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Pacific Sunwear of California (NASDAQ:PSUN)

Q1 2013 Earnings Call

May 22, 2013 4:30 pm ET

Executives

Craig E. Gosselin - Senior Vice President of Human Resources, General Counsel and Secretary

Gary H. Schoenfeld - Chief Executive Officer, President and Director

Michael W. Kaplan - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Betty Y. Chen - Wedbush Securities Inc., Research Division

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

David M. King - Roth Capital Partners, LLC, Research Division

Marni Shapiro - The Retail Tracker

Stephanie S. Wissink - Piper Jaffray Companies, Research Division

Dana Lauren Telsey - Telsey Advisory Group LLC

Andrew Burns - D.A. Davidson & Co., Research Division

Operator

Good afternoon. My name is Holly, and I'll be your conference operator today. At this time, we'd like to welcome everyone to the Pacific Sunwear of California Incorporated Quarter 1 2013 Earnings Conference Call. [Operator Instructions] I'd now like to turn today's conference over to Craig Gosselin. Please go ahead.

Craig E. Gosselin

Good afternoon, and welcome to the Pacific Sunwear of California Conference Call announcing our first quarter fiscal 2013 financial results. This is Craig Gosselin, Senior Vice President, General Counsel and Head of Human Resources. This call is being recorded and the playback will be available starting today, approximately 2 hours after the call through midnight on May 29, 2013. It can be accessed at (855) 859-2056 or (404) 537-3406, passcode 70804135. The call will also be archived on our website at pacsun.com through midnight on August 28, 2013. Your speakers today are Gary Schoenfeld, CEO; and Michael Kaplan, Chief Financial Officer. [Operator Instructions]

Before I turn the call over to Gary, I'd like to note that statements and discussions during today's call will contain forward-looking information about our future financial performance and prospects. Our actual results could differ materially from those contained in our forward-looking statements. Risks and uncertainties that could cause our business and financial results to differ materially from those in the forward-looking statements are included in our Fiscal 2012 Form 10-K and in subsequent filings we made with the SEC, as well as in the earnings press release we issued today. These documents can also be found in the Investor Relations section on our website, pacsun.com.

All information discussed on the call is as of today, May 22, 2013. Pacific Sunwear undertakes no duty to update this information to reflect future events or circumstances. This call, the webcast and its replay are the property of PacSun. It is not for rebroadcast or use by any other party without the prior written consent of PacSun.

With that said, I'll now turn the call over to Gary.

Gary H. Schoenfeld

Thank you, Craig. Good afternoon, everyone, and thanks for joining us on our Q1 earnings call. I'm pleased to say that the first quarter of 2013 continues to build on the progress that we achieved in 2012, with our fifth straight quarter of positive comps, better margins and inventory productivity, all of which are fundamental to our long-term success.

Total sales for the quarter were $170 million, driven by a comp store increase of 2% and an 11% increase in e-comm. Gross margins were up 170 basis points, and non-GAAP EPS for the quarter was a loss of $0.14 versus a loss of $0.20 last year. Michael will get into more of the financial details, including the impact of the 53rd week calendar shift versus last year, which contributed approximately 150 basis points to our gross margin improvement and $0.03 to our non-GAAP EPS improvement.

Turning to the business. Our Women's business, in particular, is off to a great start for the year, with a 7% comp, which reflects the convergence of several factors. At the highest level, the most transformative changes that we've had to make since I got here have been in our Women's business, with dramatic changes in all critical aspects, including building a new team, aging up the customer and transforming the merchandising from a tween or young teen to attractive, much more fashion-savvy 17- to 24-year-old, that I believe today is our PacSun customer. Adding to that has been the complete rethinking of design and development, as speed to market has become critical to sustainable performance. With these key pieces now largely in place, we're also seeing an exciting fashion shift to high-rise fits, which is giving her an added reason, or some might say an excuse, to have to go shopping. We're also seeing excitement connected to some of our newer brands, which includes Kendall & Kylie, Brandy Melville, Diamond Supply Co., Vans and Young & Reckless. As reflected in our guidance, we're optimistic that the combination of these factors will continue to drive strong Women's performance in Q2.

