Pacific Sunwear Q4 Earnings Call Transcript

123jump.com Staff
23 Mar, 2009
New York City

The specialty sportswear retailer quarterly net sales decreased 8% to $352 million on same-stores sales fall of 10%. Net quarterly loss from continuing operations was $27.6 million. The company lost 42 cents a share compared to earnings of 28 cents a year-ago quarter.

Pacific Sunwear of California, Inc. ((PSUN))
Q4 2008 Earnings Call Transcript
March 12, 2009 4:45 p.m. ET

Executives

Gar Jackson – Vice President of Investor Relations
Sally Frame Kasaks – Chairwoman of the Board & Chief Executive Officer
Michael L. Henry – Chief Financial Officer, Senior Vice President & Secretary

Analysts

Paul Lejuez – Credit Suisse
Kimberly Greenberger – Citigroup
Janet Kloppenburg – JJK Research
Adrienne Tennant – FBR Capital Markets
Christine Chen – Needham & Company, LLC
Liz Dunn – Thomas Weisel Partners LLC
Stacy Pak – SP Research
Marni Shapiro – The Retail Tracker
Sean Norton – Piper Jaffray & Co.

Presentation

Operator

Good afternoon. My name is Tangy (ph) and I will be your conference operator today. At this time, I would like to welcome everyone to the Q4 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. If you would like to ask a question during this time, simply press “*” then the number “1” on your telephone keypad. If you have already done so, please press the “#” sign now then press “*1” again to ensure your question is registered. If you would like to withdraw your question, press the “#” key. Thank you. Mr. Jackson, you may begin your conference, sir.

Gar Jackson

Good afternoon and welcome to the Pacific Sunwear of California conference call announcing the company’s fiscal fourth quarter and yearend 2008 financial results. This is Gar Jackson, Vice President of Investor Relations. This call is being recorded and the playback will be available starting today approximately two hours after the call through midnight March 19, 2009. It can be accessed at 800-642-1687 or 706-645-9291, pass code 87718930. The call also will be archived on the PacSun website at www.PacSun.com through midnight May 20, 2009.

Your speakers today are Sally Frame Kasaks, Chief Executive Officer and Mike Henry, Chief Financial Officer. Today’s call will be limited to one hour and questions will be limited to one per participant.

Before I turn the call over to Sally, I’d like to note that during this earnings conference call certain statements and responses to questions may contain forward-looking information including forecasts of future financial performance and estimates of amounts not yet determinable as well as our future prospects and proposed developments or business strategies. Actual results could differ materially from those projected or reflected in our forward-looking statements and reported results should not be considered an indication of future performance. Pacific Sunwear’s future financial condition and results of operations as well as any forward-looking statements are subject to change and to inherent known and unknown risks and uncertainties.

Pacific Sunwear does not intend and undertakes no obligation to update its forward-looking statements to reflect future events or circumstances. All forward-looking statements made in this conference call reflect Pacific Sunwear’s current analysis of existing trends and information and represent Pacific Sunwear’s judgment only as of today. You should not assume later in the quarter or the year that the comments Pacific Sunwear makes today are still valid.

Actual results may differ materially from current expectations based on a number of factors affecting Pacific Sunwear’s businesses including changes in economic conditions generally, changes in consumer spending demands and preferences, lower than anticipated comparable store sales, higher than anticipated markdowns, higher than estimated selling, general and administrative costs, competition from other retailers and other uncertainties generally associated with apparel retailing.

More information on factors that could affect Pacific Sunwear’s business and financial results are included in the annual report on Form 10-K for the fiscal year ended February 2, 2008 and other public filings made with the Securities & Exchange Commission. In addition, please note that during this call today additional references may be made to non-GAAP financial results. Investors are encouraged to review these non-GAAP financial measures as well as the reconciliation in our press release of these measures to comparable GAAP.

Our press release is attached to our 8-K filed with the SEC today and a copy of which can be found on our website at www.PacSun.com. This call, the webcast and its replay are the property of Pacific Sunwear. It is not for rebroadcast or use by any other party without the prior written consent of Pacific Sunwear. If you do not agree with these terms please disconnect now. By remaining on the line you agree to be bound by these terms.

With that said, I’ll now turn the call over to Sally.

Sally Frame Kasaks

Good afternoon and thank you for joining us. This is Sally Frame Kasaks, Chief Executive Officer of Pacific Sunwear. With me on the call is Mike Henry, our Chief Financial Officer.

During today’s call, I will review the initiatives we addressed in fiscal 2008 and then identify our priorities and areas of focus for what we expect to be a very challenging 2009. When I conclude my remarks, Mike will discuss the financial results and our earnings guidance for the first quarter. We will then take your questions.

Let me acknowledge at the outset that we are very disappointed by our earnings performance. However, over the past year we were able to successfully accomplish important strategic and business objectives even during these difficult times. In brief, we eliminated non-core businesses to focus on our PacSun concept. We exited our underperforming and lowest margin sneaker category to focus attention on our higher margin, faster turning apparel business.

