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Executives

Craig Gosselin – SVP, General Counsel and Human Resources

Gary Schoenfeld – President and CEO

Mike Henry – SVP and CFO

Analysts

Adrienne Tennant – FBR Capital Markets

Janet Kloppenburg – JJK Research

Tracy Hogan – Credit Suisse

Jeff Van Sinderen – B. Riley

Liz Dunn – Thomas Weisel Partners

Lee Giordano – Imperial Capital

Stacy Pak – SP Research

Dana Telsey – Telsey Advisory Group

Betty Chen – Wedbush Securities

Paula Torch – Needham and Company

Pacific Sunwear of California, Inc. (PSUN) Q4 2009 Earnings Call March 11, 2010 4:30 PM ET

Operator

Good afternoon. My name is Christian, and I’ll be your conference operator today. At this time I would like to welcome everyone to the fourth quarter and yearend 2009 earnings conference call. (Operator Instructions) I’ll now turn the call over to our host, Mr. Craig Gosselin, Senior Vice President and General Counsel. Sir, you may begin your conference.

Craig Gosselin

Hi, good afternoon everyone, and welcome to the Pacific Sunwear of California conference call announcing our fiscal fourth and yearend 2009 quarterly financial results. This is Craig Gosselin; I am Senior Vice President, General Counsel and Head of Human Resources. This call is being recorded and the playback will be available starting today approximately two hours after the call through midnight on March 18, 2010. It can be accessed at 800-642-1687 or 706-645-9291, pass code 59365693. The call will also be archived on the PacSun website at pacsun.com through midnight on May 19, 2010.

Your speakers today are Gary Schoenfeld, Chief Executive Officer; and Mike Henry, Chief Financial Officer, and the call today will be limited to one hour. 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 2009 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 on the Investor Relations on our website pacsun.com. All information discussed today is as of today's date, PacSun 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, not for rebroadcast or used by any other party without the prior written consent of PacSun.

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

Gary Schoenfeld

Thank you, Craig. Good afternoon and thank you for joining us today. I will start with a few brief comments about our Q4 results and then step back and talk more about the priorities for fixing our business and the progress we are making. Mike will then provide you with more of the fourth quarter financial details, our guidance for Q1 of 2010 as well as share some additional metrics regarding how we are looking at the year as a whole.

Fourth quarter comps were down 19% in line with our expectations. Excluding a non-cash reserve against deferred tax assets, we had a loss for the quarter of $0.26 capping another very difficult year for PacSun. Yet as difficult as the business has been, there were a few important bright spots including improving trends in our young men's business, of more than 800 basis points improvement and overall merchandise margins, and a 16% reduction in inventory, which coupled with a $26 million tax refund contributed to a strong year-end cash balance of $93 million.

Certainly when I joined I knew that we would need to move quickly to begin to dig our way out of a fairly deep hole as we can't continue to see our business decline like it has over the past two years. I believe the steps we are taking will begin to stem this decline and hopefully get us back to positive comps by Q4 of this year.

Specifically I'm going to outline the six key initiatives in areas of focus that are fundamental to fixing our business. First is strategy. The strategy I outlined last August remains the foundation for turning our business around tied directly to brands and product. We have made great progress in reconnecting with our heritage brands, and are excited about making brands like Fox, Volcom, Hurley, DC, Billabong, Roxy, Bams [ph] and Nike, and others, important destinations and reasons to come first to PacSun.

We have also redefined the role of our own proprietary brands as a complement to our heritage brands, and giving us the necessary flexibility in denim and certain other categories to compete with the many vertical retailers that have come to dominate much of the retail landscape. Additionally we are adding a select number of emerging brands, which combined with our heritage and proprietary brands give us the capability for offering 15 to 22-year old guys and girls an unmatched selection of fashionable and authentic product.

Second is organization and culture. With the right strategy and a compelling vision for the future, we have been able to embark upon rebuilding our executive team and transforming the culture within our company. Having now let go of four Senior Vice Presidents and eliminated four additional Vice President positions, I spoke on our last call about the importance of attracting the right level of experience and leadership to help turn this around.

As most of you are aware, Christine Lee joined us three weeks ago as our Senior Vice President, GMM of juniors’ merchandising. Robert Cameron started in January as our SVP of Marketing; and Craig joined us in December as our SVP and General Counsel. Christine brings a great background in apparel and accessories from a company that I think many of us have quite admiration for at Urban Outfitters, and brings the ability to fuse customer insights, fashion trends and brands in ways that I believe will create renewed excitement for our juniors’ customers. Robert comes to us most recently from Levi's with great insights from building brands and creating world-class customer experiences, and Craig brings nearly 20 years of general counsel experience and a high level of professionalism, trust and dependability, which will be integral to our reestablishing a winning and collaborative culture within PacSun.

We continue to meet high-caliber candidates for other key positions to complete the rebuild of our executive team, and just this week we hired two tented merchants to help lead the rebirth of our young men and juniors' footwear and accessories. This leads to a third pillar, and obviously the business we are in, which is buying, developing, merchandising and selling great product. As we enter 2010, we are much further along in reestablishing our young men's business, which historically has been the cornerstone of PacSun. Leading with brands, our unique assortment of tees, boardshorts, denim, fleece, knits, wovens and footwear can move PacSun well beyond whereas ever been.