On the Men's side, we had a minus 2 comp for the first quarter. Emerging brands, footwear and accessories continued to perform, yet this has been offset by softness in shorts, board shorts and heritage tees.

We have spoken before about the decline in certain heritage brands that had become strongly associated with energy drink collaborations, which have largely gone away. Those brands will hopefully rebound over time, yet we continue to feel the effects of their decline, along with some of our other heritage brands as well. Within shorts and board shorts, Hurley continues to perform, as are our most -- more basic Volcom and Modern Amusement shorts. Yet as our customer's embracing more aggressive print and pattern trends in tops, it has been pretty much just the basic shorts that are selling and similarly, what we would consider to be the more fashion-forward board short ideas within our assortment, those are also underperforming compared to what we've seen in prior years.

So as we look ahead to Q2 and summer, we generally expect Q1 sales trends to continue. And we are excited about the opening of our first pop-up store right in the heart of SoHo on Broadway in lower Manhattan, which we hope many of you will have the chance to see and we encourage you to come shop. We had a soft opening this past Saturday in advance of our Memorial Day kickoff, and the store will be open through Labor Day.

Our primary objective with the SoHo pop-up store is to bring the best of PacSun and showcase the best of our industry at one of the world's most influential fashion and shopping destinations. At more than 10,000 square feet, the store is much larger than our typical footprint and includes expansive selling space dedicated specifically to brands, including Nike, Hurley, Vans, Diamond Supply Co., Modern Amusement, Beats by Dre, Brandy Melville, and our exclusive collection with Kendall & Kylie.

So to sum up: Overall, we are pleased with our start to 2013, yet cognizant that we need to drive growth in both genders. We remain focused on continuing to work closely with our existing brands and in attracting new emerging brands, further leveraging our improved speed to market and creating a distinctive customer experience across all channels.

I will now turn the call over to Michael.

Michael W. Kaplan

Thanks, Gary, and good afternoon, everyone. Today, I will discuss our Q1 2013 operating results, the impact of the 53rd week calendar shift on our quarterly results, and then close with comments on our Q2 2013 financial outlook.

Our fiscal 2013 first quarter financial results were as follows: Total net sales from continuing operations were $170 million for the first quarter versus $162 million for the same period last year, primarily driven by a plus 2 percentage -- 2% same-store sales increase. The 53rd week calendar shift resulted in an increase in Q1 '13 net sales of approximately $6 million, by trading a higher volume week in early May versus a slower volume week in early February. Average sales for the quarter were up 3%, while total transactions were flat. E-commerce sales increased 11% in Q1 '13 versus Q1 '12.

Gross margin as a percentage of net sales was approximately 25% compared to 23% for the same period last year, which marked a 170-basis-point improvement over the same period a year ago. Contributing to the improvement in gross margin was a 160-basis-point increase in merchandise margin. Adjusting for the 53rd week calendar shift, gross margin improved 20 basis points, which included 110-basis-point improvement in merch margin, partially offset by a deleveraging of buying and occupancy costs of 90 basis points, due to prior year rent relief at the non-anniversary in Q1 of '13. Adjusted for the 50 -- for the impact of the 53rd week calendar shift, total inventory was down approximately 2% on a comparable store basis.

SG&A expenses were approximately $54 million or 32% of net sales for Q1, which decreased from 35% as compared to the same period a year ago. Approximately 90 basis points were attributable to the 53rd week calendar shift.

We recorded an income tax provision of $200,000 for the quarter, which reflects the continuing impact of the valuation allowance against our deferred tax assets. On a GAAP basis, we reported a loss from continuing operations for the quarter of $24 million, or negative $0.35 per diluted share. This compares to a loss from continuing operations of $15 million, or negative $0.22 per diluted share for the same period a year ago.

