totaled $27 million, even after the purchase of $3.2 million of our common shares since last year’s second quarter and our debt to capitalization ratio was 6%.

As we look ahead, we expect our positive performance to continue and point to these key drivers of this expectation. We're excited about the August re-launch of Contour that includes two fabrics, fit and an expanded offering as compared to last year. We are better positioned to maximize the growth of Contour this fall and holiday versus last year when we found it hard to stay in stock.

We are experiencing strength across all our categories, a testament to our compelling assortments. Our inventory is in great shape with markdowns lower than last year in the second quarter.

As I mentioned, the third quarter is off to a good start. Despite being up against our largest monthly comp store sales increases last year in July and August, I'm pleased to report our July results are positive and on plan with only three days remaining in our fiscal month. And finally, we believe we have a lot of opportunity in our fourth quarter given significantly easier comparisons and feel good about our holiday plan.

With that, I'd like to turn the call over to Maggie to review our second quarter results and guidance in more detail.

Margaret Feeney

Beginning with the income statement for the second quarter, net sales totaled $74 million, up 4.1% from $71 million in the second quarter last year. This was primarily driven by a 3% increase in comparable store sales.

Our second quarter sales increase reflected a 3.5% rise in transactions and a 3% increase in units per transaction which more than offsets the 0.5% decrease in average dollars per transaction. As we had previously mentioned our good, better, best pricing strategy is expected to slightly lower average dollar sales while raising transactions on UPC which we believe positions us well along with our merchandizing and marketing initiatives to achieve our $500 dollar sales per square foot goal.

During the quarter, we opened five stores and closed two locations as part of our plan to increase store productivity. Gross profit dollars increased $257 thousand to $34.2 million from last year’s gross profit of $33.9 million. Gross profit margins declined 160 basis points to 46.2% of net sales from 47.8% of net sales of last year. The significant portion of the 160 basis point increase would be the higher freight charges.

In addition, in the 2008 quarter, all of the AVD operating expenses are included in the cost of [inaudible]. As a result of the acquisition the company was able to reduce [inaudible] expenses which were primarily classified in general administrative expenses for last year.

The record set gross margin was also affected by our new pricing strategy. On a positive note, markdowns were down below the prior year level.

Turning to expenses in total, expenses were $31 million or 49.9% of net sales compared to $32.6 million or 46% of net sales in the second quarter of last year. Breaking this down further, store operating expenses totaled $24.8 million or 33.5% of net sales compared to $25.6 million or 36.1% of net sales in the second quarter of last year representing a 260 basis point improvement year-over-year. This decline is primarily due to lower marketing expenses in the current year.

General and administrative expenses totaled $6.2 million or 8.4% of net sales compared to $7 million or 9.9% of net sales in the second quarter last year, a 150 basis point improvement year-over-year.

General and administrative expenses for the second quarter last year included approximately $600,000 in additional legal expenses as compared to 2008 due to non-recurring legal charge settlement costs, approximately 800 basis points or half the decrease. The additional savings in general and administrative expenses are primarily related to the reduction of the duplicate expenses due to the AVD acquisition that are now included in cost of sales as part of AVD operating expenses.

Operating income totaled $3.2 million more than double last year’s second quarter operating income of $1.3 million. Operating profit margins rose [208] basis points over the prior year’s period.

Interest income totaled $197,000 compared to $758,000 in last year’s second quarter. The decrease was due to lower cash balances given the utilization of $38.9 million to repurchase 3.2 million of our common shares as well as the decrease in interest rate since the second quarter of last year.

Net income rose 64% to $2.1 million or $0.16 per diluted share on net income of $1.3 million or $0.08 per diluted share in last year’s second quarter. For the six months of fiscal 2008 net sales rose 4.7% or $141.7 million over the prior year period with comparable store sales increasing 3%.

Operating loss for the first six months of fiscal 2008 was $273,000 as compared to operating income of $801,000 in the first six months of last year.

Operating results for the first six months of fiscal 2008 included charges of $2.3 million related to store closures and $616,000 related to the previously announced management changes.

Excluding charges for store closures, the amount of change for one time legal settlement forms, operating for the first six months of fiscal 2008 were $2.7 million or 1.9% of net sales as compared to operating income of $1.8 million or 1.3% of net sales in the prior year period representing a 60 point basis point improvement year-over-year.

On a GAAP basis, net income was $52 thousand or breakeven on a per share basis which includes charges of $1.1 million or $0.11 per diluted share related to foreclosures and $388,000 or $0.03 per diluted share related to management changes. On adjusted basis, excluding the foreclosures and management changes net income for the first six months of fiscal 2008 were $1.9 million or $0.14 per diluted share.

Now turning to key balance sheet highlights, we ended the quarter with a strong balance sheet specifically on June 28, 2008 cash and marketable securities totaled $27.4 million compared to $66 million in cash and marketable securities at June 30, 2007. We are pleased to end the quarter with this level of cash given that we utilized $38.9 million to fund the purchase of 3.2 million shares of common stock since the second quarter last year.

