Gymboree Q3 Earnings Call Transcript

123jump.com Staff
17 Dec, 2008
New York City

Gymboree

The Gymboree Corporation ((GYMB))
Q3 2008 Earnings Call Transcript
November 19, 2008 1:30 p.m. PT

Executives

Kip Garcia - President
Matthew McCauley – Chairman, Chief Executive Officer
Jeffrey Harris - Vice President of Finance
Blair Lambert – Chief Operating Officer, Chief Financial Officer

Analysts

Betty Chen – Wedbush Morgan
John Zolidis – Buckingham Research
Brian Tunick – J.P. Morgan
Margaret Whitfield – Stern Agee
Thomas Filandro – SIG
Linda Tsai – MKM Partners
Dana Telsey – Telsey Advisory Group
Rick Patel – Merrill Lynch
John Morris – Wachovia Capital Market
Janet Kloppenberg - JJK Research
Marni Shapiro – The Retail Tracker
Bill Dezellem – Titan Capital Management

Presentation

Operator

Good afternoon. My name is Christine and I will be your conference operator today. At this time I would like to welcome everyone to the third quarter 2008 earnings call for the Gymboree Corporation. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer session. (Operator Instructions) If you''d like to ask a question during that time you may press * then the number 1 on your telephone keypad. If you’ve already done so, please press the pound sign now then press “*1” again to ensure that your question has registered.

Thank you Mr. Harris you may begin your call.

Jeffrey Harris – Vice President Finance

Thank you, Christie. Welcome to the Gymboree Corporation’s third quarter 2008 earnings call. I am Jeff Harris, Vice President of Finance for Gymboree. On the call with me today are Matthew McCauley, Chairman and CEO; Kip Garcia, President and Blair Lambert, COO and CFO. Blair will first make a few comments about our third quarter financial performance and plans for the remainder of 2008. Kip will discuss product performance during the quarter and update you on our merchandising initiatives. Matt will then provide some additional background and update you on our strategic plans for the remainder of 2008 and beyond. After our presentation is finished we will all be happy to take your questions.

Before we get started, I want to point out that our presentation today contains forward-looking statements including statements about trends in operations, future sales expectations and future financial performance. Actual results could differ materially from those forecast as a result of a number of factors including those set forth in our annual report on Form 10K for the year ended February 2, 2008 filed with the SEC. I would also like to point out that we intend to continue to comply with the SEC regulation FD. As such we will not be providing guidance or projections outside of public forums. You should also be aware that your participation in the Q&A session constitutes your permission to transcribe and re-broadcast any comments you may make.

Now here is Blair Lambert.

Blair Lambert – Chief Operating Officer and Chief Financial Officer

Thank you, Jeff. As reported in our press release net retail sales for the 13 weeks ended November 1, 2008 were $261.3 million, a 6% increase over the $247.6 million in net sales from retail operations reported for the 13 week fiscal quarter last year. Other revenue for the quarter attributable to our Play and Music operation was $2.8 million, compared to $3.2 million in the prior year. In total, net sales for the quarter were $264.1 million versus $250.7 million for the prior year, an increase of 5%. As previously reported comparable store sales for the third quarter decreased 2%, during the quarter we saw an increase in the total number of transactions and decreases in the average unit retail and units per transaction. The total number of stores open at the end of the quarter was 873, including 585 Gymboree Stores in the U.S., 29 Gymboree stores in Canada, 112 Gymboree Outlet stores, 110 Janie and Jack shops and 37 Crazy Eight stores. During the quarter we opened 39 new stores consisting of 9 new Gymboree Stores and 8 new Gymboree Outlet stores. We also opened 9 Janie and Jack shops and 13 new Crazy Eight stores. In addition, we closed 1 Gymboree store. Total square footage under management at the end of the quarter was 1,706,000 square feet with our average store size at roughly 1,954 square feet.

Turning now to gross profit, gross profit for the third quarter fiscal 2008 increased 130 basis points to 51% compared to 49.7% for the same quarter of the prior year. The improvement was the result of the company’s continuing product cost reduction strategies, leveraging of buying costs and higher average unit retails in the core Gymboree brand partially offset by increased occupancy costs and lower average unit retails in the other brands.

Looking at SG&A expense in the third quarter, SG&A as a percentage of sales was 31.9% of sales versus 32% in the prior year. The decrease was primarily driven by reductions in marketing, professional fees, operating supplies, communications and travel, partially offset by higher compensation. Notably, excluding non-cash stock based compensation expense; SG&A fell by 70 basis points versus the third quarter of the prior year. For the quarter, operating income rose 13% to $50.2 million versus $44.4 million in the third quarter of the prior year. As a percent of sales, operating income showed a terrific 130 basis point increase to 19% of sales. The tax rate for the third quarter was 38.5% versus 40.4% in the prior year. The lower tax rate was due in part to tax benefits associated with our international operations partially offset by additional state tax accruals.

Net income increased 15% to $30.9 million versus $26.9 million last year. Earnings per diluted share increased 16% to $1.06 per diluted share compared to $0.91 in the prior year. These earnings include a loss of roughly $0.03 per diluted share associated with Crazy Eight. Let me now move to the balance sheet. Cash, cash equivalents and investments at the end of the quarter were $93 million with no short or long-term borrowings outstanding. Inventories at the end of the quarter increased to $142 million versus $130.5 million in the prior year. On a ‘per square foot’ basis inventories decreased 6% compared to the prior year. Gross capital expenditures for the quarter were $16.2 million. Depreciation expense for the quarter was $8.8 million.