We expect to experience a diminishing comp impact and the benefit to our merchandise margins from this initiative as 2009 progresses. We consolidated in to a single distribution center and enhanced our supply chain to lower cost, improve efficiency and shorten time to market. We implemented a series of actions to better position the company in the current economic environment. We significantly reduced inventory levels, cut planned CapEx and SG&A expenses and managed the balance sheet with a focus on enhancing liquidity and preserving financial flexibility.

We exceeded our goal of apparel representing more than 80% of our mix and juniors being greater than 50% of our apparel assortment. We established a $150 million asset backed credit facility with JPMorgan and Bank of America as our primary lenders. And finally, we ended the year with nearly $25 million in cash on the balance sheet and no direct borrowing on our credit facility. We firmly believe that these actions better position PacSun in the current environment and will enhance our ability to improve profitability over time.

Turning now to the fourth quarter; although we anticipated that it would be a difficult quarter we underestimated the extent and the pace of the general economic slowdown. The same-store sales down by double digits, we increased our promotional activity in the effort to clear through inventories and to capitalize on holiday traffic. While these promotions significantly reduced our margins we were able to achieve our objective by ending the year with inventories down 30% per square foot in dollars and 19% per square foot in units. As a result, we have entered fiscal 2009 with a very clean and current inventory position.

We also took a hard look during the quarter at our organizational structure with a focus on improving management alignment and lowering costs around our single PacSun concept. We have realigned our organizational structure around brand and customer initiatives rather than channels of distribution. We believe that this new structure will result in more efficient operations in areas of product design, sourcing, marketing and promotions.

Turning now to our product assortment; overall we were pleased with the 11% sales growth in our apparel business last year. Our junior’s business driven primarily by fashion achieved a 23% increase year-over-year and our junior’s apparel business now represents 51% of our total apparel sales. Our young men’s apparel business grew 1% and represented 49% of our apparel sales. Admittedly, young men’s lost some competitive ground over the last year but with our evolving brand strategy we believe we have the opportunity to regain and grow this business over the next few years.

Accessories represented 13% of our sales mix for the year. In retrospect, we probably cut too deep on our accessory categories and walked away from some business in 2008. We believe that 2009 presents an opportunity to improve upon this business and we expect that accessories will be above 15% of volume going forward.

Let’s turn briefly to our real estate portfolio. We ended the year with 932 stores that comprised approximately 3.5 million square feet. In this environment the limitations of a one size fits all approach to our real estate portfolio have become increasingly clear. As we were liquidating footwear over the past year it became apparent that there was a value customer that we could serve better in many of our locations that average around $1 million in annual sales. We found that these stores situated in lower tiered malls or strip centers catered to a customer base seeking value. As a result, we began to expand the so-called value assortment in these stores to also include additional apparel promotions and keep opening price points. After making these adjustments in product mix, many of these locations experienced modest improvement in sales and gross margins.

Today, we operate our single concept under two groups of stores - core and value. Our core PacSun stores are comprised of approximately 525 locations primarily in A and B malls with the remainder being value stores which include our outlet. From a volume perspective remember though that core PacSun locations generate more than two thirds of our sales. I would like to emphasize this is not a new concept but rather an assortment adjustment to meet the preferences of our customers in certain locations. We have no intention at this time of changing the name of these stores or investing a material amount of capital in this initiative.

I will now touch on our new store and remodel plan. We have aligned with our landlords to defer nearly all store refresh projects into 2010 and beyond. At this time, our plan for 2009 is to open three new stores, relocate or expand nine stores and to refresh three stores.

As a reminder, we will evaluate for renewal more than 100 leases per year or roughly one-third of our current fleet over the next three years. We anticipate closing through regular course of business between 35 and 50 stores per year during this time as leases expire or as we exercise termination clauses where appropriate.

As we enter 2009 we expect it’s going to be another difficult year. While we cannot control the external environment, we are confident that we have taken the appropriate measures to position PacSun for this difficult environment as well as to deliver increased value to shareholders over time. I will now turn the call over to Mike Henry, our Chief Financial Officer.

Michael L. Henry

Thanks Sally and good afternoon everyone. In today’s environment, it is more important than ever to be prepared for the what-ifs. We have taken several decisive actions that help protect our positioning in this tough economic climate. First, entering fiscal 2009 our inventories were down 30% in dollars and 19% in units versus a year ago as Sally mentioned. This positioning provides us with significant flexibility to absorb sustained negative comps, protect gross margins, chase inventory on trend right goods and be promotional where needed to drive improved traffic. We expect to maintain significantly reduced inventory levels throughout the year.

Second, our inventory aging is greatly improved with 85% of our inventory aged less than 90 days entering fiscal 2009 versus 71% entering fiscal 2008.

Third, capital expenditures for fiscal 2009 are planned at no more than $30 million, a reduction of over $50 million from the fiscal 2008 level. As a reminder, depreciation is expected to be approximately $75 million for the year.

Fourth, SG&A expenses for fiscal 2009 are planned down by approximately $35 million on a GAAP basis versus fiscal 2008.