On a non-GAAP basis, excluding onetime store closure changes -- charges of approximately $200,000 and the current period loss in our derivative liability of approximately $9 million, and used in a normalized annual income tax rate of approximately 37%. We reported a loss from continuing operations of approximately $9 million or a loss of $0.14 per share versus a non-GAAP loss of approximately $14 million or a loss of $0.20 per share last year. The 53rd week calendar shift contributed $0.03 of the $0.06 per share improvement compared to last year. We ended Q1 '13 with $18 million in cash compared with $22 million in Q1 '12, and did not have any borrowings on our credit facility in the quarter.

We ended the quarter with a total of 638 core and outlet stores versus 729 a year ago. As previously communicated, we plan to close approximately 20 to 30 stores during fiscal 2013.

Now shifting to our Q2 2013 financial outlook. Our guidance range for the second quarter contemplates a non-GAAP loss per diluted -- or loss/income per diluted share from continuing operations of between $0.05 loss and a positive $0.02 compared to a negative $0.09 in the second quarter of fiscal 2012. And it's based on the following assumptions: comparable store sales from flat to plus 5%; net sales from $209 million to $219 million; a gross margin rate, including buy-in, distribution and occupancy of 28% to 30% compared to 27% last year; SG&A expenses in the range of $59 million to $61 million; and a normalized tax rate of approximately 37%. Included in our guidance, we estimate that the shift in the retail calendar due to the 53rd week should result in an increase of projected Q2 net sales of approximately $10 million, 150-basis-point increase in gross margin and approximately $0.05 better on a per share basis, as we are gaining an additional peak back-to-school week in early August versus a non-peak week in May. This positive impact will reverse in the third quarter, which we will address when we provide Q3 guidance. Our guidance for non-GAAP loss/income per share from continuing operations also excludes the quarterly impact of any change in the fair value of the derivative liability due to the inherently variable nature of this financial instrument.

Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question will come from the line of Betty Chen, Wedbush Securities.

Betty Y. Chen - Wedbush Securities Inc., Research Division

I was wondering if you can talk a little bit more about the Women's business. Gary, earlier, you kind of laid out the strategy from the beginning of your tenure until now. Do you feel like the Q1 accomplishment is -- I guess if you could kind of grade them, so that we can get a sense of how much additional momentum we can see. And in terms of milestones, are there some additional rollouts that we can anticipate for the second quarter or balance of this year that you can share with us?

Gary H. Schoenfeld

I'm not sure there's a lot more that I can say beyond what I already said. The plus 7% comp is obviously a strong start to the quarter. And I think what I said in my remarks, it's a combination of factors that are contributing to that. And reflected in our guidance is continued strong performance in Women's. So if there's something more specific, I'll try and respond to that, but I think that captures the essence. We're pleased with the start to the year and optimistic about that continuing here in Q2.

Betty Y. Chen - Wedbush Securities Inc., Research Division

Well, maybe -- put it another way, Gary, can you maybe talk to us a little bit about specific products or categories that did particularly well in Q1? And then also, could you remind us a year ago in the second quarter, as you think back, are there some opportunities that the team is tackling in Q2 and also the Q3 back-to-school season?

Gary H. Schoenfeld

So generally, the performance was healthy across categories. Obviously, there are some that are up versus others. I alluded to the trends that our team anticipated in terms of high-rise being significant anytime -- you're right in anticipating a change in trend. It gives her reason to shop. And if she's got to buy the new bottom, then that means she needs different tops and then some shoes to go with it. So excited, and I think give the team a lot of credit for seeing that, so we're seeing crop tops and other things match up to that. And speed to market has been really important in our ability to respond to that. I would also say in terms of brands, both some of the new Women's brands that we've added to the mix, with Kendall & Kylie and Brandy Melville, are adding excitement and I think getting new customers to come have a look at us. But I think we're also doing a better job in understanding which brands on the Men's side we think are transferable on Women's. So with Diamond Supply Co., Young & Reckless, Vans, we're seeing good traction in how those translate. And I'd say, thirdly, it was really kind of in Q2 of last year where we started to redefine our essentials business. And we've seen that consistently improve over the last 12 months. And certainly, that was a positive contributor in the first quarter. And I'd say probably the fourth comment would be a strategic shift in swim, where we purposely planned swim as a smaller part of the business, freed up that inventory to be into other categories. So bottoms and tops, I think that proved successful in the first quarter as well.