What I mean by that is PacSun will once again become the authentic retailer for action sports and California lifestyle brands as well as a great store for our customers who are more fashion savvy compared to a more typical customer in PacSun's heyday five or eight years ago. We anticipate a single-digit negative comp in our guys business for this first quarter with an internal target of making this up and getting to a positive comp for the year as a whole. On the juniors’ side, we are making a number of important changes starting with who is our customer, how do we segment our merchandising, and how do we move more swiftly both to anticipate and react to changes in the marketplace?

Four months into my time here, I made the decision that we needed to move in a new direction. Since that time, in addition to having just brought Christine on board, we have begun testing some more fashionable styles and reworked products where we could with changes starting to show up in how we look in the stores in the next 30 days, and certainly building in the months ahead. Recognizing that we are in the midst of what will be a very tough first quarter; we expect to see improvement in our juniors’ comp trends in each of the subsequent quarters targeting a positive comp by holiday.

A fourth key piece to this turnaround is store experience or as I like to say, knowing and loving our customers. Plain and simple, we need to improve the consistency with which we provide great customer connection everyday in every store. We have begun to make the necessary transformation from process to people and the overall experience this past holiday season was a significant upgrade from what it had been in our stores only six months prior. Our field team of 11,000 brand reps up to our GMs and regional directors are seeing the positive changes we are making internally, and I believe are genuinely committed to helping transform the customer experience at PacSun as we seek to become teens’ favorite place to shop.

Fifth is marketing. I said when I joined that I felt that PacSun has never fully taken advantage of the marketing potential and customer connection that could be created by truly embracing the full capabilities of the brands it carries. I am not going to be specific about our marketing plans at this time, but I can say with confidence that we have got some exciting things in the work to reestablish an emotional connection between our customers, PacSun and our brands.

The sixth critical initiative for us ties to store clustering and merchandising localization. Supporting our product strategy has been a great deal of work over the past five months to systemically differentiate our assortments across our nearly 900 stores. We recognize that teens have much more diverse interest than previous generations, and as such the one-size-fits-all approach to brands and fashion will not optimize the business with a scale and reach of PacSun across all 50 states.

Localization is about understanding fit, style, brand, fashion, economic and seasonable variables, and systemically creating methods for getting the right products to the right store groups at the right time. On the first day I joined, I asked what’s different about our back-to-school assortment in Boston and San Diego, and the answer I received was essentially nothing. Similarly, one could have shopped in Florida, Texas, Puerto Rico, California or Hawaii at anytime from July through holiday in 2009, and not seen any new boardshorts, junior swim or beach sandals from PacSun. No, that won’t be the case going forward. As an example of the importance of localization, we now have 93 stores, designated hot market stores, which will be appropriately started year around in these categories.

As we indicated on our last call, the previous decision to create nearly 300 value stores failed to improve our business. The merchandising transition for these stores will be completed by May, and with a much more rigorously developed store clustering and localization methodology being implemented for back-to-school. Each of our current 885 stores will be grouped into one of 13 store clusters. The expected result is a better mix of styles and brands specifically tailored to each of our stores, and thus we believe a key driver of better sales and better margins. So to sum up, we remain well aware that we are turnaround with a lot of work ahead of us. At the same time, I believe 2010 can be an exciting year for PacSun as we execute on our key initiatives.

I'm delighted with the additions of Christine, Robert and Craig over the past 90 days, and quite confident that with their talents and experience along with a few additional hires we will be accomplish a significant transformation in leadership and culture within my first 12 months, which will be critical to our long-term success.

As I turn the call over to Mike, I will close by saying that I am quite enthused about the opportunities that lie ahead. I remain hopeful that our combination of great brands coupled with meaningful proprietary product, efforts to improve our store environments, new methods of marketing PacSun and improvements in how we managed our assortments will begin to show progress in 2010 and set us up for further improvements thereafter. I will turn the call over to Mike.

Mike Henry

Thank you, Gary. Good afternoon everyone. Our fiscal 2009 fourth quarter results were as follows. Total sales were $293 million this year versus $352 million last year. Same-store sales declined 19%, primarily due to a decrease in total transactions. We ended fiscal 2009 with 894 stores versus 932 a year ago, a 4% reduction in total stores.

Gross margin including buying, distribution, and occupancy cost was 66 million or 22.6% of sales this year, versus $57 million or 16.1% of sales last year. Merchandise margins improved 890 basis points versus last year. Buying and distribution costs improved by a combined 20 basis points, occupancy costs declined $1 million but deleveraged 250 basis points on lower sales.

SG&A expenses declined to $94 million this year from $100 million last year. The $6 million reduction in SG&A expenses was primarily due to store payroll savings and lower depreciation expenses. Non-cash asset impairment charges were $11 million this year versus $12 million last year. Although lower-end dollars, SG&A expenses increased as a percentage of sales to 32.3% this year versus 28.4% last year, due to the leveraging these reduced expenses on lower sales. For the year, total SG&A was $41 million below 2008 results.

During the fourth quarter, we incurred a non-cash charge of $19 million or $0.29 per share to provide a valuation allowance against certain of the company’s deferred tax assets. As a result, our GAAP net loss for the quarter was $36.5 million or $0.56 per share. On a non-GAAP basis excluding the impact of this charge, our net loss for the quarter was $17.4 million or $0.26 per share. The non-cash charge to establish the valuation allowances is required by the accounting rules due to our operating losses over the last two years, resulting in the three year cumulative operating loss for the company as of the end of the fourth quarter.