Turning now to our plans for the remainder of fiscal 2008, as noted in our press release for fiscal 2008 we are planning for diluted per share earnings in the range of $3.12 to $3.20. These earnings targets anticipate a full year net loss from Crazy Eight of roughly $0.14 per diluted share. Looking more specifically at earnings for the fourth quarter fiscal 2008, as you all know there is a great deal of turbulence in the consumer markets. While we have a great deal of confidence in our product assortments, marketing plans and efforts to improve our operational efficiency the macro economic factors make it very difficult to anticipate how the consumer will respond during the upcoming holiday season. With this risk in mind, we are planning fourth quarter earnings to be in the range of $0.92 to $1.00 per diluted share and 29.3 million diluted shares outstanding. This earnings estimate is based on a mid single digit decline in same store sales and anticipates a loss of $0.03 per diluted share related to Crazy Eight.

In planning the income statement for the fourth quarter we expect fourth quarter year-over-year gross margins to decrease slightly versus the prior year due to negative occupancy expense leverage and relatively lower gross margin rates in the Crazy Eight division partially offset by slightly higher merchandise margins in the other divisions and buying cost leverage. Looking at SG&A, we should see a little SG&A leverage even after taking into account the $3.2 million stock-based compensation catch-up charge recorded in the fourth quarter of the prior year. On balance, operating margins are expected to be a little higher than those experienced in the prior year. Looking at our real estate plans for the fourth quarter, we plan to open 15 new stores consisting of three new Gymboree stores, 9 new Gymboree Outlets, 5 new Janie and Jack shops and one new Crazy Eight store. We also plan to remodel, expand or relocate 5 Gymboree stores.

Before I close I want to provide an update on the factory fire we discussed on our second quarter earnings call last summer. As we discussed, one of the factories we contract with in Indonesia experienced a fire over this summer. At the time we estimated we would experience some downward pressure on gross margin in the range of $0.02 to $0.04 due to increased air freight costs and unfilled orders. We now expect that the impact will be closer to $0.02. This result is reflected in our guidance.

Now I’d like to turn it over to Kip for a discussion on our merchandising activities.

Kip Garcia – President

Thanks Blair. During this challenging retail environment when our customer now, more than ever, is carefully scrutinizing every purchase and will not compromise, we are singularly focused across all of our brands on perfect execution of what sets us apart from the competition. With that said we are raising the bar. Our goal is to exceed our customer’s expectations of what we know she really values within each of our brands. In Gymboree it is by providing her with unique, must have mix and match outfits and superior quality that she cannot find anywhere else in the mall. At Janie and Jack it is heirloom quality product that takes her breath away with hand sewn detail, luxurious fabrics and precious styling. At Crazy Eight it is providing all-American fashion outfits at surprisingly low prices and at Gymboree Outlet it is the very best of Gymboree’s past lines at prices that are 25% to 30% less, all which is supported by a shopping experience that is second to none. We are also keenly aware of our customer’s demand for value and we are making sure we are surprising her with our great values that will be offered every day.

Turning to the third quarter, although we were not pleased with our comps across the brands we have been encouraged by our customer’s positive response to our most recent lines and the strong initial reaction to our holiday value messages across the brands whether it is Jingle Deals in Gymboree and Outlet or Great Gifts, Crazy Low Prices in Crazy Eight. Turning to Gymboree, our strongest performing lines for the third quarter included Fall One which set in mid-August. For girls the theme was dots and dogs and our customer’s loved our dot prints and patterns, multi-stripes and button details all in a cozy fall color palette. This delivery for boys was all about pirates which was timed perfectly to Halloween. Key looks included pirates, skulls and cross bones and pirate ships. Our Halloween shop was another driver for the quarter which set end August. All categories including Halloween themed sleepwear, apparel and of course costumes posted strong performance. For girls, fairies are now iconic to Gymboree where we sell pretty much anything that can be accessorized with wings and a tutu. Both boys and girls want to be doctors this year, contributing to the success of our doctor costume and finally bugs prevailed for babies with strong performance from newborn glow worms and baby bumblebees.

For newborn apparel, our new assortment of layette net essentials which we call ‘Brand New Baby’ continued to exceed our plans. New for the fall season we launched a monkey-theme concept which has resonated with our customer. Our customer’s responded to our quality knit fabric with a superior soft feel and our baby-friendly fit plus our unique style, prints and details. We also launched organics this season and based upon the success of that assortment we will be continuing organics going forward. Our holiday picture taking collection, however, which launched at the end of September, had disappointing mixed results. We feel that the customer may have been deferring her purchase for this very specific seasonal outfit this year and only purchased the items that she was sure would be sold out if she waited like our exclusive family dressing collection which included plaids for the family. Customers also bought our rich, chocolate brown velvet party dress, which was unlike anything offered in the mall at this time.

Moving forward to the gift-giving season, we were very pleased with the response to our gift line which set at the end of October. For girls the line was chocolate and strawberry bonbons which featured chocolate/strawberry/vanilla colors, dot patterns, Neapolitan color blocking and candy artwork. For boys, the line was dog with candy bean, which featured khaki green and navy plaids, argyles and dog icons. This line was a unique alternative to the traditional red and black that was flooded in the mall and gave the customer a casual to dressy alternative to holiday outfits. From a value perspective for those customers that want to stretch their dollars, these outfits can be worn well beyond the holidays. On the value side of our strategy, in anticipation of a more value-oriented customer this holiday season, we have taken our Jingle Deal campaign to new heights and strengthened our offering, presentation and timing based upon key learning’s from prior years. We have had a great response to our latest deal, outerwear vests, which is encouraging for the balance of our item offerings this season. We are also very excited about our Jingle Deal items and promotions for Black Friday weekend and feel that our customer will be impressed by the value that she can get from the Gymboree brand.