Betty Y. Chen - Wedbush Securities Inc., Research Division

That's really helpful. Now I guess, in terms of the Men's heritage brands, I guess how should we think about -- is the team's idea to continue to add some of these emerging brands that are doing well? And when do you expect some of that pressure from the heritage brands to kind of start to diminish?

Gary H. Schoenfeld

Yes, so -- I mean, without question, the shift to embracing the newer emerging brands and street wear as a trend has been critical. And if -- had we not been successful in those efforts as well as expanding footwear and other accessory categories, our Men's business would be in a much tougher position. There's a lot of change happening within sort of the longer-standing brands. There have been significant executive changes at a number of key players. And so to answer your question, I can't be specific in terms of exactly when that pressure lightens up. But obviously, we continue to focus on what we can control, which is continuing to work with the mix of brands that we have, both emerging and heritage, continuing to also bring the best that we can in terms of our proprietary design and in denim, in particular, to support changes in trends. And we think those combination of factors, along with continuing to grow sneakers and other accessory categories, that we can get our Men's business back to the kind of growth we'd like to have. But I'm not in a position right now to predict when I see that shift taking place.

Operator

And your next question will come from the line of Dorothy Lakner, Topeka Capital Markets.

Dorothy S. Lakner - Topeka Capital Markets Inc., Research Division

Just building on those questions, I wondered about your comments about the board short category, Gary. You've done really, really well in Women's. And we're certainly seeing tons of traffic on the Women's side in the store, and they seem to be really responding to new fashion, et cetera. So on the Men's side, is it a macro thing that's going on, where basic board shorts are doing well, but they're not spending up for the more up-to-date product? And then if you could give a little color on how speed to market has changed, how much faster are you getting product into the stores? That would be really helpful.

Gary H. Schoenfeld

Sure. I'll take the second part first. I mean, speed to market has been a transformational shift within this organization, and I don't think that's overstating it. And I mentioned earlier, just as high-rise is then translating to shift in cropped tops, I mean, that's a good example of something that we've been able to be nimble and respond to very, very quickly. So as I say, I don't know that, that's a competitive advantage, but rather, I think it's just fundamental to being able to be successful in the Women's business going forward. I think we all recognize the impact that social media is having in terms of the speed with which trends are being adopted, and how universally they are being adopted. The old days of the fashion-forward customer begins to wear it, and then months later starts to trickle down to mainstream, and becomes meaningful 6, 9, 12 months later, I mean, that whole time horizon has been tremendously compressed. And I think our team has done a good job of really rethinking our approach to the business and how we can be able to respond to that. And I think what you see in the stores is reflective of that. On your first part of your question related to board shorts, frankly, what we're seeing is the styles -- this is a generalization. But in general, some of the better sellers are still kind of styles closer to a year or 2 ago of stripes and plaids. There's been some interest in adoption to shorter inseam lengths, but I'd say that hasn't been universally adopted. And whereas there is an exciting shift in embracement of technology 2 or 3 years ago that was help driving up price points, we're seeing a bit of a trend in the other direction and some more basic styles, so lower price points are getting more traction.

Operator

Your next question will come from the line of Jane Thorn Leeson.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

So I was just curious if you've thought about why not dedicating more floor space to Women's since -- when it's turning really well and it would be a bigger market in general?