Fifth, we ended fiscal 2008 with nearly $25 million in cash and no direct borrowings under our $150 million credit facility. We have no direct borrowings outstanding today although we do anticipate borrowing intermittently throughout the year just as we did in fiscal 2008.

We are not subject to any financial ratios or similar covenants under our credit facility unless we are drawn to the last 10% of our total availability at any point in time and our facility does not expire until 2013. Finally, this is not annual guidance but simply a couple of points of references for the year. Even if we were to experience a same-stores sales decline of 20% we would expect to end the year with as least as much cash as we did for 2008.

We expect to receive a federal income tax refund based on our losses from fiscal 2008 of approximately $25 million near midyear. If our comp trend were a negative 15 as another data point we would expect to end the year within the neighborhood of $1 per share in cash. In each case, we would not expect to have any direct borrowings outstanding under our credit facility at yearend.

In short, taking all of these circumstances in to consideration, we believe we are well prepared for difficult economic times.

Now, turning to fiscal 2008 fourth quarter results. All comparisons mentioned in this commentary are to the fourth quarter of fiscal 2007. Total sales were $352 million this year versus $384 million last year, a decline of approximately 8%. We ended the quarter with 932 stores versus 954 stores last year.

Same-stores sales declined 10% for the quarter. e-Commerce sales grew 35% during the fourth quarter to nearly $18 million this year from $13 million last year. Gross margin declined to $57 million or 16.1% of sales this year from $122 million or 31.8% of sales last year. As a reminder, our primary goal for the fourth quarter was to significantly reduce inventories. We achieved our objective, although it severely impacted gross margin.

Merchandise gross margin declined 14.1 percentage points due to a highly promotional environment and our own aggressive efforts to clear fall inventories. Non-merchandise gross margin costs were up 160 basis points. Occupancy was up 190 basis points as a result of deleveraging these costs on a negative 10% same-store sales result.

Distribution expenses were down 30 basis points due to the consolidation of our distribution centers near the end of the first quarter of fiscal 2008. Buying costs were down slightly in dollars and flat as a percentage of sales. SG&A expenses including non-cash store asset impairment charges of approximately $12 million increased 440 basis points to $100 million or 28.4% of sales this year from $92 million or 24% of sales last year.

Asset impairments accounted for 290 basis points of this increase. Excluding non-cash impairment charges from both years, SG&A for the fourth quarter was down nearly $3 million from last year marking our third consecutive quarter of expense savings to the prior year. Although these expenses were down in dollars, they deleveraged 150 basis points in total due to the declining sales environment. Our income tax rate for the quarter was 31.6%.

Net loss from continuing operations was $27.6 million or $0.42 per diluted share versus income from continuing operations of $19.6 million or $0.28 per share last year. Results for the fourth quarter of fiscal 2008 include net gains from real estate transactions of approximately $5 million or $0.05 per diluted share which are reported within other income in our income statement.

Now, turning to the current quarter. As previously announced, we are now providing earnings guidance only on a quarter-to-quarter basis due to the unprecedented and uncertain nature of the current economic and consumer environment. Assuming a same-stores sales decline in the low 20% range we would expect to report a first quarter loss of $0.26 to $0.31 per diluted share. We expect occupancy expenses to deleverage by approximately 500 basis points which will more than offset expected merchandise margin gains and savings from our distribution and buying expenses.

We expect SG&A dollars to be in the high $80 million range for the quarter. Excluding non-cash impairment charges from both years, we would expect SG&A dollars to be down by approximately $4 million versus the first quarter of fiscal 2008. Finally, we currently expect our effective income tax rate for the quarter to be 40%.

So, in summary, we expect very challenging economic conditions to continue to pressure our sales and operating margin results over the near term. That said we have taken prudent steps to better position our company from a financial perspective and to help us weather the current economic storm. Sally, I turn it back to you.

Sally Frame Kasaks

Thank you Mike. We are very confident that we have taken appropriate defensive actions to preserve the balance sheet and to manage those things that we can control. Further, we believe that many of these actions will make us a stronger business when the inevitable but likely slow economic recovery occurs. But, we are not waiting for the external environment to turn. Yes, we may need to make some tactical business decisions in the short term around price points and selective promotions but we know that ultimately our business is about getting the product right and communicating with our customer around brands, fashion and the in-store experience.

We believe that we are providing differentiated assortments that will over time build our connection with youth culture and thus with our customer. So thank you again for joining us today. Operator, we will now take questions.

Question-and-Answer Session

Operator

At this time, I would like to remind everyone in order to ask a question, press “*” then the number “1” on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Paul Lejuez from Credit Suisse.

Paul Lejuez – Credit Suisse

You said that you pushed off some of your refreshes in to 2010 so how do we think about future cash backs? Is this $30 million a level of CapEx that you can maintain over time or will that need to pick up at some point or else you risk stores getting run down at that $30 million level?

