Destination XL Group Inc (DXLG) 2006 Q2 法說會逐字稿

Welcome to the Casual Male Retail Group second quarter fiscal 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to introduce your host for today's conference, Mr. Jeff Unger. Sir, you may begin the conference.

Thank you. Good morning, everyone and welcome to our second quarter fiscal 2006 earnings call. On the call today will be David Levin, our Chief Executive Officer and President; and Dennis Hernreich, Executive Vice President, Chief Operating Officer and Chief Financial Officer. Before we start the call, I would like to read our forward-looking statements. Forward-looking statements contained in this and other written and oral reports are made based upon known events and circumstances at the time of the release. And as, such are subject in the future to unforeseen uncertainties and risk.

All statements regarding future performance, earnings projections, events or developments are forward-looking statements. It is possible the Company's future performance and earnings projections may differ materially from current expectations. Depending upon economic conditions within both its industry and the country as a whole and its ability to achieve anticipated benefits associated with announced cost reductions and strategic initiatives to improve operating margins.

Among the other factors, which may affect future performance, are' changes in business relationships, within purchases buyer from major customers or suppliers, and concluding delays or cancellations in shipments, uncertainties surrounding timing, successful completion or integration of acquisitions, threats associated with and efforts to combat terrorism, competitive market conditions and results effecting on sales and pricing, increases in raw material costs that cannot be recovered and product pricing and global economic factors, including currency exchange rates, difficulties entering new markets and general economic conditions such as interest rates. The Company makes these statements as of the date of this disclosure and undertakes no obligation to update the,.

I would like to introduce David Levin.

Actually, Dennis was going to start.

Thank you, Jeffrey. And good morning and thank you everyone for joining Casual Male Retail Group's second quarter earnings conference call and Webcast. David and I have a number of things to go over, after which, we'll be happy to entertain any and all questions that you all may have. Overall, Casual Male Retail Group showed improved operating income by 70% in the second quarter and 125% for the year, so far, from last year's periods. The basis for this improvement in operating earnings is solid positive reaction from our customer base, as to the merchandising and marketing strategies who's appeal is starting to reach beyond Casual Male's traditional customer. And improved gross margins from CMRG's changed marketing approach of more brand imaging and less promotional pricing and tremendous strides made with inventory management.

These strategies and initiatives were the primary drivers of CMRG's second quarter and year-to-date comparative sales increases of 10.6% and 8.1% respectively, as well as gross margin improvements made in the second quarter and year-to-date periods of 190 basis points and 210 basis points respectively. David, will share more details of these initiatives. That is not only driving current performance, but also key strategies intended to continue to grow market share to levels commensurate with Casual Male Retail Group's market position in catering to the men's XL market. Meanwhile, I'll go through more particulars of CMRG's performance so far in 2006, specifically sales, gross margins, SG&A expenses, leading to operating income.

The Company's overall sales increased 11.1% in the second quarter, with comparative sales increase of 10.6%. The two primary contributing components to the sales increases were Casual Male stores with a 7% comp and a Company's direct businesses, which increased over 38% during the quarter. The significant drivers to Casual Male's store sales increases were items per guest and average ticket per transaction. The Company's direct business benefited greatly by a 56% increase in its Web businesses in the second quarter.

In addition, the catalog circulation during the second quarter is increased by 32% to support the Company's new customer prospecting activities as well as the Sears Casual Male co-branded catalog circulation. Approximately 35% of the second quarter's circulation was prospecting related. And while in most instances, catalog productivity when conducting sizable prospecting activities decreased, but in fact a direct catalog productivity increased 5% during the second quarter. For the year, Casual Male sales increased 8.5% with comparative sales increase of 8.1%. Casual Male stores comps increased 5.6%, while its direct business improved by 29%.

As in the second quarter, so far for the year, the Casual Male store sales are benefiting from strong increases in items per guest and average ticket per customer. During the year, catalog circulation has increased 15%, much of this circ increase related to prospecting activity, which made up almost half of the total circulation for the year so far. At the same time, catalog productivity has improved 12% and its Web businesses have improved a strong 54%.

CMRG's direct business sales represents approximately 14% of total sales this year so far, compared to 11.5% during the same period a year ago. We expect that over the long-term, continued new customer prospecting activity will result in healthy increases in its data base, fueling further increases and resulting in impressive ROI's. During the year, CMRG has opened seven stores and closed five other stores, raising the total store count to 520 stores with 1.857 million square feet of leased space.

In addition, during the first six months of the year, CMRG has relocated five stores and renovated two others. For the balance of the year, the Company intends to open four new stores but close 12 others, ending the year with a total store count of approximately 512. In addition, six stores are planned to be relocated and one other to be renovated. CMRG's overall second quarter gross margins rose by 190 basis points to 45.3% from 43.4% a year ago. While for the six months, gross margins rose by 220 basis points to 44.6%, up from 42.4% during the same period a year ago.