Average inventory, per store at cost reached 17% at quarter end from the prior year period. Total inventory on the balance sheet rose 9% and includes piece list inventories now that given that we're now vertically integrated. Last years quarter included no piece list inventory. We are comfortable with our inventory level and believe we're well positioned for the fall and holiday season.

Also at June 28, 2008, the company had $5.1 million of debt related to the purchase of AVD inventory design. Capital expenditures for the quarter totaled $2.5 million and for the first half of 2008 were $5.7 million.

Now regarding our forward outlook, we will be maintaining our previously issued guidance for the third and fourth quarter of fiscal 2008 and raising the low end of our full year guidance for 2008. For the third quarter of fiscal 2008 we continue to estimate net sales in the range of $62 to $64 million and diluted earnings per share in the range of $0.01 to $0.02.

We continue to expect third quarter fiscal 2008 comparable store sales to increase in the low to mid-single digit range. This compares to actual third quarter fiscal 2007 net sales of $60.6 million and diluted earnings per share of $0.01.

For the fourth quarter of 2008 we continue to expect net sales in the range of $82 to $84 million and diluted earnings per share in the range of $0.38 to $0.40. We continue to expect fourth quarter comparable store sales to increase in the low to mid-single digit range. This compares to actual fourth quarter fiscal 2007 net sales of $78.5 million and diluted earnings per share of $0.32. For the full fiscal 2008 we estimate net sales in the range of $286 to $290 million and diluted earnings per share on a GAAP basis in the range of $0.39 to $0.42.

This guidance includes cost of $0.14 per diluted share which we incurred during the first quarter of fiscal 2008 and relates to foreclosures and costs associated with the previous management team. On an adjusted basis, excluding store closing and management changes we expect fiscal 2008 diluted earnings per share in the range of $0.53 to $0.56.

This guidance compared to actual fiscal 2007 net sales of $274.5 million and diluted earnings per share of $0.40. Adjusted diluted earnings per share for fiscal 2007 were $0.44. For fiscal 2008 we expect capital expenditures which fund our new store openings and remodels to range from $11 million to $12 million. This compares to capital expenditures of $11 million in fiscal 2007. We also continue to expect to open 16 new Cache stores and close 21 locations, ending the year with approximately 292 locations and 590,000 square feet in operation.

And now, I'd like to turn the call back over to Tom.

Thomas Reinckens

In conclusion we are pleased with our positioning heading into the back half of the year. Our stores look great. Our current trends are solid and we remain very excited about the future. Our key priorities are working which is evident in our sales and earnings this quarter and we expect this performance to continue. We recognize that the environment remains [cost] and as such are planning conservatively.

Nonetheless, we are very pleased with our assortment across all categories, and expect to fully capitalize on the many opportunities we've identified during the balance of the year. In total, we expect 2008 to represent a strong year for Cache.

With that, I would like to begin the question-and-answer portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Margaret Whitfield - Sterne, Agee & Leach.

Margaret Whitfield - Sterne, Agee & Leach

Regarding the gross margin, I wonder if the operating expenses for AVD were included in cost of goods last year in the third quarter. I wondered what the dollar amount of piece goods was in the quarter in inventory. Also you had some stores that have not yet been closed that are planned to be closed, what was the loss imbedded in the quarter, and what is the timeframe for closing these stores? And if you could give us some outlook for the impact Q3 from these stores as well, that would be great.

Thomas Reinckens

First you asked about the inventory I think, the piece goods inventory. And that's apples versus oranges. Last year we didn't have AVD in our second quarter results, the AVD acquisition started July 1. The piece goods, I think we're over $8 million of inventory at the end of quarter two this year.

The good news is the majority of that relates to the great programs that we have in Contour fabrics. We added fabrics. We have lots of new silhouettes that have been hitting into the stores. You get a little bit more discipline in using offshore and shipping some goods via boat. Included in those numbers were good products on its way from Central America on the launch which are now hitting our stores and have hit our stores.

So we're excited because last year we were not in a position of piece goods and it took us awhile. We were running out of stock in many of the Contour items through out the fall season so we're in a much better position.

The answer on the third quarter, yes, the AVD acquisition costs, the operating expenses were included in the third quarter. But I'll caution you. As we acquired AVD on July 1, we obviously had two organizations that had duplicate functions in its arena. As a result of that, we really started to eliminate some of the these expenses in quarter three and even in quarter four last year as we integrated the two companies together.

So right now we're fully integrated and we've got the maximum savings achieved from that integration in our second quarter results from a standpoint of headcount reductions and duplicate functions and that reflected really in the G&A savings that we reported in quarter two. We would expect this year to see that continue into quarter three and quarter four as we move forward.

The store closing costs, I’ll give you an update. We have closed two already of the Cache Luxe locations, and I’ll say three. We've scheduled to close another one very shortly, the fourth one. We are also in negotiations to close the remaining ones as we speak. We're hopeful that a majority of them will be closed prior to the year-end.