Turning to Janie and Jack, for the third quarter we saw a shift from reg price to mark downs as even this customer looked to stretch her dollar and as a result this brand did post the weakest performance across the brands. At the department level our strongest performance came from our boy line whereas girl’s was weaker, partly due to the tougher comparisons with some of our strongest lines that we had last year at the same time. Also in girls our customers are asking for brighter color palettes, much more than she has in the past which is definitely an area we have adjusted for in our next line which lands in the stores next week and lines going forward. Also, specifically for boys, our customer’s buy menswear inspired silhouettes and fabrics which we will also expand going forward. As has been our trend, our special occasion product for boys and girls continues to be a winner.

Regarding line performance for the third quarter, our strongest performance came from our fall line set in September. The customer responded most positively to our boy products which featured menswear fabrications and styling and fun dog icons. Overall, at Janie and Jack we are focused on delivering the most elevated shopping experience in the mall for our customers. We have made sure that we are offering our customers must-have gift outfits in fabrics, details and styling that are available nowhere else, surrounded by the shopping experience that is as special as our product. In that effort we have created magical holiday windows displays that feature moving trains, animated ice skaters and downhill tobogganers in a wintry scene that has become a heart-warming, must see experience for the family and a reason to return to our shop again and again during the holiday season. We have been moved by the amount of positive feedback that we have received in response to our windows this year.

Turning to Crazy Eight, for the third quarter although our average store volume was lower than we wanted, we do have key learning’s in action that we have already put in place going forward to improve the performance of this brand. For example, our graphic tees continue to be a customer favorite for boys with rock-n-roll, humor, sports and scary animals leading the pack. For girls, our best selling sales came from our holiday dressy line. The customer responded most favorably to our classic, family dressing style which included traditional red party dresses for girls from sizes zero to 14. Our most recent line of baby boy has also resonated with our customer. It features cute styling with crazy monsters and funny poses which reflects the humor that our customer loves. Generally across all departments we are seeing our customers buying classic styling and colors, all American looks, mix and match outfits, and she loves humorous graphics and scenes which we clearly did not have enough of in the third quarter. We are making sure that our product going forward reflects those attributes.

Looking to fourth quarter, Crazy eight is all about value and we are pleased that our value item campaign for the holiday season, Great Gifts, Crazy Low Prices, has started off strong with our sweater deals for all the kids in the family which launched last week. Turning to outlet, we experienced mixed results across the lines through back-to-school in fall, which were also our tougher performing lines for Gymboree last year. We are seeing more positive line results as we receive our Q4 line, which were quite successful at Gymboree last year. For Q3, our strongest performance came from our back-to-school collection, with the best results coming from boy, where the customer responded to rugby’s, the classic football theme and navy based color palette. Accessories were also strong in this line which was driven by sleepwear, underwear and shoes.

Our fall line which set in September was driven by our boy department which featured Pirates and Halloween graphics. Based upon the strength of the little Halloween product that we offered in Outlets this year, we plan to expand this category next year to also include costumes. Finally, Outlet has the Jingle Deals this year and we are pleased that our latest Jingle Deal, outerwear vests, at $9.99 has been a hit. In summary, looking forward to the fourth quarter, obviously it is turning out to be a challenging holiday season. However, I am confident that we have the right product, the greatest gifts and exceptional values offered every day across all of our brands in order to maximize our share of the market and position Gymboree brands as the destination for children’s apparel outfits this year.

Now I’d like to turn it over to Matt.

Matthew McCauley – Chairman and Chief Executive Officer

Thanks Kip. We are very pleased with our third quarter results. Our strategy and focus on customer acquisition, margin expansion and expense reductions drove 16% earnings growth and increased our operating margin 130 basis points. However, like most retailers we are anticipating a more difficult environment in the fourth quarter and into 2009 and though there could be downward pressure on 2009 earnings, we feel this is the time to lay the groundwork for future growth. We are in a solid cash position with $93 million. Our year-to-date gross margins are very healthy at 49%. We are able to significantly increase our cash, even with negative comps. We will continue to open new stores and for the first time in several years we are seeing more favorable leases. We will continue to invest in customer acquisition even though consumers are spending less, we are seeing more transactions year-over-year. Our new stores and remodels are exceeding the customer’s expectations and are costing less to build. This is a time for us to compete and gain market share. We plan to do this by delivering unique, high quality product and investing in marketing, new stores and the customer experience.

We will also continue to invest and grow our newest concept, Crazy Eight. Based on the sales we are seeing in Crazy Eight we have built a model that will make it profitable and from our experience with our other concepts we are confident that we can achieve these metrics. The lower price points in Crazy Eight are key in this economy and with the stronger emphasis on sweet, wholesome outfits in mid-2009; we see both top line sales growth as well as long-term leverage for the company. The areas of improvement for Crazy Eight continue to be more frequent newborn fashion deliveries, younger and sweeter outfit driven girl products and reduced basic active wear in boys with an increase in true all American fashion. We will also expand the accessories business as the order size has increased and as IMU’s grow we will compete more effectively in seasonal sales.

We will also continue to invest in growing the boy and newborn departments in Gymboree. The market share opportunity in boys is substantial and could be worth as much as $170 million in sales. The focus on newborn reflects a major effort to rebuild our customer base that will stay with us for up to 9 years. On the defensive side we are continuing our focus on store payroll efficiencies and cost of goods reductions. We rolled out a new payroll tool for stores, simplified and focused the sales approach, set new higher wage and hour standards and streamlined our tasks in stores. As a result, we are anticipating leverage in store payroll in 2009. As mentioned in previous calls, cost of goods reductions will continue to benefit us in 2009. Gymboree reductions will be modest while more significant reductions will continue in Outlet, Janie and Jack and obviously Crazy Eight. Year-to-date we have increased gross margin 130 basis points due primarily to cost of goods reductions. This will be an ongoing focus for us in the years to come.