Occupancy costs, the component of gross margins, dropped as a percent of sales by 110 basis points in the second quarter and by 80 basis points for the six months. Therefore, merchandise margin improved by 80 basis points for the quarter and by 140 basis points for the six months. Meanwhile, the Company's aged inventories represents approximately 2.5% of its total inventories, compared to 4.5% of total inventories a year ago. The Company's ability to consistently improve upon its gross margins is based on three key factors, which will continue, we expect, to have a positive impact on gross margins performance for the balance of the year.

One, seasonally fashionable inventory levels are tightly controlled and managed on a store by store basis and therefore, is able to clear these efficiently at the end of each season. Number two, this year's comparative sales increase of 8.1% has been accomplished with a sizable reduction of promotional pricing eliminated from its marketing campaigns, leaving only the compelling holiday events such as Easter, Father's Day, Thanksgiving and Christmas. Instead, the Company's customers are being driven by the merchandise quality and lifestyle relevancy without the previous pricing discounts that negatively impacted margins.

Number three, CMRG's product development team has quickly but effectively been able to meet our targets with merchandise sourcing costs dropping. Due to these factors, we expect that gross margin improvements will continue to trend as they have for the first six months of the year and expected to be over 200 basis point improved for the year as we close 2006. CMRG's SG&A expenses, as a percent of sales, dropped by 40 basis points in the second quarter and 20 basis points for the six months compared to a year ago.

Ordinarily, CMRG's model would have expected at least 150 basis point leverage on an SG&A expense base, given the sales performance during the year. However, there were important incremental investments made in CMRG's SG&A expense from last year, which are important to note. One, much of the increase in catalog circulation during the year relates to new customer prospecting activities, which Casual Male had previously not done in any significant way.

Number two, as we previously have discussed, i, the second quarter, Rochester acquired the Jared M. brand. Jared M. business generated its expected operating expenses, all incremental to last year's SG&A of base, but also we are making important infrastructure and resource improvements to enable long-term sales and operating income growth. Number three, just as important, CMRG is accruing appropriate levels performance bonuses being earned by its management team and that the Company is achieving its profit targets for the year. And number four, and finally as a result of the previously discussed sale leaseback transaction, CMRG is incurring occupancy expenses where it wasn't in the past.

After considering these important investments in SG&A during the year, SG&A expenses increased approximately 2% during the year and less than 1% for the second quarter. CMRG is anticipating that it will incur an incremental $5 to $6 million of SG&A expenses above last year's levels in the second half of 2006 related to the same investments that I just discussed in its SG&A base. In addition to expected ordinary increases in SG&A expenses related to its sales volume increases. Within an increase in sales of 11.1%, and gross margin dollars of 16%, partially offset by SG&A expense increase of 10%; second quarter operating income increased 70% to 6.9 million from 4.1 million in last year's second quarter.

Likewise, for the six months of 2006, with a sales increase of 8.5% and gross margin dollars of 14%, partially offset by an SG&A expense increase of 7.9%; operating income increased by 125% to 9.3 million from last year's 4.2 million. Finally, earnings per share on a fully diluted basis increased from a pro forma after-tax $0.04 per share for last year's second quarter to $0.09 per share this year. For the year so far, CMRG reported earnings per share of $0.13, compared to a break-even level last year.

In the second quarter when computing earnings per share on a fully diluted basis, the weighted average shares outstanding assumes conversion of the outstanding convertible notes, representing 8.9 million shares. The if-converted method required by GAAP measures for each period presented. In this case the second quarter and first six months of 2006, whether by the affects of assuming conversion are dilutive to EPS. The formula is straightforward. To determine if the dilutive, the tax effective interest for each period being tested is added back to net income and the 8.9 million shares are included in the fully diluted share base. If earnings per share then are impacted negatively, it is considered dilutive and you include in the fully diluted EPS.

An important point to note is that you independently test each period to determine if dilutive. Therefore, in this period, consuming conversion of the convertible notes was dilutive to the second quarter but not to the six months. The Company's capital expenditures for the six months this year approximated 7.8 million, compared to 6.6 million a year ago. Although CMRG's debt levels were at approximately 103 million, including 94.7 million in convertible notes compared to year ago levels of over approximately 150 million.

The Company has not only reduced its debt levels by almost 50 million over a prior year, but also repurchased approximately $13 million in its common stock, representing 1.3 million shares at a cost of $9.74 per share during the second quarter of this year. The Company's liquidity available under its revolving line of credit is at a very healthy level, above $65 million. This concludes my remarks about the second quarter results and now I will turn the call over to David.

Thank you, Dennis. We've now delivered 11 consecutive quarters of positive comparable store increases, with the second quarter performance being the strongest since we acquired Casual Male four years ago. Our 10% comp was attributable to several factors. Our in-stock performance continues to improve. We have maximized our ability to maintain our guaranteed in-stock program of our top seven items that represent 18% to 19% of our total Casual Male sales.

