Destination XL Group Inc (DXLG) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Casual Male Retail Group third quarter fiscal year 2006 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. [OPERATOR INSTRUCTIONS] I would now like to introduce your host for today's conference, Mr. Jeff Unger. Sir, you may begin.

Good morning. Welcome to Casual Male's third quarter fiscal 2006 earnings call. On our call today will be David Levin, President and CEO and Dennis Hernreich, Executive Vice President, Chief Financial Officer and Chief Operating Officer. I'd like to read our forward-looking statements and then turn over the call to Dennis. Forward-looking statements contained in this and other written and oral reports are made based on known events and circumstances at the time of the release and as such are subject in the future to unforeseen uncertainties and risks. 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, strategic initiatives to improve operating margins.

Among the other factors which may affect future performance are changes in businesses relationships with, and purchases from major customers or suppliers including delay or cancellation and shipments, uncertainties surrounding timing, successful completion or integration of acquisitions, threats associated with and efforts to combat terrorism, competitive market conditions and resulting effects on sales and pricing, increases in raw material costs that cannot be recovered in product pricing and global factors including currency exchange rates, difficulty entering new markets and general economic conditions such as interest rates. The company encourages readers to refer to part one item 1a of the company's annual report on Form 10-K for the year end January 28, 2006 previously filed with the Securities and Exchange Commission on March 31, 2006. The company makes these statements as of this date of disclosure and makes no obligation to update them. I'd like to introduce Dennis Hernreich.

Thank you, Jeff and good morning. Thank you for joining us on our Casual Male Retail Group's third quarter earnings call. 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.

The company reported an earnings per share loss of $0.02 this morning compared to last year's third quarter loss of $0.05 per share. To add clarity to this, [TF1]CMRG's operating performance for the quarter it is important to note that this year's loss was burdened by two factors. First, the company recorded a $1.2 million charge associated with remaining employment contract costs with certain personnel located at our company's Rochester offices in San Francisco. Employment will be discontinued in San Francisco as part of our decision to integrate the remaining Rochester operation at the company's headquarters in Canton, Mass. At the same time, we have installed a Newfield supervisory staff to oversee and direct Rochester store operations and are adding merchandising staff to manage Rochester's merchandising direction and execution. All other Rochester operations had previously been integrated.

Secondly, CMRG incurred an operating loss at Jared M. a recent acquisition of approximately $500,000 in the third quarter as we continue to build its staffing resources and infrastructure to enable scalability going forward. I anticipate a similar operating loss in the fourth quarter before reaching modest profitability in 2007. As I said, CMRG acquired the Jared M. business in the second quarter of this year to better service the higher end custom clothing needs of Rochester. After excluding these two items, CMRG's earnings per share for the third quarter was $0.01 per share income in comparison to last year's loss of $0.05 per share. For the nine months through quarter three, CMRG reported earnings per share of $0.13 although $0.16 per share after considering these special items in comparison to a year ago's break-even level.

Essentially, CMRG has been improving its earnings per share about $0.05 to $0.06 per share in every quarter during 2006. Further, CMRG's operating earnings of $9.3 million, or $11 million after considering these special items, was in comparison to last year's $4.2 million during the same period last year. As an overview of CMRG's operating performance, sales improved by over 11% while gross margin dollars increased 16% and after including increased SG&A by 16%, which I'll go into further detail in a moment, operating earnings improved by $2.6 million.

For nine months through quarter three, CMRG sales increased by 8.5%, gross margin dollars improved another 14 points partially offset by an increase of just over 10% for an increase in SG&A for an increase in operating earnings of $6.4 million.

Now I will drill further - - drill down further into the components of the Company's operating performance starting with sales. The company's comparative sales increase of 13% obviously drove this overall sales increase. The two primary contributing components to the sales increases were one, Casual Male stores with a 9.4% comp increase in the third quarter and the company's direct businesses increased over 36% during the third quarter. Also, Rochester stores improved sales with a 4.5% comp. The significant drivers to Casual Male stores sales increases were not only items per guest and average ticket, but also traffic added to almost half its comp increase. The company's direct business benefited greatly by a 60% increase in its web businesses in the third quarter.

In addition, the catalog circulation during the third quarter was increased by almost 50%. This supports the company's new customer prospecting activities as well as the Sears Casual Male co-branded catalog circulation. Approximately 45% of the third quarter circulation was prospecting in nature. As a direct result of the company's prospecting activities throughout the year, its active -- direct active shoppers in our direct business has grown by over 35% for the year, helping to not only fuel current year growth but what will be instrumental in continuing the growth of this important channel in 2007. For the quarter, CMRG's direct business approximated 16% of its overall sales up from 13% during last year's third quarter. Our new customer prospecting activities continue into the fourth quarter with a TV campaign currently running as well as another boost in our catalog circulation plant.