Michael L. Henry

Paul, our CapEx number is going to be subject to change as we go through this environment. If we experience a 2009 that is as bad or worse than 2008, what we would be doing is continuing to negotiate with landlords to defer refresh projects even further than what we have so far. So, I wouldn’t suggest maybe that $30 million is the exact amount of CapEx to think about every year but maybe a $50 million number might be a good center of gravity for now understanding that we will be making adjustments depending on what the environment shows us as we finish the year.

Paul Lejuez – Credit Suisse

As you think about inventory do you think for the full year ’09, is that a source or use of cash? It seems like you might not be able to go lower per square foot but you are closing stores so I’m just wondering how you’re thinking about that on the cash flow statements?

Michael L. Henry

Well, I think if you track our inventory as we go through the year we will keep it down per square foot consistent to where it is now. Depending on exact timing of receipt close and other adjustments we might make it might move a few percentage points one way or the other at a given quarter but we expect to maintain significantly reduced inventory levels throughout the year until we see some kind of change in the average sales trend.

If we are to see an improvement, naturally we might ease up a little bit and chase some business but for the time being I would expect that we will maintain levels that are consistent with what you see and what we just announced.

Paul Lejuez – Credit Suisse

Even once you get to the fourth quarter though?

Michael L. Henry

Yes, because if you think about the third and fourth quarter we had way too much inventory, I mean that’s really what damaged our merchandise margins in the back half of the year. In the fourth quarter in particular more than anything is we just had way too much inventory and had to promote our way out of it. So we have considerable room to maintain significantly reduced inventories and still have a very good amount of inventory in the stores.

I would encourage you to go to a store today, even though inventory is down 30% in dollars and 19% in units, go to a store and have a look and you’ll see that there’s an appropriate amount of inventory in the store, we don’t look anorexic or anything of that nature.

Paul Lejuez – Credit Suisse

Great. Thank you and good luck.

Operator

Your next question comes from the line of Kimberly Greenberger with Citigroup.

Kimberly Greenberger – Citigroup

Great. Thanks. Good afternoon. I am sorry if you’ve addressed this question early on, I apologize, I hopped on a couple of minutes late. Sally, I was wondering if you could talk about spring, it seems like your guidance here for comps assumes that things will get worse in Q1 relative to Q4. Is that simply a function of having dramatically lower inventory levels or is there something about the spring merchandise execution that is troubling you?

Sally Frame Kasaks

No, it’s not that. I think certainly as Mike indicated, our inventories are more current now so we have less sales goods within our mix right now which is a good point to bear in mind. We also, don’t forget there was some footwear business last year so it’s an accumulation of things from an apparel point of view. Plus, there is a calendar shift and we just weren’t quite sure how to do the March/April plan. So, it’s not a function of assortments or inventory levels, we were just being conservative in Q1 and we believe that’s the right way to go. I feel very confident we did the right thing there.

Kimberly Greenberger – Citigroup

Thanks. That’s helpful. And as you look at the inventory levels, are there categories that are currently trending for you or that are performing where you feel like you’re under inventoried but you are in a position to chase goods? Or, do you think that the inventories were brought down pretty dramatically to just cushion the downside risk in the business and you’re sort of willing to forego those sales if they would materialize? I’m just asking for your high level thoughts on how you balance inventory management with sales opportunities?

Sally Frame Kasaks

Yes, good question. We’ve actively brought down our inventories but we have actually wanted to build in some flexibility to be able to adjust. So, for example in young men’s we accelerated T-shirt deliveries, we brought goods forward where we could. In juniors again, we brought some things forward not because we were concerned about sales in the month of February. I think our issue was to get these products in so we could get a good read on certain categories that we know we’re going to have to project for back to school.

That said, I do not think we’ve been too low. I believe we’re about right; it gives us the opportunity to chase. We had product positioned out there, are bringing some forward. We’re just doing the basic merchandising that happens in an environment which is not predictable. So, I feel like that the inventory levels are right. The only hindsight I might bring is that we probably should have slowed goods a little bit earlier in February just to be in position but it was not a significant amount.

Kimberly Greenberger – Citigroup

Okay. Thanks for the perspective, Sally.

Operator

Your next question comes from the line of Janet Kloppenburg with JJK Research.

Janet Kloppenburg – JJK Research

Hi Sally. Sally, I heard you talk a lot today about the assortment planning going forward, it seems like you might have a focus on pricing. Do you think that there’s some part of the assortment that can be skewed lower and is that more for the value stores? If you could talk a little bit about that on both the men’s and the women’s side? As far as the accessory build in inventory goes, when might we see that be complete?

Sally Frame Kasaks

Okay. First of all on the pricing, a couple of years ago we did identify key opening price points in the junior business in particular and I think we’re pretty level set give or take a dollar or two on some of these items. Young men’s, as you probably don’t recall but last July we did bring some very strong opening price points in fleece and a couple of areas and the response was uniformly very strong.