Gary H. Schoenfeld

Well, a 2-part answer to that. Number one is, we're absolutely committed to being a dual-gender business, to have confidence in our long-term Men's business, the brands we work with, and absolutely committed to maintaining the market. Second, as we're approaching store productivity in the range of $300 a foot, we don't think space allocation is a limitation for us just yet to driving sales. So we think we can grow the Women's business within the space that it has in the box and we hope to continue to do so.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

Okay, great. And then what are some of the drivers within those categories or -- in addition to footwear and accessories? Like how should we think about the category drivers within Men's as the biggest drivers versus incremental?

Gary H. Schoenfeld

I mean, Men's starts with brands, and so it's about brands continuing to bring excitement and innovation and connecting to customers. And so as we work closely with our brands, our conversations continue to challenge that, and that's product innovation, as well as marketing excitement, to get guys excited. So that certainly is one part. As we look to the back half of the year, that's when denim and long bottoms become a bigger part of the business. And at this stage, we don't see huge shifts in trends there that are going to be the obvious catalyst. So as we look at our Men's business right now, again, confident in the brand relationships that we have, pleased with the continued progress in footwear and the growth of our accessories business, but at the same time, cognizant that we need to just be better and better ourselves and with our brands, and do everything that we can to give him a reason to buy versus spending his money on technology or something else. So on the Women's side, God love her, she continues to shop. And if the fashion's right, that gives her a reason to spend. On the Men's side, we need to work a little harder right now, without any obvious fashion trend to get him to want to spend.

Operator

Your next question will come from the line of Adrienne Tennant, Janney Capital Markets.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

So Gary, I'm going to start with a little bit of a broader question. I'd like to know how PacSun's relationship with its vendors has changed over the past couple of years. I think when you had initially come in, it was sort of tougher to get those -- that dialogue going. Specifically, if you can sort of talk about how the Brandy Melville arrangement came about, is it exclusive? And if you can kind of use that as an example of whether you went out to them or they came to you, and whether it's easier to get these relationships now that you're showing signs of turning?

Gary H. Schoenfeld

Well, broadly speaking, I think it's profoundly different than it was a couple of years ago. And I think you see that with the portfolio of brands that are embracing us. And for those of you that hopefully will have the opportunity to go to our SoHo store, I think you'll see brands making a great statement. I think we're showcasing our industry the best that there is out there, U.S. and maybe even go so far as globally. So -- and we made all that happen in a very short period of time, and our brands stepped up as well. So yes, you see what Nike and Hurley did in that store, you'll see what Vans done, you'll see -- Beats by Dre is a new brand at PacSun with a cool merchandising display and assortment, stands [ph] did a great build out, and then we had something fun with a smaller up-and-coming brand called Rook. And you'll see a Poler [ph] sleeping bag in the store, so we're excited about the brand relationships, excited about Neff and DGK joining us this quarter, excited about Brandy Melville joining us, working with Kendall & Kylie. It's a lot of fun, and I think creating a lot of buzz and driving new customers. So I love talking about this, and I think the shift in perspective of brands towards PacSun, I think is pretty significant, and I think it's fundamental to where we want to take the company going forward.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Okay, great. And then I mean, it really sounds like they're -- that kind of back and forth, where they're approaching you as a partner really has shifted, so that's great.

Gary H. Schoenfeld

Yes, I don't know that I'll split hairs over who is approaching who, we would like to pick up the phone now and then, but less important about who asked who out in today's era and more important just that you get the date.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Right. Fair enough. Can you talk about some trends in the footwear piece of the business? Is footwear comping positively and...

Gary H. Schoenfeld

Yes.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Okay, great. Any color on how positive?

Gary H. Schoenfeld

It's very strong and continues to be driven predominantly by Nike and Vans, 2 great brands and great organizations and great understanding of their customer and the strong product assortments. And they come at the market with different brand identities. And the 2 together continues to drive very strong business at PacSun.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Okay, great. And then for Michael, really quickly. Is $6.8 million a good quarterly number to use for D&A for the out-quarters? And can you talk about any trends in IMU? And that will be my last question.

Michael W. Kaplan

Yes, so we have some favorability on IMU in the quarter. So that was a factor in the improved margins. Yes, I don't have D&A right in front of me. I'll get back to you on that, Adrienne.

