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The Children’s Place Retail Stores, Inc. (NASDAQ:PLCE)

F4Q08 Earnings Call

March 19, 2009 10:00 am ET

Executives

Jane Singer – Investor Relations

Chuck Crovitz – Interim Chief Executive Officer

Susan Riley – Executive Vice President, Finance and Administration

Richard Flaks – Senior Vice President, Planning, Allocation and IT

Richard Paradise – Senior Vice President, Chief Financial Officer

Dina Sweeney – Group Vice President, Merchandising

Analysts

Kimberly Greenberger – Citigroup

John Zolidis – Buckingham Research

Margaret Whitfield – Sterne Agee

Analyst for Brian Tunick – JP Morgan

Betty Chin – Wedbush Morgan

Janet Kloppenburg – JJK Research

Marni Shipiro – The Retail Tracker

Linda Tsai – MKM Partners

Dana Telsey – Telsey Advisory Group

Tom Filandro – Susquehanna Financial

Operator

Welcome to today’s program. (Operator Instructions) It is now my pleasure to turn the conference over to Ms. Jane Singer. Please go ahead.

Jane Singer

Thank you. Good morning everyone. Thank you for joining us today for a review of The Children’s Place Retail Stores, Inc. fourth quarter and fiscal year 2008 financial results. Participating on this morning’s call are Chuck Crovitz, Interim Chief Executive Officer and Sue Riley, Executive Vice President of Finance and Administration. Also on hand to answer questions at the end of management’s remarks are Richard Flaks, Senior Vice President of Planning, Allocation and Information Technology and Dina Sweeney, Group Vice President of Merchandising.

Before we begin, I would like to remind participants that any forward-looking remarks made today are subject to the Safe Harbor statement found in this morning’s press release as well as in our SEC filings. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially. The company undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date hereof. Please also note that a reconciliation of certain non-GAAP financial measures discussed on this call is contained in this morning’s press release which can be found on our www.ChildrensPlace.com website.

Now I will turn the call over to Chuck for his opening remarks.

Chuck Crovitz

Thank you Jane. Good morning everyone and thank you for joining us today. As you saw in this morning’s press release The Children’s Place reported solid fourth quarter and full year 2008 financial results. We also undertook four significant actions during the year to strengthen our business and help ensure the long-term success of the company. These include reducing inventory levels, identifying opportunities to reduce our cost structure, strengthening our balance sheet and cash flow and exiting the Disney Store North America business.

To briefly review the highlights of our financial performance our net sales were flat for the fourth quarter and comparable store sales declined 5% due in large part to the negative impact of foreign exchange. Net sales increased 7% for the year with comparable store sales up 2% for the year. E-commerce sales increased an impressive 70% in the fourth quarter and increased 64% for the year.

Excluding unusual and one-time items, income from continuing operations for the fourth quarter increased 10% to $21.3 million or $0.72 per share. It increased almost 60% to $66 million or $2.23 per share for the year. We also strengthened our balance sheet and cash position throughout the year. Sue will elaborate on this in a few minutes but it is noteworthy that The Children’s Place improved its year-end cash position by nearly $150 million net of debt during fiscal 2008.

We are proud of our performance particularly in light of recent industry trends. According to NPD spending on children’s apparel in the U.S. declined 3.2% during the fourth quarter of 2008 and declined 1.7% for the fiscal year. Three shifts in shopping patterns appear to be happening in the market. Consumers are going to malls less frequently, they are making a greater proportion of their purchases on sale merchandise rather than full price and they are delaying purchases and buying much closer to need. We expect that all three factors will continue to impact the overall growth of the children’s apparel market during 2009.

The Children’s Place expanded market share in 2008 from 3.6 to 3.9%. Nevertheless, it is clear that the global macro economic conditions are impacting the children’s apparel market in significant ways. Our business is not immune to these external pressures and we are managing accordingly. We are carefully reviewing our promotional and marketing programs to ensure they are as effective as possible in this environment. We have undertaken a number of initiatives to address shifts in consumer purchasing trends in order to drive top line growth in 2009.

However, we expect comparable store sales will remain challenged until the economy begins to improve. Here are some examples of the initiatives we have under way. In line with consumer shopping patterns we have moved to more of a “wear now” strategy. For example, we kept winter merchandise in our stores during January and February 2009 because we expected that moms shopping closer to need would be looking for warm replacement clothes if the cold weather persisted. It did and the strategy worked to our advantage as the sales of winter product helped drive volume during the months of January and February.

From a marketing perspective we are focused on increasing the efficiency of our marketing programs and driving traffic. We are continuing our targeted direct mail efforts which have been effective drivers of traffic and sales and we have reduced spending in some of our print publications this year as we increase our online marketing and email campaigning as well as integrated marketing programs.