Their losses in Q2 were approximately about $0.02 I think versus $0.01 last year of a loss for those locations. And on a year-to-date basis it's roughly about $0.04. In the third quarter it probably will look for similar amounts between $0.01 and $0.02 of losses. Incrementally no more than a $0.01 I think over last year in our projections for Q2. Q4 obviously is diminished impact and significant earnings capability for the company in Q4.

Margaret Whitfield - Sterne, Agee & Leach

The new Contour line is in the stores now, can you give us more color on comps with three days remaining and the response to the flyer which I think is out to some homes on the new line.

Thomas Reinckens

The new flyer is fantastic and we’re attacking merchandising on two fronts and one is value. We want to make sure that our consumers are getting better value for the great quality of piece goods and silhouette sets the designers have given us particularly the Contour collection. It's responding very well.

We are however, up against a 6% comp in July from last year and we're up against a 7% comp from a year ago. I'm pleased that we're comping positive in today's environment. That's all the color I will tell you. We're on plan. Our estimates were for lows if not mid-single digit on our comps in Q3. Our opportunity really is in Q4 on the comps.

But the good news is that we have the piece goods. They're flowing in. We've got great design silhouettes, significantly more than a year ago, and we're able to really move in very quickly with the way we're positioned now, the good assortments or the silhouettes that are performing the best out of each of the collections. So even off of about 10 days worth of selling, we've made changes and increased and added additional silhouettes based upon the current trends that we see for the back half of the year.

And Contour really is a fabric that goes right through into the winter months and so we're very excited about the outlook and the value that we're giving the consumers, particularly when you get into fall. Its early now for customers to start buying jackets and woven coats, our trench as well as the bottoms, our skirts, and our pants.

Operator

Your next question comes from Robin Murchison - SunTrust Robinson Humphrey.

Robin Murchison - SunTrust Robinson Humphrey

My question is on the cost side of the equation. Because you mentioned freight costs, the negative impact on gross margin, so I wanted to see if you could help us think about gross margins for the balance of the year and how we ought to be approaching that, things like maybe only year-over-year basis due to the freight costs. Are we looking at flat at best and maybe down a little bit?

Could you talk about where we should be on the tax rate for the balance of the year. You've been tracking I think at 37%. Should we expect that for the balance of 2Q? And then just overall bouncing back to gross margin for a second, merchandise margins from what you're seeing on the cost side of the equation now that you've had a little bit more time. Clearly it is to industry wide inflation and such.

Thomas Reinckens

Freight charges first of all, what we're seeing is significantly these fuel surcharges as much as 30% to 40% on top the normal rate. That really is what is attacking us on the freight side.

With respect to guidance going forward, and we really don't specifically give any details other than our top line and bottom line but I'll just give you a little color. The third quarter obviously is basically revenues are lowered consistently because of July and August, September are historically lower revenue months, and the second quarter months for June 4th quarter which is obviously our strongest.

We do expect gross margins however, to be slightly below last year’s but we will pick up those savings from the reduction in expenses here in P&A which now are included obviously in the ADV function with our design talent, our production talent. We changed our business model from a merchandise driven, buyer type organization to a vertically integrated organization. So we expect the fourth quarter should show some significant improvement in gross profits and that's because of a couple of things.

One, I think our comp store sales were down, Victor, in the quarter 7%. I know they were down 10% in December alone. So just from the leverage issue in gross profit, we pick up significantly with occupancy in our production expenses, significantly more revenue. And we're very conservative by the way in planning again our fourth quarter only off those low to mid-single digits.

Tax rate is really predicated on our pre-tax income, meaning the Federal level the 34% versus the 35% I think Victor, and we’re at that 34%. But we're comfortable right now in our projections on the Federal piece that the overall tax rate is around that 37%. And that’s what we think that it will be for the year, the same as what we had in the first quarter.

Robin Murchison - SunTrust Robinson Humphrey

For a few years you seemed to have opportunity in the fourth quarter and have for a couple of years back and so yet it always seems like something sneaks up a little bit or there's some, is there a way, is there some defensive strategy or something that you can, or some variable that in the event that fourth quarter is a more difficult despite the easy comparison that you have. And maybe dovetail that just what your assessment of the environment as we head into the second half. Probably fairly obvious, but if we could just hear what you have to say about that.

Thomas Reinckens

The number one thing I think that we have to be responsible for is really in our inventory commitment and what we expect and how much we put in our stores. I think plus the whole industry people are being very diligent to really reduce and control the inventory flow into your stores. And we are very diligently watching that.

We are planning our inventory very conservatively. When we are looking at our merchandise plan and in any merchandise organization there is always in a push to buy more, more, more, and what our philosophy is, let's plan our inventory purchases even lower than our sales expectations and turn the merchandise faster.

What I'm excited about in Q4 is really the merchandising strategy that the designers and the whole team collectively have worked on is really to focus on giving value. I've walked into other stores and I won't say the names but you look at the quality and we all look, and we all are consumers and we see diminished quality in fabrics and so forth. You won't see that at our store. But you will see better value. And to me that's a win.

