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Pacific Sunwear of California, Inc. (NASDAQ:PSUN)

F1Q09 Earnings Call

May 21, 2009 4:45 pm ET

Executives

Gar Jackson – Vice President Investor Relations

Sally Frame Kasaks – Chairwoman of the Board & Chief Executive Officer

Michael L. Henry – Chief Financial Officer, Senior Vice President & Secretary

Analysts

Christine Chen – Needham & Company

Liz Dunn – Thomas Weisel Partners, LLC

Janet Kloppenburg – JJK Research

Liz Pierce – Roth Capital

Jeffrey Van Sinderen – B. Riley & Co.

Analyst for Brian Tunick – JP Morgan

Analyst for Brandon Farrow – Keybanc Capital Markets

Shawn [Naughton] – Piper Jaffray

Connie Wong – Wedbush Morgan

Analyst for Paul Lejuez – Credit Suisse

Simon [Stykel] – FBR

Operator

Welcome everyone to the first quarter 2009 earnings conference call. (Operator Instructions) Mr. Jackson you may begin the conference.

Gar Jackson

Good afternoon and welcome to the Pacific Sunwear of California conference call announcing the company’s first quarter 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 May 28, 2009. It can be accessed at 800-642-1687 or 706-645-9291, pass code 99066033. The call also will be archived on the PacSun website at www.PacSun.com through midnight August 19, 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 would like to note that statements and discussions during today’s call will contain forward-looking information including forecasts of future financial performance and statements about our future prospects and proposed developments or business strategies.

Actual results can differ materially from those projected or reflected in our forward-looking statements and reported results should not be considered an indication of future performance. The potential risks and uncertainties that can cause the company’s business and financial results to differ materially from those in the forward-looking statements are included in the company’s form 10K for the fiscal year ended February 2, 2008 as well as in the earnings press release included as an exhibit to the form 8K we furnished to the SEC today. Both of these documents can also be found in the investor relations section of our corporate website at www.pacsun.com.

All information discussed on the call is as of today, May 21, 2009. Pacific Sunwear does not intend and undertakes no duty to update this information to reflect future events or circumstances. This call, the web cast 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.

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

Sally Frame Kasaks

Thank you Gar. Good afternoon and thank you for joining us today. I will begin with an overview of the first quarter and then turn the call over to Michael Henry, our Chief Financial Officer, who will discuss our financial results. We will then open the line for questions.

Overall I believe that our first quarter results reflect our continuing efforts to manage our business through what has been a very challenging environment. We finished the first quarter ahead of the earnings guidance we provided in March due to a combination of factors including somewhat better than expected sales results, improved merchandise margins and rigorous expense management. Also contributing to these results was our disciplined inventory management strategy. We ended the quarter with inventory down 35% in dollars and 25% in units.

Our balance sheet is in good shape with $104 million in working capital including $32 million in cash and no borrowings against our credit facility. Let us now turn to the specifics of the quarter.

Apparel represented approximately 88% of our total sales versus 77% during the first quarter last year. Apparel same store sales were down 7% in the quarter primarily as a result of lower average unit retail driven by planned lower opening price points. However, we saw the benefits of improved merchandise margins.

Our junior same store sales were down 6% and represented 52% of our total apparel sales. Bullhead denim continued to be the primary driver of our juniors business. Unfortunately, the strength of denim was offset by weakness in swim and shorts which we experienced for the second year in a row.

Although we scheduled deliveries of swim and shorts later in the season to be in line with warmer weather, these categories performed well below plan. On a positive note, we have been pleased by the acceptance of a broader range of fashion tops. Young men’s apparel same store sales were down 8% although the trend improved as the quarter progressed. Bullhead denim was the primary positive driver but was offset by the continued weakness in board shorts.

Over the course of the quarter we expanded the breadth of our t-shirt assortment to include a variety of new brands in different regions of the country. When you shop in our stores you will note a dominance of printable, branded tees that touch a variety of themes that include actions sports, music, mixed martial arts and organics. We are encouraged by the response to this expanded assortment.

Turning to accessories, earlier I noted that apparel was 88% of our business in the first quarter. As I have previously said we believe that we reduced accessory inventories too deeply and have been subsequently chasing business into jewelry and scarf. We will continue to buy into trend in junior accessories as we build our fashion business. We believe there is additional opportunity to expand a tightly edited young men’s accessory business as well. Ultimately, we see accessories representing 12-15% of the overall assortment.