In stores we are continuing to offer two-for and three-for promotions which provide great value while encouraging multiple unit purchases. Overall, we feel good about our spring merchandise and our upcoming summer line. Both spring and summer lines feature streamlined SKU counts so outfits can be more clearly displayed. We fine tuned the architecture of the lines to offer more goods and better products that can live in the stores for 12-16 weeks. In this economy our goal is to offer a focused assortment of value priced merchandise day in and day out while continuing to offer a selection of unique fashion pieces at somewhat higher prices to enhance the special outfit.

In store inventory levels will be slightly lower in 2009 and operationally we have improved our inventory flow strategy to stores. Smaller initial shipments and more frequent replenishment help us to get the right product to the right stores at the right time.

In terms of our three sales and earnings growth drivers for 2009, we believe that our online business has significant additional growth opportunity. The relocation of our e-commerce fulfillment operation to our Southern Distribution Center in Alabama in June 2009 will provide additional capacity and lower the overall costs of fulfillment. We are continuing to invest in systems to ensure that our infrastructure and platform have adequate capacity to support current and future growth strategies and to add new features and functionality to assist customers shopping our e-commerce site.

In terms of new stores, we plan to increase our fleet by a net of 30 stores in 2009. Longer term we believe the chain can grow from 917 stores to at least 1,100 stores in the U.S. and Canada. Through value engineering we have lowered the build out costs for our new stores. In addition to saving money this lower cost format gives us more options in terms of the types of locations and markets where we can open and profitably operate new stores.

Finally, a disciplined focus on expense and cost management is becoming an integral part of our culture. During the first quarter of 2009 we implemented several cost control initiatives which are expected to result in approximately $20 million of annualized savings. This $20 million in annualized savings is on top of the $12 million in costs that we took out of our shared services department in 2008. We continually look for additional opportunities to reduce spending and increase efficiencies across the organization. For example, we announced today we are relocating to a new headquarters building in the fall of 2009. With this transaction we are consolidating five local offices into one. This will result in positive cash generation beginning in late 2009.

We continue to believe the company is well positioned in this economic environment with our high quality, trend right fashion and value pricing. Longer term we are fully committed to restoring the company to its historical levels of profitability once the economy returns to a more stable footing.

With that let me turn the call over to Sue who will review the financials.

Susan Riley

Thank you Chuck. Good morning everyone. Most of my discussion today will focus on continuing operations of The Children’s Place business only. As previously disclosed we have classified The Disney Store business as a discontinued operation in accordance with generally accepted accounting principles given our decision to exit that business last year.

Net sales from The Children’s Place business for the fourth quarter ended January 31, 2009 were $441.5 million, slightly below last year’s fourth quarter net sales of $443.3 million. We had a 5% decline in comparable store sales during the fourth quarter 2008 on top of a 7% increase last year. The decline was the result of a 4% decline in transactions consistent with the 4% decline in mall traffic, a 1% decline in average transaction size. This decline was largely offset by strong e-commerce sales which increased 70% for the quarter and growth in our store base.

At the end of fiscal 2008 our store count was 917 compared to 904 stores at the end of 2007. During the quarter sales were negatively impacted by the decline of the value of the Canadian dollar relative to the U.S. dollar. The currency swing negatively impacted top line sales by approximately $12 million compared to the fourth quarter 2007. Foreign exchange negatively impacted our comparable store sales by approximately 3 percentage points. In constant currency the fourth quarter comparable store sales declined 2%.

Gross profit dollars declined 1% to $175.8 million. Gross margin decreased 40 basis points to 39.8% from 40.2% in the fourth quarter of fiscal 2007. The decrease is the result of lower IMU, higher shrink, a negative impact from foreign exchange and slight de-leverage of our distribution and occupancy which were largely offset by fewer mark downs during the quarter.

We expect continued pressure on our gross margin during the first half of 2009 for several reasons. A lower IMU due to cost pressures in Asia at the time that we purchased our spring and summer inventory, the negative impact of foreign exchange which we expect will continue to affect our business through the first half of the year or possibly longer depending on the Canadian dollar and given the difficult economy we believe it is unlikely we will be able to further reduce mark downs so we do not expect to have the favorable mark down offset that we had in 2008.

For fiscal year 2009 we expect gross margin to decline approximately 100-150 basis points with most of that decline occurring in the first half of the year. With the cost pressures we are currently experiencing we now expect gross margin for the first quarter of 2009 to erode somewhat further from the fourth quarter of 2008.