Therefore, Charlie and his team have really impacted that so if you’re in our stores today you’ll see some key opening price points in some knitwear, cotton sewn and we’re building on that. We’re more sensitive I think in our value stores, some of those prices tend to be a little bit lower on some product and in some product we are probably going to have compatible opening price points in both stores based on assortment. So, we’re still learning and it’s not just the store, it’s the value. We’re seeing it day in day out in our mall stores, the need for opening prices. The only concern I have and we’ve just done a walk through on that, we may not be strong enough in communicating some of that but those items are performing well.

In terms of part two on accessories, those are being flowed in, we just accelerated some product there. It will probably be I guess about end of March/April before we feel comfortable and certainly on the young men’s side though we brought in a lot of hats and sunglasses, I think you’ll see a stronger representation as we go in to back to school

Janet Kloppenburg – JJK Research

Okay and then will we start to see total inventory levels begin to come up a bit Mike as we move through the second and third quarter?

Michael L. Henry

As I mentioned earlier a bit perhaps from quarter-to-quarter it can move a few percentage points one way or the other so if it’s down 30% in dollars at the end of the year maybe it could be 25%. At any particular point in time it can move a few points either way.

Janet Kloppenburg – JJK Research

Okay and do you feel like your cost structure is now lined up or in line with this level of sales decline?

Michael L. Henry

Yes. We mentioned in our commentary that we took a really hard look at our organization structure and tried to come up with what do we really need to run this business, what are some things that we need to reinvent in terms of how we’re doing them within the corporate office here and that was reflected in the recent work force reduction that we undertook. It was a painful process, a painful thing to go through but we did it so we are structured appropriately for what we expect this environment to be.

Janet Kloppenburg – JJK Research

You had said SG&A down $35 million so should we take the fiscal ’08 SG&A dollars of $381 and deduct $35 million and spread that out? Is that how you want us to think about this?

Michael L. Henry

Right, you should because what’s in that $381, if you recall we had an $8 million asset impairment on the Anaheim distribution center and materials handling equipment that certainly would not be a repetitive item. We had a $6.5 million goodwill impairment in the second quarter. Those are the two primary things that you probably would not have in your model because you run on kind of the more operating levels I’m sure. So those are the two things you’d want to take out of consideration.

Janet Kloppenburg – JJK Research

After that then you’ll go down another $35 million?

Michael L. Henry

No, we go down $20 after taking those other two things out.

Janet Kloppenburg – JJK Research

I’ve got it.

Michael L. Henry

So $35 on a GAAP basis, $20 on a non-GAAP basis.

Janet Kloppenburg – JJK Research

Okay, many thanks and lots of luck.

Michael L. Henry

Thank you.

Janet Kloppenburg – JJK Research

Hope to see you soon.

Operator

Your next question comes from the line of Adrienne Tennant with FBR Capital Markets.

Adrienne Tennant – FBR Capital Markets

My first question is on the comps, the negative low 20% for Q1, can you help us think about the comp progression to the extent that obviously there’ll be the March kind of shift into April and I would assume if that’s the case then perhaps February is running lower than that at current levels. And then secondly, Sally can you talk about any macro shifts that you’re seeing with the customer in the active board sports arena? And, any changes that you’re making to merchandise categories to address maybe some of those changes for spring in particular? Thank you.

Michael L. Henry

With regard to comps we’re not going to comment on intra-quarter movement. As you know, we’re not reporting monthly comps anymore. We believe it just creates too short term a data point and we lose kind of the broader perspective and the broader picture of what’s going on with the business. I think we do expect some movement from March into April because of the Easter shift certainly but I wouldn’t want to get any more specific than that.

Over the course of the entire quarter we are expecting to be down low 20s. We tend to look at March and April together to take the whole shift discussion out of consideration. We look at February as a percentage of the quarter; we look at Q4 to Q1 historical builds, all those sorts of things in terms of level setting what our expectations are.

Adrienne Tennant – FBR Capital Markets

Okay, fair enough.

Sally Frame Kasaks

In terms of the macro shifts Adrienne, certainly our business, it’s still dependent on the board sports various activities there but, we’re also seeing the customer evolving in terms of what action sports look like and some of the references in some of the product lines. We’ve also seen a distinctive shift to our denim business.

So, we’re seeing shifts but I’m not so much certain it’s board shorts or something else. What we are just seeing is some custom preferences just moving in terms of the bottoms business right now. It is really very much a denims business. I think if you go in to our stores you’ll begin to see kind of an evolving assortment on the T-shirt business which was typically more around the more traditional board sports but that whole area is evolving in terms of art, in terms of reference points, in terms of the nature of the brand mix there.

Adrienne Tennant – FBR Capital Markets

Are there any categories in spring that we will notice as we walk the stores that are down trending or kind of getting bigger as a percentage of the floor or smaller?

Sally Frame Kasaks

Not really. I will say one thing, we sort of got a bit of a wrap and I know the Internet and the blogs were going crazy that we were getting out of the board shorts business and that’s not true. But, what we did do is we did reduce our dependence on those in most of the country for that February period both in terms of swimwear and board shorts. So, clearly that business is going got be a little bit less over the course of the six months but it was because we just opted not do as much as we had done in the past in those categories.