I will now speak a bit to real estate. During our last earnings call we spoke to an intense review of our real estate portfolio. As you may recall, we found that in a number of malls our customer is more sensitive to price than other locations. As a result, we have reclassified our stores from a product assortment perspective into 525 core PacSun stores and 402 PacSun Value stores that also include our outlet division. This has been work in process with assortments improving with each delivery. The important take away is that while trends are similar regardless of the customer and location between our core and value Pac stores we are making adjustments in an effort to maximize the performance of two different store profiles. We will continue to rigorously monitor and evaluate our real estate portfolio from a merchandising perspective as well as overall productivity.

We have in excess of 100 expiring leases in each of the next three years which will provide us the opportunity to make adjustments as appropriate. Another important initiative we have underway is the development of a more robust PacSun.com website that better supports commerce and community. I would urge you to visit our website as we continue to make improvements in presentation and content. We view PacSun.com as an essential part of our strategy to speak to the music, action sports, social connections, fashion and emerging trends that are rooted in youth culture and the So Cal vibe.

This site links a range of interests of our customers be they our sponsorship of the USA Amateur Surf Team, our sponsorship of two showcases at the South by Southwest Music Festival in Austin, Texas or attending the Coachella Music Festival in Southern California with our style leaders who blogged about the fashion and music scene.

Over the past few weeks I have visited over 35 stores across the country, most of them with their newly appointed Senior Vice President of Stores, Linda Campbell. During the course of these visits I was generally pleased with the progress we have made in our assortments, in-store presentation, expense control initiatives and supply chain improvements. The front of the house and the back of the house have become aligned over the past year and we are doing a better job of working in concert.

Yes there was still some inconsistency in execution but significant progress has been made and we are continuing our efforts to improve in this area. As we look at 2009 our focus remains on providing the customer with a compelling apparel assortment while we continue to control expenses and inventory. We believe that the environment will remain challenging for the foreseeable future.

Against this backdrop we will continue to focus on making progress in the areas that we can control while positioning our business to be agile and to seize opportunities when and as the environment improves.

I will now pass the call to Michael Henry, our Chief Financial Officer.

Michael Henry

Thanks Sally. Although our sales environment remains challenging we are pleased with the results of our continuing efforts to manage expenses and inventories during this recession. Some important call outs underlying our first quarter results include; first, on a GAAP basis SG&A expenses were down $19 million versus a year ago. Second, merchandise margins improved 140 basis points versus a year ago. Third, our inventories are down 31% in dollars and 25% in units versus a year ago on a per square foot basis and are highly current with more than 80% aged less than 90 days. Finally, we ended our smallest revenue quarter of the year with $104 million in working capital and no direct borrowings outstanding under our credit facility. We improved our cash position at quarter end to $32 million versus $25 million entering the fiscal year.

Now to some of the financial details of our first quarter performance. All comparisons in this commentary are to the first quarter of fiscal 2008.

Total sales were $223 million this year versus $267 million last year. Same store sales declined 18% for the quarter. Apparel same store sales declined 7% and represented 88% of total sales. They were 77% of sales last year. Non-apparel same store sales declined 57% and represented 12% of total sales. They were 23% of sales last year.

Our former sneaker business which we exited during 2008 accounted for $12 million of last year’s sales and caused a 4 percentage point drag on our first quarter same store sales results. E-commerce revenues grew 17% to $9 million from $8.4 million last year. We ended the quarter with 927 stores versus 942 stores last year.

Gross margin was $61 million or 27.4% of sales this year versus $75 million or 28.3% of sales last year. As a percentage of sales merchandise gross margin improved 140 basis points primarily due to our increased penetration of apparel and proprietary [bands]. Distribution costs improved by $3.6 million or 100 basis points due to the consolidation of our distribution centers a year ago. Buying costs were flat as a percentage of sales and down $1 million versus last year.

Offsetting all of these gains was a 320 basis point increase in occupancy costs as a percentage of sales due to de-leveraging these costs on the negative 18% same store sales result. In dollars, occupancy costs were down nearly $600,000 year-over-year.

SG&A expenses were down $19 million to $77 million and by 150 basis points to 34.4% of sales this year from $96 million or 35.9% of sales last year. Of the $19 million improvement in SG&A expenses $7 million was due to lower non-cash asset impairment charges; $6 million was due to payroll savings in our stores and home office and the remaining $5 million was primarily from savings in areas such as legal, depreciation and consulting expenses.