In summary, our focus is building for the future. We have a strong balance sheet, a solid strategy with aggressive, offensive and defensive initiatives and we have incredibly talented, committed and nimble teams in every function of the company that make it possible to navigate an every changing environment.

Now we’d be happy to answer any questions you have.

Question-and-Answer Session

Operator

(Operator Instructions) At this time if you''d like to ask a question please press * then the number 1 on your telephone keypad. If you’d like to withdraw your question press the pound key. Our first question comes from the line of Betty Chen with Wedbush Morgan. Your line is open.

Betty Chen – Wedbush Morgan

Thank you, good afternoon everyone. Congratulations on a great quarter.

Matthew McCauley

Thank you.

Betty Chen – Wedbush Morgan

I was wondering if you can speak a little bit more about the divisional performances Kip? I think it sounds like Crazy Eight and especially Janie and Jack were seeing some softness. Janie and Jack perhaps the price point. How should we think about that for the holiday season in addition to the product and the window display in the in-store environment? Will we see any change to pricing strategy at Janie and Jack? And then as for Crazy Eight are we still on track to think about break even or profitability for Crazy Eight in 2009?

Matthew McCauley

Betty this is Matt. So couple of things, first of all, during this time it is really important for us to remember who we are. We want to compete but we want to make sure that we are true to our brand and Janie and Jack obviously we are going to be competing price point wise but you are not going to see much of promotions and overhauling of the pricing strategy there. You might see us take mark downs a little bit earlier. You may see us hold on to further mark downs a little bit longer. In terms of the divisional performance, Crazy Eight is performing slightly below what we expected in sales primarily because we have had some disappointing performance on the girls side of the business where we feel like we skewed it a little bit too old. It needs to be younger. It needs to be more wholesome and the real challenge there is that we don’t have the IMU’s that we really need to compete during this time and so as the order sizes grow we will get the margins and the real message there is, we basically know the sales now. So we know exactly what the model needs to look like. We know the size of the store, what the payroll needs to be and we know the margins we need to get and we are very comfortable we can get those in line and you have another question around, will we be profitable for next year? When we give guidance for next year we will guide on where we think Crazy Eight will come in but we are not guiding that right now. We’ll see where it lands.

Betty Chen – Wedbush Morgan

Okay and then Kip, I guess you said that in the third quarter the outlet division saw some softness mainly because of the Gymboree product also seeing mixed reaction the year prior. Could you talk about the holiday season? Remind us how the November did last year?

Kip Garcia

Yeah, absolutely, last year in Gymboree they were actually some of the best ever lines in the history of the brand through the fourth quarter particularly the gifts through winter line. So there were like three spectacular lines. Normally we have to tweak the lines a little bit to try and make them better than they were at Gymboree but with these lines they were so great as they were we pretty much adopted those lines for the outlet without a lot of changes. We actually had our first line come in a week ago from that group of lines and it started off really strong at the outlet. It is giving us a really strong indication of what is going to happen for the rest of the season in outlet.

Betty Chen – Wedbush Morgan

That’s perfect. Well thank you so much and good luck for the holiday.

Kip Garcia

Thank you.

Operator

Our next question comes from the line of John Zolidis with Buckingham Research. Your line is open.

John Zolidis – Buckingham Research

Hi good afternoon.

Kip Garcia

Hi John.
Matthew McCauley

Hi John.

John Zolidis – Buckingham Research

Hi, two questions, one thing that jumps out at me is that you still produced an increase in the number of transactions at same stores in the third quarter in an environment where your mall traffic was probably down 4% to 5% throughout most of the quarter. So, looking at the fourth quarter guidance for negative mid single, obviously you are up against a +10 which was a stellar performance last year, are you thinking that rate of transaction increase is going to slow or do you feel that customers are just going to increasingly buy more and more stuff on mark down to such a degree that it will take comps down more?

Kip Garcia

It is really hard to say where it is going to come from. Basically the trend we have seen is obviously the average tran coming down and we have been able to hold steady on the number of transactions driven primarily from our marketing efforts and so fourth quarter I guess at this point it is pretty hard to predict. But if history is our guide we would expect that it would be a similar trend but there is a good chance that the number of transactions could dip a little obviously with the lower guidance that we are giving, mid single digits versus a negative two.

John Zolidis – Buckingham Research

Okay thank you and then an additional question, I know you don’t want to get into too much detail on FY09 right now, but I was wondering if you could give us some parameters around potential store openings and if you could talk to whether you considered slowing down the Janie and Jack a little bit considering the economic environment and in conjunction with that could you comment on the magnitude of the lower rents that you are starting to see?

Kip Garcia

Yeah absolutely, at this stage we are not going to guide to a total number of stores but as we are seeing what is happening by brand, we are definitely adjusting the mix of the stores that we would open next year and we are very opportunistic. We are not going to force a store count. In the past it was pretty predictable what the leases were going to be and so we could very accurately forecast how many stores we would open. At this stage we are going to be very opportunistic. We will be aggressive on leases that make sense for us, and this quite frankly is a great time to be opening stores. Construction costs are down. Lease rates are down and so if we find the right deals we will definitely throttle the store counts where it makes sense. But in terms of magnitude it is really hard to say. It is kind of the same story that everyone is probably telling you that in the high end malls not seeing a lot of movement in the leases. In the medium to moderate there is a lot more negotiation taking place.