SG&A as a percentage of sales was 27.1% in the fourth quarter of 2008 representing 250 basis points of leverage. I want to point out several one-time items that impacted our results during the fourth quarters of 2008 and 2007. This year we had one-time benefits to SG&A from the recovery of accrued legal fees and residual income from transition services which we provided to Disney as we exited that business amounting to approximately $900,000.

Last year we had one-time expenses in SG&A for professional and legal fees related to the company’s stock option investigation, related re-statements and the review of strategic alternatives, stock option tolling expense and executive severance expense. The net impact on SG&A was $6.1 million.

Excluding these items which we consider to be unusual or one-time in nature for both periods, SG&A as a percentage of sales for the fourth quarter of 2008 was 27.3% representing approximately 90 basis points of leverage due to better management of store expenses resulting in approximately 190 basis points of leverage. This was partially offset by higher accruals of management bonuses and an increased charge for equity awards in the fourth quarter of 2008 resulting from the company’s significantly improved performance this year versus last year which accounting for approximately 80 basis points of de-leverage and slightly higher IT costs which resulted in approximately 20 basis points of de-leverage.

In fiscal 2009 we expect to hold SG&A dollar spending flat excluding one-time items as a result of our company-wide cost savings initiatives in 2008 and 2009. As Chuck mentioned earlier, during the first quarter of 2009 we implemented cost control initiatives which are expected to result in approximately $20 million pre-tax in annualized savings. Approximately half of the savings will be in store related expenses. The other half are cost savings initiatives at corporate headquarters.

We will get some benefit to the SG&A line in the first half of the year and expect to be up to the full $5 million quarterly run rate by the third quarter of 2009.

Moving down the P&L we had asset impairment charges of $5.4 million during the fourth quarter of this year compared to $15 million last year. Most of the impairment charges in both years are related to items which we consider to be one-time in nature. In the fourth quarter of 2008 we had a one-time asset impairment charge for under performing stores in our 2007 fleet. In 2007 we incurred a large impairment charge related to our decision not to move forward with the building the company had planned to use as the new corporate headquarters.

Excluding these one-time items the impairment charge for the fourth quarter of 2008 is approximately $500,000 compared to $200,000 last year. Depreciation and amortization expense as a percentage of sales during the fourth quarter was 4.1%, similar to last year.

Income from continuing operations before interest and tax more than quadrupled to $32.5 million compared to $7.9 million in the fourth quarter of last year. Net interest expense was $2.1 million this quarter compared to $1 million in 2007 as a result of the term loan which we closed in the second quarter of 2008. Our effective tax rate for the quarter was 23% as we benefited from a one-time favorable resolution of a state tax issue.

In the fourth quarter of 2007 our effective tax rate was significantly higher as the company incurred tax provisions related to our decision to repatriate funds from overseas and a valuation allowance against the deferred tax assets of a foreign subsidiary. We expect our effective tax rate for 2009 before any one-time items to be approximately 42%.

Income from continuing operations net of tax was $23.3 million or $0.79 per diluted share compared to a loss of $4.2 million or $0.15 per share in the fourth quarter of last year. Our diluted share count for the quarter was 29.6 million.

Excluding the one-time items for both periods, fourth quarter adjusted income from continuing operations net of tax increased 10% to $21.3 million or $0.72 per share compared to $19.4 million or $0.67 per share in the prior year quarter. Foreign exchange negatively impacted our fourth quarter 2008 earnings per share by approximately $0.11 per diluted share. GAAP net income for the quarter including the impact of discontinued operations was $38.8 million or $1.31 per share compared to a loss of $58.5 million or $2.01 per share last year.

To briefly touch on the year, as Chuck mentioned fiscal 2008 was a good year. Income from continuing operations net of tax was $73.9 million or $2.50 per diluted share compared to $10 million or $0.34 per diluted share the previous year. Excluding one-time items from both years income from continuing operations after tax increased 59% to $66 million or $2.23 per diluted share compared to $41.4 million or $1.40 per share in 2007.

Foreign exchange negatively impacted our fiscal 2008 earnings per share by approximately $0.05 per diluted share. As I mentioned earlier, we anticipate the company’s financial results will continue to be negatively impacted by foreign exchange through the first half of 2009 and possibly longer depending on the Canadian dollar.

Moving on to the balance sheet our quarter ending cash balance was $226.2 million compared to $81.6 million last year. We have $85 million of borrowings from our term loan this year compared to borrowings of $89 million on our credit facility last year. Our cash position for the quarter reflects our strong business performance as well as the funds received from the term loan. The company continues to have some cash costs associated with The Disney Store exit which we expect to continue to come in at the low end of the estimated range.