We are also projecting to incur an operating loss in fiscal 2010. By continuing to maintain a valuation allowance against our deferred tax assets, we will no longer be recording income tax benefits against future operating losses, and thus will have a very low tax rate going forward. The valuation allowance would be reversed in the future when the company returns to sustained profitability.

Now to the balance sheet. We ended the fiscal year with $93 million in cash, no borrowing base debt, and our total inventories at cost were 16% below last year's level. We did not access our credit facility for borrowings at any time during fiscal 2009.

Turning to the first quarter of fiscal 2010. We expect to report a loss per share in the range of $0.50 to $0.60 for the first quarter. This earnings range reflects the continuing impact of having a very low tax rate as noted previously. On a non-GAAP basis, using a normalized 37% effective income tax rate, we would expect to report a net loss of $0.32 to $0.38 per share for the first quarter. This earnings range is based on the following major assumptions. Same-store sales ranging from a decline of 13% to 18%, gross margin rate including buying distribution and occupancy of 19% to 21% versus last year’s 27% due to a combination of merchandised margin declines and occupancy deleverage.

SG&A dollars of $71 million to $74 million versus last year’s $77 million, including estimated non-cash store asset impairment charges of approximately $3 million to $5 million compared to $2 million of such charges in last year's first quarter. As we will no longer be recording income tax benefits against future operating losses, we currently expect our tax expense for the quarter to be approximately $500,000 due to taxable income projected to be generated in certain state and local tax jurisdictions.

While difficult to predict our full-year results for fiscal 2010, we are currently planning for sequential improvement in our same-store sales trends as the year progresses with a goal of returning to positive comps by Q4. As a percentage of sales, we are currently targeting gross margins to improve by approximately 50 to 100 basis points based upon improvements in merchandise margins offsetting further deleverage of occupancy expenses.

We currently are forecasting selling, general and administrative expenses to be in the range of $310 million to $320 million versus fiscal 2009’s result of $340 million. We are forecasting total capital expenditures for the year to be in the range of $20 million to $30 million with depreciation and amortization expenses in the range of $55 million to $60 million.

Operator, we will now take questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Adrienne Tennant with FBR Capital Markets.

Adrienne Tennant – FBR Capital Markets

Gary, can you talk about the pressure on merchandise margins, and kind of the mix shift from private label to branded, how that’s doing? And when should we see kind of that impact sort of offset the pressure that I am assuming is coming from markdowns? Is that what we are continuing to see in the first quarter? So I’ll start with that, if that’s okay, and then I’ll have one follow-up.

Gary Schoenfeld

I think the short answer to your question is, we expect improvements in the second quarter.

Adrienne Tennant – FBR Capital Markets

So I guess my first question would be, is the pressure from March margins coming from additional markdown activity in Q1? And then are you saying that the merchandise margin mix shift should improve and offset any markdown pressure in Q2?

Gary Schoenfeld

It isn’t really markdowns, per se. And I wasn’t here a year ago, so I can’t recreate everything that fits that. But yes, we came into first quarter pretty comfortable with our inventory position. The weakness in our business sits in our juniors business, and there will be some lower margin in moving through that business, but net net it’s just a matter of, as we build strength in the business, going from Q2 going forward, we are hopeful of margins improving. We certainly had improvements in margins in the fourth quarter, and there’s not a lot of detail under that and it is not a specific question of branded versus proprietary. It really is about the underperformance of juniors as a whole.

Adrienne Tennant – FBR Capital Markets

Okay. And so, I guess this leads into – so what gives you the confidence and what are you seeing that the company should get to positive comps by Q4?

Gary Schoenfeld

That’s a good question. I think it’s everything that I spoke to, I mean, the six initiatives that I addressed are around product strategy, relationships with the brands, clarity of customer, localization in merchandising, marketing initiatives, leadership that we brought into the team. This is going to be a very different company moving forward, and as we get underneath that and look at the opportunities that we have in both genders and in key categories of both genders, that is our expectation that we will turn the business around in that timeframe.

Adrienne Tennant – FBR Capital Markets

So, the team that you're putting together, I mean normally it takes anywhere from six to nine months for the team to really impact, given the lead time. Does that incorporate the lead time for everybody full 100% impact?

Gary Schoenfeld

I think that's realistic expectation, which is again, why we look to fourth quarter. As I indicated, we’ve got a solid team on our young men's business, and we continue to see improving trends there. So we're quite hopeful about the young men's business, really leading the turnaround of our business, and seeing good trends in several categories of our young men's business that gives us confidence in that. And then on the juniors’ side, with the addition of Christine, with things that we began working on in the 90 days prior to her joining, with projects we're working on with the brands, our Head of Design just returned from 12 days in Asia reworking some product for back-to-school, and so we're moving as quickly as we can, and yet I think that's right. I think six to nine months is a fair expectation to begin to see the culmination of the changes we have been making.

Adrienne Tennant – FBR Capital Markets

Okay. And the men's business is about what, 55, 45, men's to women's now?

Gary Schoenfeld

Give or take, that's a pretty good stab at it.