Today, I think you would find the appropriate level of board shorts and swimwear for both juniors and guys and I don’t think you will notice anything that is particularly down trending. You’ll see our T-shirt business getting larger and I think you’ll see our denim business about where it should be. We’re still looking at our shorts business overall and if we haven’t gotten a really clearly defined trend in young men’s or in juniors at this point but that’s more seasonal and we’ll deal with that as the season goes on.

Adrienne Tennant – FBR Capital Markets

Just my last follow up is what was the thought behind the board shorts for February and early spring?

Sally Frame Kasaks

Not, it’s not early spring, it was specifically February. Our goal was how do we use our inventory and frankly we hit with board shorts, we use to bring them in sometime in January/February and we’d sit with them until the third week of March, is that the best use of inventory? Now, certainly Florida and certain markets had them where they’re appropriate but we just absolutely thought that it was not worth the investment based on past sales and experience particularly over the past four or five years that I have been watching this business.

The same thing with swimwear, it was a much more reduced assortment in most of our stores. However, we’re pretty much into where we would want to be between this floor set and the next. I think you will see a fully fresh stock, very appropriate level of swim and board shorts in relationships to the sales we’re expecting.

Adrienne Tennant – FBR Capital Markets

Okay, wonderful. Thank you very much and good luck.

Sally Frame Kasaks

Thank you Adrienne.

Operator

Your next question comes from the line of Christine Chen with Needham & Company.

Christine Chen – Needham & Company, LLC

Thank you. I was wondering your denim category has performed well yet you seem to have led your promotional activity with denim. You’re currently running buy one get one free and you don’t have very much of the colored denim left because it sold out so I’m just wondering what the thought process behind that is? Thank you.

Sally Frame Kasaks

Thank you Christine. We have typically run twofers on denim since I don’t know, forever, as long as I can think back about seven or eight years, maybe even longer back so that twofer is pretty much a standard operating procedure in our company. Certainly in young men’s you put some up to two for $59 and it has worked to a way that we are very pleased with. So there is some price elasticity if the fashion is correct and so forth, so this is not out of the ordinary.

You did see us put up in junior’s a free, which is a free jeans with a purchase which is basically a buy one get one free or a twofer deal. So, it’s the same deal just rebranded and remarketed. That was I guess the primary question, I forget you had a second part to that I believe Christine?

Christine Chen – Needham & Company, LLC

The color denim did well; it looks like you sold through?

Sally Frame Kasaks

We did very well. We sold out and there will be another package coming shortly. We just felt that we needed to clean out and we were able to get back in and I think the assortment that’s going to hit shortly is just going to knock everyone’s socks off.

Christine Chen – Needham & Company, LLC

Okay, great. Thanks. We look forward to seeing it. Good luck.

Sally Frame Kasaks

Thank you, Christine.

Operator

Your next question comes from the line of Liz Dunn with Thomas Weisel.

Liz Dunn – Thomas Weisel Partners LLC

Good afternoon. I guess in relation to your comment that a 100 leases per year are coming up for renewal in each of the next three years and you expect to close 35 to 50 stores per year, does that suggest that you think 35% to 50% of your real estate are stores that might not be something you want to be in go forward? I mean, how do we just sort of think about that?

Sally Frame Kasaks

This will probably be two part because Mike is somewhat closer to some of this in the more recent weeks. As we looked at our portfolio out there we do a very robust store-by-store evaluation. We started this a couple of years ago. As we looked at these we’ve looked at volume, merch margins, term of lease, it’s not necessarily that we believe a percentage is not productive but there are certain very specific locations that in the course of business become less important over time and that’s really how we’ve approached it and it’s a very detailed sort of an evaluation. So, as we look at it the 35 to 50 is probably the center of gravity. Now, certainly there are renegotiations going on, it’s almost a placeholder. Certainly there are negotiations, there’s discussion with landlords on any given basis but clearly there are some that just over time the volume levels are just not going to grow sufficiently to meet our models. They’re certainly our much lower volume stores that we would be considering exiting.

Michael L. Henry

Right. Just to kind of take off of that Liz, we did just recently go through our annual store-by-store process and we discussed each and every store that we have and discussed the merits of the market, what’s going on with maybe other properties as it opened, since we started the lease 10 years ago looking at kick outs, all manner of things, should we refresh a store, should we not refresh a store. So the whole range of possible actions on stores were discussed with each and every store and we have targeted what we expect to do with each and every store over the next three years.

So, most directly to your question I think the broad answer is yes to some extent that we’ve identified 35 to 50 stores over the next three to four years that absent renegotiations with landlords or some other actions that we would probably walk away from.

Now, the other follow on to that that sometimes gets asked and I’ll just cover it here, is that why don’t you just go out and close 100 now or close 150 now? We have studied that from a cash flow perspective and it just does not make any sense. When you consider what we would have to pay in terms of lease terminations to get out of a lease any earlier than what is contractually allowed to us by a natural lease termination, expiration I guess I should say or a kick out and you line that up against the cash flow of even our worse stores, it just doesn’t make any sense. I think there is one store in our most recent look of this that it would make any sense for us to try and close earlier than contractually allowed.