In addition to that, the second component is our designers are working very carefully to try to give our appeal to our merchandise to a broader based audience and that's really where Contour comes in and I think that's going to work for us. We're going to have value in our sweater assortment, our knit assortment in the back half. Our marketing department is working very diligently in giving us the tools that we can show all traffic during those magical five weeks when traffic is significantly higher than it is the rest of the year, to get people to look at the assortment that Cache has and to relook at it and rediscover Cache.

That's really the focus and the excitement that our whole organization feels about the quarter four, but saying that, as you pointed out, the environment it is very difficult. We know it is. It's encouraging at least over the last week or so to see oil prices slip and as I drove in today, I actually saw a $0.05 decline at one of the gas stations. I thought buy and that's the first time I've see a decline in a long, long time.

So psychologically a lot of it is driven physiologically. I still think it will be difficult. It is difficult now and, but I think we're doing the things that could increase our business. So I'm confident and we're being very conservative on our back half because of the concerns that you brought up and I think we all feel that way. But we are excited about our prospects.

Operator

Your next question comes from Analyst for Neely Tamminga – Piper Jaffray.

Analyst for Neely Tamminga – Piper Jaffray

Tom, I'm wondering if you could comment on what you are seeing in terms of the customer response to your lower price plans. For example, is this a new customer that is shopping or is this a lap customer? If you could just give us a little more color on that please.

Thomas Reinckens

We're seeing a little of both. The real key is what Maggie said earlier, our average dollar transaction is roughly down 0.5% year-over-year. That's a combination of a couple of things. It's a combination of really of the biggest thing is the UPT. Our UPT's are up so customers that are coming in are buying more. And I think that's a direct reflection of our good, better, best pricing strategy.

And I want to say, the low prices across the board. We're excited about some of the things at the higher prices as well, and we will continue to put those in our best and ultimate categories. But year-over-year it's really being driven by units per transaction and more transactions. And our sign ups are increasing. Our Cache Accents program, so there's no question that we are getting some new customers, but I think our core customers welcome the assortment as well.

Analyst for Neely Tamminga – Piper Jaffray

I'm wondering what the percentage of sales of sportswear is currently.

Thomas Reinckens

We didn't compare that schedule right now. That business is very strong. Our accessory business is very strong. But as we said in the last quarter conference call, you will see sportswear and accessories actually growing as a percent primarily due to the lower level of dress business, long dress business in our formal area in the month of April of our second quarter. There were declines in that in April, significant decline. We don't disclose that. We only disclose that at year-end. So that's all I can pretty much answer right now.

Operator

Your next question comes from Liz Dunn - Thomas Weisel Partners.

Liz Dunn - Thomas Weisel Partners

Relating to the overseas sourcing effort, can you provide any additional detail on what percent you are on now and where you're going, and whether or not you actually expect to save overall, or is it just really offsetting cost increases and you expect a net impact of flat IMU from that move?

Thomas Reinckens

What we said last quarter on our conference call, starting in March most of the entire goods that we produce ourselves through our own supply chain are on order from March through the end of the year. It's roughly about 2/3 of all of that is being done offshore of what we produce ourselves. We still produce. We still purchase from domestic resources and foreign resources about a third of our product through vendors, what we call the vendors.

But 2/3 of all of our merchandise is done for our own production. Of that 2/3 is done offshore from the period of March to the end of the year. Your assessment is right. It is offsetting some of the cost increases that we are seeing and by being more disciplined with boating goods versus airing goods, we're able to pass along those savings to our customers and that's really what we're trying to accomplish.

We need to get again, throughout organization better value to the consumer. You can't fool the consumers. If you give them better value and better piece goods, better quality, then they're going to respond favorably to your assortment and as long as you give them the right styles they respond favorably to that. And that's what we're trying to accomplish.

So I can't answer specifically where we are because we have lowered our pricing and lowering our IMU in effect, but we are doing everything that we can, including going offshore, boating, sourcing piece goods at better pricing. Anything that we can do to lower our cost and give the consumer a better value at the same time building our top line to be more productive in our business model.

Liz Dunn - Thomas Weisel Partners

I previewed some of the product for Chico's and Coldwater and I just came from Ann Taylor, and all are calling out use of this ponti fabric for fall. I think that's what you use for the Contour line and have you thought at all about the competitive environment in that sort of Luxe. You were clearly early, but it seems like others are duplicating that look out there in the marketplace and what do you think about that?

Thomas Reinckens

I can't answer what others are doing because I haven't seen it. But we do use a double knit fabric in one of the fabrics. This year we introduced a second fabric in Contour so in our mailer we have two different fabrics that are included now in Contour. I can tell you that you are 100% right that yesterday's home run could be tomorrow's double. But what I can tell you is our value relationship and our pricing is much sharper.