Adrienne Tennant – FBR Capital Markets

Okay, great. Best of luck.

Gary Schoenfeld

Thank you.

Mike Henry

Thank you.

Operator

Our next question comes from Janet Kloppenburg with JJK Research.

Janet Kloppenburg – JJK Research

I hate to believe at this point about the gross margin but I'm a little unclear, am I right that from the 19% to 21% you're forecasting for the first quarter that you look forward to be up 50 to 100 basis point in each of the next quarters, or just another 50 to 100 basis points as we go through the year?

Gary Schoenfeld

Now let me clarify, our expectation for the year is to be up on margins 50 to 100 basis points.

Janet Kloppenburg – JJK Research

Versus fiscal ’09?

Gary Schoenfeld

Versus fiscal `09. So we know that we are starting behind in the first quarter, and it's our expectation that we will make that up and turn positive for the year as a whole.

Janet Kloppenburg – JJK Research

It’s just a little confusing to me, Gary that you had such a rebounding gross margin for the fourth quarter, why gross margins would be so depress in the first quarter. Is it because of the volume of business is smaller in the first quarter and the deleverage, is that much more significant on occupancy?

Gary Schoenfeld

You know, that –

Janet Kloppenburg – JJK Research

Or it’s something going on in the women's business?

Gary Schoenfeld

There's a couple of pieces. So, yes, the seasonal falloff in Q1 versus Q4 accentuates the deleveraging on the real estate expense, which is a substantial number.

Janet Kloppenburg – JJK Research

Right.

Gary Schoenfeld

So, you're absolutely right, that is one piece of it. And then it's the relative weakness of the juniors, that is the second piece.

Janet Kloppenburg – JJK Research

Is it weaker than it was in the fourth quarter? That's what it feels like that the juniors business instead of firming or becoming less negative; it feels like it's weaker given these estimates.

Gary Schoenfeld

You know, the run rates are comparable. What I would tell you is we have really taken a cautious approach on inventory, and we came into Q1 with a significant decline in our juniors business. So what I can really kind of back up is say, I really made the decision in November that I was very uncomfortable with the trends and directions of our juniors business. Made change to the leadership at that time and made the decision that we are going to clamp down on inventory. Plan our juniors business cautiously, get the right team in place, get the right strategy in place, and then rebuild the business. And that's what we are in the process of doing.

I do expect that after a tough first quarter where there was almost nothing in November, I think you can appreciate there was very little at that time that we could do to meaningfully change what was going on other than try to cancel orders. And so against that, there are some things that are beginning to show some encouraging signs. There is some product we have begun testing and for the variety of reasons that I mentioned, we're optimistic about showing progress in the subsequent second and third quarters and set a target for ourselves to be positive by fourth quarter that I am optimistic we will achieve.

Janet Kloppenburg – JJK Research

Given the time you have been there and I know you have a new GM in running the women's business, have you identified what went wrong in women's and have identified a clear strategy for remedying that situation or could this be a test in refined strategy?

Gary Schoenfeld

I think we are good ways the way there in terms of strategy but at the time I want to let Christine have a bit of time to put her mark on that. I would share certain lay few things. One I don't think we had a good perspective on who our customer is and where we want the business to go. And one of the references that I began to hear out in the store was a reference to older brother, younger sister, and it only took two or three times to hear that to ask what I knew was the answer but I mean the reference that we had really made progress in terms of getting to that older teen guy customer.

Janet Kloppenburg – JJK Research

Right.

Gary Schoenfeld

Is that we have really been quite young on the juniors side, which then puts us in a very price promotional tough business with a lot of competition. And so I think one part is recognizing that we need to mirror some of the steps on the young men's side in merchandising to elevate the age range of our juniors customer, and then I think our second key part to that is understanding and we often use some of the brands to point to the difference, a customer who loves Fox as a brand has a pretty different aesthetic that a customer is walking in looking for Hurley or Roxy or Billabong.

And we hasn't done a good job of really understanding the differences between the customer, the brands side benefits with and the fashion as threat, they have been looking for and I think we have made very important progress on that kind of customer segmentation and I feel strongly – these businesses absolutely start with knowing our customer and only with that can merchant and product teams really go execute. So I do believe in Christine shares that we actually have a pretty solid foundation in terms of our strategy going forward that is materially different from how the company has been operating previously.

Janet Kloppenburg – JJK Research

Okay and just the last question, Mike, you're not going to love me for this one but given where productivity levels are, I was wondering if you guys were thinking at all about other opportunities to cut back on operating expenses. I mean, it's really pressuring the bottom-line and I am just wondering if there would be any other opportunity, I know there's a savings reflected in your guidance, but I am just wondering if there is a plan B here in case you don't get the sales productivity, if there's other opportunities to turn down some of these operating expenses.

Mike Henry

Fair question to ask. My answer is the same as it was six months ago. The fix of this business is going to come from recapturing the top line, and that is our focus. At the same time, hopefully appreciate by the results and the guidance. A, we're quite mindful of managing cash and inventory and I think we have demonstrated that. And B, we're looking for incremental opportunities to reduce expenses and that’s reflected in our guidance as well.

Janet Kloppenburg – JJK Research

Okay. Thanks for all your time and good luck to you all.

Gary Schoenfeld

Thank you.

Operator

Our next question comes from the line of Paul Lejuez with Credit Suisse.