Liz Dunn – Thomas Weisel Partners, LLC

Okay that makes sense and just one follow up if I may, are there any sort of quantitative metrics you can share with us for the value stores? Has the cash flow improved or the four wall profitability of those value stores since you’ve converted them to more that format?

Sally Frame Kasaks

This has sort of been an evolutionary process so I’ll let Mike speak to some of that and in some of these we did see some improved margins and this isn’t like a grand curtain up reopening of a bunch of stores. I just want to make sure everyone understands this is under the current fleet. We’re just adjusting inventories within these stores because we did find there was greater price sensitivity and the fact they are good liquidation points to some extent to some excess inventory in the chain. Mike, would you like to --

Michael L. Henry

It hasn’t been anything dramatic to this point Liz because understand that part of this was going on while we were liquidating footwear and certainly in the last two quarters that was done at minimal to no margin, even at a loss towards the end. So, there is a little bit of a tough read there but on average we did see around 150 to 200 basis points of improvement in gross margin productivity out of these stores and did see a sales lift out of these stores that is consistent with that.

Liz Dunn – Thomas Weisel Partners, LLC

Okay, great. Best of luck.

Sally Frame Kasaks

Thank you.

Operator

Your next question comes from the line of Stacy Pak with SP Research.

Stacy Pak – SP Research

Thanks. I guess a couple of follow ups, one is, Mike, can you tell us how that SG&A, the $35 decline gets split by quarter? Two is, did you say, I just want you to repeat I think you said there’s a $25 tax refund in Q2 and then are you pretty much scraping the bottom of the barrel now on cost reductions or are there more opportunities? And Sally, to the extent you’re comfortable, can you comment on the spring assortment in juniors in particular and kind of what feels right to you? Thanks.

Sally Frame Kasaks

I’ll take it first. I will just take up on that quickly because I think those are the questions probably we can go a little deeper. We have a little less emphasis on our key item, in the past we might have had more inventory in key items. Although we have key items out there we have broadened our assortment somewhat on a SKU and fashion basis so I’m feeling pretty good right now. There are some categories we’re going to accelerate deliveries on because there’ve been some good trends but I don’t want to get ahead of ourselves there. But, I think by broadening the assortment a little bit and depending a little bit less on those very high piles of key items I think we’re going to attract an increasingly more diverse junior’s customer within the store.

Stacy Pak – SP Research

Okay, great.

Michael L. Henry

I’ll take those three parts, with regards to SG&A, we are only guiding one quarter at a time at this point so I would just suggest for now the safe thing to do is take that $35 million savings, divide it by four and put it across each quarter equally and you’ll be close enough for now. We’ll certainly provide greater clarity as trends change and we go through the next quarter and see what the run rate is then and we’ll certainly be updating that each quarter as we go. But, that should be safe for now.

Yes, we did say we do expect approximately a $25 million federal tax refund somewhere in the middle of the year, latter half of Q2; early Q3 is probably the appropriate timing for that. And then, are we at the bottom of the barrel? No, as we think about CapEx I’ve stated that it would be not more than $30 million. We can pull that down further by another $5 to $10 million or so.

If we see things get considerably worse, we can decide to pull other things off the table and defer them until a later time if that came to pass. If things were to get worse than the trend has suggested for Q1 we’d certainly have the ability to reduce store payroll and do other things here related to travel and other projects that are planned for the year. There’s a variety of things that we can still squeeze. It wouldn’t be a dramatic number but we still have the ability to pull several million more dollars out of the model if we had to.

Sally Frame Kasaks

Stacy, one other thing too, in terms of the assortment, you highlighted particularly the junior’s but our young’s men business, we are building inventory in certain categories which I think this week you’ll begin to see. We have pulled some goods forward because I think so often our conversations get focused around the junior’s business but I think you’ll see greater conviction in our T-shirt business and I just think you have to understand that that’s happening, it’s not a key item but it’s a key category that offers a lot of diversity and I think value to our inventory.

Stacy Pak – SP Research

Okay, great. Thanks guys and good luck.

Sally Frame Kasaks

Thanks Stacy.

Operator

Your next question comes from the line of Marni Shapiro with The Retail Tracker.

Marni Shapiro – The Retail Tracker

Hey guys, how are you? I had a couple of very quick questions around accessories, you said that you maybe took them down a little too much and I noticed in the stores over the last couple of weeks that you’ve taken a little bit of a bet on scarves, on sunglasses, certain pockets but I haven’t noticed things like jewelry or hats building back in there so I was curious what your thought was on accessories. And I was also curious, I couldn’t remember if swim was in your accessory department or was that in your apparel number?

Sally Frame Kasaks

It used to be. I think because of a buying responsibility, it has moved back and forth. It’s in apparel. I just saw Mike moving his mouth and I just wanted to be careful. We switched some of that out a couple of years ago. I think your observation is, if you noticed a couple of years ago our accessory business was all over the place, we peeled back and then we went after very aggressively the handbag business which was absolutely the right thing to do in junior’s, that business has slowed a little bit but I think more to the point we believe that accessories do complete the look for the junior’s customer so sunglasses and scarves clearly.