At the end of the fourth quarter we improved our cash position by nearly $150 million net of debt versus 2007. During the first quarter of 2009 we are required to pre-pay approximately $30 million of the term loan. The provisions of the loan include a mandatory principle repayment based on excess cash flow calculation whereby the company is required to pre-pay a portion of this loan without penalty.

Excluding merchandise in transit in both years inventory at cost at the end of the quarter was down 1% in total or 4% per square foot. Total inventory including merchandise in transit at the end of the fourth quarter was up 7% in total or 4% per square foot. Year-end inventory levels were impacted by higher in transit inventory primarily as a result of the earlier Chinese New Year in 2009. Carry over inventory was 7.5% of total inventory at the end of the fourth quarter compared to 6.5% last year consistent with our strategy to keep more wear now merchandise in the stores longer.

We expect to end the first quarter of 2009 with total inventory per square foot flat to up slightly due to an additional inventory investment to support our e-commerce growth. In store inventory is expected to be down slightly in 2009.

During the fourth quarter we opened four stores and closed seven. During fiscal year 2008 we opened 26 stores and closed 13. At the end of fiscal 2008 we operated 917 stores with a total of approximately 4.4 million square feet. During 2009 we plan to increase our net store count by approximately 30 stores.

Turning to CapEx, 2008 capital expenditures totaled $52 million somewhat below our previous estimate. Given the increasingly difficult economic climate during the second half of 2008 we were proactive in conservatively managing our capital spending. We expect 2009 capital expenditures will be higher in the range of $75-80 million including approximately $17 million of CapEx associated with the build out of our new corporate headquarters. Approximately half of the 2009 CapEx will be used for new store openings, remodels and maintenance and the remainder for IT projects and distribution centers.

In summary, The Children’s Place had solid operating results during the fourth quarter and fiscal 2008. We are pleased to be entering 2009 with a strong balance sheet and cash position particularly given the uncertainty of the economic environment.

Thanks and now I will turn the call back over to Chuck.

Chuck Crovitz

Thanks Sue. Operator we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Kimberly Greenberger – Citigroup.

Kimberly Greenberger – Citigroup

Chuck I was hoping you could expand on your comments about improving inventory flow to the stores. If you could just explain a little bit more what that is about and when do you expect that initiative to be fully implemented? That would be helpful. Then I just wanted to double check if I heard you right. An $0.11 impact from FX in the fourth quarter? If you could just clarify that it would be helpful.

Chuck Crovitz

In terms of the flow to the stores, what we are doing this year is trying to reduce the initial flows to store. Traditionally we probably did about 90% flows to the stores of new product initially and replenished about 10%. At this point we are probably closer to 70% or 60% and replenishing the rest. What that helps us do is it eases the workload on the store first of all. They don’t have so much merchandise to have to deal with. Most importantly it helps us to reserve merchandise to the stores that really need it so we are not out of stock in one store and marking down at another store the same merchandise.

That has been a big help to us both operationally as well as from a mark down standpoint. We started that in the fall of last year and every quarter we have been slightly improving it. I am not sure we can ever say we will be fully implemented because we keep finding ways to fine tune this. We have made some significant strides on it. In the spring we have some additional plans and fall of this year.

Susan Riley

Yes, you heard correctly that there is an $0.11 negative foreign exchange impact from the Canadian dollar in the fourth quarter and it is $0.05 for the year.

Kimberly Greenberger – Citigroup

Any idea what the FX impact in Q1 and Q2 might possibly be or any ranges?

Susan Riley

It should be closer to the $0.11 than the $0.05. That is because we really saw the big decline in the Canadian dollar in the third quarter of 2008.

Kimberly Greenberger – Citigroup

Each quarter $0.11 in each quarter?

Susan Riley

Approximately yes.

Kimberly Greenberger – Citigroup

Chuck, the move of the direct business fulfillment center down to Alabama, are you going to be up and running in Alabama in June or how does the transition work if you could just help us understand that. That would be great.

Chuck Crovitz

We are going to be up and running in June. What we are doing is on the seasonal shift we will be shipping the old season out of our current facility and the new season out of the new facility. Then we will transfer some of the remaining stuff out of our current facility down as a clean up once the shift has happened. We will be up and running in June.

Operator

The next question comes from John Zolidis – Buckingham Research.

John Zolidis – Buckingham Research

A question on the top line performance. I was wondering if you could give us a little bit more of your personal impressions on how the business did during the fourth quarter given the kind of economic distress that was going on out there. You are only down 2% in constant currency which stacks up pretty well relative to other areas of retail. Do you think the product is doing well? Do you think you are really benefiting from trade down from more higher expensive brands? What are you hearing from your customers? How do you feel about your sustainability of that fourth quarter top line performance?