Operator

Your next question will come from the line of Dave King, Roth Capital.

David M. King - Roth Capital Partners, LLC, Research Division

I guess following up on some of the earlier questions. I guess, first off, I'm trying to get an understanding of how you think about the Men's and Women's business and what's driving it. I guess, where do those different businesses stand today as a percentage of the mix? And then Gary, maybe you could talk about how you think about where those should be longer-term, particularly in the context of, I think, one of your earlier responses when you say, more in the existing box, et cetera?

Gary H. Schoenfeld

Yes, so I've always been very consistent since I got here, that I was never focused on really what is the percentage of Men's to Women's, 54-46, 44-56, what-have-you, that fundamentally committed to both genders. Believe that we can provide an elevated experience that starts with brands but similarly, embraces on-trend merchandising and a box where both guys and girls are excited to shop and experience our California lifestyle. So that remains very much our view. The business is still a little bit more Men's than Women's. And we think both have the opportunity, and really key to our success is to what you alluded to and what I said earlier, is we need to drive more productivity in the box in both genders to get ourselves financially where we want to get to.

David M. King - Roth Capital Partners, LLC, Research Division

Yes, fair enough. And then so maybe thinking about that productivity then and as you think about the Men's comp this quarter being down 2%. And I think you talked about that being board shorts, but then also some of the energy drinks stuff. Is that -- is it both of those driving that? Is that energy drink, when do -- should we start thinking about that no longer being...

Gary H. Schoenfeld

So I think to clarify, so shorts, board shorts and heritage brand T-shirts have been 3 of the areas really kind of underperforming within Men's. And within the heritage tee, we've talked before about a couple of what were the bigger brands at PacSun, 12, 18, 24 months ago, got strongly aligned with the energy drink trend and rode that trend up. And unfortunately, we've seen that largely go away as an influence. And it's had a pretty significant impact on a couple of those brands. And so even though the energy drink phenomenon ended, frankly, probably about a year ago, we're still seeing those brands struggle kind of post that. And in addition to that, some of the other heritage brands that weren't as big, but were still, again, pretty meaningful if you go back aways, we're seeing some of them find pretty challenging in the marketplace as well. So conversely, Hurley, Ruka [ph], Volcom, you continue to see those as a prominent part of our merchandising mix. And we expect that to continue. But we do also see where Diamond Supply Co. and up-and-coming brands like Us Versus Them, JSOB [ph] and Rook, and certainly Neff and DGK, and some of the others that have joined us more recently, and a brand like Riot Society, you're going to continue to see those be more prominent as we go forward, along with our footwear and accessory brands, which we think are important in their respective categories. But we're also excited about growing the Apparel business with brands like Nike and Vans, specifically.

David M. King - Roth Capital Partners, LLC, Research Division

That's extremely helpful. And then the other follow-up on an earlier question that I have is that speed-to-market question. I guess, I think, Gary, you've talked in the past about a need to update, a new system, there's still room for better micro merchandising, distribution, inventory management, e-comm databases, all of those things, where do we stand in that process? And when should we start to think about some of those things -- implementing some of that stuff?

Gary H. Schoenfeld

Yes, I mean, in the context of our turnaround, we continue to not have the luxury that maybe some other retailers have about their capital investments and some of those things, but as a company and as a board, we recognize that the importance of one-to-one connection with customers, Omni-Channel integrated experience is going to only increase in terms of importance. So we feel like we can continue to make a lot of improvements in the business without transformational investments in systems. At the same time, we're seriously evaluating what those opportunities are. And those are the things that we'll talk about more in the future.

Operator

Your next question will come from the line of Marni Shapiro, The Retail Tracker.

Marni Shapiro - The Retail Tracker

The stores really look fantastic. So a couple of quick things. I was curious to -- not to harp on the Men's side, but how much of that do you think is also weather-related, because I find that in the store, the Men's business tends to be a bit more buy-now, wear-now versus the Women's business? And then I have one other quick follow-up to that.