So when you look at the mailer that was sent last week you can see that jackets are at $148, $158 when last year they started at $198. You can see pants at $88, $98 where last year they started at $118. So we were very consciously aware of that and in our pricing decision, we took that into consideration. But Contour is about lifestyle and as I said, we added a great new style which is responding equally as well as our double knit fabric.

Liz Dunn - Thomas Weisel Partners

In the past we've talked about the customers' perception of the brand and I believe you've done some research as part of your evolution of the brand that has indicated that her awareness of the brand and her meaning the customer’s awareness of the brand, and intent to shop lower than some of your competitors. Have you updated that research and what is that telling you now about your customers' view of the brand particularly in light of the evolution of the product and the fact that stores look a lot more cohesive than they did a year or two ago?

Thomas Reinckens

I'm not sure we ever specifically said what you said, but what I recall that our marketing services have told us is that our customers said that a) we were too expensive for what we were. That was one of the complaints that we saw in these studies. And I think that really attacked it. And also what Cache was known for, and you're right, in the evolution of the brand, was really known as the destination dress store, the after five, the special occasion store.

What we're obviously trying to do is to broaden the scope of what we can serve to our customers from a standpoint of value and not only in price but in use. In what we call multi-use, multi-function, long wear ability, something a woman can wear to work and then wear out for an evening or for dinner or event, or whatever it may be.

So what we're trying to do is really attack through the Cache Contour line, through the collection of a group of designers who worked on dresses, jackets and bottoms and great tailored pieces along with wearable and useable tops in both knits and wovens that put together an outfit or look that the customer feels that she can use it for more than just that after five special occasion.

That's what we're trying to do. And I think it's working, and we will continue down that path. We’re excited about the fourth quarter, particularly the fourth quarter where the volume is for all of us in the retail business and we'll continue to have that in our knits and our wovens as well as our structured and tailored pieces.

Operator

Your next question comes from Eric Beder – Brean Murray, Carret & Co.

Eric Beder – Brean Murray, Carret & Co.

Prom was a little bit of a drag in Q1, a little drag in Q2, Prom is in a very variable position for you for the last few years. What had you do a post mortem on the prom, how do you look at it differently. What can you do going forward in terms of prom.

Thomas Reinckens

We haven't actually completed our post mortem yet. I think from what we've talked about collectively as a group I think prom probably shifted a little bit to shorter length this year which is great for us for the future because we still do a great business in our evening dress business in the shorter lengths, and we pass along value there. It's working. Our dresses are very good right now today.

So we'll do a post mortem with it officially. I think we're scheduled to do that sometime in the month of August and we'll sit down with the merchants, with the design team and we'll make some decisions but I think we're not going to expand it on the long basis at all. If anything, we'll probably retract it slightly. We've been very careful, and I think we'll stay away from the long piece of the business even today other than for the casual looks that are doing pretty well right now, the long casual type look. But that business, we're not sure how that translates into the fall. It's really more of a summer evening outside soft dressing part of the business.

But we're anxious to really take a real hard look at it and prom really is you are right. It affects really February, March, April period and we took a big hit in it this year, and we'll take a look at it very carefully, but we're certainly not going to expand that business.

Eric Beder – Brean Murray, Carret & Co.

In terms of going forward for fall, I know you were going to do more ready to wear to work products. When are we going to start to see that and what's the focus on that type of a business?

Thomas Reinckens

Well again, it's all in Contour. You're seeing it flow in the stores right today. As I said earlier, we're really in a good position as you called out last year, we're selling out by the piece. We didn't have it. It was out of stock. And some of your notes throughout the fall, we own the piece goods. We have, the designers have given us a great array of silhouettes in each of the collections of the new fabrics as well as the double knits that we had before. So we're able to react very quickly and that's why we'll continue to use our domestic partners to do that, and our domestic manufacturing capabilities.

We're excited because right now launching Contour right now in July when it's 95 degrees here in New York, 90% humidity, it's really not wearing out our fabric but it's doing very, very well. It did very well last year when we launched it and we expect it really to take hold after Labor Day. And that's when historically our volumes start to pick up.

We have a great new catalogue that will be in homes after Labor Day, and it will feature that look. The cover shows that look. It's not an embellished, or the cover is not actually embellished. It's really, it's a little different from what Cache's know for. So again, we're going to have that mix of trying to widen the base, widen the scope of what customers can expect to get from Cache. So you'll see it more in August and obviously a lot more of it in the month of September.

Eric Beder – Brean Murray, Carret & Co.

You've got this 500-10, 500 and 10 goal which is 500 sales per square foot, so I guess it is 10% operating margin. I can see the 500 goals. Tell us how you take it to the 10% operating margin goal. You had historically last year it was 3%, this quarter is about 6%. How do you get from those levels to double-digit operating margin?

Thomas Reinckens

It really has to be on the top line okay? So we really need to focus and really drive the top line by expanding our assortment, by giving value and getting more market share.