For the year, CMRG's comparative sales increased 9.7%, Casual Male stores comps up 6.4, its Rochester store comps up 2.2 while its direct business improved by 31%. CMRG sales increases on a dollar basis have been generated virtually equally by its stores and direct channels. During the year, CMRG has opened nine stores so far and closed six others, raising the total store count to 521 stores with 1,867,000 square feet of leased space. Sales per square foot for the nine months has improved by 7% so far. In addition, CMRG has relocated eight stores and renovated three others. For the balance of the year, the company intends to open one more store but close 13 others, ending the year with a total store count of 509 stores. In addition, three stores are planned to be relocated and two others to be renovated.

Talking about gross margins. Gross margins at CMRG overall third quarter rose 290 basis points to 44% from 41.1% a year ago while for the nine months gross margins rose by 240 basis points to 44.4%, up from 42% during the same period a year ago. Occupancy costs as a component of gross margins dropped as a percentage of sales by 100 basis points in the third quarter and 80 basis points for the nine months so far. Therefore, merchandise margin improved by 190 basis points for the third quarter and by 90 basis points for the nine months. Meanwhile, the company's aged inventories represent approximately 4% of its total inventories. As we have previously discussed, the company's ability to consistently improve upon its gross margins is based on several factors including improved fashion product performance, significantly reduced promotional pricing events to drive customer traffic, resulting in greater full-priced selling and sharper merchandise product cost produced by our new product development and sourcing capability.

We have continued to increase both penetration of private label merchandise in Casual Male, expected to approach 70% of its assortments in spring 2007 and building Rochester private label products towards our initial goal of 20% of overall merchandise offerings. Further, CMRG expects to source almost 40% of all its merchandise assortments in spring of 2007. As a result of these factors, we expect after 2006 year, gross margins will improve by between 220, 240 basis points. This will be the second consecutive year in which Casual Male has produced over a 200-basis-point improvement in gross margin. As we think about 2007, CMRG gross margins should continue to improve but at a pace of approximately 100 basis point improvement on a per quarter basis consistent with how we have been planning the business.

CMRG's SG&A expenses in the third quarter increased by 16% and as a percentage of sales increased by 80 basis points to 39.4%. For the nine months through quarter three, SG&A expenses increased by 11% and as a percentage of sales increased by 10 basis points to 37.8%. Overall, SG&A dollars increased by $5.9 million in the third quarter and $11.7 million for the year so far. Let me go through the points, which make up much of this increase. First, Casual Male marketing strategy for 2006 was to intensify new customer acquisition activity by using its catalog for prospecting and convincing a TV media program. Although partially funded by reduced promotional mailings, there's been an investment in marketing spend of $700,000 in quarter three and $1.2 million for the year so far. This net investment made in marketing is partially responsible for an overall 11% increase in CMRG's active customer base so far in 2006.

Number two, as we previously discussed in the second quarter, Rochester acquired the Jared M. brand. Therefore Jared M. SG&A is all incremental to last year's SG&A base in the amount of $750,000 for the third quarter and $1.2 million for the nine months through quarter three. Needless to say, we are as excited about the potential of Jared M. business as we were when we acquired the business in the second quarter. Number three, just as important, CMRG is accruing appropriate levels of performance bonuses being earned by its management team and that the company is achieving its profit targets for the year, resulting in bonus accruals of approximately $500,000 in quarter three and $2.5 million for the nine months through the third quarter.

Number four, as a result of the sale leaseback transaction netting the company $56 million in sales proceeds in the first quarter, CMRG is incurring occupancy expenses of approximately $900,000 for the third quarter and $2.7 million for the year so far. And finally in the third quarter of 2005, CMRG accrued approximately $1 million in SG&A benefits related primarily to the Visa credit card settlement with the retail industry and unfortunately, we enjoyed no such benefit in 2006. After considering these important expense investments and other SG&A items that I just explained, SG&A expenses increased approximately 5% during the third quarter or $0.15 for every incremental sales dollar in the third quarter and for the year 2.8% up on a dollar basis or $0.10 for every incremental sales dollar so far this year, all for mostly transactional related costs to support the increased sales volumes during the year. To be clear, much of CMRG's expense based increase of 10% for this year so far is largely to help support CMRG's growth with one-time investments in SG&A.

Although for the year, CMRG SG&A expenses are expected to remain at a 10% increase, we are planning 2007 for SG&A expense increases of 2 to 3% in 2007 plus $0.10 for every dollar increase in sales volume. The resulting operating income as reported improved in the third quarter from a year ago by almost $900,000 and for the nine months to the third quarter improved from year ago levels by over $6 million. We are very pleased with performance of the business this year, and that we are exceeding our internal expectations by over 30%. Therefore, our initial goal of reaching a 10% operating margin is within sight as we have been envisioning in 2008 or with continuing sales positive sales trends and continued market share improvement resulting from our strategic growth initiatives could approach this goal even in 2007. The company's capital expenditures for the nine months through the third quarter approximated $15.9 million over of which $8 million was used to rebrand Casual Male anchor stores to Casual Male XL.