Our commitment to our customers is that if we don't have a guaranteed item in stock or cannot deliver it to one's home in five business days, we'll give to our customers that item for free. This spring, we sold 850,000 of these seven items. And we had to ship less than 6,400 units through our fulfillment center, which means we had an in-store availability over 99% of the time. And even more remarkable was that we only gave away 21 units on a demand of 850,000 garments. And this is the result of developing what I believe is an incredibly powerful inventory management system.

And our product mix continues to improve season after season. We are flowing product today much more on a buy-now, wear-now mentality and our customer is responding quite well. An example, is that we continued bringing in new receipts of shorts throughout the season, and not only was it our strongest category, but for the entire month of July, notoriously a discount month for seasonal product, we sold every pair at full retail. Casual Male sellthroughs continued to improve and we ended July with $5 million less in seasonal product than a year ago.

Certainly, another factor for our performance was the name change this quarter from Casual Male Big and Tall to Casual Male XL. The results we got from the six month test market cities over nine months, came to fruition when we converted the stores over. With the conversion, our new to fall basis, which our shoppers who have shopped us for the first time, has increased significantly. Also, as we planned, we're starting to get a higher penetration of sales in smaller sizes where we historically have not performed well. So generally speaking, we've had nothing but positive feedback about the name change.

Finally, in terms of our comp performance, we also believe our Casual Male XL commercial; "Why be average when you can XL?" which ran for 30 days this quarter, had a positive impact on our sales. And based on our results, we will have have a TV campaign around the holiday period. This will not be incremental to our marketing budget, as we have cut back on some direct mail and catalog circulation to offset it.

Also in terms of marketing, we now have an official launch date of October 15 for our new loyalty program with a mailing to 1 million of our customers. We had tested both a points program and a lifetime discount program, which was similar to the Chicos passport program. But after nine months of results, it's clear that the Casual Male customer responded much stronger to the points program. During the last six months, customer spend in our test markets was quantifiably greater than the chain average. So for our launch, we'll offer a free in-store gift to our top 15,000 customers with an automatic enrollment. We will also be mailing our loyalty card to our top 300,000 customers. And an additional 600,000 customers will receive a prepopulated application form in our October direct mail piece.

Dennis also spoke of our continued improvement in gross margin performance. An integral part of our improvement is the growth of our private label brands. This fall, private label will be 67% of our inventory mix versus 58% last year. Our young men's line, 626 BLUE is getting stronger every quarter. This month, we launched our new contemporary brand called Synrgy in 200 stores. The early reads are excellent and we will have the label in all stores for spring '07. And we're also seeing positive results from our brand extensions. 626 BLUE belts, boxer shorts, sunglasses, and footwear are additions this fall, along with belts and footwear for Synrgy.

Another positive impact on our margin is due to the growth of our direct sourcing business. This past spring, 20% of our private label was sourced direct. For fall, it increases to 40% and for next spring, it jumps to 60%. During the last Webcast, I mentioned our acquisition of Jared M., which caters to selling custom clothing to mostly professional athletes, almost all who are big and tall. And we're on schedule for a February launch date with a catalog, Website, and Jared M. concept shops in several of our Rochester stores. Jared M. is part of our strategic plan to gain market share in the big and tall arena.

With the platform we have created for managing big and tall sizes, along with our expertise and understanding how to fit a big and tall customer; gives us the confidence to look for growth opportunities outside of our current customer base. We now have Jared M. catered to the highest income customer, then Rochester, and then Casual Male. But what's interesting is that the average household income of the Casual Male shopper is $71,000. If one looks at the statistics of big and tall men, the highest percent of big guys is in the lower economic tier. And CMRG plans on expanding its enterprise by creating a direct to consumer business, which addresses the largest part of the big and tall market, which is the lower to moderate customer.

We see a tremendous opportunity to leverage our direct channels of the Internet and catalog. We've had this in the planning stage for the last year, and on September 15, we will first launch our Website. And on March 15 of next year, we will deliver our first catalog. The name of this new enterprise is B&T Factory Direct. We will feature the same product line that we offer in our outlets today, almost all private label and almost all source through our direct division. We will have parallel lines between our full price stores and our outlets. Our traditional lifestyle of Harbor Bay will be Canyon Ridge in the outlets and B&T factory direct. 626 BLUE will be 555 Turnpike and Comfort Zone will be Flex Zone.

While retails will be about 25% less than in our full price stores, our IMU, or markup, will be very close to our full price stores. The look the look and feel of factor direct will be totally different from Casual Male and our intent is to keep a clear distinction between the two franchises. We will be able to leverage our existing infrastructure and there will be no CapEx requirements.

To help launch this concept, we will initially utilize a base of 1 million Casual Male customers with household incomes of less than $30,000 and who are no longer active in our existing direct mail plans. Our Internet and catalog business continues to grow at an incredible rate. Our success with Sears is just another example of how we are growing our market share without cannibalizing our existing business. B&T Factory Direct will be another vehicle for us to continue on growing market share as the business moves forward.