Tracy HoganCredit Suisse

Thanks, it’s Tracy Hogan, filling in for Paul. A couple of questions. First, if you could give a little more detail on what is working in young men – you have talked about feeling more comfortable there, so just wanted to know what categories are working and which categories are lagging behind. And then secondly, out of your CapEx budget for next year, I was wondering if you could break that down into how much is for IT and how much store refreshes, if any, you will be doing? Thanks.

Mike Henry

You bet. Thank you. I was hoping somebody would ask that, delighted to talk about that. The short answer is there’s a lot of good things going on in our young men’s business. We are making a great statement in board shorts and very pleased with initial reactions to that. Similarly, our denim business has remained quite strong in – over the last several months. We are encouraged by trend we are seeing in our T-shirt business, which is fundamental. We have got exciting things going on in our cut-and-sew business and in addition to Bull Head, gaining more and more recognition.

Charlie and the team have done a great job of creating on the (inaudible) brand and we are getting customers starting to walk in and ask for that. So, there are several dimensions to our young men’s business that show great promise and give us the confidence in our outlook for the year. The only two real soft spots on the business have been – one has been fleece and the effect of that really lessens as we go forward in 2010, and more near-term, about the only category in the store right now that is a bit soft is just in casual shorts where there isn’t a lot of newness or excitement in the marketplace, and as a result, our expectations is that’s going to probably be a pretty competitive category as we go through the spring.

Tracey HoganCredit Suisse

And the CapEx?

Mike Henry

Yes, so your CapEx question about two-thirds to three-quarters of our projected CapEx would be store related. Very small number of new stores, less than five, and also less small number of refreshes or relocations, not more than ten, but also, maintenance capital factored into that and certain visual elements that we will be working on as we go through the year. We are going to do some things just building on that with an eye towards our top doors, somewhere probably our top 200 doors, doing some things that we think will be impactful in upgrading the overall improvement and perception as we re-launch PacSun. So, as Mike said, that's a key part of it. There are some I.T. opportunities that we are exploring, and those will be what kind of influences where within that range we end up. Obviously if we choose to do those, it will be because we believe that there's very compelling returns but those decisions haven't been made yet.

Tracey HoganCredit Suisse

Great. Thanks.

Operator

Our next question comes from Jeff Van Sinderen with B. Riley.

Jeff Van Sinderen – B. Riley

Good afternoon. Gary, I was wondering if you can give us little more color on how your new girls merchant is approaching the business, maybe some of the changes that we should expect over the next couple of quarters, if you can give us a sense – maybe is it shifting more to fashion, are the turn going to increase? What's happening with the shift or is there a shift in penetration from branded to private label? Any color on that would be helpful.

Gary Schoenfeld

Sure. I would say in short we have an opportunity to embrace fashion more, move quicker in how we execute that. And elevate the profile of who the customer is from an age standpoint. So beyond the things that I said at a few minutes ago, those would be the additional comments, and certainly we feel like we have an important opportunity to grow our tops business and we think – there's fashion component of that. But a second piece also ties to the better understanding of brands and the aesthetic that those brands represent, and then matching that through localization to the stores where those brands and that customer really resonate.

So as everybody internally knows, this whole effort around store clustering and localize merchandising I think has a huge ramifications for our business and certainly in our juniors business where trying to target fashion across 900 stores. I think you end up with kind of the lowest common denominator merchandizing approach and meetings and conversations with three of our top brands just a last 24 hours. We're all recognizing there's opportunity to elevate the merchandising targeted into the right stores, and then having a core level of merchandising that goes to all doors.

Jeff Van Sinderen – B. Riley

Okay. It sound like you're – well, you mentioned authenticity in the guys business. I'm wondering does that means you might start sponsoring some sort of action sports events or how should we think about that? And also, is that a different – the guys business have a different, more different authentic feel than the girls business or should we think about them as both being sort of duly authentic?

Gary Schoenfeld

Well, first and foremost, we are very committed to reestablishing PacSun as a very authentic brand and authentic in-store experience. Within the two genders, we believe that for guys, brand really leads, and then fashion follows. In terms of rank and total on the juniors side we would flip that and say fashion leads and then brand importance comes after that. So, there are some differences in execution between girls and guys.

To your question around sponsorship, PacSun does do some sponsorship. I think you're probably aware of the amateur surf team and a few other things. Sponsorship won't be a huge initiative for PacSun but is an important part of the brands that we work with and there will be opportunities for the brand certainly to continue to elevate their presence and their messaging with PacSun not just limited to sponsorship, tough it's everything they do from athletes to music to fashion and just youth culture. And as we tap into that with our core heritage brands there are some fun things on the horizon.

Jeff Van Sinderen – B. Riley

Okay. And then as far as inventory planning, I assume with your guys business doing better that in some categories you're planning the guys business up for back-to-school or maybe you're increasing orders in the guys business for back-to-school, is that a fair assumption?

Gary Schoenfeld

Yes.

Jeff Van Sinderen – B. Riley

Okay. And then finally, Gary, maybe you could update us on discussion you have had with your landlords and any opportunities there might be to close underperforming stores more than just what's coming up for lease?