We expect to incur a total of $22 million of capital expenditures for the year including the rebranding of Casual Male outlet stores late in the fourth quarter. Next year, we are planning for a $15 million capital expenditure level for projects such as relocating approximately 15 Casual Male stores, the opening of four or so Rochester stores and six other Casual Male stores, further remodeling Casual Male's most profitable stores and another $3 million in IT projects. In addition, CMRG is planning to spend approximately $3.5 million in new sortation systems for its distribution center, which will not only improve labor efficiencies, but also vastly improve its daily capacity to appropriately handle its growing business, particularly in its expanding direct business.

My last comments about the third quarter is with regard to CMRG's inventory levels, which grew by approximately 16% from a year ago. As I've stated earlier, its staged inventory levels have actually shrunk from year ago levels so the increased inventories are at current product to support its growing direct business and build inventory levels in Rochester to support its core product and stock positions, supplement its merchandise assortments with private label product and prepare for upcoming new store openings in early spring 2007, which were, in fact, delayed from originally planned -- which we originally planned for fall 2006 openings. This concludes my remarks about the third quarter results. And now I will turn the call over to David.

Thank you, Dennis. This was our 12th consecutive quarter of comp sales increase. The third quarter results of a 13% comp increase were the best we have delivered yet. And for the year, we're very close to a 10% comp. This year is a significant improvement over the low single-digit comps we've delivered the previous two years. With the recent acceleration of our performance it will be difficult to pinpoint to any specific reason, it's more about the execution of our strategic agenda to increase our overall market share of the $5.5 billion big and tall market. With over 500 stores and a robust direct to consumer business, our market share today stands at about 8%. The market's extremely fragmented because we're dealing by definition with men with 42 inch waists and up and men who are 6' 2'' and taller. And while CMRG has a significant market share in the larger end of the size spectrum, we're extremely underpenetrated in what I would call the smaller big sizes, especially 42 and 44 inches. And these two sizes alone represent 65% of that $5.5 billion market.

We identified this opportunity about 18 months ago through focus groups, surveys and in the second quarter of this year, we changed Casual Male Big & Tall to Casual Male XL and also redesigned the interiors of our store to reflect a more contemporary look. Of all of the strategic plans we have laid out to grow our market share, we felt that the rebranding initiative would have the biggest impact. I believe it's coming to fruition and has been the leading catalyst to our current sales performance. Since the day we converted our signage to Casual Male XL, the metrics we measure quantifiably show the impact that has taken place. This year, the average age of our customer has dropped from 48-1/2 years old to 47 years old and we continue to be trending down month to month. And in terms of sizes sold, our tops penetration in XL and XLT have grown from 4.9% to 7.7% and our bottoms are also gaining in sale on the smaller sizes with each month improving over the previous month since July.

And as Dennis mentioned, traffic and average transactions are up. But what is most significant is since the brand conversion, our active store file of customers who have shopped our stores in the last 12 months has increased 11% over last year. And this is the first time, since we acquired the company in 2002, that our new to file has ever grown. In the past when we brought a new customer to our database, a customer who hasn't shopped with us in the last 12 months would drop off. We had a net gain of zero. And finally on the subject, based on the success of our full priced retail stores, we will be rebranding our outlet stores to the new format at the end of the fourth quarter. Another key success to our performance is in the growth of our private label business, the strength of our 626 BLUE lifestyle brand was critical to our back to school performance. We were prepared for a buy now wear now strategy and sales were driven by cargo shorts and T-shirts. At the same time, we launched our new contemporary lifestyle brand, Synergy, in 200 stores and it was so successful that the brand will be in the chain for next spring.

Also new in the third quarter, we introduced a platinum series of suit separates and sport coats in 100 stores. This new private label is about better quality fabrications and constructions and the suits retail for $300. And the response of that has been excellent and by next fall we will be expanding to 200 stores and also adding upgraded dress shirts and ties to complement the assortment. Our in-stock performance continues to improve every quarter and also is a contributor to our top line sales performance. But I've spoken in detail about these improvements so -- that we have made in our inventory management systems over the last several calls. So I will move on.