Our income tax rate for the quarter was 44.4%. Net loss for the quarter was $18 million or $0.13 per diluted share versus a net loss from continuing operations of $12 million or $0.17 per diluted share last year.

Now turning to the second quarter. We continue to experience a very challenging sales environment and we are not expecting this environment to improve during the second quarter. Accordingly, assuming a same store sales decline in a range of 17-20% for the second quarter we would expect a quarter loss of $0.11 to $0.17 per diluted share. At these sales levels we would expect merchandise margins to decline by approximately 50-150 basis points due to necessary mark downs to clear spring and summer goods for the arrival of our back to school assortments.

We would also expect occupancy expenses to de-leverage by approximately 350-400 basis points. We currently expect SG&A dollars to be $84-85 million and our effective income tax rate will be 43% for the quarter.

Operator, we will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Christine Chen – Needham & Company.

Christine Chen – Needham & Company

I was wondering as you look ahead to the back to school season in comparing last year what do you think some of the merchandise opportunities are?

Sally Frame Kasaks

We are looking at a number of things. Certainly as we have called out denim has been a strong part of our business and I think most of us in the teen space shall we say, or in the youth market, are seeing this is happening. So I think you can count on our denim assortments continuing to increase. I think you are also going to see both in young men and juniors [the same] assortments that we had last year and we have been testing and trying some new things in product categories. So you will see some newness within our stores in both genders.

Certainly in the young men’s business printable tees continues to grow and were grossly under penetrated on that last year. So we do see some opportunities essentially in denim and tops which is the teen uniform. On top of that we have seen some good fashion direction that we can build on.

Christine Chen – Needham & Company

As far as color palette do you see any changes there? Are we moving away from color into a darker palette or do you think color is still going to be important?

Sally Frame Kasaks

Color will be important but it is going to be interpreted in a different way and regardless of whether it is denim or plaids there is going to be color within the assortments because it does tend to lift and there will certainly be a cast to it that will be more appropriate for late summer and fall transitional colors.

Operator

The next question comes from Liz Dunn – Thomas Weisel Partners, LLC.

Liz Dunn – Thomas Weisel Partners, LLC

I think you mentioned that you were expecting to need to mark down spring goods to clear them to prepare for fall. Is that any shift in timing of the promotions? Did anything shift from Q1 to Q2? I was also curious about your outlook, just an updated outlook for cash for both the end of the second quarter and for the year end?

Sally Frame Kasaks

Mike why don’t you speak to cash and then I will go back to the other?

Michael Henry

In terms of cash nothing has changed in terms of the previous guidance we gave relative to depending on where sales land we know we can run a -2 comp all year long and end the year with as much or more cash than we entered this year with. Nothing has changed about that expectation. If we run closer to a -15 for the year we would expect to have $1.00 per share in cash. Nothing has changed about that as we figured it out.

Sally Frame Kasaks

In terms of mark downs, as we indicated our inventories are over 80% less than 90 days old. So we are in the process of turning and keeping inventories clean. We are very fresh right now. We were no more promotional in Q1 than before. So we are very clean on that. I think it is really going to be a function of sales because we do not want to go into the third quarter with an overhang of spring and summer goods. So our goal is to go into fall frankly cleaner than last year and then we would really be prepared for whatever fall business lay ahead. We see no value in holding on to any goods that haven’t sold in the spring/summer season. So it is going to be a function of sales quite honestly.

Liz Dunn – Thomas Weisel Partners, LLC

Do you think you can accomplish the higher penetration of accessories in the same amount of space? The only other question I had was I just wanted to clarify there was no difference of performance of the value stores versus the core stores?

Sally Frame Kasaks

No, effectively not. We were a little bit lighter in inventory there but as the mix has come together the trends are very similar. In terms of space, we have really mapped a lot of this out. Certainly we have increased throughout the quarter in juniors and we are managing to the space as all the stores have accessory fixtures and in some cases we have put them in the back room and are just bringing them out on the floor. Certainly as we go into back to school we always do convert certain walls to backpacks and some traditional back to school accessories. I think you will see us be very much in line with the overall look and feel of the store and we will just bring fixtures out that haven’t even been off the floor for a couple of quarters.

Operator

The next question comes from Janet Kloppenburg – JJK Research.