Gary Schoenfeld

In short, as you imagine landlords want to keep the lights on. So, our expectation is we will probably end the year somewhere between 850 to 875 stores give or take. And like we have had very constructive conservations with the landlords, and at the same time we're talking about stores we want to get out of. We also have some pretty good stores where leases are coming up for renewal and if you're sitting on the landlord's side or if you're a landlord shareholder, you're talking about rent increases.

So when we look in aggregate we like outcome of what we’ve already result with several of our landlords and we’re still in active discussion getting closure on a substantial number of stores still with the couple of significant landlords as well. So in total I feel good about the direction that it's going. At the same time anybody should have an expectation that our rent is going to materially decline as a result of closing underperforming stores and it will decline some but there's also some pressure on some renewals and net probably keeps us where that number doesn't change in a profound way one way or the other.

Jeff Van Sinderen – B. Riley

Okay. Got it. Thanks very much, and good luck.

Gary Schoenfeld

Thank you.

Operator

Our next question comes from Liz Dunn with Thomas Weisel.

Liz Dunn – Thomas Weisel Partners

Afternoon. I guess, I apologize if I missed it but can you address what your cash flow expectations are for the year and within your SG&A guidance, does that include further anticipated impairments? Those are my first two questions.

Gary Schoenfeld

We didn't give a specific cash flow guidance and not intending to. We're not at this point in time trying to predict what sales are going to be over the course of the year. As to the second part of the question, sorry if you could just say that again?

Liz Dunn – Thomas Weisel Partners

The second part was did your SG&A guidance for the year include further impairments?

Gary Schoenfeld

Yes, it does.

Mike Henry

Yes, it does.

Liz Dunn – Thomas Weisel Partners

Okay, on the cash flow, I am sorry to come back to it but looks to me like your guidance implies a net income loss of somewhere around $70 million. So would $93 million on the balance sheet, you know, I think we deserve to know whether or not you expect to generate cash, the cash flow, you know, breakeven, or to use cash? I think that's a critical question for the shareholders.

Gary Schoenfeld

With all due respect, we haven't given the guidance for the year. So the conclusion about earnings per share for the year, we have given you as much of –

Liz Dunn – Thomas Weisel Partners

You have given sales gross margin and SG&A. I mean, guys, common you have given cash flow guidance in the past. It is really important. I mean, its fine if you can't answer it, but I don't think that bodes well for your stock so.

Gary Schoenfeld

Excuse me. I don't appreciate being interrupted. We have not given the sales guidance for the year. Let me be very clear about that. We have given indications for other key metrics for the year, which we think are important, and are prudent in terms of our outlook. We feel it’s premature to give sales guidance given the turnaround and so we have tried to give you as much of an indication on the business that we can.

From a cash perspective, we have given you as much guidance as we can in term of SG&A margins, CapEx and depreciation and amortization, but we are not comfortable making a sales forecast or guidance in which case we are not in a position to give you specific cash flow guidance. What I can say is we ended the year with $93 million in cash. We just went through a very tough year, having not borrowed a dime at any point in the last twelve months from a $150 million credit facility, and so those are the facts and expectations as best that we can share them. And, I appreciate the sensitivity around cash that existed 12 months ago. I think we sit in a much healthier position today, but we have commented as much as we are comfortable at this point in time.

Liz Dunn – Thomas Weisel Partners

Okay. And are there any discreet items we should know about, building sales or benefits of any sort other than what you have provided about depreciation and CapEx?

Gary Schoenfeld

No, not at this time.

Liz Dunn – Thomas Weisel Partners

Okay, great, thanks. Good luck.

Gary Schoenfeld

Thank you.

Operator

Our next question comes from Lee Giordano with Imperial Capital.

Lee Giordano – Imperial Capital

Hi, good afternoon, guys. Just a quick question, can you remind us what position just to looking the fill on the management side? Just want a sense there? Thanks.

Gary Schoenfeld

Yes, in two areas. The first is head of stores and the second is with respect to operations and inventory management.

Lee Giordano – Imperial Capital

Thanks.

Operator

Our next question comes from Stacy Pak with SP Research.

Stacy Pak – SP Research

Hi, Gary. A few questions, I guess, first of all, just I want to understand one more thing on the Q1 gross margin. I mean, it looks to me like you are expecting merchandise margin decline of, like, 500 basis points, if I am doing my math correctly, and then sort of just still wondering why that is? Can you – I don’t think you gave us, Mike, what the inventory plan is at the end of Q1? Is there some – is there a lot more juniors’ inventory and that's why you're expecting so much more pressure on merchandise margin in Q1? I know the comparison in Q4 was, ridiculously easy, but if you could just address that and then I have some other questions more about the future. Thanks.

Gary Schoenfeld

I appreciate the questions. There's not a lot more to add to the discussion in factors other than what we have already talked about in terms of the de-leveraging and pressure that comes as a result of fixed occupancy costs versus seasonally lower sales, and second, the weaknesses in the business. Those are the primary things; I guess kind of the only other factor that contributed some as you all know the way reseller accounting works. The company took substantial markdowns at the end of fiscal 2008, so going into first quarter of 2009 there is low owned merchandise that then get sold through at good margin, even though in reality in the stores to the customers, it is markdown; but under the resale accounting methods, that still flows through at good margin in terms of the income statement.