The final big factor to our top line success has been the strength of our direct business with the real driver being the Internet. As Dennis mentioned, Internet sales this quarter were up 60%. Our ability to drive traffic to our web site and prospect for new catalog customers has improved dramatically this year. It took Casual Male four years to grow its e-mail database to one million customers. In the last year alone, we will add another million customers to our database, which means going into next spring we'll be e-mailing twice as many customers as we did a year ago. And in addition with Casual Male being the exclusive direct channel provider of Big & Tall product for Sears U.S. and Sears Canada, it's just another vehicle that will continue to add to our market share. We've invested in new marketing programs aimed to bring in new customers through our television campaign and increased circulation of our catalog and internet affiliated programs. We believe once we get a new customer acquainted with Casual Male, they'll stick around and stay with us for a long time. And this investment has been paying off and we will continue to prospect for new customers as part of our strategic plan.

Another initiative to increase the average spend of our existing customers is through a loyalty program. We launched our points-based program in October with the luxury of having been in the test market situation for a year. And we have quantifiable results that show the loyalty customers spent more money in the last year than those not in the test markets. And I visited several stores during the launch week and the customer and sales employees' feedback has been outstanding. And while it will take several months to feel the impact of the loyalty program on the top line, we're confident that this will be another impetus for continued comp growth in the future.

Moving on to update on our store growth, Casual Male stores' priority for the next few years is to improve upon its current store sales per square foot. We've identified 50 existing stores that need to be relocated within the same market. These are older stores that today are in high tenant vacancy strip centers where the retail activity has moved to another part of the area. So far we've relocated nine stores this year and their comps are exceeding 20%. And it'll take us about three years to get all these stores moved. And we're assuming we can get about 15 done for next year.

At the same time, to improve our sales per square foot goal, we're closing 13 stores at the end of this year and those stores average sales per square foot were $122. Also with the recent turn around performance of our outlet stores, we'll be opening up five new ones next year. In Rochester, on the other hand, with only 25 stores, will continue to be our focus for new-store growth. Next spring we'll be opening two very key locations and hopefully have at least two more in the back half of the year.

I'd now like to focus on our new initiatives that will grow our market share in the future. We acquired Jared M. in May of this year as a way to develop a high end custom business for our Rochester division. Custom is a growing category, especially at the luxury end, yet Rochester currently does less than 3% of its sales in a business where it should be double digits.

Today Jared M. currently caters mostly to professional athletes and the average spent per client is in excess of $40,000 a year. As Dennis mentioned, this year we are building the infrastructure to make Jared M. a scalable business. We'll be ready for spring '07, we'll be launching a catalog, an Internet site and open Jared M. concept shops in Rochester's New York, Chicago and Atlanta stores. And in addition, the new Jared M. show room at 35th and 7th Avenue in New York City will be opening late in December.

Also, as I've noted, that we are underpenetrated in the small big sizes and also with the younger consumer, we're also underpenetrated in the lower economic tier. The average income of the Casual Male customer is $70,000, yet statistically, the lower the economic income of the consumer, the higher the propensity to being big and tall. And to capture market share of that demographic, we are on schedule to launch our B&T Factory direct catalog this spring. Price points will be about 25% less than in Casual Male but we will be able to maintain similar gross margins because we direct source most of the products and it will be the same private labeled brands that we carry in our outlet stores.

Once again, it's another opportunity to parlay our infrastructure, our knowledge about the Big & Tall customer and our database to expand our horizons. Today, I'm excited to announce an acquisition that plays right into that strategy. In October, we acquired a Dot-Com business called SuperSizeWorld. The company is a life support for the larger lifestyle, carrying over 250 products catered to the needs of large people. Products vary from household accessories like high capacity scales, extra large bath towels to seat belt extenders to portable chairs, extra large floatation devices and I could go on and on. But in analyzing the profile of the SuperSizeWorld shopper, the sweet spot is in size 3x, the same spot that we have for Casual Male. We'll be able to utilize our database to market to millions of potential customers through the Internet and catalog channels. We're going to change the name of the web site from SuperSizeWorld.com to Think big.com and we'll be launching around May of next year. And with our sourcing capabilities, we see this new division delivering strong margins for the company. Again, another strategy where we have the ability to increase our top line performance without investing substantial capital.

With these initiatives in place, we see no reason why we can't grow our market share from 8% to 12% in the next several years. We understand the big and tall market better than we ever have. Our core competency of size management and our infrastructure allows us to expand beyond the scope of a traditional specialty retailer. Our strategy is to take on this fragmented market and gather market share. We're going after the total age spectrum and income spectrum from 626 BLUE to Harbor Bay, from B&T Factory Direct to Jared M. From the clothes they wear to the everyday products that cater to their needs.

And on a final note, we announced today that we're closing the Rochester home office in San Francisco and moving the operations to our corporate headquarters in Canton, Massachusetts. These are never easy decisions, but from an operational point of view, we need better vision and more structure to ensure that Rochester can maximize its potential. With respect, we respect and commend the Sockolov family for building Rochester's to being what it is today, the premier retailer of luxury clothes for big and tall men and the management team at CMRG will strive to maintain a legacy of a hundred years of success and passion for the business. And now we will open the lines for any questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Gary Giblen of Brean Murray.