Janet Kloppenburg – JJK Research

I just heard the question about the value stores versus the core stores. I was just wondering if profitability of one or the other is better and if you have more work to do on the value stores to sharpen the assortment? Is this just an evolving idea that is being transitioned?

Sally Frame Kasaks

Profitability, we can’t really talk to that right now because we have got some assumptions out there and it is very early in the game. Also our inventories were very light. It is one thing to be anemic. We were probably anorexic out there. That said, the goods have started to flow in for summer and some things and we are seeing I think if you get out there you will be able to tell value stores as you get out there as the assortments get more full. Unfortunately in the value stores we are very light on denim which clearly has been a strong business driver in the core business. So that is work in process. Certainly over time we are anticipating reasonably good profitability and it is really not such much of profitability but we really have discovered there is a slightly different customer in a number of these locations and we think we are meeting their needs right now. We will have a much better idea as we come out of Q3.

Janet Kloppenburg – JJK Research

I just wanted to ask about the junior women’s apparel, this problem with shorts and swimwear. Looking back how would you have better executed there? It has been a couple of years now; it was a good looking assortment. Is there a strategy to get by this? Be able to bring it in even later than you already did?

Sally Frame Kasaks

We had to bring it in for that spring break time period in certain hot markets we had it and it was not resonating. We looked at the assortment and in fact I have talked with a couple just before this call I was talking to one of their suppliers and they believe their assortment is probably the best it has been but it is just not resonating. I have to believe maybe swimwear is more discretionary. Maybe if you are not going on vacation you don’t need to go out and buy, particularly in the junior’s side in the bathing suits. A number of things. It is beginning to appear in that case it has become more price sensitive. I think from a delivery point of view I don’t think I can second guess as well on that because we did bring it in about six weeks later. I think the broader issue is it is a continuing smaller part of our business particularly in the juniors and young men’s. It is becoming a smaller part and we just have to figure out if there is a pricing strategy or something that we are not hitting on. To date, I am just glad that we continue to reduce our dependence on that category and hopefully over time in particularly the swim we can offset it.

Shorts to some extent, I am a little bit critical of the assortment particularly in juniors. Young men’s hasn’t been so bad but in juniors we probably went back to the well a little too far. Frankly color did well and there were some really good items within that. I think there are some lessons we are learning there as well. Certainly across the board shorts has just not been that strong.

Janet Kloppenburg – JJK Research

On the Bullhead denim will we see a new presentation for back to school? New washes and finishes? Can you comment a little bit on colors now only because others have raised concern that color segment may be going down?

Sally Frame Kasaks

We have not noticed any slow down in colored denim. We shipped a package that came in actually mid-March which is typically a late time to be bringing in additional denim and we never even put it into the two for $55 deal. It was sold $42.50 day in and day out. It was turning. I think our assortment of our neon that went back to our printable tees creative and that will fit and in our environment we are very pleased. Some of you have said oh you look like you have a lot out there. That is because we are replenishing to our best stores in that category. So I think color will change as you go into fall. There will be new dimensions that are there both in young men’s and juniors but we are committed. Don’t forget though color is a very small part of our assortment. Ultimately it is the shapes and the styling between the skinny and the super skinny and all that is going on in that unit as color is just another dimension on key styles.

Operator

The next question comes from Liz Pierce – Roth Capital.

Liz Pierce – Roth Capital

How do you feel about hoodies for this fall?

Sally Frame Kasaks

Hoodies? We feel good about it but we did end up going beyond. It is not so much hoodies as fleece and we think fleece is expanding as a category. We did learn something last year and we did learn that price is somewhat of a factor. We have been able to source to that. I think we have expanded in the category with some styling, originality and it is not just about hoodies. Fleece is about hoodies, about outerwear and we are very acutely aware of some of the price sensitivity which we learned about last year. You will probably see fleece coming in a little bit later but we are committed to that business. Do know that we will probably be $39.50 and $59.50 generally.

Liz Pierce – Roth Capital

If I can just circle back on your comment to Janet’s question about swim, I guess I think of PacSun in California and whatever I think of swim. So I am just trying to reconcile how that becomes less of a category for you and still kind of what the brand is about?