I don’t know if you’ve been in the stores in the last three days but jewelry has started to hit and all the girls are wearing it, it’s starting to move there so jewelry is clearly going to be a part of this assortment as are girl’s sandals. We’ve got flip flops but, girl’s sandals are a part of that as well. So, scarves, sunglasses, jewelry, the key leaders, handbags, a little less important now as that business has evolved.

Certainly in young men’s the hat business, the sunglass business important, belts remain somewhat important but I think for fall you’ll see a little more expanded in that areas. I won’t go in to all the details but we do have product starting to build in that area again because we think it’s really important to our concept.

Marni Shapiro – The Retail Tracker

Great. And then just a follow up, as the mall has become so promotional, it’s become basically sort of a mess but, at the same time your stores have been a little cleaner and I feel as if there’s a shift towards authenticity from the customer’s perspective away from just pure price. I’m curious if you guys have thought about ’09 and thought about some of your marketing agenda and trying to keep that past authenticity, the surf culture because the stores feel very California but can you take that to the next level? Is there a further way to do this?

Sally Frame Kasaks

Yes, I think there is and we’re working through some of that now. Charlie is heading off to Europe as is Brad as we speak. They’re looking for more products or ideas. We’re looking at for more branding ideas. I think price unfortunately is going to be a part of the component though, I don’t think we can get away from that right now. I do believe though that we can’t let price lead our positioning though and to that extent we’re re-looking at our back to school launch, when we launch denim in June which is what we typically do and a cadence of events around product categories that are important some of it being price depending upon the category, some of it is just highlighting it.

But, I agree, we cannot be run by just price alone though clearly we do see sensitivity particularly on opening price points and some of the deals we’ve done. I don’t mean deals in a deal like it’s a negotiation but there are some activities we’ve done that do drive sales and frankly drive other categories, we just have to understand that better.

Marni Shapiro – The Retail Tracker

Great. I am glad to hear that and good luck to you guys for spring.

Sally Frame Kasaks

Thanks a lot Marni.

Operator

Your final question comes from the line of Sean Naughton with Piper Jaffray.

Sean Naughton – Piper Jaffray & Co.

A quick question on the lease renegotiations, can you talk about if there’s any differences between your A mall locations, B or C with those landlords?

Michael L. Henry

Yes, I think it has been pretty consistent when we’ve been at conferences or in broader discussions. I think all of us retailers are seeing kind of a consistent approach where in the A and B locations, top tier malls there’s not been a lot of flexibility in terms of negotiations because quite frankly those properties are so successful that there’s just not a lot of willingness on behalf of the landlords to bend too much.

There are more discussions on the lower tier stores where certainly that would be where some of our closures are coming from, that would be where we might need different structures to get to better levels of profitability that make a store more sustainable and we are having better conversations, more thorough conversations with our landlord partners in that regard.

Sean Naughton – Piper Jaffray & Co.

Okay, that’s helpful. And then in terms of the comp trends for Q4, was there any difference between outlet and full price or where they relatively consistent?

Michael L. Henry

They were relatively consistent with each other. It was tough across the board and certainly we were very, very promotional in all of our stores as we were just trying to get through inventory predominately.

Sean Naughton – Piper Jaffray & Co.

And then the mix of product within some of these lower tier mall locations, the value stores as you’re calling them, is there anything different in those stores in terms of the mix of product or is it similar to what you guys have in the full price locations or the higher price locations?

Sally Frame Kasaks

Very similar, Sean, very similar at the margin, there may be a little more T-shirt business in some than others depending upon locations but the mix is very similar.

Sean Naughton – Piper Jaffray & Co.

Okay and then lastly on the sourcing we have heard obviously things, commodity prices going down, and then gas obviously going down, is there anything on that front where you are able to engineer products to lower opening price points to maintain some of the margins?

Sally Frame Kasaks

Could you just repeat the last part of that? I wasn’t --

Sean Naughton – Piper Jaffray & Co.

Oh, if price compression is going to happen at retail, are there opportunities where you continue to work with vendors in order to help maintain margin? I understand the inventory liquidation and the desire to get down for Q4 and why the margin was hit then but are there opportunities moving forward there?

Sally Frame Kasaks

We have probably been finding more flexibility on our direct sourcing capability than the brand, that’s just sort of the nature of things so there’s always opportunity to work with our brands but I think our direct sourcing is clearly providing greater flexibility and as we’ve gotten better, particularly areas like denim and those areas which we really run our own brands and we have seen some movement on that. We’ll just have to play that through as the season goes on. Don’t forget that a lot of our orders are placed sort of middle of last fall and a lot of these prices weren’t dropping then so it’s sort of a month-by-month kind of evaluation.

Sean Naughton – Piper Jaffray & Co.

Understood. Best of luck this year.

Sally Frame Kasaks

Thank you very much.

Operator

Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.