John Zolidis – Buckingham Research

Okay I mean obviously lease costs and construction costs being down are favorable but I think when you are doing your pro formas you probably are also assuming that your sales are going to be a little bit softer for new stores in ‘09 compared to ‘08. So it changes the equation in terms of when you are going to get an attractive return. So I am curious, just are rents coming down like 10%, 15% or more like 5%?

Kip Garcia

It just depends on the mall. It depends on the location. It is all over the board. I don’t think we will throw a number out there on average but there are certain places where it is coming down substantially and it makes sense for us even with reduced sales plans. So you are exactly right. We are putting new sales targets on all of the new store openings and then backing into what do we need for it to make sense. Not even just in the long-term but even in the short-term. This is a time to not just be thinking about how these things will pay back over the long haul but they can pay back even in the short run if the leases are attractive enough.

John Zolidis – Buckingham Research

Okay great. I’ll let somebody else ask a question and congratulations on a good quarter and best of luck for the upcoming holiday season.

Kip Garcia

Thanks.

Operator

Our next question comes from the line of Brian Tunick with J.P. Morgan. Your line is open.

Brian Tunick – J.P. Morgan

Okay great hey guys.

Kip Garcia

How are you?

Brian Tunick – J.P. Morgan

So I guess the first question is on the defensive side, we may be hoping you could elaborate on the SG&A opportunity or like you mentioned about payroll. So, SG&A dollars look like they have grown double digits over the last couple of years. Can we expect that to slow down to mid single digits if in fact comps continue to trend down in the 3% to 5% area of ‘09? I’d love to hear about that, and then the second question, in terms of marketing, you have talked in the past about how you changed up your marketing and we are just curious what are some of those changes in the fourth quarter versus last year and where are you getting the best ROI?

Kip Garcia

Yeah a couple of things, you are definitely going to see that growth rate slow down for sure. The biggest opportunity is obviously in store payroll. We have some pretty tangible initiatives that we are putting in place that will definitely move the needle in terms of our payroll leverage. I can go into more detail about that if you really want to but you can absolutely expect the SG&A rate growth to slow especially as we are anticipating more challenging comps.

In terms of marketing, really the big shift that we have made is we made a lot of investments in the early stages in direct mail. We have shifted a lot of the dollars from direct mail to a couple of different places. One in print with incentives within the magazine in addition to partnerships where we have free partnerships where we can partner with individuals or groups, so we benefit from sharing names and leveraging each other’s brand. So we have done both of those things and are seeing great returns on both and so that’s where actually you have seen some leverage and some decrease in our marketing spend in the third quarter but getting very nice returns on.

Brian Tunick – J.P. Morgan

And following up on that payroll comment, if you do comp let’s say down 3% to 4% next year, we would expect less de-leverage or could you actually have flat payroll as a percentage of sales?

Kip Garcia

We are looking to leverage payroll no matter what happens to comp. That is our goal and so that’s the target we are setting, running different scenarios on it whatever the comp is that is our goal to leverage payroll. Obviously at a certain point you kind of go backwards and that won’t happen but at this stage we are feeling pretty good based on what we have seen that we are forecasting leverage in payroll even with negative comps next year. So, that’s the plan in addition to other expense savings. We are going through every single vendor, not just real estate but looking at every single opportunity to see if we can improve rates that we pay on everything that we buy.

Brian Tunick – J.P. Morgan

Okay and finally do I say, did you mention what November month to date was running or did you just sort of put out what the quarter is?

Kip Garcia

No, we didn’t put out a month to date. We will continue not to guide monthly comps and just report on the quarter.

Brian Tunick – J.P. Morgan

Okay terrific good luck.

Kip Garcia

Thank you.

Operator

Our next question comes from the line of Margaret Whitfield with Stern Agee. Your line is open.

Margaret Whitfield – Stern Agee

Good afternoon and congratulations. I missed what you were saying about SG&A in the fourth quarter, something about stock option or stock compensation?

Kip Garcia

From last year?

Margaret Whitfield – Stern Agee

Pardon me?

Kip Garcia

Last year we had $3.2 million catch up charge related to stock based compensation that was included in the quarter.

Margaret Whitfield – Stern Agee

Right, right, right, I recall that.

Kip Garcia

And so what we said is even after taking that out of the last year number we still expect a little bit of SG&A leverage.

Margaret Whitfield – Stern Agee

Okay, I wonder if you could comment on your expectations for the tax rate in Q4.

Kip Garcia

Probably in the 39% to 40% range.

Margaret Whitfield – Stern Agee

That percentage okay and where do you think you will end the year with inventories per square foot?

Kip Garcia

We are looking at slightly down actually.

Margaret Whitfield – Stern Agee

Okay and could you comment on input costs in terms of sourcing and what number of stores do you need for Crazy Eight to break through and give you some opportunity in terms of the order size?

Kip Garcia

At this stage every single store is helping. We actually saw very, very nice margins in our outlet business even when we started to approach the 100 store mark and even quite a bit before then. So, I think once we start to get over that 100 store mark we definitely will start to move the needle on the margin.

Margaret Whitfield – Stern Agee

In Crazy Eight are you seeing any disparity in performance in geographic sense or is it pretty uniform?

Kip Garcia

We are seeing the same kind of trends across all brands, about where geographically where it is the toughest and where it is the best and certainly Florida, California is getting hit the hardest. Rockies is very difficult and it is very consistent across brands.

Margaret Whitfield – Stern Agee

I noticed Play and Music was down sequentially which doesn’t normally happen in Q3, anything special going on there? I know it is a small part of your business, but it is a customer opportunity.

Kip Garcia

Absolutely, actually the good news is the timing of when we have recorded some of our sales numbers in terms of transactions on deals. What we are seeing over time is that the domestic business the average site is positive comping, growing very, very nicely. The challenge that we are seeing is that the re-sales on the domestic side is a little bit more difficult because of the credit market and so that’s the only place we are actually experiencing softness is on the re-sale being more than made up for on our average comp sales on the average sites and international we are still seeing very nice growth there.