Hi, good morning, everybody. Wondering what the annualized savings would be from the Rochester head count reduction?

Yeah. Gary, we took these maneuvers to improve the company's Rochester's performance over the long term as we expand the chain. We don't view this as a money-savings maneuver, rather, we've reinvested in field supervisory staff. We've reinvested in other merchandising resources here in Canton. So the actual savings is really very small, but rather we feel that we've really built Rochester's support to support the growth plans we have for it.

Gary, one other point. Today up until this point, there was one person buying all the product for Rochester, whether it was suits, swimwear, underwear, socks, shoes, which doesn't really allow us to maximize our merchandising potential. So we're adding some merchandising staff, too in the terms of buyers to really support that business.

Oh, okay. And does this mark the exit of the Sockolov family from management involvement in Rochster?

Well Bob Sockolov is continuing to stay on as a director of the company on the board. And Steve Sockolov is continuing to play a role as - - as one of the merchants for the Rochester division. Those are the only two major positions that will be left.

Okay. Understood. And the - - does the Rochester comp of 4.5% represent some deceleration? I mean I know in general they've been high single digit comps so - -

Rochester since we acquired the business has been in the range of 4.5 to 6, so it's there.

Okay. And Men's Wearhouse noted some clear deceleration in tailored through October and even specific specified for early November, too. So anything happening there that you would see at Rochester?

I mean, we've had the solid performance. Casual Male's stronger. We heard what they had to say but again, I think our business is more about execution. We're gaining back business that should have been there, so it's difficult for us to probably measure against a very mature business. So maybe our comps would be even higher but they're where we would expect them to be today.

Okay. Then last one and then I'll maybe come back later, but the - - does the - - is SuperSize.com losing money now and, you know, if you have to invest in it to upgrade it, is that all going to be some dilutive drain, so to speak? And if so, what range of expenditure would it be?

What's different about the SuperSize acquisition, Gary, different from that of Jared M., SuperSize is in - - other than the product offerings, which are different obviously than what we sell today. But otherwise, the running of the business, the Internet operation, the catalog operation, basically virtually folds right in and integrates almost immediately in with Casual Male Retail Group. So therefore, incremental expense-wise, loss wise, nowhere near the scale of Jared M. Jared M. custom clothing business quite a bit different type of operation from Casual Male's Retail's Group. So that's the difference between the two acquisitions.

Okay, understood. Okay, great. Thank you.

Your next question comes from Scott Krasik of C.L. King.

Hi, guys. Thanks for taking the call. Is there anything different about the - - I guess nine relocated stores that are comping up so much now versus what you're doing in the future? Was that sort of the best location you could get or do you expect that performance to continue?

We think that performance will continue. We're in the right market, there's no doubt about that but we're in centers that could be 20, 30% occupied that, you know, we're waiting when the term comes due, we try and get those stores moved. Whether we move them a mile or five miles, we've been exceeding 20% consistently and, you know, we do pro formas on each new reload that comes up. Those are the type of increases that we expect to get on the 50 going forward.

Good. Okay. Can you talk about finding real estate for Rochester and, you know, how you might have viewed your overall expansion plans for how they've changed? Seems like they're opening a little slower than what you thought.

Again, it's a little it's more challenging because in Casual Male, we could focus in on a much wider range of a market we want to be in and Rochester we want to be in a specific high profile street, which is very critical to us. So we have had lots of opportunities but we're being very discretionary making sure that we're getting the optimal locations for each one. We had two stores that we thought we were going to get open in this quarter, but they're not going to open till next spring because of lots of - - more zoning issues, more permitting issues going on with these type of stores. But we think we're back on track for next year. What we have in the pipeline should get us back on track to what we said, four to five a year.

And do you still believe that you can open second format or a lesser productive format in secondary cities or are you sort of limiting what you think you can do with Rochester at this point?

All we're doing right now is prioritizing. We have Buxton who does our consulting and they analyze each location. We're going for the absolute big bang stores that we can get and next year we'll assume we will be announcing what our locations are, and they're very high profile, have high forecasts behind them on their performance. So we're taking it from the best down, so I don't think we will be in secondry markets for a couple of years. We've still got some very big markets to open before we get there.

Okay. And then Dennis, just there's a lot of moving parts going on, on the expense line. Fourth quarter SG&A directionally, do you expect it to be up significantly from the third quarter?

Well, I said I think that, Scott, for the year we're going to be up about 10% overall in SG&A.

Okay that's good. Okay. Thanks, guys.

Our next question comes from [inaudible] of Deutsche Banc.