So, it's probably the combination of all three of those factors that contributed to what the first quarter is. And I haven't spent a lot of time trying to reconcile that, but I appreciate the importance of the question. So what I can be clear about is that we are going into the first quarter with a relatively clean inventory position both guys and girls and so it's not that we're sitting on real problematic inventory that's creating that pressure, and we similarly feel good about what our inventory plan looks like relative to starting the second quarter, and being in a position to capture – chase some business. So for the first time since I have been here this week, we have placed a T-shirt business with one of your junior T-shirt branded vendors, some pretty good consequence and that was pretty fun to talk about that.

Similarly was on the phone only a couple hours ago with another one of our key heritage brands, who believes that they've got some exciting juniors’ product for some at once and spring early summer business that we're not taking advantage of. So we're going to follow-up on that next week and see what some opportunities can be. So, I feel good about where we sit in inventory. I feel good about the position that Christine has walked into of rather than having to work through a whole lot of problems. We can look for opportunities, chase some opportunities, learn from some of those. And hopefully build our business back as the year goes forward and by Q4, which we all appreciate is our biggest quarter be back to where we're positive comps on both girls and guys.

Stacy Peck – SP Research

Just a couple more things, I mean, what is working in juniors? You haven't really touched on footwear overall. Love to hear any glimmers you can give us at all on marketing. And then, the bigger question I have is can you – my sense is you guys have some great information on what brands work in what store and what fashion work in what stores, and what stores are more guy-driven than girl or juniors, and I would like you to tell me is that in fact the case? Do you have that great information, and if so, how are you going to change the way you flow product through the year? I mean does it start in summer with swim? Talk to me about that one, how you're allocating? Thanks.

Gary Schoenfeld

Okay. So, as I spoke before about localization, we really see that impacting the business going into back-to-school. And as I mentioned each of our stores has been grouped into one of 13 store clusters, and in addition to those store clusters and bearing of assortments within those, we are now starting to drill store-by-store to see where particular brands overperform or underperform and develop methodology for distributing product to really maximize that. So, a lot of very good work has been done over the last few months to set ourselves up to do that, and the benefit of that I think will begin to really bear itself out going into back-to-school.

Stacy Peck – SP Research

Okay, so that's when the systems will work for you, so there's no other change in flows before that, Gary?

Gary Schoenfeld

No, I wouldn't. They play a role in the outlook that we have given and expectations for improvement in Q2 but I think they become more profound as we go into back-to-school, which is when the assortments really start to vary and weather and other factors play into that. But as a second part in terms of brand and better understanding where brands really have strength. Yes, we are now communicating that information and working with our key brands on looking at ways to drive that even more. And elevate presentations where stores are really strong and I think all of those factors will mean much more productive inventory, a much better customer experience of being in stock and the stuff that they want, and I think it's going to be an important part of the margin improvement we have set ourselves out for the year because we will have some real estate deleveraging is likely, and we're still optimistic that we can achieve overall margin improvement and it is the ability to deliver against the store clustering, along with overall better execution in merchandising in both genders.

Stacy Peck – SP Research

Okay. And can you just – I'll stop, I won't keep going on the questions but can you just address what is working in juniors?

Mike Henry

It's a pretty short conversation, and look forward to giving you updates about some things that are starting to work. That is we tested some things, some more fashionable bear in tank top, zipper front is certainly a key trend in bear and in dresses that we're seeing is happening. Our t-shirt business is improving relative to where that's been. Obviously denim is a really important category for us. That has not been performing well for the last several months. We think we have taken some important steps to address that as we get back into it go into back to school and then in fall. But, you know, we hope to tell you more as we really see the trends change as we go through the year.

Stacy Peck – SP Research

Okay, great. Thank you very much.

Mike Henry

Thank you.

Operator

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

Dana Telsey – Telsey Advisory Group

Hi, good afternoon, everyone. As you execute this turnaround and obviously there's always fits and starts as you move along, Gary, what is different than you may have expected when you first arrived? And how much of the difference, what's internal that’s different you may have expected and what's macro or external in the environment whether it's real-estate or competition, things like that? Thank you.

Gary Schoenfeld

Boy, that's a good question. Gosh. I should pause on that one for a moment. Being honest, what's different than what I expected is the opportunity to improve the leadership of the organization and the culture within the building as well as out in the field. So I am going to phrase those as important opportunities that I maybe didn’t fully appreciate the day I walked in but eight months later, I am pretty excited about the transformation that’s taking place in that regard.

I’d say secondly I have been really pleased with the degree to which we have been able to change the conversation with brands and re-engage with them in what I think will be highly productive ways that will continue to unfold during the year and going forward. And I mean, I’ll be more specific, we had a great meeting. We were over at early this morning and I think they’re really doing some great things in developing their organization and their brand. I’d say the same about a meeting that we had yesterday down at Fox’s office and as we talk about the other core brands that we work with, Volcom, Roxy or DC or Billabong. These brands are very in tune to youth culture. They’re very in tune to what’s happening competitively.

There’s a lot of talent and a lot of passion and we sit in a very exciting position to really be a cornerstone to all of their businesses. So I was quite hopeful that that would exist within the companies. I was pretty confident that they would re-embrace us, and I am pleased that’s the way that is, in fact, unfolding. Having said that, it’s a plenty competitive market out there, but I knew that when I signed on.

Dana Telsey – Telsey Advisory Group

Thank you.