Margaret Whitfield – Stern Agee

Okay good. Congratulations and best of luck for the holidays.

Kip Garcia

Thank you.

Operator

Our next question comes from the line of Thomas Filandro with SIG. Your line is open.

Thomas Filandro – SIG

Thank you, impressive results guys.

Kip Garcia

Thank you.

Thomas Filandro – SIG

A question first on the AUR, I’m trying to understand was lower AUR a function of the higher mark downs or an increased mix of Jingle Deals and those type of key item strategies and given Kip’s comments that customers are fully focused on and you guys are focused on delivering what the customer wants should we anticipate a continuation of lower AUR’s in the holiday season and in ‘09 as well?

Kip Garcia

Actually in the third quarter our AUR was actually up slightly and for the fourth quarter it is just an anticipation of the fact we have got to compete and the AUR was driven up on Gymboree during the third quarter and it was offset by the other brands by down being a little bit more promotional, taking more mark downs and we are anticipating something similar in the fourth quarter.

Thomas Filandro – SIG

So up AUR in the fourth quarter overall are you saying that?

Kip Garcia

No, no, no. Not overall in the fourth quarter. We are anticipating that it will be probably down just like in all the other brands. Last year third quarter we had a different comparison for Gymboree. So we felt as we mentioned those lines particularly in girl were a little bit tougher in the third quarter last year. We had a lot more mark downs. We are anniversarying that and this year we are able to sell a little bit less at mark down and drive the average unit retails up and in the fourth quarter we feel like that normalized a little bit more and with us being more competitive we are not anticipating AUR’s to be up in the fourth quarter.

Thomas Filandro – SIG

Okay I understand thank you and then I think I heard you say this in your opening comments you said maybe possible downward pressure on 2009 earnings and if you did say that can you sort of elaborate on what you meant by that? What assumptions are you incorporating? Did you mean earnings growth or down EPS on a year-over-year basis?

Kip Garcia

We are just acknowledging the consumer trend. Obviously we are going from a negative two comp and forecasting a mid single digit comp in the fourth quarter and if those trends continue then certainly there is going to be downward pressure on the earnings and my point was, even if there is downward pressure on earnings we feel very confident in our strategies and cash position to be able to continue to invest in long-term growth in terms of opening stores, investing in marketing and acquiring new customers. That was the point. We are just looking at what is happening out there and anticipating that could continue. It could get worse and that’s certainly a possibility.

Thomas Filandro – SIG

One other just quick one, obviously no debt, strong cash position, stock is down significantly here, any I’m not sure where you guys are? Any update or comments on share buybacks?

Kip Garcia

We currently don’t have any share buybacks authorized. It is certainly something that the board talks about every time they get together. What is the best use of cash and maximizing shareholder value and I’m sure we will continue to have those discussions.

Thomas Filandro – SIG

Okay thank you very much, best of luck, not just for the holidays but 2009 as well.

Kip Garcia

Thank you.

Operator

Our next question comes from the line of Linda Tsai with MKM Partners. Your line is open.

Linda Tsai – MKM Partners

Yeah hi, as you have more Crazy Eight stores on line what kind of distinctions are you seeing between the Gymboree Outlet customer and Crazy Eight? Are there any differences?

Matthew McCauley

Definitely, we feel like a lot of the Gymboree Outlet customer is a portion of Gymboree customers where we are getting more wallet share, a portion of brand new customers that are being introduced to the brand and then customers who have been buying our competition in the past but are now purchasing Gymboree because we are in the outlet malls. The customer for Crazy Eight is much more of a customer that from us talking to them tells us they have been shopping Target. They have been shopping Old Navy. They have been shopping Children’s Place and so a much smaller percentage of them are Gymboree wallet share and much more of them are new customers that are shopping competition.

Linda Tsai – MKM Partners

Okay and then can you give us more color on the organics line? Does that carry a higher AUR or margin? And what kind of merchandise are you replacing that with?

Kip Garcia

This is Kip. It is a slightly higher AUR. It is definitely still within the brand new baby assortment. For right now it is knit driven and we are keeping it right this minute in the sort of organic natural colors and it is online only at this point but we are looking to expand it.

Linda Tsai – MKM Partners

How much higher is the AUR? Is it pretty minor?

Kip Garcia

It is minor. It is only slightly higher.

Linda Tsai – MKM Partners

Okay thank you.

Kip Garcia

Thank you.

Operator

Our next question comes from the line of Dana Telsey with Telsey Advisory Group. Your line is open.

Dana Telsey – Telsey Advisory Group

Good afternoon everyone. Can you talk a little bit about the POS system and the benefits that you have seen from it? I think it became operational this quarter and also, if you think about 2009 any thoughts on terms of initial inventory plans for all the different concepts and also if you think about capital spending what will be different next year compared to this year? Thank you.

Matthew McCauley

On the POS system, the benefits we are seeing right away is the transaction time is much faster which helps us out a lot in our big events. We at times have huge lines during some of our big events and so that’s helping a great deal. We are also able to…we just started capturing names for the first time in the company’s history in an electronic way which we are very excited about. So we are actually building our customer list and seeing that grow very nice without any major incentives at this point, so only opportunity to grow on that front and so we are excited about that and your other question was regarding inventories for the brands next year?

Dana Telsey – Telsey Advisory Group

Exactly.

Matthew McCauley

We purchased a good chunk of next year and so what you will see is pretty much flat to slightly up in Gymboree. We will be down in Janie and Jack, in terms of inventories and Crazy Eight will be pretty insignificant to the total but it will be flat roughly.