That's really the number one element or the number one need we have to focus to get to that double digit operating margin. Any time we post a comp four sales increase, obviously it's going to effect and be positive effect on our sales per square foot, gives us good leverage, more gross margin dollars and then obviously it turns into better profits as operating profits.

We're planning the back half of the year very conservatively. One could argue that we're up against 6% comp in July and 7% in August, and 2% to 3% in September and if we comp positively there, why shouldn't we do a lot better business in the fourth quarter when we drop 7%? And that's a very good question.

But right now we don't know the external factors and how customers react, how traffic patterns will be. But certainly if we continue on the trends we are, we would expect that we should hopefully be at the higher end of our sales target. But it's a month-by-month approach that we're taking and we'll be very conservative with the inventory. But I think we'll have enough of it that if we do get some acceleration that we will end up at a stronger level closer to our operating target.

Operator

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

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

How should we think about inventory at the end of this quarter? Obviously it was down a lot per foot at the end of the quarter that just ended. How should we thinking about that for this quarter?

Thomas Reinckens

I think the same. I think we're going to keep piece goods inventory, in store inventory low. It actually, I even think some of our work in progress inventory will be slightly lower because a large portion of it is to make the Contour, and some of that obviously will flow into the stores by the end of September, a good chunk of it. And then as we get ready for our holiday assortment and which is more offshore knit and a bigger concentration of comps in quarter four than maybe you'll see in quarter three.

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

In terms of penetration of lower price merchandise, how should we think about that this quarter and then looking forward into the holiday.

Thomas Reinckens

They're approximate numbers or percentages. There's roughly 30%, 35% terms.

Margaret Feeney

About 40% will be in the good category.

Thomas Reinckens

And the balance in the better...

Margaret Feeney

In the better and best.

Operator

Your next question comes from Elizabeth Pierce – Roth Capital Partners, LLC.

Elizabeth Pierce – Roth Capital Partners, LLC.

Good is the opening price point, the tee shirts for $58, etc.

Thomas Reinckens

Yes, it's a combination, camis, our square-necked tops as well some of our $58, $68 tops.

Elizabeth Pierce – Roth Capital Partners, LLC.

Can you give me the range for better and then for best, or do you not want to?

Thomas Reinckens

I don't think we really want to talk about that because it fluctuates by season.

Elizabeth Pierce – Roth Capital Partners, LLC.

And by category I presume?

Thomas Reinckens

Yes.

Elizabeth Pierce – Roth Capital Partners, LLC.

So is Luxe the best one then, and where does Contour fit in?

Thomas Reinckens

Well, you can look at the pieces. Contour pieces are obviously for jackets starting at $148. At $88 to $98, so obviously that's in a better price and how we look at it. But clearly it's competitive we think. Yes, you're right. Luxe is the higher, would be at the higher end in the best category.

Elizabeth Pierce – Roth Capital Partners, LLC.

Is Luxe, I've only seen it in a couple of stores. Is it going to be just at high traffic, high destination stores?

Thomas Reinckens

It will only be in a very limited number of Cache stores, in our top, top Cache stores.

Elizabeth Pierce – Roth Capital Partners, LLC.

It sounds like on the Contour products you are in a position to chase?

Thomas Reinckens

Yes, absolutely, we own the piece goods. Last year we didn't and we were, designers gave us lot silhouettes. As a I said earlier on the call, one of the good news is just after about 10 days worth of selling a certain silhouette, I'm not going to tell you which ones, but we saw great sell-through and we immediately adapted one of the Contour fabrics into a very similar silhouette which designers put on the table literally last week, and it's in production now. So we're able to really chase it in a good way.

Elizabeth Pierce – Roth Capital Partners, LLC.

And that was something that was in the last grouping, the last catalogue?

Thomas Reinckens

Yes. It was in the last catalogue.

Elizabeth Pierce – Roth Capital Partners, LLC.

Did you give out what percent of the product in the store is actually from Adrienne, her team. You haven't given that out.

Thomas Reinckens

What we said roughly 2/3 of all the merchandise that we source on a month-to-month basis is through our own production channels. That's through our Adrienne design team, and then a portion of that goes to domestic manufacturers that we work with and a larger portion going forward has been going offshore, primarily China, we did some in Central America. We're also looking at other parts of the world as well again to reduce expense that's associated with increasing costs, principally China.

Elizabeth Pierce – Roth Capital Partners, LLC.

Just to get back on the pricing a bit, currently you don't have specific goals that, in terms of distribution, right? It's going to be directed by the category, the value, the season.

Thomas Reinckens

Yes, absolutely, a crop pant or a short is a different price point than a pant or a skirt or a jacket. So the pieces then change obviously in the fall season, and it's slightly a little bit higher. Again, we're just trying to give the better value to get more. You can't fool consumers, and that's what we're trying to avoid. We're trying to get more women to come to us because we're giving them much better value in each of these styles that we have in our store, and that's what we're trying to do.