Gary Schoenfeld

Great. I think we have about five more minutes, so maybe if we could take perhaps two more callers, please?

Operator

Understood. Our next question comes from Betty Chen with Wedbush Securities.

Betty Chen – Wedbush Securities

Thank you. Good afternoon. I was wondering if you can speak a little bit to any sort of regional differences you might be seeing, the west as we understand it, is quite important for Pacific Sunwear and we are starting to hear that region has been firming up. I am wondering what you are seeing. And then secondly in terms of the SG&A guidance, I believe, Mike you said earlier that did include impairment? Could you give us what the impairment charge would be for the full year? Thanks.

Mike Henry

So as to the first part of the question, we aren’t seeing demonstrable differences regionally that are worth calling out and speaking to. In addition, I would want to kind of clarify to the extent that perception is out there. We are pretty diverse around the country, and where we have stores we are pretty well spread out geographically as I think you could appreciate with almost 900 stores. As to the second parts, we made some internal assumptions with regards to ranges on impairments. I am not in a position to comment specifically on that yet because that assumes different sales and performance scenarios, and we're not in a position to – I think we commented on this a few moments ago but I think this is a little different context and spirit. So but not in a position to speak more specifically in terms of what we think that impairment range might be at this time. But we have given you the guidance for the first quarter and I hope that's helpful.

Betty Chen – Wedbush Securities

Okay. And then as a follow-up, I was wondering in terms of the localization effort and clustering effort. Gary, do you have all the systems you need to implement those initiatives, or are there additional investments as part of your CapEx plans for the year?

Gary Schoenfeld

I.T. is part of the CapEx budget and as I alluded to earlier, the range within the guidance hinges to a pretty significant degree on some potential investments in and around I.T. More specifically, though, to your question about localization, which is a good one, we are looking at some service solutions that can provide us some additional tools around price optimization and localization. But in the context of our overall P&L, they're immaterial in terms of that and we're exploring some of those tools as we speak. So we're making progress without that but to answer your question, we are looking at some additional I.T. tools that will help us maximize that. And again, that's part of why we anticipate more of the benefit coming in the second half of the year.

Betty Chen – Wedbush Securities

Just lastly, I'm sorry if I missed this earlier. In terms of shoes, I think one of the strategies was to get back into maybe sneakers and get them back in the stores. Where are we and will we be able to kind of see that in the stores by back to school?

Gary Schoenfeld

Yes. So our hope had been to be able to start during holidays. We were only able to get a very limited at-once assortment, so wasn't particularly meaningful, and we now, as we're going into March. You will see footwear in close to 200 doors and we look forward to build that store count and the depth of footwear as we go into back-to-school and continue to be excited about reclaiming that part of our business. We don't expect everybody to walk in day one and say I'm big all my shoes at PacSun again. But we certainly have our eyes set on reclaiming that business that we think is rightfully ours and rebuilding it.

Betty Chen – Wedbush Securities

Great. Thank you and best of luck.

Gary Schoenfeld

Thank you.

Operator

Our final question comes from Paula Torch with Needham and Company.

Paula Torch – Needham and Company

Hi, Good afternoon. Thank you for taking my question. I was wondering if you could update us on the accessories categories for men’s and juniors and maybe what trend you are seeing there. Are you going to putting any more emphasis on these categories for spring and maybe if you could touch on how you are thinking about these businesses going forward? Thank you.

Gary Schoenfeld

Sure. Again, we look at footwear as part of accessories and think they are important parts to the overall experience and lifestyle and teens wanting to shop. As I mentioned in the last week, and neither of them have started yet but it just turned out that we found what we think are talented people to head up the buying teams on both juniors and young men's, respectively. So, we feel like there is opportunities to improve that on both genders and look forward to making progress as the year unfolds.

I wouldn't say right now when you walk into PacSun any of us feel great about our accessories presentation and believe it's an opportunity to fix that. As I say, contribute to sales productivity of the store, but as importantly contribute to the overall experience and getting back to our goal of being a teen's favorite place to shop.

Paula Torch – Needham and Company

Great. I apologize if you’ve already touched upon this, just a follow up. How early should we expect to see Christine's influence on the juniors merchandise assortment?

Gary Schoenfeld

Someone earlier made the comment that realistically it's probably six to nine month, given product lead times, getting up to speed on a business, etcetera, etcetera. So, I think that's probably a pretty good expectation and is part of why we have said we really set our sights and seeing if we can get back to positive by the fourth quarter.

By the same token, I hope that each month between now and then as you go into our stores, you will start to feel like the overall juniors presentation is getting a bit better but I think the bigger impact is going to come in hopefully the biggest quarter of the year.

Paula Torch – Needham and Company

Great. Thank you very much and good luck for the first quarter.

Operator

That's all the time we have for questions today. I now turn the call over to Gary Schoenfeld for any closing remarks.

Gary Schoenfeld

Thank you. Appreciate everybody's interest and appreciate the hard work of the team here. We’re quite confidence and we've got a lot still to do. And we hope that we've given you more information how we're thinking about the business to the extent we have we haven't been able to answer every question with the specificity that people would like for the year as a whole. We obviously look forward to continuing to keep you apprised as we progress through the year. So, thank you all very much.

Operator

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

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Source: Pacific Sunwear of California, Inc. Q4 2009 Earnings Call Transcript
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