Hi, guys. I was curious about, the custom business that you acquired. You said you can make it scalable. That strikes me as a tough thing to do. How would that work? How do you scale a custom business?

We need infrastructure. It's a different skill set than what we have here in buyers and planners and allocators. We have to get into the product development side and that's where we're building our staff and we need sales people out there to go out and sell all these clients. So, you know, the expense that we're incurring is almost all in head count issues as we're building our staff and we have a plan for next year and to support that sales plan, we had to build some infrastructure. Jared was basically on his own. He had a small staff and he was tapped out at let's say 2.5, $3 million. He could not grow that business anymore. Now we're trying to scale it up where we can do 10, 20, $30 million worth of business. So it's a ramp up and in this quarter and next quarter we have very little revenue coming in as we're preparing for the spring launch.

All right. Thanks.

Our next question comes from Margaret Whitfield of Ryan Beck.

Good morning, everyone. Dennis, I wonder what you could tell us what the extra week adds to your bottom line this year?

Yeah. It's kind of like a bonus week, isn't it?

Mm-hmm.

It's the month of January, our typical sales that tie $4 to $5 million range. You know it could add. It's really not - - has not been in our thinking. We really haven't spoken to it, and we'll certainly speak to it when it happens that 53rd week generated this, but you know it's a $0.5 million, $750,000 type of EBIT addition perhaps for that week is what we're thinking.

Okay. And you mentioned the possibility that you could get to your 10% operating margin goal sooner, perhaps next year. Would that stem from greater upside in the gross margin line than you spoke to, which was the 100 basis points of improvement or would it come from more leverage on the SG&A line.

No I think it's more largely now having done a lot of our SG&A buildup to support the level of business growth that we're seeing, Margaret.

Mm-hmm.

We obviously don't see that happening back-to-back years. So much of next year's leveraging is not so much gross margins side but much more on the SG&A side. And I think that - - what makes next year very, you know, possible is the fact that if our trends continue, our product offerings remain as impactful as they seem to be this year. We gain market share from these other initiatives that it would only make that much more SG&A leveraging possible and therefore operating margin 10% might not be that far away.

Of course when you achieve the long sought target then people want to know where do we go from here. Does that max you out or do you think you can move that margin up over time?

No I definitely think there's more margin to be had. We've always spoken as you know kind of the mountain is 10% but certainly there's more horizon even after that, because again market share at that point is only going to be something less than 10%. We have ample number of opportunities still on the market share side. Our SG&A is still very scalable for additional growth. So there's no reason to think why operating margin's going to plateau at 10%.

Will this recent acquisition which you'll rename think big be dilutive next year? What are your thoughts on that?

No, it should be accretive.

And for Dennis, I wonder if you could comment how November comps running to date at Casual Male?

Still running well. We're not going to comment on it, but we've had a lot of momentum going for the last six months now. We were at - - we used to be this 2, 3% comp company and now we've been hitting double digits. It's way too early in the fourth quarter but our trends have been very strong. In fact, as we've moved month to month, we've gained a little bit more every month.

I was curious when you said you're adding in more upscale suits, dress shirts and so forth. The additions of those lines, what comes out? Where are you cutting? And in time if there's a good response, could this, you know, lead to a concept in between Casual Male and Rochester? Can you contain everything in your existing corps?

I'd hate to dilute it, I think we're right. There's a clear demarcation between Casual Male and Rochester. I wouldn't think there would be one in between. But what's coming out in these stores will be the balance of the entry price point suits where in these stores they're looking for better, and again, it's not every store. I said next year it will be 200 stores but we're in a lot - - like I said, the average income of our customer is $70,000. We're talking about taking them from $225 suit to a $300 suit and he sees the perceived value and has been responding very well. So again, it's the mix within each store that we always try and balance for the right demographics of the stores, but not for every store but we've had quite good success with this one.

I know Synergy has gone well and before that Caribbean Joe. Any new lines for next year or do you think you've covered every base in terms of private label for Casual Male?

I think we've got all our lifestyles covered. We're looking at doing a little more micro-marketing. I think there's room for a little more of an outdoor lifestyle for some of our stores in, let's say Minnesota, Wisconsin, the Midwest, a little more rugged looks to them with some flannel treatments. We'll develop that next year but our core lifestyle lines are now covered between the brands that we have today.

Okay. Thank you.

Yep.

Our next question comes from Marc Bettinger of Stanford Group.

Close. It's Bettinger. Hey guys listen congratulations on a great quarter I mean all of the metrics look great. Couple of things. Dennis, the 10% that you're talking about maybe reaching next year, is that something that you would think would be for the entire year or would that be a run rate by the end of the year?

No that's an operating margin number and that would be the result for the year.