I think right now its working. Hopefully it will continue to work. We're very excited about the fourth quarter because that's a big opportunity for us when there's lots of traffic in the malls. Lisa Decker, our VP of marketing has given us great ideas for ways to get mall traffic and we're going to hopefully attack some of those and get some market share during that great month of December.

Operator

Your next question comes from Mark Montagna – C. L. King & Associates, Inc.

Mark Montagna – C. L. King & Associates, Inc.

First, just with catalogue, and books and postcards, wonder if you could just compare the counts in terms of the number of units of each that you've been sending out during the second quarter versus last year.

Thomas Reinckens

The second quarter I don't have in front of me, but it was down significantly this year versus last year. Our marketing expense in the quarter was down I think $1.6 million in Q2 alone. That's in store operating expenses and as Maggie said, they were down over 200 basis points.

Mark Montagna – C. L. King & Associates, Inc.

Does that have anything to do with timing, perhaps some missing a quarter by a day or two?

Thomas Reinckens

No. We just reduced mailings, reduced postcards, reduced pieces year-over-year.

Mark Montagna – C. L. King & Associates, Inc.

What is the Luxe store count as at the end of the second quarter?

Thomas Reinckens

13 stores.

Mark Montagna – C. L. King & Associates, Inc.

Then question about special occasion dresses. When you look out to Christmas, what are your expectations and plans towards that set of merchandise?

Thomas Reinckens

Actually as I said earlier, the short evening dress has been very strong for us. And again, your know our designers have designed in greater value there. That's part of it. They've been very careful with a great merchant who's really risen to the occasion and given a lot of value back to the consumer.

That business is very strong. It will be strong. You've got a homecoming business. Primarily college girls from the third week of September into the first or second week of October and then it's big around obviously New Year's Eve. So it drives a huge amount of business for us that week between Christmas and New Years, and it also in the month of December in general is a little bit stronger.

So we're keeping those inventories light, lighter than where they were a year ago. Again, the mantra in the organization is ‘turn the inventory faster’. So we are keeping all areas of our inventory lower than where they were a year ago, including the shorter length evening dress business.

Mark Montagna – C. L. King & Associates, Inc.

So for that category, with a worsening economy, do you still think that you can hold sales flat at least in that category? It is sounds like prom you're dialing back a little bit.

Thomas Reinckens

Yes, we would expect it to be flat. It's actually running positive right now. It's encouraging to us. Again I think it goes back to the value equation and turning the inventory faster and being able to give better styling I think too. So it's not as huge part of the business as obviously the longer part of the prom business was in the month of February, March and April. You're right. We will dial that back next year and if anything, we'll shift a few more dollars probably into the shorter lengths.

Mark Montagna – C. L. King & Associates, Inc.

It sounds like you've got the infrastructure related to Contour in better condition this year with more piece goods and all that, so are you increasing the chase file accounts of the Contour merchandise. With, it sounds like you're expecting a bigger emphasis on Contour this fall as you are more able to fill any of the demands of, are you anticipating a higher style count for this merchandise or any gauge as to the impact of Contour versus last year.

Thomas Reinckens

It goes back to yes, absolutely. We added a new fabric which obviously, enabled us to add bottoms, jackets, coats, a skirt, a dress, a couple of dresses actually in the new fabric in addition to the knit fabric that we had last year. We have the same number of silhouettes as well.

And the good news is, the designers are pretty good. They come up with several different versions and styles so we can cut 150 pieces and put them out in the locations, the stores and see how they perform and that's exactly what we do. And based upon that performance we'll use our production and our in stock division on piece goods to be able to shift and move dollars that we allocated for one silhouette into another. So that's really what we're accomplishing.

Obviously we have to make commitments on base blazers and base pants but as we have thought about it as to the whole fall season, our second or our third re-order position may be in a base pant, we're then able to move that third allocated re-order for that bottom into a dress if that dress is performing comparatively better.

That's how we approach it. And you're right. This year we're in a much better position because we own the piece goods. Last year we didn't have them. Last year we were a little tentative. It was our first foray into this whole selection of tailored dressing and it was a real lesson. We were a little nervous and we went about it a little more cautiously. This year because of our planning, giving more value and the approach we took last year on a test basis on each silhouette, we're able to be a little bit more aggressive.

Mark Montagna – C. L. King & Associates, Inc.

Then just a last question with your goal of $500 a square foot. As I do my calculations it seems like you can get to that number next year and by year-end. Does that mean, is that plausible and then the question is, you had talked about when you hit $500 that's when you're going to grow your store base more aggressively. With growing the store base based on getting a couple years in a row at $500 or once you hit the $500 mark, then you're going to be confident enough that you will be able to continue that trend and then therefore, maybe after just one year you ramp up the store growth?

Thomas Reinckens

I think for '09 we're going to be very conservative and haven’t given any guidance obviously. But based upon where we are and the climate that we're in today, the environment that we're in today, we're still learning. We just got started. We've had very limited success. We need a little bit more time to develop and really expand our market share, to get more of our market share I should say by the looks that are in Contour and the direction that we're taking the business.

