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Tickers in this Article: TLB, ANN, CWTR, CHS
The third-quarter profit posted last week by Talbots (NYSE:TLB) was a surprise. Wall Street was expecting a $0.14 loss and investors, shocked by the news, sent the stock up over 10% at the opening bell Tuesday.

Following last quarter's glimpse of turnaround success, Talbots announced further progress in cleaning up its highly leveraged balance sheet, trimming its cost structure and improving its merchandising strategies.

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The Progress Made

Management successfully reduced inventory by almost 30% on a per square foot basis while simultaneously widening the pure merchandise margin by over 900 basis points as full price conversion increased. SG&A expenses fell 22% and cost of goods sold declined 30%. And most importantly, in a series of three transactions, Talbots finally took the necessary steps to de-leverage.

The company ended its relations with Aeon, its majority shareholder, by repaying all debt and retiring its equity stake. It organized a plan of merger where Talbots will acquire BPW in exchange for Talbots common stock.

And finally, it repaid all existing debt and secured a new commitment for a $200 million senior secured revolving credit facility from GE Capital. It was a complicated process, and the dilution effects on shareholders are not yet fully known, but the bottom line is that it will ultimately reduce Talbots' debt by $330 million.

The efforts made by Talbots certainly paid off, translating into an adjusted profit from continuing operations of $0.31. But the company still faces strong headwinds.

Persistent Top Line Woes
Total sales dropped 13.5% and comparable sales plummeted an even greater 16%. And Talbots is bracing for another 6-8% decline in sales during the fourth quarter, causing management to predict a loss from continuing operations of $0.06 to $0.14 for the quarter. This demonstrates that leaner operations and improved inventory selection can only drive temporary profitability if sales can't be revived.

The sales declines aren't necessarily a bad thing in this situation, though. While traffic and sales are down, full price conversion is up. Talbots is focusing on re-branding itself by refusing to use drastic markdowns to move inventory, a tragic mistake it used in the past. While it may be foregoing sales by pushing full-priced items, it should help the company emerge back into the premium retailer it once was known as.

The women's retail scene is not pretty right now. Ann Taylor (NYSE:ANN), Cold Water Creek (Nasdaq:CWTR) and Chico's FAS (NYSE:CHS) are all failing to appease their target demographic. Talbots seems to be making the most drastic changes, but that's no feat given all of its competitors are operational messes themselves.

Still Not A Sure Bet
Talbots has shown signs of success restructuring its operations and stabilizing its balance sheet. However, it remains to be seen whether Talbots will be able to revive sales with its turnaround efforts and we won't know the answer until the recession fully passes. Eventually sales will have to revert to positive growth to sustain profitability and until we have proof that Talbots is capable of this key component of restructuring, I still wouldn't consider this stock a turnaround play. (Learn to pick out your investments on your next trip to the mall in our related article Analyzing Retail Stocks.)

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