Now, that CMRG has progressed beyond the turnaround stage, we're now focused on growing the division. The Casual Male business will get most of its growth from increasing our sales per square foot and also from our strength in multichanneled retail. Rochester is our store growth vehicle. With only 24 stores today, we see tremendous opportunity to expand their store base. And in addition, Rochester's catalog and Internet channels are also growing at a stellar rate. The addition of Jared M. for our Rochester stores will also improve their growth by developing a premier custom business. And now we'll go after the lower economic strata with B&T Factory Direct.

The bottom line is that this is a niche industry, that's highly fragmented and our market share is less than 8%, even with 520 stores, with the next largest specially player at 16 stores. A 1% increase in market share is equal to a 15% comp. And according to a report by one of the analysts who follows us, on the women's equivalent side of the business, Charming Shops has a 30% market share of the plus-sized business. CMRG has certainly positioned itself for at least getting to double digit market share in which would give us tremendous leverage and would give us the ability to deliver operating income at the level of the top performing specialty retailers out there today.

One final note, 2.5 years ago, we launched the private label line and endorsement deal with the legendary George Foreman. As a result, Casual Male benefited from a tremendous amount of publicity at a time when we really needed a boost in our business. It certainly was the right strategic move for us in helping us revitalize a chain that was in the early stages of a turnaround. George Foreman product grew to over 30% of our sales in a relatively short period of time.

But in the last year, as our merchandising team revitalized our other house brands, we have been weaning the George Foreman product to the point where it is now less than 18% of our sales. And as we have transitioned the labels out of George Foreman, our sales have not diminished at all. Today, the only George Foreman labels in our current assortments are in the comfort technology features of our Comfort Zone product. George has been a wonderful partner and a great inspiration to our Company. But we're not the same Company we were three years ago. And it is in our best financial interest to continue the transition from George Foreman Comfort Zone to Comfort Zone by Casual Male, which will improve our margin performance going forward.

And therefore, we will not be exercising our option to renew with George. And I would personally like to thank George for his commitment over the last two years and for his professionalism from start to finish. And on that note, we will open up the Webcast now to Q&A.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Tom Filandro.

Thank you. Great quarter, great job, great turnaround, fantastic news. First question is on the George Foreman transition. Can you just identify what the savings will be from a royalty standpoint? I'm sure there were travel expenses and other. And then I have a second question. I'm not sure -- Dennis, I think we need a little more detail on this incremental $5 to $6 million in SG&A. Will it be a commensurate increase in the topline? How do we view that from an earnings perspective in the second half? Thank you.

I'll do part one. If you take George's royalties plus his endorsement fee and travel, all in, it's about $2 million a year. So, again, we see that going to the bottom line. We have surveyed our customers, thousands of our customers. We've posed this question to them. They clearly say, "look, give us the right product with comfort features and it doesn't -- we don't need a celebrity endorsement to make that purchase." And, again, I've got to reiterate. At the time, George got us to a great level and we respect his power to bring in the customers for us. Dennis will pick up the second half.

Thanks, David.

I think, Tom, in terms of pointing out these investments in SG&A, I was largely first really trying to point out why our SG&A had increased from last year's levels more than one would expect knowing what our SG&A model is. So because of these investments, we have larger than normal SG&A increases that impacted our first six months in the way that it did. And I think just to point out when you think about what our SG&A base looks like in the second half of the year. Starting with last year's levels and then adjusting for these investments and what you would expect normal increases to be just based on our volume increases. It will give you an idea of, therefore, what we are expecting our SG&A levels to look like.

In terms of our earnings performance, it will impact us in the same way that it impacted us in the first half. Much of these investments are giving us topline and margin improvements right now, namely in the catalog area. The Jared M. investment isn't really impacting earnings at all because it's basically operating close to a break-even level at this point. And then obviously, the performance bonuses and the occupancy is impacting earnings but I think you're seeing the impact in earnings at least for the first half.

Okay.

So I hope that is able to --.

But basically, what you're telling us is you're putting some investments here that are obviously going to generate some topline gains as well, so it's not as if the $5 to $6 million is a hit to the second half earnings?

No.

Understood. Thank you very much and best of continued success.

Our next question comes from Marc Bettinger.

Hi, guys. Congratulations on a super quarter. Stock is cheap at 12.

No comment.

I didn't think so. A few things. Just to recap some of the numbers, the $2 million savings that you're talking about on the George Foreman is going to start when?

That will start in spring '07. There'll be really no impact throughout the rest of this year.

Okay but in '07 you'll realize the $2 million?

Theoretically, we should, yes.

And that will all fall to the pretax line?

Yes.

Okay. Dennis, if I understand the SG&A part, it's ordinary growth plus 5 to 6 million in the second half?

Yes, Marc.

And you're looking for --?

Your base, of course, is last year's numbers.