Going back to your first part of the $500, it's a mathematical number. If we do X% on comp, eliminate some of these underperforming stores which we have slotted to eliminate, then obviously the needle moves. But again, we're not, I can't make a prediction. I hope it's sooner than later. But time will tell and every quarter we're going to do our best to get to the goal sooner than later.

Operator

Your next question comes from Harry Ikenson - Ikenson Research and Consulting.

Harry Ikenson - Ikenson Research and Consulting

On Contour, could you give us a little bit more of a description on how much it's expanded? For instance either by SKU’s or you've given a bullet description but it just says that you've expanded it. What is the SKU count for Contour for this year versus last year or a percent that has changed this year in Contour versus last year. Is there some broader way of describing the change in that. Since you gained more customers with the Accent program, what do you plan to do now with those customers in order to get them in the store more frequently?

Thomas Reinckens

Contour, going back to that, again I don't have the skew count in front of me but I have to think it's double what it was a year ago right now where we stand. But again, the designers are working on new silhouettes based upon trends that we see and if we added one to the equation after about eight days worth of selling in a similar type silhouette of certain styles, and that I think will happen as we move forward.

They are still taking trends. I saw some things yesterday that look unbelievable that took some of the Contour fabrics and did some applications to it that again are trending in other areas, not necessarily Contour styles, but treatments in other areas that again we're incorporating it in Contour.

So we're able to move quickly based upon those trends as long as we have the piece goods and we do have the piece goods. So we're very pleased. So the skew count will be significantly more, double, could go a little bit higher. It depends on how our designers interpret current trends and things that are happening right now today.

The customers, it's a good predicament. We lowered our marketing significantly year-over-year with we're taking out real more rifle shot approach as opposed to a shotgun approach. We have a lot of opportunity there in micro marketing and we haven't even touched that. Our marketing events have really been primarily the catalogues that we send. We supplement that by postcards right today, as well as in store signage. And that will be the mantra for the rest of the year, and we will, we are trying very hard to attack the in store signage parts in the fourth quarter to drive new traffic into the stores, to reeducate them and show them the great styles that the design team has given us and the merchant team has given us.

So that's really the approaches that we're taking. But we have a lot of upside opportunity. Our marketing database and we're looking for resources to help us with that. We brought on another consultant who has a tremendous amount of experience on a limited basis that understands these Accent programs and the numbers behind them. And so we're working with that person to help us capitalize on that great asset.

Harry Ikenson - Ikenson Research and Consulting

Also on the last conference call you talked about units in sportswear. You didn't give us an update on units in sportswear. Has it slowed or are the units still strong?

Thomas Reinckens

Unit comps are still up double-digit. The good news is we're seeing strength in our accessories. We're seeing strength in our dresses both in the daytime looks of dresses which has been expanded in Contour. We have more silhouettes in the daytime look as well as the evening look in Contour in our collection. But we are up double digits on our unit performance right now.

Harry Ikenson - Ikenson Research and Consulting

You said the change year-over-year was sportswear and Contour, so what it would be?

Thomas Reinckens

I think the main thing for the second half and primarily for the fourth quarter is the two approaches that we're taking from a merchandise standpoint. Contour being broaden the scope, broaden the appeal, and broaden the use of the clothes. That's number one. Value being number two, to be competitive with other mall based specialty apparel retail stores. That's the two approaches. That's an awful exciting proposition for us when we get to the month of December which is the biggest month for every retailer. All the earnings are there. We're the same as everyone else, so we have a tremendous opportunity to hopefully get some market share.

If we can market this right, which I think we're going to do, and the assortments that I've seen, whole entire collection from tops to bottoms to accessories to dresses, all are getting better value back to the customer.

So we have to sell more units. We are selling more units and I expect that we will sell more units in December and November and October and it is a great opportunity for us because we were not really in position in many of these, in any of this philosophy of change of our merchandise last year.

We did introduce the Cache [inaudible] last year. It was very successful. It was a very, very small part of overall business. Now we're looking across an entire assortment that is a new approach both in value and in wearability, usability in each of the silhouettes that are in the assortments. That's really the approach. We're excited about it.

Operator

Your next question is a follow-up from Robin Murchison – SunTrust Robinson Humphrey.

Robin Murchison - SunTrust Robinson Humphrey

I do have a question about accessories. It sounds like you're pleased with them?

Thomas Reinckens

Yes. We're very excited because we have brought in some new talent in the accessory area. The AVD team brought some great point of view on the accessories as well and we added more daytime accessories. We added an accessories fixture in our stores that gives us better visibility to help us showcase accessories. And we're really making a big focus on gift giving in the fourth quarter to have accessories that people can pick up for gifts.

Operator

There are no further questions at this time.

Thomas Reinckens

Thank you again for joining us. We look forward to speaking with you on our third quarter earnings call in the fall if not sooner. Thank you.

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Source: Cache Inc. F2Q08 (Qtr End 06/28/08) Earnings Call Transcript
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