Okay. Great. David, the 42 and 44 sizes that you're talking about, do you have that in every category that you have in the store?

Yes, yeah. We've moved it to whether you're in a dress pant or casual pant or in a denim or in a top, yeah, we've definitely been moving it. To this point, we overfunded somewhat as it's building in. So on an ownership of inventory to its sales, we're in pretty good shape. We have it pretty well protected but literally every month there's another movement of a half a percentage point as its percent to total. So we're watching it happen. It's quantifiable. It's very real that we're starting to get in. These guys who have been reticent to walk into a Casual Male store. We've never had any movement in the four years I've been here prior to the name change.

Okay. So then every pair of pants or style that you offer is coming in a size 42 and 44?

I can't say 100%, but I would - -

Are you close?

Yeah, very close.

Okay. Can you see dropping to a 40 or 38?

One step at a time. I think this market is where we're going - - we have to focus on. Again it's twice the size of our market that we're really strong in, but not to say that over time we won't go in that direction. Probably more so in the young men's brand because there is a bigger void with the American Eagles of the world who really stop at 38, or Abercrombie. So, yes, down the road, we see that potential, but right now we've got a big market to fill.

Okay. And In terms of your sourcing, I think Dennis said you'd be at, what, 40% of direct sourcing by spring of '07?

Yes.

Is that different than what was said in the past?

I think to define it Dennis - - he said 40% of total purchases. It's closer to 60% of our private label purchases.

I'm speaking to the company, Marc.

Okay. So the 60% is consistent with what you said in the past?

60% --

Of the private label. Yes.

It's just two different ways it.

For Casual Male. My 40% is of all purchases for CMRG, not just - -

Right. Okay. And I think you said the $750,000 for Jared M. will repeat itself in the fourth quarter?

Yes.

Okay. All right. Thanks. Congratulations again.

Thank you, Marc.

Our next question comes from Evren Kopelman.

Thank you. Good job guys. I have a question, well two questions. One's about your guidance for gross margin and SG&A dollar growth for next year. In the SG&A, I believe you said 2 to 3% growth in dollars. What catalog circulation growth and what marketing spending growth does that assume?

We'll maintain our current level of marketing spend of course. On an absolute dollar basis, it needs to increase to keep up with our growing customer base. But as a percentage of sales, marketing overall should be dropping next year and it's part of our overall SG&A plans. Also, Evren, too, I want to make sure two to three points plus there's going to be some transactional cost increases related to volume. For every dollar of volume increase, there's a $0.10 cost increase on the SG&A side. I want to make sure you get that.

ok so it's 2, 3 plus - - so it's not - - so okay got it. And then the gross margin, it sounds very significant, 220 to 240 basis points. What kind of private label penetration does that assume and also markdown levels does that assume markdown levels stay flat with this year?

That 220 to 240 range, Evren is for 2006. 2007 we're planning for about a 100 basis point improvement overall in gross margins.

Okay thanks for that correction. So for then the 100 basis points, what does that assume for markdowns and private label penetration?

Much of the markdown plan next year is virtually level to this year's plan. Some improvement but much of our improvement we've enjoyed this year. Rather next year we'll continue to drive some improvement on gross margins more from product cost decreases resulting from our private label sourcing programs.

Okay. Then final questions on the new acquisition, can you tell us what their sales and earnings were last year and what you paid? I assume you paid cash to buy them?

Yes. Again, this is a very entrepreneurial grassroots business. We paid $400,000 with $190,000 consulting contract with the principal of the company. You know, earnings couldn't be there - - there's not much there on the earnings. What we're saying is that he had a customer base of about, I don't know, 20, 30,000 customers. We have millions of customers now to market, what he's created by gathering all these product lines specially suited to big and tall guys. So it won't take us a lot of capital. We just have to put them on our platform and start marketing to our bigger guys, and we see this as a great opportunity of a low-cost -- low entry cost business in an area that we never even previously considered. But again, we have the database. We know who - - which customers of ours are 3X and larger and they're great products. They're great products to help this guy through his lifestyle. So we're very excited about this one.

Good. It's - - I like the new URL.

Right.

Thank you.

Thanks.

Our next question comes from Rob Wilson of Tiburon Research.

Yes thanks for taking my call. David, could you talk about what the Casual Male XL revamp branding whether the impact that you're seeing in your comp sales may be related to that versus more simply just increased catalog circulation?

That - - Dennis kind of broke that out. Half of our increase is coming from the stores and half of it is coming from our multi-channels, but if you had the insight to, as we roll these stores out and convert them over, it has pretty much an immediate impact on the traffic once we got these stores converted. What's nice about it is we have stores in the test markets that have had the XL up for over a year now and what we saw wasn't a one-time hit. It just didn't happen once and then things normalized. It's sustainable because we are destination. It is a matter of discovery. And it could take a customer a year before he's going to drive by that specific intersection, notice a sign and come in our store. So this is not, again, not a one-time hit for us, but very sustainable and we continue to see the jump. Again, we were running in the single - - the mid single digits in the first quarter, and we converted and they went to double digits. Without a lot of other things going on around it, we didn't spend any more money in direct mail to these customers at all.