Chuck Crovitz

I think that we, as you mentioned, were pleased with the fourth quarter in relative terms. I think we held up very well relative to competitors that had higher priced positioning than we did. I think the product was well accepted overall but it was certainly not the level we would have hoped it could be. You have a financial impact from that. We did throughout the year see some impact of trade down from higher income consumers coming into the brand. The latest data we have looked at there is a little bit less clear on those trends than it had been through most of the year.

I do think from a positioning standpoint I feel really good about where we are. I think from a product standpoint we feel the strategy we are putting in place of getting consumer acceptance in just an overall weaker environment. Good relative performance but the absolute performance was not where we would all like it to be.

Dina Sweeney

I am seeing the same thing. Overall I would have to say the customer responded fairly well to what we gave them for the holiday time period. We are continuing to watch and see how their spending habits continue into the first part of this year. We have seen some shift. There is clearly more of a slow down on the basic side of the business. We will continue to watch it. It really looks like they are more likely to spend their money on fashion colors and items they maybe don’t have within their wardrobe and really just stretching their current wardrobes by just creating updated looks and outfits with what they are purchasing.

Operator

The next question comes from Margaret Whitfield – Sterne Agee.

Margaret Whitfield – Sterne Agee

You mentioned you had lowered your build out costs. I wonder if you could quantify that. Does that allow you to open in smaller markets? I think you said that. Could you comment on the nature of the smaller markets? Also, e-commerce has been on fire. What percent of your sales is it at year-end and what is the goal in that business as a percent of sales? Finally, if you could comment on the Easter shift impact on your business?

Chuck Crovitz

In terms of the build out costs, we have significantly reduced our build out costs and are playing around with some new formats. It is difficult for us to give guidance on that because it so depends upon whether you are building in an A mall, B mall, strip center, etc. One big store can really throw that off when you are building 30-40 stores a year. I am very pleased with the level that we have brought it down. We have brought it down significantly. You are right; it does allow us to operate more profitably in many more locations than we previously had. We are doing some experiments in some smaller markets. I think we define a smaller market as 100,000 to 200,000 population. It is way too soon to say how we are doing there. We have only opened a couple of those stores. With the several weeks of sales we have seen we have been very pleased but you don’t base a strategy on two weeks’ worth of results.

In terms of e-commerce, e-commerce this year was about 5% of sales. I don’t think we have sort of publicly stated our goal but I think you can look at the penetration percents across the industry. What we have observed is that team retailers and people with direct mail backgrounds tends to be up in the mid to high teens. We are certainly shooting to get from where we are up closer to that neighborhood over the next period of time. The next several years. We feel very good about that e-commerce business and we are investing heavily in it.

Lastly, in terms of the Easter shift around here we talked about MARPL, March and April, because it is so tough to see what happens. We have lots of theories and we can convince ourselves it helps March or it hurts March. It is very difficult to predict. We tend to manage this thing by the quarter and whether Easter hits in the end of March or the beginning of April really doesn’t affect the way we are going to manage it because we do tend to look at things on a quarterly basis.

Margaret Whitfield – Sterne Agee

Buying closer to need that might shift more into April, right?

Chuck Crovitz

It certainly could.

Operator

The next question comes from Analyst for Brian Tunick – JP Morgan.

Analyst for Brian Tunick – JP Morgan

I was hoping to clarify; did you say we should expect SG&A to be flat for the full year with most improvement coming in the back half?

Susan Riley

That is correct. That is flat in absolute dollars year-over-year notwithstanding the fact that we are opening new stores.

Analyst for Brian Tunick – JP Morgan

I know you mentioned half of that $20 million should be coming from stores and half from the home office. I was hoping you could talk more specifically the buckets of opportunity? Maybe talk about store payroll, marketing and processes?

Susan Riley

We are not going to comment specifically on store payroll but what we did at the store level is we are tightening up on certain store expenses. For example we are looking at whether or not we really need to be providing boxes to customers who are shopping in outlets and so there is a store expense savings there. We have looked at levels within our stores and we actually eliminated a level of management within our stores which is resulting in savings. On the marketing side we are cutting back on the longer-term brand building marketing. We absolutely want to do that but in this environment we are just scaling that back somewhat and we are continuing to invest in our highly focused marketing, [magalog] that really do generate incremental top line sales.

At corporate headquarters we did have to eliminate some positions which we have already announced. The employees who are impacted are aware of that at this point in time. We expect to see the savings…that is a savings we expect to see in the early part of the year.

Chuck, anything you would add to that?

Chuck Crovitz

No. Various different programs just finding ways to reduce costs on medical, insurance, cars and things of that nature. Just sort of across the board focus on cost containment.