Gary H. Schoenfeld

I don't think anyone would say that weather has been a friend to the marketplace in the first quarter. At the same time, we're not prepared to say, boy, a hot summer is going to dramatically change some of those issues that we've spoken of. But that being said, we'd welcome the hot summer and be open to finding out.

Marni Shapiro - The Retail Tracker

Fair enough. And then I've noticed in your stores, and, I'll use just 2 brands that I've seen a lot, a brand like Diamond in every store I walk into, but then a brand like DGK, definitely magnified in certain stores, where it -- where frankly, where it belongs. And I'm curious how much of this, I guess, store by store, or is it region by region, micro merchandising, are you doing with these brands because to me, it struck me as important and very right in the stores that you had it. So I'm just curious how much deeper this goes.

Gary H. Schoenfeld

Not going to spell publicly exactly how we approach it. But I'd say it falls somewhere in the middle. We don't make lots of decisions at a store-by-store level. But by the same token, we're certainly not a one-size-fits-all approach to merchandising. And thinking about store clustering and what's the right criteria to drive merchandise assortments and deviations between different stores and store groups is something that I think we all think is important to continuing to drive both top line as well as margin, which remain the 2 critical pieces for moving the business forward.

Marni Shapiro - The Retail Tracker

So assuming that those criteria are not based solely on things like warm-weather stores and cold-weather stores, they're based on a lot of other things, based on what I'm seeing?

Gary H. Schoenfeld

Correct.

Operator

Your next question will come from the line of Steph Wissink of Piper Jaffray.

Stephanie S. Wissink - Piper Jaffray Companies, Research Division

It's Steph. Michael, just a quick question for you, as you think about the operating loss improvement over the course of the year, how should we think about the balance between gross margin and SG&A leverage. And then Gary, just as a follow-up to some of the earlier questions. When you kind of step back and think about the operating model over the longer term, it sounds like you have the right people in place now and the merchandising strategies are taking hold. But can you talk about the business infrastructure? Is there a cost allocation opportunity? Or are there other tactics that you're taking to better align the structure? Or do you feel comfortable with where it's positioned today?

Michael W. Kaplan

I'm sorry, just to clarify the last. When you say there's a comp allocation, I didn't understand that last part.

Stephanie S. Wissink - Piper Jaffray Companies, Research Division

Cost allocation. Do you feel like the costs are appropriately allocated across the organization to suit the merchandising initiatives that you have?

Michael W. Kaplan

Yes. I'm going to kind of speak to all of it on a high level. I mean, we've spoken before about margin expectations or opportunities in the 50 to 100 basis points for the year and that, that remains consistent with what we think about. And kind of in that vein, felt it's important for people to sort of understand the magnitude of this 53rd week shift, which is pretty significant from quarter to quarter. And from an SG&A perspective, pursuant to what I just said on the last question, I mean, the drivers of our improved financial performance is really going to be sales and merchandise margins. The occupancy benefits that we had in the past, as Mike alluded to, that's not continuing. And as we reduced the store count in the prior 2 years, we worked hard at cutting SG&A. But that's not what's going to be driving the business going forward. As to the overall infrastructure and team and support of the business, I got a lot of confidence in the team. I think a pretty proud moment right now, we put this whole SoHo pop-up store together in about 30 days. And much like Chevrolet used to say, it's not your father's pop-up store. We're pretty proud and genuinely, that was a heck of a team effort to make that happen. So I've got a lot of confidence in the team, our ability to continue to move the business forward. And if there's something else more specific you wanted me to speak to, I'm happy to.

Stephanie S. Wissink - Piper Jaffray Companies, Research Division

No, I think that's very helpful. I was just curious about -- if you think about the total SG&A dollars spend today, do you feel like it's appropriately allocated to where you find the best opportunity? Or are there opportunities to continue to refine to where the costs are allocated?