Fair enough. Also, if I remember correctly, last year, you had a $20 no strings attached coupon in December. Are you going to anniversary that?

Absolutely. It was one of our big successes last year that, again, last year's fourth quarter was really our first breakout quarter. And that was a great response. Customers really appreciated that one. And it was effective. The average spend of that customer coming in with the free gift card was quite high.

Are you sending more gift cards this year?

No. We've actually, again with our database which is much more robust, we are able to identify customers who used the gift card but didn't spend any money and those aren't the type of customers that we want to invest in. So we should get a higher return rate but the circulation is no higher than last year.

Finally for Dennis, maybe more of a philosophical question but do you think that 10% operating margin target for next year is a little aggressive?

Well, it obviously would assess - - the prerequisite for that is our top line trends continue but it'll just give you a sense perhaps on if the top line continues to enjoy the trends that we're seeing today that getting to a 10% is not impossible next year.

Well thanks for taking my call.

Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Gary Giblen of Brean Murray.

I'm afraid I'm coming back for more. On the 13 stores to be closed, are those in trade areas where's you would expect to pick up the business for the most part with other stores?

We always get some pickup to the next closest store. Again, it's not going to be significant to what we're - - to our sales or earnings, I don't believe. A couple of these are in markets where we can't - - where there's just not enough volume in those markets because they've been around 15 years and doing little volume. There's no reason for us to keep them going, but I think our point is, you know, mixing out what we're doing by moving stores to better markets, closing some of these stores that are doing $350,000 a year. Really raises our sales per square foot. We've always talked about getting over $200 a foot and we're certainly going to be very close to that number by the end of this year.

Okay. Were those stores EBITDA positive or just neutral? I know it's a small amount either way, but - -

They were either break-evenish, Gary or even losing in some cases.

Okay. Well good. That's out of the picture. And the nine relo's that you did this year, I understand they were not cherry picked for any particular reason but were they just the ones coming up on the real estate schedule or what was the basis for picking those nine?

That's precisely right, Gary. We don't sequence them from best to least best. They're more sequenced by lease expirations primarily.

Gary, we have 25 ready to go today and it's up to the real estate department to find those new locations. That's why just from a forecasting point of view, we're forecasting 15 for next year. If it goes to 25, that's great, but we have to plug in a number somewhere and were going to guess we'll get 15 up to 25 next year. Then the following year there's another 25 to get to.

Okay so In other words, the store that gets closed is like on a month to month and then it's a matter of finding the optimal - - a good - - an excellent location?

Exactly right. Situations where a tenant at will.

Okay. And just a couple of -- a number of questions. Interest and D&A came in just slightly higher than my model so I guess should the current quarter's number be used as a run rate more or less?

Yes, Gary.

Okay. Finally, why would there be - - why would you have people at Rochester under contract when you bought them two years ago, you know if there were retention bonuses or something, those would be I would think maximal two-year retentions?

There were four individuals, which were under a three-year employment contract as part of the acquisition.

Oh, okay. Those people are not coming back. Great. Thanks very much.

Our next question comes from Scott Krasik of King Asset management.

I got thrown off the call so if you mentioned this I apologize. I know you don't give specific earnings guidance but if we look at next year on opearting margin whether it's 8, 9, 10%, are you assuming full dilution from the convert or are you assuming some sort of effort to deal with that, Dennis?

We are in the final - - in the midst of finally determining our direction on that point, Scott. I think - - expect to hear from us over the next 30, 60 days as to our intentions. So if I can defer that question until then, let us finalize our plans. But certainly as we have stated in the past, we'll reiterate now that dilution is something that we intend to mitigate and minimize so that's first and foremost on our minds as we make our final deliberations.

Good. Thanks, guys.

[OPERATOR INSTRUCTIONS] We'll pause one moment to see if there are any further questions. I'm not showing any further questions from the phone lines. Would you like to continue with any concluding remarks?

Yeah. Just to say that again, we're pleased that we've got three years of these comps going in our favor. Over 400 basis points of improvement in our margin over the last two years. I think the point I want to stress is we've been accomplishing that by becoming less promotional. I know one tends to lead to the other yet in our case, we're cutting back our promotional side. Most of our marketing is going into institutional, building our brand and it is working. So we plan on continuing along that path and building our customer loyalty more through being in stock and customer service. So I thank you all for joining us today and we'll look forward to having a strong fourth quarter and talk to you after the quarters. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.