Sally Frame Kasaks

Frankly the customer has been moving away from the brand for about three years now. We have seen the business, and I think it is more of a structural issue not about PacSun. We used to be more dependent upon swim for our total business. We have seen it decrease now for about three years, two years more significantly. The question is how do you manage it? It is primarily brand driven. We don’t have the flexibility on pricing that some people do and there is some indication that in that category companies, I will be honest, we are hearing Target. We are hearing Wal-Mart. I think that is part of teens being sensitive to the crisis and what is value. So we are committed to swimwear both in young men’s and juniors but it is going to be a smaller part and I think our customer is telling us that it is not as important a part of their wardrobe. In the mean time they are buying more denim, printable tees and a range of products. I think the brand was at one time driven by swimwear and I think we are going to have more balanced assortments that become less dependent on seasonal categories.

Liz Pierce – Roth Capital

So that swim is a category, men’s, boy’s, guy’s whatever and girl’s? Right?

Sally Frame Kasaks

Girl’s swim and then board shorts. Both of which did not meet the conservative internal plans.

Liz Pierce – Roth Capital

In terms of delivery for fall with the later back to school how does that line up with possibly some of the tax free days shifting as well?

Sally Frame Kasaks

We will see more business move into August. Last year we saw things that happened. I guess Florida moved tax and I forget which one it was last year because a lot of these are moving around. We incorporate that into our planning so I do believe it will be somewhat later in terms of pure back to school business. On the other hand, we have seen categories not slow down, just lack of inventory. So denim frankly I wish we hadn’t done what we typically do and bring it down a bit in April because we have just seen denim be a function of inventory now. So there is some shift in what people are buying. You will probably see a little earlier movement on some denim categories. You will see some earlier deliveries in some areas. But we will be getting ready…by mid-July we will be pretty well set up for back to school.

Operator

The next question comes from Jeffrey Van Sinderen – B. Riley & Co.

Jeffrey Van Sinderen – B. Riley & Co.

Can you talk a little bit more about your strategy regarding how you are evolving the PacSun concept? Specifically we know that you have converted some of your stores to a more value oriented format. Are you considering anything more sweeping in regards to that as far as the positioning of the concept, regarding price points and value orientation going forward?

Sally Frame Kasaks

Nothing more sweeping. I think as I noted in my earlier comments there are 525 stores that we see as our core Pac stores. That reflects the full expression of the brand. Our value stores we have noticed during a real estate review that many of these were in areas where the customer demographic was the lower consumer income base and I have been out there looking at our value stores as our assortment comes through and am pleasantly surprised by it honestly with how compatible they are with the core brand. I think the execution of the way we reorganized the business in terms of using similar design teams and so forth to create the product and source the product definitely has the Pac hand. So do not look for wide disparities and I would not look for any sweeping changes in terms of how we merchandise and the price point.

I did note we have more sensitive opening price points in the core stores as well. I think you will see on opening price points we are going to be very sensitive to price points in that area. Does that answer your question?

Jeffrey Van Sinderen – B. Riley & Co.

A quick follow-up on some of the other questions surrounding denim strategy for back to school. How do you see the mix of products playing out there between private label and branded? Can you give us any commentary on how you see the price points and promotional playing out versus last year?

Sally Frame Kasaks

Last year effectively, though we do carry some Levi’s, our denim business is practically all under our Bullhead label so we do see improving some of the brand presence as we go into back to school. From a promotional cadence point of view we do not see any change. In fact, in some categories and some styles we have actually seen that we can raise prices without reducing any unit sales. So when the styling is right price is not as big an issue as when perhaps the styling is too basic or too core. So our cadence, we are going to be pushing a lot more on the fashion of denim. Price is one component but fashion is going to be an important part of our projection to our customers.

Operator

The next question comes from Brian Tunick – JP Morgan.

Analyst for Brian Tunick – JP Morgan

I guess I’m just trying to still understand why would you see merchandise margin pressure in the second quarter given that your inventories are so lean and you talked about carry over at levels below last year. Do you think merchandise margins will be up in the back half? You certainly have a good opportunity coming up in the fourth quarter.

Sally Frame Kasaks

We see an opportunity in the back half but it is hard to predict right now. Frankly, even with lower inventories it is a function of sales. The margins. Deep sales plan up side on sales and we will get up side on margins. Any down side on sales and we are going to keep the inventories clean and turning. Until we can establish the bench line for sales that is why we are looking at the range we are talking about. I wish a couple of points in sales would take care of it all but I think at this point we have all seen that predicting sales has been problematic at best.

Analyst for Brian Tunick – JP Morgan

Can you give us an update about your private label penetration? Is that something you are still growing in juniors? How did your private label perform during the quarter?