Michael W. Kaplan

I think directionality it is about right. And to kind of the earlier questions and comments, again as it relates to Omni- Channel, we think that there are going to be investments in that over time. It's premature for me to comment on when and how much because we honestly don't know the answers to that yet. And we don't think those are things that have profound impact in fiscal 2013. But as we look beyond that, that's something that probably we do anticipate some additional investment.

Operator

Your next question will come from the line of Dana Telsey, Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

Just following up on the real estate question, given that it's ICSC week this week, certainly the pop-up store is very interesting. How are you feeling about renewal of existing leases, how is the rent changing for that? And also store sizes, do you see any adjustments being made? And lastly, when you think about the complexion of the gross margin, given the improvement in comp, how do you think of the levers and the dynamics there with the private label and branded going forward, for back-to-school?

Gary H. Schoenfeld

Okay. A lot there, I'll try and speak to it. If I miss something, let us know. In terms of real estate, as Michael said, we still are on track with closing 20 to 30 stores during the course of this year. Our store count came down by 7 or 8 in the first quarter. And that aligns to that -- it aligns to what our expectations were 18 months ago. So we feel good about the overall makeup. And as we have some stores that just reached their expiration, there are some that won't be renewing. In general, good feedback from landlords, certainly up in Las Vegas, where we were yesterday. I think they, too, see the positive changes that we're making in the stores and feel that their partnership with us, over the last couple of years, has been worthwhile in terms of our long-term viability. Are we going to have cost pressure in renewals? I believe that we are, and we're going to do our best to mitigate those over the next few years. Do I think they're going to profoundly alter the makeup of our P&L? I don't think so. But we know we need to continue to, again, drive store productivity because I don't think we're going to see real estate cost go the other way. As to your questions about makeup between proprietary versus branded, no changes in our strategy in that regard. In our Men's business, outside of denim, brands continue to make up plus or minus 90% of the balance of the business and we expect that to continue to be the case. Conversely on the Women's side, as we've said before, our Women's side is much more driven by proprietary, the speed to market really is the key to that. So we expect that to continue. At the same time, though, we do view brands as an important part of differentiating PacSun from the many vertical retailers in the mall. And as I said, we think the brand mix that we have in the Women's side of the business today is help driving new customers into the store.

Operator

Your next question comes from the line of Andrew Burns, D.A. Davidson.

Andrew Burns - D.A. Davidson & Co., Research Division

Just a quick question here. Michael, you mentioned a 90-basis-point, I think, headwind to occupancy expense due to your rent relief going away. Is that a level that we should think about for the balance of the year?

Michael W. Kaplan

It's primarily a first half impact, Andrew.

Andrew Burns - D.A. Davidson & Co., Research Division

First half impact. And then is that -- it goes away, I mean, are you ready to talk about -- a comp where you'll start to see leveraging occupancy cost?

Michael W. Kaplan

No, beyond what we've gotten for Q2, we're not talking beyond that.

Operator

[Operator Instructions] And your next question is a follow-up question from the line of Adrienne Tennant, Janney Capital Markets.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Michael, this is really quick. I just had a very quick question. What is the fully diluted share count that we should use in 2Q if you were to make a profit? Because it's been basic for so long, that I just want to make sure I have the right number, if it's profitable.

Michael W. Kaplan

Yes, the diluted share count we have is around 68,000,400.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

So if you make a profit, if you go into the $0.02 profit range, should I use a different number because that -- is that the basic number?

Michael W. Kaplan

Yes.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

I can get it offline. It's not a big deal.

Michael W. Kaplan

That's the number I have in front of me. I do have an answer to your other question. It's about $6 million for D&A, is the number you should use.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

For Q2 and go forward?

Michael W. Kaplan

On average, yes.

Operator

At this time, there are no further questions. I'd now like to turn today's conference over to Gary Schoenfeld for closing remarks.

Gary H. Schoenfeld

I appreciate everybody's interest. And send a friend to our SoHo store, we'd appreciate it. Thanks very much.

Operator

Thank you for your participation on today's conference call. You may now disconnect.

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