So it's the base of last year's numbers, plus ordinary growth, plus 5 to 6 million?

There you go.

And for the year you're looking for gross margins to be up 200?

That's right.

With respect to -- you said the buyback was 13 million, right?

Correct.

And your direct business for the second quarter, you said, was up 38% and the Web business was up 56%?

Yes, the Web business is part of our direct business.

Right. Now, you said the UPT;s were up and the average dollars -- the average ticket per transaction was up?

Yes.

Can you quantify that?

We're just trying to, Marc, give you a -- kind of what the drivers are. We don't -- haven't spoken to, don't like to speak to specific numbers as to that. But just directionally, what's driving our business is what we're trying to indicate to you.

No problem. And the other component of comps, what about traffic?

It's transactions, not a big driver, but positive.

Okay. And as far as comps, you still sticking at 4% as guidance?

I don't think that we commented to that.

Okay. Well, is there anything to base it on? You're coming in near 11 for the guidance, and -- there's got to be something to base it on?

We feel good about our business, direct business. The same initiatives that brought us the sales so far this year are being employed in the second half of the year. We are making the same investments. The product, we feel confident about. So, we're expecting good things in the second half, Marc.

Okay. Last question. The B&T factory direct, how much impact do you expect that to have in '07?

On earnings, no real impact. This is a business to be built. We don't think it's going to be negative to earnings but we're not expecting and not counting on any earnings contribution from that business as we build the customer base.

Great. Thank you very much. Congratulations again.

Our next comes from Margaret Whitfield.

Good morning, everyone. Congratulations. On the gross margin, it's coming in better than advertised. I wondered if that in any way diminishes from your forward ability to continue to improve? I think your plan was to improve gross margins 100 bips this year and 100 next. That's the first question I had.

I think we're a little ahead schedule. We did say 200 basis points over the next two years and looks like we're going to get the 200 basis point this is year. And we have some upside opportunity next year because of the growth of our direct sourcing, our management improvements. We haven't given anything beyond what we've said before but it looks like we certainly are outperforming our earlier expectations on longer-term margin improvement.

Okay. In the press release, you gave the inventories versus the beginning of the year, January levels. Wondered if you can comment on your inventories per square foot, how they ended the quarter? It sounds like you're very low on clearance, which bodes well for forward periods.

Low on clearance, higher on a per square foot basis, Margaret. I think, again, our commitment to the basic private label in-stock positions are helping to increase our inventory levels. But our fashion inventories are down from a year ago and well where we want them to be. And I would think looking forward ahead another six months, I think you'll find -- you should expect the same kind of trends as you're seeing in the first half of this year.

Okay. And I take it all the factors you cited for SG&A expense will continue to affect the second half?

Yes.

Are there any additional things we should factor in? The marketing spend isn't changing because you're shifting dollars around?

No, I think we've tried here to quantify what to expect incrementally from last year. And the factors for those things.

And the circulation will also include a lot of prospecting in the second half?

That's correct.

All right. Well, thanks again.

Our next question comes from Gary Giblen.

Yes, hi. I appreciate the rationale for the George Foreman decision. I'm just wondering, is it fair to say that you're going to have no sales reduction to offset the $2 million? There must be some customers who are in love with George and might not come?

Well, again, I think we've been -- anybody that's been really watching our stores, the amount of George product we have today is half of what it was a year ago and look at our comp performance. So, we're not getting any loss of sales at all. And we've been converting programs over all year long. Again we've -- as I've said, we surveyed our customers and we don't see any loss at all. In fact, there are some customers, of course, that don't respect having anybody's celebrity label. They don't believe in that themselves. So Gary, we've done this very wisely. We've been out there asking, converting. We got the support of our store personnel, who we talked to, our field people, our customers. So I would confidently say, we anticipate no loss of sales by the conversion.

Okay. And the -- so this means no George Foreman images or cardboard cutouts or anything like that?

No, again, we haven't, if anybody's noticed, we haven't utilized George's endorsements for over a year now.

Yes, no, I understand. Separate question is, I've been very excited to see the Rochester private label in most categories, most merchandise categories over the last three months. And the anecdotal data from store people says that it's selling well but could you elaborate on that?

I would say the biggest concern I had going into this half of the year was the introduction of Rochester private label. And one never knows if the Rochester customer is going to embrace it and say -- versus its traditional polo buy or other luxury brand. But they like it a lot. And it's going to be major growth for us in the future. The margin differential on the private label is huge and it all came down to quality. Honestly, a couple items we delivered were not up to the quality that we expect.

To me, it's typical start-up issues but going forward, we're going to continue to improve the quality. Our motto is deliver Cadillacs. We don't need -- the customer will certainly respond strongly to the quality. So very excited. And we're going to be delivering more product and we just delivered our first [Kastanya] product, which is more of a Italian influenced product label and that stuff looks great out there.

And also you mentioned in the last call that Rochester was going to pick up their shoe initiative. And what's the update there? And were you talking about mostly an assortment or also in just marketing emphasis, merchandising emphasis of shoes?