Sally Frame Kasaks

I keep going back, denim is a significant part of our business and much of our owned proprietary brand is under Bullhead so clearly it was a growth of denim in Q1, a significant number of growth increase. It has increased in both young men’s and juniors. Denim was very strong in young men’s. It has increased our proprietary mix. Also recall Q1 is really the smallest quarter of the year so a big jump up in denim is going to skew.

Going forward we have said before the juniors will probably be about 50% proprietary and young men’s depending again on denim and some other things probably 25-30%. Really it is going to be hard to predict because denim is a big catalyst for the proprietary brand there.

Analyst for Brian Tunick – JP Morgan

What about the private label in tops for women?

Sally Frame Kasaks

We don’t break this all out. Certainly in juniors it is a significant part. We do have a lot of printables for our brands. If you go into our stores you are going to see a lot of brands in printables. Billabong. Roxy. There are other brands out there. So we do see the importance of brands in certain categories. So the mix will be shifting. Again the big wildcard is going to be denim.

Analyst for Brian Tunick – JP Morgan

I’m not sure if I missed this but did you break down your AUR’s versus transactions and UPT for the quarter?

Michael Henry

We didn’t call that out but I have it here for you. Total transactions for the quarter were down low single digits. The AUR was down very close to 20%. It was down 19%. Units per transaction were actually up a little bit. Everything relative to comp if you look at that it is really driven by AUR rather than anything else.

Operator

The next question comes from Brandon Farrow – Keybanc Capital Markets.

Analyst for Brandon Farrow – Keybanc Capital Markets

Just a further question on the brands. Do you see a significant shift in the brands possibly creating space for maybe new brands at the expense of older, more established ones?

Sally Frame Kasaks

I’m not sure we see it as at the expense of. We see there are emerging brands and even within some of the brands the companies that shall we say own brands I think they are seeing shifts. A lot of them have their own portfolios right now. Again, I can’t speak to their business but some of them have made acquisitions to better balance theirs. As entities, I think our brand and partners have positioned themselves to be more flexible. Certainly we have been pleased to see the beginning of some smaller brands beginning to emerge and we will see how that plays out over the next couple of years.

I think the larger organizations mitigated some of the dependency on single brands and we are working on them depending where those shifts are but there are probably some new ones coming along that are a little bit under the radar right now and that is the nature of the business.

Operator

The next question comes from Shawn [Naughton] – Piper Jaffray.

Shawn [Naughton] – Piper Jaffray

SG&A savings in the first quarter was pretty significant at $11 million. Is the $35 million number for the year still accurate?

Michael Henry

I think if you just do the math there certainly we would expect that number to be higher now because we made that statement entering the year we would expect to have $35 million savings. We had given a Q1 expectation and obviously we beat that. So if you just take the Q1 to the bank and leave Q2 through Q4 you are going to come to a higher number.

Shawn [Naughton] – Piper Jaffray

Can you remind me of when your peak working capital requirement is? I’m not sure if you have broken that number out before.

Michael Henry

Not in any specific dollars because it all has to do with inventory receipts. It is always right in front of back to school. The back half of July and early August time frame and then in the October/November timeframe in advance of holiday. Those are the repetitive annual peaks. That is not going to change.

Shawn [Naughton] – Piper Jaffray

Lastly, on the source front you are clearly skewing a little bit more towards opening price point. What is the situation there in terms of sourcing the private label? Are you experiencing any deflation right now for the back half of the year?

Sally Frame Kasaks

Let’s just say we are in a better negotiating position. I think that is perhaps the best way to put it. We see that factories and suppliers are more cognizant of needs. Some of these factories that need our orders. So we are finding it is a better negotiating position than it might have been eight months ago.

Shawn [Naughton] – Piper Jaffray

Do you think you can receive enough in cost concessions on that front in order to potentially maintain that gross margin level in the third quarter from last year?

Sally Frame Kasaks

Hopefully from a purely merch margin we have talked about it being somewhat better because don’t forget last year we were liquidating footwear and a lot of our “story” has been based on the reasonable assumption of improvement in merchandise margins going into the back half because of the footwear liquidation in 2008. We certainly have seen, as I think I noted in my comments, even though we have lower price points and we have had to be more agile in terms of meeting some of the promotional cadence which was about equivalent to last year we did still continue to see merch margin improvement and I would expect that to hold.

Now again, a lot of it is predicated on sales. If we have to get more promotional there comes some point where all of us will see a little bit more.