Dana Telsey – Telsey Advisory Group

And just lastly any learning’s from Crazy Eight as it has been around a little while now of what works better there than in a core Gymboree?

Matthew McCauley

Yeah absolutely, what we are learning from it is that certainly this customer likes younger, wholesome, and sweet. They definitely are not responding to the older styling in girls. There are a lot of similarities in the things that they want. We are finding that outfit is very important. That is a great opportunity for us because we are very strong there and quite frankly we went into this business because we felt like there was a void in the market. We felt like the competition was not really servicing outfits in a strong way at this price point and we felt that was a core strength of ours and that is what we are trying to service.

Dana Telsey – Telsey Advisory Group

Thank you.

Matthew McCauley

Thank you.

Operator

Our next question comes from the line of Rick Patel with Merrill Lynch. Your line is open.

Rick Patel – Merrill Lynch

Hi good afternoon. Can you just talk a little bit about your promotional strategy? It seems that some of your promotions ran a little longer and I know you have been a little more vocal about them. Have you considered discounting a little bit deeper?

Matthew McCauley

In the third quarter we said going into it just like we did in the back half of the second quarter that we would make an effort to run our events longer and not go as deep and that helps us bring the AUR’s up and drive a lot more profit and that has been working for us and you will continue to see that in the fourth quarter. Certainly in cases we will have to go deeper but for the most part the general strategy is to hold events longer and not go as deep as we otherwise might have.

Rick Patel – Merrill Lynch

Okay and then on the inventory you talked about having purchased a big amount for 2009 already. Do you have the ability to pull back on those orders if comps decline a little bit more than you expect?

Matthew McCauley

We do for about halfway through the year. We have the opportunity to impact inventories for the back half of the year. At this stage we are feeling pretty comfortable especially in Gymboree because we are able to kind of hit the accelerator. Our inventories have never been radically up or down but we can drive huge comps if things are good with flat inventories and if things are a little bit tougher we are able to hit the gas pedal with our promotions and events and move through more inventory and not really get really stuck. We are feeling pretty comfortable with Gymboree. Janie and Jack we have reduced the inventory already in anticipation the economy will be tougher on the upper end price points.

Rick Patel – Merrill Lynch

Great thank you.

Matthew McCauley

Thank you.

Operator

The next question comes from the line of John Morris with Wachovia. Your line is open.

John Morris – Wachovia Capital Markets

Thanks, my congratulations too in a pretty tough environment in the quarter. On Crazy Eights, I recall earlier in the year you talked about some geographic learning’s, I guess I should say with respect to real estate locations. As I recall you guys said that you were finding that those Crazy Eights that perform in malls where there are Gymboree’s tend to be the better performing ones. Any update to that thought process? Is that what you are still finding to be the case that you would continue to look at those near Gymboree’s?

Matthew McCauley

We are definitely seeing that because the middle to middle upper end malls where we are finding the most success. We have also talked about finding some success in some of the off-mall locations where the rents are much, much lower and there is not as much pressure on the sales to achieve great four-wall contributions and so you will continue to see kind of the same store opening trend. They will be mostly predominately in Gymboree locations, middle to upper end, and we will continue to test and explore some off-mall locations, lifestyle centers and so forth.

John Morris – Wachovia Capital Markets

Yeah for Crazy Eight in particular do you consider, as we are hearing from a lot of our other retailing companies, they are holding off on some of the store growth plans not only to preserve capital, which you guys are obviously in really good shape on, does it make sense to hold off for something like Crazy Eights just to see what kind of better rent deals you can get longer term? You referred to this a couple of times earlier. But I’m just wondering, clearly you are going to move forward with the growth plan but does it make sense to slow it down a little bit on Crazy Eight in particular?

Matthew McCauley

That’s what we said, we are not going to force a store count. We are going to be very opportunistic. We know exactly what we need to pay in rent. We know how big the store needs to be and so we have developed the model and wherever we can find the deals that make the most sense we will do them but we are not going to force a store count number.

John Morris – Wachovia Capital Markets

Yeah good and finally I think this is for Blair, the freight cost charges from the fire; do those pretty much go away from consideration once we get into Q1?

Blair Lambert

Yes.

John Morris – Wachovia Capital Markets

Okay great. Congratulations and good luck for the holiday.

Blair Lambert

Thank you.

Operator

Our next question comes from the line of Janet Kloppenberg with JJK Research. Your line is open.

Janet Kloppenberg - JJK Research

Hi everybody and congratulations.

Matthew McCauley

Thank you.

Janet Kloppenberg - JJK Research

Really nice job and great control on the inventories, Matt, I listened a lot to the call and I hear you talking about next year and the possibility of comps worsening. I know how bad the economy is. I’m wondering, given the easier comparisons, I mean do you really think that the comp will get that much worse than what your fourth quarter outlook is right now?

Matthew McCauley

Our point of commenting on next year was not to give any kind of guidance at all. Just to say we are acknowledging things are tough. We are forecasting a tougher comp in the fourth quarter. We hope we are wrong on that.

Janet Kloppenberg - JJK Research

That might be the right number but you are up against I think a 10% comp for last year in the fourth quarter.

Matthew McCauley

That’s right.

Janet Kloppenberg - JJK Research

And so, if you do that comp, which is a 10 you are doing pretty damn well.

Matthew McCauley

Thank you.

Janet Kloppenberg - JJK Research

I’m just saying the comps get easier, much, much easier as we go into 2009 that you are up against.