Did you say footwear?

Yes, I said shoes.

That project is still in the planning stages. We have not got that where we want it to be. That's an '07 issue for us.

Okay. Great. And then finally, is there any way to quantify how much better would the comps had been if you had completely finished the exterior packages? I know there wasn't a big difference but how much more could you have gotten if the exteriors?

I don't know, that's hard to quantify. Just to give the update, it's virtually complete. We have 29 stores still waiting for permitting issues. They still have their banner up. They will get done. But as we've been tracking these stores that have not had their permanent sign up, there was still a differential in their performance versus those who have converted. So, look, we're really happy with the way the customer responded to the name change.

Okay. And the last one is the -- I'm sorry, the -- could you just elaborate on the focus on the direct channel? Just what kind of steps does that entail, obviously some more Web listings and things like that and more prospects, more mailings, but anything more specific than that?

We're finding success in prospecting. It's an expensive way to get -- draw in customers but we're finding some great efficiencies out there. But the important thing for us to emphasize is, this investment we're making to get this new customer has a long term impact on it. If we get a new customer into the catalog or the Internet or drive them from the catalog into the store, we feel we own them for a long time. So, what we're building in new customers from prospecting is going to pay off dividends over the next several years. So we're really -- we've had the luxury for the first time to invest in prospecting by reducing the money we've historically spent on price point promotions. Our direct mail is down significantly, which really doesn't bring in new customers, it's just hitting the same customer over and over again. And taking those dollars to find new customers is much healthier for us long-term to gain market share.

Sure. Okay. I understood. Well, okay. Everything is working great. Congratulations.

Paula Kalandiak.

Good morning, nice quarter. I just have two things that I wanted to clarify. One relates to the B&T Factory Direct. If I understand correctly, you're not going to be designing or manufacturing additional SKU's, you're just going to be changing the labels of the SKU's that you're already featuring in the stores?

Yes, it really works well for us because we have 70 outlet stores. And what's happened in the outlet stores, we changed that model. They used to be a dumping ground for the full-price stores when we would end season and we would consolidate them, ship them back. In fact, last year, we brought back 250,000 units from our full-price stores, put them in storage for six months, repackaged them, then sent them out to the outlets. Well, the product wasn't great in the first place. And today, this year we've sent back zero.

We've been able to liquidate everything through the full-price stores. And now the outlets for fall are getting all new product, which is great. Because the sellthroughs are stronger, the margins are much stronger. So, we've put a lot of emphasis on our outlets and our outlets, we anticipate next year will have the highest comp sales increase. And at the same time, the product that we're building for the outlets will be the same product that we will put into the B&T Factory Direct business. So, we get great leverage by using the same product. And again, it will have al different names than our full price stores have.

But will the names in the outlets and B&T Directs be the same?

Yes.

Okay. And the other thing I wanted to clarify is, I was unsure, was this the last year without renewing George's agreement, or are you ending your relationship with him early?

No, it was a three-year contract that ends at the end of this year and we just gave notice that we're not renewing. So, the contract is still in effect through the rest of this year.

But there's no charge associated with ending the relationship or anything like that?

No. Just an option we had.

Okay, great. Thank you.

Our next question comes from [Everan Koppelman.]

Thank you, good morning. I have a couple of questions. On the B&T Factory Direct, your outlet stores, you didn't change those stores to XL, correct?

No, I did not mention that, but we do have it scheduled for change in the first quarter of next year. With the success we've had at the full-price stores, we want to keep our brand image the same. So, those stores will be converted to Casual Male XL outlet in the spring.

So the outlet stores will be converted to the XL name but they'll have the same product as the B&T Factory Direct?

Right.

But the B&T Factory Direct Website and catalog will be branded B&T Factory Direct?

That's right.

Okay, but the labels and the product and the merchandise will be the same?

That's correct.

Okay. I understand. So now, you said the largest portion of the 5 to 6 billion big and tall market is the lower end. Can you maybe quantify what percent of the market is the low end?

It's really -- it's more than 50%. It's very interesting. If you look at the map of the United States by obesity, the highest concentration of big guys would be in states like Mississippi, Alabama, Georgia, and that is actually our weakest penetration. Even though that has the highest concentration, we don't perform well with our stores because the price points are too high. So we believe -- that's what really started this idea going, was we started to look into our own customer base. We have a lot -- we found we had a huge customer base. That 1 million that we're going to deliver to, this catalog, are no longer active on our Casual Male data base because they're not productive enough for us. They don't spend any money -- a lot of money within the year. So we're going to try and revitalize that customer and get more into a price point where he could afford to make that purchase.

Okay. And what kind of plans do you have to make people aware of this new business that is going to go direct on the Website in September before you send out any catalogs? How will you attract people to the Website?