Analyst for Brian Tunick – JP Morgan

As we look out beyond 2009 it sounds like there is still further opportunities for SG&A cuts. Is there an SG&A rate as a percent of sales that you guys think of as an appropriate goal down the road?

Susan Riley

What we have said is we look at our longer range plan and project out a rate of sales growth we would expect SG&A to grow at half that rate. That is how we are looking at SG&A on a longer term basis.

Operator

The next question comes from Betty Chin – Wedbush Morgan.

Betty Chin – Wedbush Morgan

I was wondering Sue if you can comment just to clarify if we heard you correctly that we are going to have to expect some gross margin pressure in 2009 with primarily a lot of that pressure coming in the first half because of product costs?

Susan Riley

That is correct. You did hear me correctly. If you look at our product cycle we are out buying a good 9 months prior to any given selling season. If you consider what was going on about 9 months ago there was an awful lot of consolidation in Asia. That is actually impacting and had somewhat of an impact on our fourth quarter and we expect that to continue in our first and second quarters of next year and then to moderate we have bought back to school and we are seeing a moderation in those costs. It is largely driven from the U.S. retail environment where demand is in fact down. So we do expect gross margin pressure in the first and second quarters. That is compounded by the weakness in the Canadian dollar. Again, as I said earlier the Canadian dollar took a precipitous decline in the third quarter so we have two full quarters of the full impact of the Canadian dollar weakness. In this environment where the consumer seems to be buying on promotion we are just not counting on the level of mark down savings that we had seen throughout 2008.

Now Richard and Dina and the team are managing mark downs but at this point in time we are being a little cautious on our gross margin for the first and second quarters.

Betty Chin – Wedbush Morgan

Is it possible then given some of the product costs you have already seen for the fall and perhaps in the upcoming holiday season we could see gross margin improve in the back half?

Susan Riley

I would say you could see gross margin in the back half. Again, we are not sure how long this economy is going to stay where…how long we are going to be in this recession. So I think you could see gross margin improve as it pertains to IMU. I think we will see IMU improvement. I think the impact of the Canadian dollar, again depending on where the Canadian dollar trades relative to the U.S. I don’t expect to see a huge negative impact. However, the mark down issue the longer we stay in a recession the more consumers we think are going to wait to buy product on mark down so the higher we might see the mark down rate which could mitigate the positive impact from those two events.

Betty Chin – Wedbush Morgan

I was also wondering will we be able to see additional SG&A savings after the consolidation of the five different office locations that will happen in the later half of this year.

Susan Riley

You won’t see P&L savings on that. The reason for that is we had to take a charge last year for lease expense associated with that facility we were going to use as a corporate headquarters. There is a cash savings from this consolidation. So you won’t see it in SG&A but you will see it in the cash and that is about $3 million a year in cash savings.

Operator

The next question comes from Janet Kloppenburg – JJK Research.

Janet Kloppenburg – JJK Research

On the product cost, we are hearing that for the back half some companies are benefiting from some price advantage now going on. I wonder if you could comment on that or even the outlook for the first half of fiscal 2010. We are also hearing about in some cases a skew to price points at the good level, fewer at the better and best levels. If you could talk a little bit about that it would help as well. Then just to clarify on the SG&A I know the $20 million in savings a bit in the first half, the $5 million level reduction in each of the third and fourth but I’m not sure we should expect $20 million reduction in entirety this year. If you could comment on those items I would appreciate it.

Susan Riley

Let me take your first and third question and I’m going to have to ask that you repeat your other question with regard to the price points. I didn’t catch the whole question. Product costs, yes we did see an increase in product costs which is impacting the first and second quarters and we do expect that to moderate for Q3 where we have already gone out and done the fall buy.

Janet Kloppenburg – JJK Research

The question is, are you getting advantages in the second half. In other words could product costs in the second half be down versus last year in the second half?

Susan Riley

The answer is yes. Then with regard to SG&A you are correct. You won’t see the full $20 million this year. What you will see is the quarterly rate will be $5 million and we expect to get up to quarterly rate of generating the savings by the third quarter so you should see about $10 million in each the third and fourth quarters and a couple of million in each of the first and second quarters.

Janet Kloppenburg – JJK Research

I didn’t mean to be confusing on the price points. You have a strategy of good, better, best. So my question is in this type of environment are you working towards skewing your price points more towards the good or the value end with less at the best end? And, if you could give us an idea of what tax rate you want us to be using for this year? I think you might have said 43.

Dina Sweeney

In the back half we have shifted products of the best category and shifted it into both good and better.

Janet Kloppenburg – JJK Research

So that could put pressure on the average unit retail in the back half of the year?