Matthew McCauley

They do. We are looking at the same thing everybody else is looking at, anticipating more and more people losing jobs. We are just trying to make sure that we plan ourselves and budget ourselves in a way that no matter how tough it gets, we protect the things that are most important and that’s what we are trying to do. We are trying to set the expectation for ourselves and externally that we are going to continue to fund and protect the things that are most important regardless of where the earnings land next year.

Janet Kloppenberg - JJK Research

Okay and then on the cost side of things I imagine prices are coming down. Perhaps there will be some sourcing advantages as we move through next year?

Matthew McCauley

We have bought most of next year and we guided to the fact we have pretty much know what those reductions are, modest in Gymboree and more aggressive in the other brands. Some of the other challenges that you see though is a lot of factories are having a hard time.

Janet Kloppenberg - JJK Research

I hear that yeah.

Matthew McCauley

So a lot of factories are going out of business and so we are having to move some things. So yes, there are opportunities to take advantage of better pricing and then there are some challenges that offset it as well.

Janet Kloppenberg - JJK Research

Okay so you don’t want to talk about any outlook for next year at all yet?

Matthew McCauley

That’s right. We just want to message what we are focusing on and what we are protecting.

Janet Kloppenberg - JJK Research

The promotional strategy that you have been pursuing which is to be actively promotional but perhaps not as deep as last year, that is included in your guidance for the fourth quarter or might you be a bit more promotional?

Matthew McCauley

It is. We have several back up plans and scenarios if things are a little tougher than we think, the we have got step two to jump into or phase two of our promotional strategy and so we are very well prepared that if things are tougher than we think we have already got marketing material printed and ready to go for us to go deeper if we have to, hold things longer if we have to and that is all included in our range of guidance.

Janet Kloppenberg - JJK Research

Right, so that’s extremely great that you have included it that way so they are some contingencies and I want to wish you the best of luck.

Matthew McCauley

Thank you very much.

Janet Kloppenberg - JJK Research

Thank you.

Operator

(Operator instructions) And once again if you have a question simply press * then the number 1 on your telephone keypad. Our next question comes from the line of Marni Shapiro with The Retail Tracker. Your line is open.

Marni Shapiro – The Retail Tracker

Hey guys congratulations on the quarter.

Matthew McCauley

Thank you.

Marni Shapiro – The Retail Tracker

I love the talk about parties. I’m curious about two things, first on your outlet division do you have Janie and Jack outlets or any Crazy Eight and if not could you clear through some of the Janie and Jack or Crazy Eight product through the Gymboree Outlet?

Matthew McCauley

We have two right now Janie and Jack outlets that are not traditional outlets that we have been testing, dipping our toe in the water. We are in outlet locations but they are acting a little bit more like consolidation so we can get a read on the market. We have enough brand presence, is it strong enough to roll out stores? We just did that in the third quarter and so to answer your question do we see that as an opportunity? Not really sure at this point, certainly not in a traditional sense that we have been running Gymboree where we produce goods for it. For Crazy Eight we are absolutely looking at opportunities to test some of the real estate there. Obviously the cost of doing business there is much lower and yet they have got great traffic and we have seen a lot of retailers go in there with the retail concepts and do very well there. So, we are going to try that next year. We will open a few Crazy Eights in outlet locations with Crazy Eight products.

Marni Shapiro – The Retail Tracker

Great, it sounds great and then my other question, the product that you call the fairies I call the Broadbury clutter and crap, it takes up so much space. It looks amazing in your stores. It is in my house that I don’t love it.

Matthew McCauley

Okay it’s good that you clarified.

Marni Shapiro – The Retail Tracker

All right, but it does look great in your stores. You don’t really have it at all or anything like it in Janie and Jack, and then I haven’t seen it in Crazy Eight and I was wondering if that too was an opportunity?

Kip Garcia

Yea actually more so in Crazy Eight because it is still sort of that same customer aesthetic that Gymboree has just at a value. So we did introduce tutus in Crazy Eight and it is going to go after the Halloween business next year. If we get a good read on those you will definitely see more of it going forward.

Marni Shapiro – The Retail Tracker

Great, good luck to you guys for the holidays. Let us see how it goes.

Kip Garcia

Thank you.

Operator

And our last question comes from the line of Bill Dezellem with Titan Capital Management. Your line is open.

Bill Dezellem – Titan Capital Management

Thank you. You may have already addressed this question, but relative to your inventory at $83 per square foot, if the environment became tougher than what you currently anticipate how far down could you bring those on a per square foot basis and still feel like your stores were adequately inventoried?

Matthew McCauley

How far could we reduce our inventories and still feel good about it?

Bill Dezellem – Titan Capital Management

Yes.

Matthew McCauley

At this stage, just to give you a couple of examples a couple of years ago we had flat to slightly positive inventory and we were driving double digit comps. The point of that is that we are able to when things are good we sell things at a higher average unit retail and feel very comfortable that we are not going to get stuck if we have flat to slightly negative inventory. So we at this stage if we wanted to bring them down 10% that certainly wouldn’t impact us if we had a great economy. At this stage we are feeling more comfortable with a flat to slightly up inventory because we have very, very strong initial mark ups and we are able to compete and move through the inventory pretty quickly and generate a lot of margin dollars. So, at this stage we are not really looking to decrease Gymboree inventory substantially. Janie and Jack is a different story. Smaller store count, a little different four-wall configuration there and we are anticipating bringing those inventories down at a pretty decent clip.

Bill Dezellem – Titan Capital Management

Thank you.

Operator

Once again if you have a question simply press * and the number 1 on your telephone keypad. We have no further questions sir.

Blair Lambert

Okay Christie thank you very much and thanks everyone for participating in our call. If there are any questions feel free to call us at 415 278-7933. Thank you very much.

Operator

Thank you. We all had a great evening. This concludes the conference call for today. You may now disconnect your lines.