Well, it will start small. We'll be doing what we do in Casual Male. We'll have search engines, affiliate programs, a lot through Google. And then we have our own data base of e-mail customers who have similar profiles in the lower economic tier. But we have the ability to launch the Website right now because we have the inventory available from our outlet so we could do it. But the real launch of this is next spring.

Okay. And then the expenses are almost nothing this year, they'll be the catalog expenses next year?

Correct.

I'll move on from the B&T. What's the margin differences between your Casual Male stores and the direct business?

They are -- because the direct business, Everan, has a bit more brands than our Casual Male store, the margin difference is around 200 or so basis points. Between our stores and our direct business.

Meaning the direct is 200 basis points lower?

Yes, slightly, that's correct.

Okay, all right. And then the next question is, you talked about your margin goal, longer-term, 9% to 10%, that didn't assume the George Foreman going away or this B&T Factory Direct business, correct?

That is correct. It's very dynamic, of course, as you know, Everan. But again, I don't think -- we're not expecting the B&T Factory Direct strategic plan to have much impact on the 9% to 10% goal, at least in the time frame we're achieving that goal.

Right, so you're not changing the time frame, okay. And then the private label, you said, is 67% of your inventory. What's your target and what's the balance you're trying to achieve between third party brands and private label? And also, how does that break out between Casual Male and Rochester?

In Casual Male, I always felt the target we were going to go to would be 70% private label. But we're almost there and private label continues to outperform our brand, so I don't -- right now, I would say maybe it's 75% to 80% down the road. One of our biggest brands is Reebok and that's a brand -- that's an area where we will not go private label to buy that. That's clearly, the one area that we will protect with our brand. In terms of Rochester, I have thrown out the number, 20% private label would be our initial goal. Boy, that number will -- I'm sure over time I'll be raising that number as we get more product in.

And your goal is to source all of private label directly, right?

Well, it doesn't necessarily have to go direct. If there are certain vendors that have economies of scale or want to work on low margins, that's not our issue. Sometimes programs don't go direct because we couldn't get the same price. And we won't move programs if we could get vendors that could match our own prices, if we're happy with the deliveries and the quality. So, it's not 100% sure that everything will go direct over time.

Okay. And finally, can you just update us on your plans for your convertible?

Well, as you see, they're in the money, as you see. So, we're working out now our long-term capital structure plans, Everan, with obviously the ultimate goal of driving shareholder value. We're, as you know, well aware of the share count dilution potential impact. And so, we're working up plans now to determine exactly how to proceed with that. But obviously, we're here to drive shareholder value and there's a lot of ways in which that can be done.

All right, thank you. Great job.

Our next question comes from Scott Krasick.

Hi, guys. David, talk a little bit about your consulting relationship now with Jim Frain. And now that you've got the marketing loyalty program set and this move towards TV advertising, what's the role going to be there going forward?

Well, actually, as of this month, we're not needing -- we're not utilizing Jim's services. He's really lined up everything we needed to do and we mutually agreed that he hasn't -- we haven't needed a lot of his time. Jim is always available for any advice that we need to get from him. But his mission is virtually in play right now between the loyalty program, helping us with the XL conversion, and the commercial. So, again, as of now, Jim is no longer going to be a paid consultant for us.

Are you looking to hire other senior marketing people, or is the new initiative with TV, you'll just continue to do with the people you have?

We're very proud of our current marketing team. They've been running things for several months right now and we see no change in that.

And do you see TV becoming a bigger and bigger part of it, or wait and see after holiday?

I think it's wait and see. I think it will be -- I love that it's a part of the mix. I don't think it will ever be the big part but maybe I'm -- time will tell. But we looked at a lot of metrics. Our call-in numbers to our 800 lines, traffic in the stores. While that commercial was running, that certainly had an impact. We had a lot of other things going for us, too, so it's always hard to say who takes credit for our success right now but we clearly saw good results from the television piece we did.

Okay, good. Just lastly, what would get you to commit to opening more Casual Male doors?

Well, we've identified at least 120, 130 more locations we would like to get to, that we have the capability of getting to. Priority one is Rochester. Again, the productivity, the ROI is so much stronger right there and again, there's only 24. Our strategy for Casual Male, first and foremost, right now is the relocation program. We've got 40 stores that are in the right markets but really in the wrong location. A lot of our stores are in centers that are 20%, 30% occupied.

We've been moving those stores and getting double digit increases almost across the -- almost every time. So again, our strategy for Casual Male is; raise that sales per square foot, get these stores relocated in the next few years because a relo still costs us money, not quite as much as opening a new store, but the CapEx is needed there. But that's almost a slam dunk. We're going into a market where we already have strong sales performance and to get a 20% or 15% lift on a fully matured store is -- the cash flow on that is quite dramatic.

And just, Dennis, I missed the comment earlier in your presentation, did you say the Casual Male stores had a 5.6% comp in the quarter?

Yes, for the year, Scott.

For the first six months?

Correct.

Okay, thanks.

Our next question comes from Rob Wilson.