Dina Sweeney

A little bit but I wouldn’t really say that. I think we really have adjusted the mix appropriately to support the AUR’s that we need to have.

Susan Riley

42% is a good tax rate to use.

Janet Kloppenburg – JJK Research

With the $0.72 on the quarter that you just reported will we use that tax rate as well?

Susan Riley

As an ongoing tax rate yes. It is a little lower than that but it should get you very close.

Operator

The next question comes from Marni Shipiro – The Retail Tracker.

Marni Shipiro – The Retail Tracker

First of all absolutely no boxes to the outlet shoppers. Let them buy them for a couple of bucks and make money. Everyone else is charging for boxes these days why shouldn’t you at the outlets? I was curious a little bit about the outlets. Your stores in the malls look very clean and I know for a little while you were transferring goods to the outlets to clean up some excess inventory as I recall. I was curious if you are still doing that or have you really been able to clean through that channel and what I am seeing in the outlets is made for the outlets? Can you talk about how big the outlet business was in the fourth quarter and the store opening net for next year, a little more detail there. How many openings? How many closings? How many of those are outlets?

Chuck Crovitz

I’ll let Richard answer the first question on outlet strategy and then Sue can answer the store count.

Richard Flaks

In terms of outlets, it has always been our strategy for outlets to get their products really from three sources; first is they sell full priced product which is exactly the same as we have in our full product stores. That is representative of about half the volume we do in our stores. We don’t make separate products because being value, if we have a $5 or $6 t-shirt it is very hard to come up with an outlet version that is cheaper than that which works. The second thing is obviously outlet generates its own mark downs through the full price product we send them. We have always used outlet as a clearance vehicle for our full price product we have transferred. During 2007 when we had too much inventory the level of transfers into those stores was way above what is optimal for us. So the strategy hasn’t changed and we continue to move goods into the outlets, just the extent of it has been coming down.

Right now as you go into our stores we talked about pricing the seasons and a little bit more carry over inventory. Part of it was about strategy of selling wear now. Most of that inventory is now sitting in the outlets. There is really pieces left in the full price stores. So if you do go into the outlets you would see a higher proportion of winter products in the outlets than you would last year.

Susan Riley

To answer the second part of your question I would use about 35-37 new stores with about 5-7 closures for the net of 30. We just don’t disclose the type of stores that are opened before we actually do. So I can’t tell you the number of outlets versus full price. I’m sorry.

Operator

The next question comes from Linda Tsai – MKM Partners.

Linda Tsai – MKM Partners

In terms of buying closer to need from what you are seeing with your customers you kept more winter inventory in January and February. Does this change how you flow inventory in the fall? Like conversely will you keep more light weight clothing in your stores longer headed into fall?

Dina Sweeney

We did make some product adjustments to have some more short sleeved and shorts available in July which would then live on the floor until August and with the flow strategy in trying to not do as many transfers there would definitely be more of that summer product in the stores through August and probably into September this year.

Linda Tsai – MKM Partners

Do you think this would impact your AUR at all?

Richard Flaks

We don’t believe so because what we do is we look at the total mix and we have been protecting the AUR’s. Again, even though we are letting some product live as wear now we don’t swing the pendulum all the way across. There still is going to be obviously long sleeved product in the store it is just a higher percentage of short sleeved.

Linda Tsai – MKM Partners

In terms of Chuck’s comment saying that basic sales were a little bit lackluster, are you shifting the percentage of fashion to basics as you move through 2009?

Dina Sweeney

We are actually monitoring our basics business slightly differently than we have in the past and we are making adjustments to categories like the denim, graphic tees and some of the basic chino programs to make sure we are not over-investing in that.

Linda Tsai – MKM Partners

Historically what would you say your percentage was of basics to fashion? What might it look like this year?

Dina Sweeney

I think if I combined all of those categories together on an annual basis you are probably looking at about 20-25% and now I would probably say based on what we can ship maybe closer to 15-20%.

Linda Tsai – MKM Partners

So that would be 20-25%...

Dina Sweeney

Originally.

Linda Tsai – MKM Partners

For fashion or basics?

Dina Sweeney

For basics. I’m sorry.

Operator

The next question comes from Dana Telsey – Telsey Advisory Group.

Dana Telsey – Telsey Advisory Group

Can you talk a little bit about the gross margin and how the sourcing impact benefits come to fruition in light of the promotional environment and how you see gross margin trending throughout the year? Are there differences in terms of what you expect the pricing environment to be? If you think about Canada, any update on Canada and how that business is doing compared to the U.S. and the foreign currency impact?

Chuck Crovitz

The first part of your question really is more about the retail aspect of the gross margin in this environment?

Dana Telsey – Telsey Advisory Group

Right.

Chuck Crovitz

Before Dina gets started on that, I think we are not really trying to change our retail strategy in general. We have a strong value message and we are going to keep having that message. Obviously we remain flexible. If sales slow down and we see an opportunity to go after more business we are going to react in terms of retail prices. So I don’t see a big change other than our continuing to be flexible and opportunistic about that.

In terms of Canada…

Dina Sweeney

In terms of Canada we are seeing some comps in February were stronger than what they were the prior year. We are seeing some shift there. I think when we look at it Canada sort of has entered based on the currency almost equaling the dollar at some point last year. Business was tougher for them then and it looks like now that the currency rate has changed we are seeing Canada sort of come back.

Susan Riley

Importantly, our Canadian business has a strong margin structure notwithstanding the decline in the Canadian dollar. The Canadian business has a stronger margin structure than our U.S. business. Our business is priced higher in Canada so the gross margin, again notwithstanding the fact you are buying product with a weaker Canadian dollar and our operating margins are in fact stronger than the U.S.

Operator

The next question comes from Tom Filandro – Susquehanna Financial.

Tom Filandro – Susquehanna Financial

I just want to highlight here for a second in light of the recent concerns about product safety issues, can you just update us on where TCP stands on that front? As it relates to testing is that also increasing part of your cost structure due to safety issues? Then I have a follow-up.

Chuck Crovitz

The Consumer Product Safety has been a big issue of late. I think one of the benefits we had with The Disney Stores is we had to deal with that in toys. That really put us well ahead of the game in terms of developing protocols around these regulatory issues. Back in 2007 we put in some fairly rigorous testing policies on garments to make sure we met all of these Federal standards. The Consumer Product Safety Improvement Act has been discussed here in the past when it was first proposed in Congress our people started really monitoring those discussions and they began to prepare for these new regulations.

What happened there was in February, actually February 8 of this year, they set the level of lead to about 600 ppm. In August it is going to go down to about 300 ppm. So we have a couple of areas of concern. One of them was rhinestones. We use a lot of rhinestones on our garments. As a result of just trying to stay ahead of this game we made sure the lead content in the rhinestones that we have in our product even in holiday of 2008 was already at the August 2009 standards. So I think we are in good shape there.

The other issue is phthalates which is a plastic softener which really impacts our rain gear and some of the grippers we put on the bottom of our pajamas and our socks. Again, we saw those things coming and we made adjustments early and got our holiday product to be compliant with that. In general, this sourcing is one of our core competencies and we tend to just stamp these things in. I think our team has done a very good job staying ahead of it.

Tom Filandro – Susquehanna Financial

From a cost standpoint not a huge issue because you have been doing this obviously?

Chuck Crovitz

No question it does increase costs. We ask our vendors to do a lot of this for us. We do actually some testing for our vendors at a charge to them but ultimately that raises everybody’s costs.

Tom Filandro – Susquehanna Financial

My second question really relates to the store count. Moving I think you said from 917 to 1,100. I was wondering if you could give us the split between U.S. and Canada long-term and given the environment I would suspect you have an opportunity to maybe accelerate and get better deals. Is that a possibility to you? Are you thinking beyond e-commerce new concepts, new category growth for the future?

Chuck Crovitz

In terms of the 1,100 store count I want to be clear. I’m saying I think we can get to at least 1,100 stores over the next several years. I’m not trying to put that as an upper limit on the chain size. But I do think we easily have that opportunity over the next several years. In terms of Canada we really don’t talk about the split there. We do see Canada, as Sue mentioned, as one of our most profitable businesses so we would like to grow there. It tends to be a little more difficult to find property in Canada than it is in the United States so it is a little slower than we would like it to be.

Help me with the last part of your question with the new opportunities? A little bit more about what you are…

Tom Filandro – Susquehanna Financial

On two fronts, the acceleration of store openings given the environment and opportunity to get more aggressive early and I think the second piece of this is really looking even further out into the future e-commerce right now is the current growth path. Are you thinking about new concept growth? New classification growth? Anything beyond what your core competency currently is?

Chuck Crovitz

In terms of accelerating store growth given the environment we are open to that and we are looking at that but we are not making any commitment on that at this point. You are right. This is a good environment in which to grow and we are doing a lot of experiments as I mentioned earlier in terms of some of these new core mix and new locations. So we will remain flexible on that.

In terms of yes you are right, we can use e-commerce to experiment with new categories and new products and we are looking at those opportunities right now but we are not in a position to announce that.

That concludes our call today. Thank you all for your interest in the company.

Operator

This does conclude today’s teleconference. You may disconnect. Have a good day.

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