Operator

The next question comes from Connie Wong – Wedbush Morgan.

Connie Wong – Wedbush Morgan

I wanted to see if you can give us an update on product lead times? I think you had mentioned you were a little lighter on the better trending Bullhead denims so I kind of wanted to see where you are on the product lead times.

Sally Frame Kasaks

We are finding, part of the denim I don’t want to go too far out on this but typically denim starts to trail off in March and April and we did not see that typical trail off. That is why we were caught a little bit low on product. I think we may need to expand that. Plus, we wanted to make sure we didn’t get overloaded on our older styles as we moved into back to school and we probably could have extended our deliveries longer. Our suppliers worked very closely with us. We are trying to be, I have talked about agility so much, we are attempting to cut some of the lead times. Part of this is how many meetings we have here. We have cut those way back. We are trying to make sure we can place orders as late as possible, particularly in our proprietary brands, to ensure we have the right styles. To some extent we chase goods and value and frankly they have got some good styles out there that our core stores wish they had. These things were put into work later. We are looking to cut weeks off cycle times. I think we have positioned our denim business for flexibility. As styles begin to trend we can always air ship in but because of a number of supply chain initiatives we are significantly reducing the cost of transport so it is not just in the cost of goods but how do we ship, when do we ship. I feel we are much better along than we have ever been in terms of the agility we need to respond to trends. Does that answer your question?

Connie Wong – Wedbush Morgan

A follow-up question regarding promotional cadence. We have noticed changes to your Pac Loot promotion. Are you doing some testing go forward to see where you can bring more traffic to the stores?

Sally Frame Kasaks

Yes we are looking. Certainly value. We dropped the price of entry and we are testing in the core stores. This is something we have to be sensitive to in this environment. So you probably have seen a couple out there.

We are testing a number of things. Sometimes if I hear things that people see out there and I go, “Yep. Somebody just saw a test.”

Operator

The next question comes from Paul Lejuez – Credit Suisse.

Analyst for Paul Lejuez – Credit Suisse

I was wondering what kind of terms you are seeing on leases that are coming up for renewal in the next couple of years?

Michael Henry

We are very consciously working on our lease re-negotiations and trying to improve terms where we can. I think the same general theme holds true as we have been saying for the last couple of quarters in that we are seeing more flexibility in the lower tier malls than we are in the top tier malls. That is where there is more conversation and more flexibility. We are trying to use every bit of leverage that we have to improve those things. It is going to take some time. It is something that is going to reveal itself over the next couple of quarters as we continue to go through this process.

Operator

The next question comes from Simon [Stykel] – FBR.

Simon [Stykel] – FBR

I was wondering whether you could share any early May reads or commentary? Should we assume it is running at negative high teens now? Then just to touch back on the brands quickly, could you provide any color on specific new brands and their performance and if there is anything we should look towards for new brands for back to school?

Sally Frame Kasaks

We have kind of started to make it a practice not to talk about certain brands. It gets me in trouble and it gets them in trouble. I think at this point as you are out in the stores you will see particularly in the young men’s mix a slightly different approach to that part of it. Frankly we are just not talking about go forward numbers but certainly we have not seen major up tick in business and we are playing it very, very tight.

Operator

The next question comes from Liz Dunn – Thomas Weisel Partners, LLC.

Liz Dunn – Thomas Weisel Partners, LLC

I was wondering if you could address trends within the quarter? I don’t think we heard that. Was the trend fairly consistent comp wise throughout the quarter x the Easter shift?

Michael Henry

With the Easter shift obviously we saw a double digit swing from what we were running across February and March versus what we ran in April. The magnitude of the swing between the February/March run rate to April was larger than what we expected. That is how we ended up with somewhat better sales than we expected coming into the quarter as the impact of that Easter shift was greater than what we expected.

Liz Dunn – Thomas Weisel Partners, LLC

So it would be fair to say you were running in line with your plan in February and March and then April you exceeded your internal plan?

Michael Henry

I think we were probably a little bit worse early and a little bit better in April.

Operator

Thank you for your questions. At this time I will turn the call over to Mr. Jackson and other presenters for closing remarks.

Gar Jackson

Thank you for joining us today for the earnings call.

Sally Frame Kasaks

Thank you everybody.

Operator

Thank you for joining today’s conference call. You may now disconnect.

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Source: Pacific Sunwear of California, Inc. F1Q09 (Qtr End 05/02/09) Earnings Call Transcript
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