Thank you. Dennis, can you comment, as you're growing the direct business, what the impact on gross profit margin would be or how we should think about that going forward, considering it has no occupancy burden?

The operating margin of the direct business is very strong, as you would expect it to be. As we grow the direct business, I think it will -- its operating margins will continue to improve as we continue to lever off this expense base.

But Dennis, I'm really speaking to gross profit margin. Isn't there a natural benefit there of growing that business, given it does not have any occupancy?

I see, without occupancy. Yes, that is correct. On the public documents that you see with occupancy in there, a stronger-growing direct business will improve upon the Company's consolidated gross margins, yes, correct.

So does that increase your 200 basis points gross profit margin outlook for the next couple of years?

I think that incorporates that, Rob.

Okay. And is there any thought, now that it's 14% of your business having some segment reporting in your SEC filings?

No, we have no plans to segment report the different channels.

Okay. At what juncture would you do that, if it was 20% of your sales, would you do that? What's the threshold?

We have not considered that. I think -- there's a lot of different ways that -- or reasons why one would segment report. I'm not sure -- channels is one of the major criteria that we would look at. The customer base is distinct, virtually the same amongst the channels, and therefore, I don't think even at 20%, we would consider segment reporting.

Okay, fair enough. And one final question. Did you comment on the pickup in traffic that you've hopefully seen as you've changed the banners? Maybe David could speak to that.

Well, we're certainly getting new faces in. That's what I referred to on the new to file. It's been increasing every month. We're getting more customers that have never been in a Casual Male store before in our stores. That was the curiosity factor when they saw the name change come up. So, again, that's where we're getting our strength from. We don't give out traffic numbers anymore. We just -- it's not an issue with us anymore, but traffic -- with our comps the way they are, obviously traffic is not a problem for us.

But I did say, Rob, that the major drivers of our comps, are average ticket and IPG's.

Will that change in Q3 as now the new banners are up?

That -- November will see.

Right. Fair enough. Thanks for taking my call.

Okay.

Our next question comes from Brian [Runick.]

A couple of questions, CapEx for the year?

Will be in the range of 20 to 22 million, Brian.

And D&A?

D&A, it's almost like the six months times -- in the 13 range area.

Okay. Can I assume that the 8.9 million shares from the convert will be included as long as the stock price is over 10.65?

The accountants don't look at stock price as the indicator. They look at, is it dilutive or not? And we would expect that in the third quarter it won't be dilutive and therefore will not be part of EPS. But for the year, it will be dilutive and will be in EPS.

And how about Q4?

Q4, expect it to be dilutive.

Okay. Appreciate that. Regarding the $5 to $6 million in SG&A increases that you're calling for in the second half on top of the ordinary expense increases that you were previously guiding us to, how would you think about that between Q3 and Q4?

The volume piece?

The 5 to 6 million of increase in SG&A?

Well, I think -- how I would think about that is go to last year's third and fourth quarter's SG&A.

And break it down percentage-wise?

What?

Break it down percentage-wise?

Yes.

George being $2 million a year, how did he break out through the year, was he equal by quarter?

Basically, that's right. Much of that is in the gross margin category, based upon of flow of receipts in. I wouldn't say it's equal per quarter but it's more commensurate with sales volumes by quarter.

So, is he more like a royalty based on sales?

Based on purchases.

Purchases, I got it. Okay, that's enough info.

The quarter before the sales is when you'd expect the purchases to be made. You know what I mean?

Yes, absolutely. Regarding the direct business that I think you said was up 38% for the quarter, is that correct?

Yes.

The Web business of that portion was up 56% and catalog circulation, which is a portion of that, was up 32%. What were catalog sales?

Catalog sales was positive, but we're not breaking that out for you. It's all part of the direct piece.

Direct piece being up 38%?

Correct. The direct -- that's correct.

One of the -- let me say one thing. One of the things that we're finding is that prospecting catalog sales is difficult to measure because a lot of our customers that get the catalog and then they buy online, or they come in the stores. So, it's difficult for us to really quantify where prospecting is going to, it's all working together, though.

So, if you were going to say Web was up 56%, what portion of direct business is the Web?

What portion of direct -- it differs between Rochester and Casual Male. Casual Male approximates 60%. Rochester approximates about 40%. So it's -- why we look at it as one, we're not trying to be cute. We're just -- catalog is really an integral part of catalog and Web. So if we gave you catalog and Web, I think it wouldn't tell you what you think it would tell you. We look at it as one animal.

So you're looking at catalog circulation relative to sales in the direct business?

That's correct.

I understand, okay. When you talked about inventory, I believe it was up 16.8% for the quarter. And what was it up per square foot in the stores?

Square feet remained unchanged, so basically the same.

About the same. Okay, great. Thanks a lot, guys.

At this time, I show no further questions.

Okay. Well, thank you all for listening in. We feel confident the third quarter will be a good one for us. So. we look forward to the next Webcast. Thanks again.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect.