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Pier 1 Imports, Inc. (NYSE:PIR)

F4Q10 Earnings Call

April 8, 2010 11:00 am ET

Executives

Nancy Benson – Director of Treasury and Investor Relations.

Alexander Smith – President, Chief Executive Officer

Charles Turner – Executive Vice President, Chief Financial Officer

Analysts

Budd Bugatch – Raymond James

Brian Nagel – Oppenheimer

Irfan Senesi [ph] – Bank of America

David Berman – Berman Capital

Bradley Thomas – Keybanc Capital Markets

Anthony Chukumba – BB&T Capital Markets

Operator

This is Pier 1 Imports quarterly conference call. (Operator Instructions) I would now like to introduce Mrs. Nancy Benson, Assistant Treasurer and Director of Investor Relations for Pier 1 Imports. Ms. Benson you may begin.

Nancy Benson

Good morning everyone. Thank you for joining us this morning. Earlier today we issued a press release which included the detailed financial results for the fourth quarter and fiscal year ended February 27, 2010. In just a few moments we will hear comments from our President and Chief Executive Officer, Alex Smith, and Executive Vice President and Chief Financial Officer, Cary Turner about those results followed by a brief question and answer period.

Before we begin I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1935 and can be identified by the use of words such as may, will, expect, anticipate, believe and other similar words and phrases. Our actual results and future financial condition may differ materially from those expressed in any such forward-looking statements as a result of many factors that may be outside of our control. Please refer to our SEC filings including our annual report filed on Form 10-K for a complete discussion of the major risks and uncertainties that may affect our business.

The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update our forward-looking statements. The press release issued earlier today also includes a reconciliation of any non-GAAP measures that are being discussed today. If you do not have a copy of today’s press release you may obtain one along with copies of prior press releases and all SEC filings by linking through to the Investor Relations page of our website Pier1.com.

I would now like to turn the call over to Alex.

Alexander Smith

Thank you Nancy and thank you everyone for joining us this morning. Amazingly to me it was three years ago that I spoke to you on my first earnings call. It seems like yesterday. At that time I talked about how we were going to return out company to profitability. I didn’t know then what the economy was going to throw at us. So the recession has obviously extended our turnaround timeline. It has cost us a year but we stayed with our strategy, took advantage where we could and focused not only on the execution of our business priorities but on building the culture we all want for ourselves here at Pier 1 Imports.

Consequently we arrive here today stronger, leaner, more effective and more determined to take market share than ever before. Now Kerry is going to talk about our fourth quarter and year-end results. You will hear how our business has dramatically improved and will grasp just how much potential lies ahead of us. Kerry?

Charles Turner

Thank you Alex. Earlier today for the fourth quarter we reported net income of $35 million or $0.30 per share, a $64 million improvement over the net loss of $29 million or $0.33 per share reported for the same period last year.

Results for the fourth quarter of fiscal 2010 included special charges of $1 million which I will discuss later. Excluding these charges the company’s net income on a non-GAAP basis for the quarter would have been $36 million or $0.31 per share. Despite having started the quarter with 49 fewer stores than the year-ago quarter total sales for the fourth fiscal quarter increased to $396 million from $389 million. The increase in total sales during the quarter was primarily due to a comparable store sales gain during the period of 6.5%.

Comparable store sales increased as a result of traffic improvements in December and higher average ticket, average unit retail and conversion rates for the quarter. Merchandise margins for the quarter were $221 million or 55.8% of sales, a 1,150 basis point improvement over $173 million or 44.3% reported for the same period last year. A fourth quarter merchandise margin rate at this level has not been achieved since fiscal 1999.

Store occupancy costs at $67 million declined from $71 million last year due to the reduced store count and rental rate reductions achieved in existing stores. Gross profit for the quarter calculated by deducting store occupancy costs from merchandise margin dollars improved to $154 million or 38.9% of sales from $102 million or 26.2% of sales in the fourth quarter last year.

Fourth quarter selling, general and administrative expenses were well controlled and declined to $113 million, a $9 million decrease when compared to $122 million reported for the year-ago quarter. During the period, SG&A consisted primarily of $18 million in marketing costs, $77 million in payroll and $17 million in other G&A costs. Also, these expenses included approximately $1 million in special charges resulting from store closings and severance charges.

Reductions in store payroll, special charges and other relatively fixed expenses were partially offset by an increase in administrative payroll related to annual incentive compensation costs. As a percentage of sales, ongoing SG&A costs showed an 80 basis point improvement as they declined to 28.2% of sales from 29.0% of sales in the prior period. Overall, the increase in sales, improved merchandise margins and controlled expenses resulted in operating income for the quarter of $36 million, a $63 million improvement over the $27 million operating loss reported last year.

For the full-year fiscal 2010, we reported net income of $87 million or $0.86 per share compared to a net loss of $129 million or $1.45 per share last year. Total sales were $1.291 billion compared to $1.321 billion last year. The decline in sales during the year was primarily attributable to a net store reduction of 38 stores. The decrease from store count was offset by an increase in comparable store sales of 1.5% for the fiscal year. Excluding the January clearance event, traffic increased over the second half of the year, positive affecting comparable store sales. In addition, we experienced increases in average ticket, conversion rate and average unit retail. The comp store sales gain for the last six months of the year was 9.7%.

We are very pleased with the performance of our Pier 1 rewards program in fiscal 2010. For the year, the penetration rate improved to 24% of sales, up from 22% a year ago. Total sales on the Pier 1 Rewards Card increased 9% over last year. We will continue to work closely with our partner, Chase, and are pleased with what we have been able to accomplish. We will work together in fiscal 2011 developing dynamic marketing promotions aimed at growing our rewards card business. Our penetration rate target for this coming fiscal year is 26.5%. Chase has been a great partner and we look forward to continued success.

Merchandise margins for the year were $707 million or 54.8% of sales compared to $647 million or 49% of sales last year. The 580 basis point improvement is the result of reduced markdowns, lower supply chain costs, reduced freight costs and more advantageous vendor costs. Store occupancy costs at $267 million declined $17 million from $284 million in fiscal 2009. The decline was achieved primarily through 38 store closings and the reduction of rents in approximately 350 locations throughout the year.

Gross profit for the year improved to $440 million or 34.1% of sales from $363 million or 27.5% of sales last year. For the year, our attention to cost control resulted in a decline in SG&A expenses to $421 million down from $453 million in fiscal 2009. The expenses consisted primarily of $285 million in payroll, $61 million in marketing and $62 million in other G&A costs. Additionally these expenses included approximately $13 million in special charges resulting from the store closing costs, severance and other charges.

Ongoing SG&A expenses showed a 90 basis point improvement as a percentage of sales as they improved to 31.7% of sales from 32.6% last year. Inventory at the end of the year was $313 million or $38 per retail square foot compared to $316 million or $37 per retail square foot at the end of last year and included a much smaller percentage of clearance inventory as of the end of this year when compared to last year.

At the end of the year, cash and cash equivalents were $188 million, a $32 million increase over last year. For the year, operations generated cash of $71 million which included the receipt of a $56 million tax refund relating to changes in tax laws that occurred during the third quarter. Cash flow from operations were used primarily to fund the associated pause [ph] and repurchase of convertible debt as well as capital expenditures. Capital expenditures totaled approximately $5 million for the year and were primarily spent on existing stores and technology.

In addition to cash, our secured credit facility had a calculated borrowing base of $229 million as of the end of the year. After taking into account all reserve amounts and outstanding letters of credit of $86 million, $113 million remained available for cash borrowing. We did not utilize the secured credit facility during fiscal 2010 for any purpose other than letters of credit. Taking into account both the cash and cash equivalents and the availability under the line of credit for cash borrowings, our total liquidity as of the end of the year was $301 million.

Total debt as of the end of the year including the current portion was $35 million compared to $184 million a year ago. The reduction in debt was primarily accomplished through the repurchase of $79 million of our outstanding 6.375% convertible senior notes during the first quarter of the fiscal year. The notes were acquired in privately negotiated transactions at a purchase price of $27 million including accrued interest and as a result a gain was reported on this transaction of approximately $15 million during the first quarter.

Subsequently, during the second quarter, we entered into a separate set of privately negotiated transactions under which we repurchased an additional $5 million in notes and exchanged $64 million of the remaining notes for newly issued 9% convertible senior notes. As of the end of fiscal 2010, $17 million of the 6.375% convertible notes remained outstanding and is reflected on the balance sheet as a current liability net of discounts.

During the third quarter of fiscal 2010, all of the newly issued 9% convertible notes were converted into common stock. As a result we issued approximately 24 million additional shares of common stock. In connection with this conversion, the holders also received an additional interest payment of approximately $14 million. As of the end of the fiscal year outstanding shares of our common stock totaled approximately 116 million shares.

During the fourth quarter, we closed five Pier 1 Import stores. We ended the year with 1,054 Pier 1 Import stores with 973 stores in the U.S. and 81 stores in Canada with approximately 8.3 million retail square feet. Over the year, we closed 38 stores. Throughout the fiscal year, we have engaged our landlord community in rental reduction negotiations to achieve better store contributions across our entire portfolio. As a result of these efforts, we have negotiated approximately 350 rental rate reduction agreements with an average reduction of 23% over a two-year period.

During fiscal 2010, these agreements resulted in expense savings of $6 million and cash savings of approximately $10 million. We will continue to partner with the landlord community to achieve rental rates that ensure the long-term success of each Pier 1 Import store.

Looking ahead to fiscal 2011, we are not giving comparable store sales guidance but we will give you a framework from which you can build an earnings model. Comparable store sales are expected to outpace total sales gains by 500 basis points in the first quarter and 400 basis points in the first half of the year due to the significant store count reduction that occurred in the first half of fiscal 2010.

For the year, comparable store sales will outpace total sales by approximately 200 basis points. Comparable store sales face a tougher comparison in the second half of the year as we cycle back around to the 9.7 comp store gain achieved over the last six months of last year that I mentioned earlier.

Merchandise margins will further increase and should be at least 55% of sales for the year. It is anticipated that 10-15 stores will be closed in fiscal 2011 and we will open 3-5 stores. Taking into account the lower store base and average rental rate reductions, store rental expense is expected to be approximately $6-7 million less in 2011 as compared to 2010.

We also expect that SG&A expenses will be leveraged as total sales increase. Fixed expenses will remain relatively flat while variable expenses will increase at a rate equal to approximately one-half of the comparable store sales gain. Operations are expected to generate positive cash flow which will be used to reinvest in the business infrastructure.

As of year-end, we had a net operating loss tax carry forward of approximately $100 million. We will continue to utilize this carry forward to offset future taxable income. Once the NOL tax carry forward has been used up, the effective tax rate will be approximately 37-38%. Capital expenditures are expected to increase to $25 million as we update and expand our store portfolio and invest in additional systems improvements to further enhance the store experience for customers and to improve operating efficiencies wherever possible. Now I would like to turn it back over to Alex.

Alexander Smith

Thanks, Kerry. Over the past three years, we have improved and strengthened every aspect of our business, and as a result our relationship with our customers, our vendor network, our organization and our balance sheet are all overwhelmingly stronger than when we began this journey to return our company to profitability.

For some time, we have demonstrated that we can run a lean and efficient infrastructure and that we can improve our merchandise margin by being better merchants and better importers. What has been harder to demonstrate was that we could grow the top line and we have the recession to thank for this. However, it now seems as though the economy is getting a little stronger and giving us some tailwind. Consequently we are finally beginning to reap the rewards of our efforts with the comp store sales growth that we always knew would come in time.

We are now focused on unlocking the considerable opportunities we have at Pier 1 Imports for organic growth. Not that long ago our sales per square foot peaked at $235. Today our sales per square foot are $152. What a huge opportunity. We know our square footage can work much harder than it does today. There is no change of direction needed to accomplish this. We just need to keep getting better at being who we are.

As I have already said, we are now positioned with stronger vendor relationships, stronger customer relationships and a stronger balance sheet, all of which make us able to meet any future economic challenges. Internally, we have shifted our mindset from a defensive to an offensive position. Externally, we must capitalize on the strength of our brand starting with our unique market position.

Even though the economy has improved a little, our customers are still not spending as freely as they did before the recession and so the quality, design and price relationship in our merchandise is critical. Over the past three years, our expanded buying team has been traveling extensively working very closely with new and existing vendors to develop assortments that give our customers unique and special merchandise that remains affordable.

We have further improved the good/better/best differentiation in all categories to provide our customers with a broad range of options. All of these ongoing activities are helping us to create very compelling merchandise assortments that meet the current and changing needs of consumers and will help us to gain market share. Comp store sales gains, growing conversion rates, more traffic and expanded merchandise margins are all evidence of this.

We are extremely pleased that over the past six months we have seen improved sales throughout the store. Every product category has shown gains over the last year. Of course, we still have significant room for further improvement. Opportunities exist to grow sales in all major categories, including furniture. I have every confidence that our buyers and our leadership will continue to raise the bar as they struggle to reach our Shangri La; the perfect assortment.

Our merchants are not alone in their quest. They have strong P&A partners, improved systems, improved planning routines and more sophisticated analysis are helping to optimize the effectiveness of every SKU we buy. Consequently, improvements in sales will be achieved without corresponding increases in inventory.

Our second opportunity for organic growth is to capitalize on our strong brand name and our loyal and broad customer base. Our market research tells us that for an overwhelming majority of our customers Pier 1 Imports is one of their favorite stores. This is no surprise to us as 24% of our sales are on our loyalty card. Over the past two years, we have spent more of our marketing dollars on communicating to our cardholders rather than acquiring new customers. This made sense in a recessionary environment. However, we are now ready to cast our nets a little wider. There are still former Pier 1 Imports customers out there who we need to reconnect with and then of course there are brand new customers.

Our media mix for fiscal 2011 is not dramatically different from fiscal 2010 but it is skewed more heavily to acquisition. Our FY11 budget has a holding marketing cost at around 4.5% of planned sales. Having said that, we have constructed our plans so that we can increase our spend if we feel certain the economy is improving and our customers have a propensity to spend. We call this our “pushing on an open door” strategy.

Pier1.com, our website, is looking much, much better. We are very pleased with it. Over the past year, the number of visits to the site has increased 19% and amazingly our dwell times are longer than when we were selling on the website. For a great many of our customers, the website serves as our first sales associate. Therefore we plan to invest additional capital dollars into further improvements. For the time being, Pier1.com will continue to be utilized for marketing and pre-shopping purposes but at some time in the near future we will make a return to online selling. At this stage, our plans are embryonic but they are plans nevertheless.

Pier 1 Imports has something that no other specialty home retailer has; a store portfolio that puts over 80% of all target customers within a comfortable drive of a Pier 1 Import store. This is a huge strength that is not always fully appreciated. High quality customer service and the treasure hunt atmosphere that customers enjoy so much is something that no catalog or website can provide. Our store managers and their leaders assisted by a very strong visual merchandising team deliver a store experience that is vastly improved but it can be even better. Going forward we will continue to work towards a superior in-store experience for our customers and this year we can start to reinvest in our stores as Kerry has indicated.

We will be modest initially, testing new fixtures and floor sets to see how best to help drive up those sales per square foot. Our stores will be the engine room of our company for the foreseeable future which is why we have worked so diligently to partner with our landlords over the past year to retain our coast-to-coast network of stores. I don’t like to close stores. In fact I hate it but sometimes we have to and we will continue to do that when and where it is necessary.

In FY11 we will open a few new stores which is great news and expect net closings of 10-15. The strong relationships we have built with our landlords is helping us develop a pipeline of new locations and we anticipate that in fiscal 2012 we will be opening more stores than we are closing.

Over the past three years, we have demonstrated our ability to dramatically cut costs in a smart way. Our leaner and more efficient infrastructure has made us better equipped to meet the challenges presented by the recession over the past 18 months. These reductions are permanent. While some variable costs will increase with sales, we remain committed to controlling costs and keeping our company lean and efficient.

We have also been able to reduce our merchandise costs by working with our vendors to reduce vendor product costs and by working with our transportation and shipping partners to lock in reduced transportation costs. We have significantly reduced the mark down risk in our inventory by refining our buying processes and making smaller initial purchases. Although we have generated significant improvements to our initial margin there is still further room for improvement.

Our stronger merchandise margins are a consequence of this and of course more of what we buy hits the bulls eye. As a result of these margin and cost improvements, we expect to see a good percentage of sales gains flowing through to the bottom line, further improving our cash flow. Because we have taken significant costs out of our business, we believe we can achieve double digit operating margins at a sales per square foot less than our previous peak.

Fiscal 2011 is off to a good start as the sales and margin trends we saw in the second half of 2010 have continued into this year. As we told you earlier today, our comparable store sales for March increased 19.4% driven by improvements in traffic, conversion rate and average ticket. Early Easter helped of course and our seasonal sell through was very good but it was more than this. We are seeing positive results in every merchandise category and our merchandise margins continue to be strong as well.

We started the new year with a strong balance sheet and a very strong leadership team. It has taken us three years to fully transform our leadership but I feel very good that we have the right players in place; a great combination of skill and experience, our management team is fully able to realize the potential for organic growth that exists in our business. Our team will work together to generate cash so we can strategically and judiciously invest in our business. We will make physical store improvements and enhance our technology and infrastructure.

Although we cannot predict what the economy will do, it is our plan and our expectation that by executing our updated business priorities, we will be able to move even closer to reaching the historical highs for merchandise margin and make significant improvement in our sales per square foot in fiscal 2011.

Thanks for listening to us today. We will now take your questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Budd Bugatch – Raymond James.

Budd Bugatch – Raymond James

You talked a little bit about updating the store portfolio and being a reason for the increased CapEx. Can you give us a vision to the extent that you can of what you are looking for in an updated store portfolio and what the penetration might be and the kind of timeframe?

Alexander Smith

We are starting the first wave now and there will be a second wave during the quiet time over July and August. We are planning to touch around 50 stores this year for a fairly major overhaul that will include the infrastructure pieces in the store, making sure they are painted and decorated and the lighting is up to -- there is quite a bit of lighting upgrading we need to do. Then we will be taking out some of the older fixturing and replacing it with new fixturing which we think will better show off the assortments. We are not at this stage going to touch the perimeters but we are going to look at those as we move into the new store program.

Budd Bugatch – Raymond James

Any ability to disclose what might be the financial impact per store of that kind of updating?

Alexander Smith

Not really. I said in the prepared remarks that we are going to be judicious. That is really why we are doing this sort of spending a relatively large amount of money per store over a small number of stores so that we can really evaluate is it cost effective or do we need to simplify it or can we do even more. I think as we move through the year and we start to get some response to those early conversions we will update you as we go.

Budd Bugatch – Raymond James

On another topic, and maybe Kerry can help us with some math in taking the penetration of reward cards up 250 basis points over the year, what is the impact on comps of that penetration? I thought the reward cards have a higher average ticket. Is that correct?

Charles Turner

Right now I am not going to answer that just because we are trying to see exactly how that penetration works and see if those trends do continue.

Budd Bugatch – Raymond James

Is the average ticket on a reward card still about three times?

Charles Turner

It is 2-3 times. The more rewarding piece of all of this is the fact we are capturing her name and she starts shopping with us more frequently.

Budd Bugatch – Raymond James

What is the frequency of shopping differential between a rewards card customer and…

Charles Turner

Almost up to double.

Budd Bugatch – Raymond James

You talked about being able to control transportation costs going forward and we are hearing that containers obviously are in shorter supply and more costly than they have been. Can you talk a little bit about how you have been able to do that and maybe what the impact of that container shortage might be?

Alexander Smith

If we go back a year when the costs were at rock bottom, we talked to the shipping lines and the guys here did a very smart thing. They said you cannot afford to ship goods at those prices you have quoted us. So we said we are happy to pay a little more but we need to lock in a two-year deal. We are in the second half of a two-year deal with our major shipping lines. Clearly that sort of spirit of collaboration goes a long way. What we are now doing during the second of those two years is starting our renegotiations so that we can do a back-to-back contract. We don’t expect any huge hikes. Pier 1 Imports is not suffering any disruption or disturbance to our shipping at all. Others may be short of containers. We are not.

Charles Turner

More importantly I think what we are trying to do is just lock those prices in for a longer period of time.

Operator

The next question comes from the line of Brian Nagel – Oppenheimer.

Brian Nagel – Oppenheimer

As we look at the March sales performance which you provided us and you commented not only the sales but also the margin performance, could you help us understand maybe the cadence of comps through the month so we can maybe better isolate whether there was any benefit from the Easter shift?

Alexander Smith

Through the month?

Brian Nagel – Oppenheimer

Yes, through the month.

Alexander Smith

Actually the month was surprisingly consistent. It was a five-week month as you know and our comps were actually pretty similar every single week. Having said that, there obviously was an Easter impact in there. We think that could have been sort of 3-4% of our sales gains. It was a really steady month. I don’t want you to think it was just a great big hiatus around Easter because it wasn’t.

Brian Nagel – Oppenheimer

With sales starting to improve now you have obviously made a lot of very positive structural changes in the business over the last few years. As we look at these improving sales trends, do we have a better idea now how much of your cost controls and structural improvements you have made in the business will be able to stick as we layer in better sales?

Charles Turner

I think I tried to give you that. I think if you take a look at our ongoing SG&A costs and if you want to model, keep the fixed costs relatively flat because as Alex said we are going to be very prudent in trying to limit those. The variable costs take them up probably half of what you are modeling the comp increase to be.

Operator

The next question comes from Alan Rifkin – Bank of America.

Irfan Senesi – Bank of America

This is Irfan Senesi [ph] in for Alan. A question on traffic. I want to delve into that a little more. If you could provide any directional breakdown between ticket and traffic for the quarter? And in particular, you had called out in the press release traffic improvement in December. If you could give any color on posted December trends?

Charles Turner

I think what we said for the last six months if you take a look at the last six months of last year and you take a look at that 9.7% comp it is really 1/3, 1/3, 1/3. One-third is being driven by traffic. One-third is being driven by conversion rate and one-third is being driven by average ticket. Those are the same trends we saw from March.

Irfan Senesi – Bank of America

With getting a higher penetration of your card holders, just any color you can provide in terms of the customers that are coming in, the new versus prior and existing customers, I know it is going to be a focus to kind of broaden your marketing efforts but of the traffic increases you are seeing any breakdown of the customer demographics?

Alexander Smith

I don’t think we can give you that. Not because it is a secret but we don’t really track it like that. We measure total traffic and we have good stats on that and we know what people are spending on the card but the balance we really can’t tell you who are new customers and who are repeat customers.

Charles Turner

I would just add all we really know is anecdotally we are having people come into the store that haven’t been there for a while and in addition to the people who are coming in are coming in more often.

Operator

The next question comes from the line of David Berman – Berman Capital.

David Berman – Berman Capital

I am wondering if you could embellish on your internet business which you said is in the embryonic stage. I am curious how much you have learned from it at the moment because you said people dwell longer on it. So I am wondering how much that has helped you look at your product and what you are selling? Secondly how do you speed it up because obviously that could be a potential for profit.

Alexander Smith

What we are finding at the moment with the dwell times, we have a percentage of our total assortment on the site but it isn’t all of the assortment. The first thing we are going to do is get a much higher percentage of what we sell on the site. We think that is going to help significantly. That is one of the enhancements we are actively working on as well as giving customers more suggestions about uses of the merchandise, room settings and design ideas and all those good things. In terms of when we actually start selling via the web, we are looking at that very actively. I think as soon as we have some clear dates in mind we will update you.

David Berman – Berman Capital

In terms of the month of March, you mentioned the improvement in business came from a variety of areas. What surprised you the most in terms of the big improvement in your products that did much better than you would have thought?

Alexander Smith

I don’t know that I would call it a surprise or just kind of pleasing that we got what we wanted is the fact we did see across the board improvements. Our furniture businesses did well. We got a good start this season in our outdoor business. Our home décor businesses did well. Our tabletop business did well. I know that sounds like a very bland answer but actually it is the truth. We haven’t seen this for a long time. What we have seen previously is one category would be doing quite well but then we would be struggling a little bit in another. What we are really pleased about is the evenness of the business throughout the store.

David Berman – Berman Capital

Since you mentioned outdoor, the outdoor stuff the weather must have helped some. A question earlier you were asked what the business was like during every week and you said it was very stable. I guess what that analyst was trying to get at was what is the run rate. You said it was fairly stable. What is the run rate roughly right now do you think at Pier 1? Are we looking at 15%? What is the run rate right now?

Charles Turner

I think we just want to take a look at this and continue to monitor it. I think Alex did answer your question. The run rate for March remember last year was a -9.75% comp and without the impact of Easter maybe the comp was right around 15-16%.

Operator

The next question comes from the line of Bradley Thomas – Keybanc Capital Markets.

Bradley Thomas – Keybanc Capital Markets

I wanted to follow-up a bit more about merchandise margins. You are not too far off of that prior peak that I believe is about 55.3%. I know you mentioned you thought merchandise margins would be at least 55% this year. Can you talk a little bit more about structurally what kind of permanent costs you have pulled out of the merchandise margin side of the business and maybe where you think highs could go if you do plan your inventory appropriately?

Alexander Smith

Here is what we absolutely know. Our sort of initial mark or buyers mark is very strong and we think that will continue to strengthen a little bit throughout this year. We are pretty confident our mark down as a percent of sales is going to reduce throughout this year just because we are doing everything a lot better. The piece that we are not quite sure on is how much we are going to have to spend on promotional mark downs because that is a function a little bit of the economy. So all the time we are trying to balance that promotional mark down spend versus the revenues. So that is the piece that is harder to pin down.

The stronger the economy gets, the lower the amount of promotional mark down we will have to spend. So therefore the merchandise margin will go up. That is kind of all the moving parts we look at. We are pretty confident there is upside in the merchandise margin.

Bradley Thomas – Keybanc Capital Markets

To follow-up on your comments about the marketing and potential investment to try and increase the acquisition of new customers, could you share with us a bit more about the possible marketing avenues you might take this year?

Alexander Smith

It is not too dissimilar to last year. The backbone of our marketing is our in-store events which are supported by either retail mailers which go to targeted addresses, our customer base obviously, and then some lists that we buy. Then on top of that we do a slim down version of the books that we distribute through sort of shared mail and newspapers and things like that. That is less specific in terms of targeting. That is kind of the backbone of our print.

We will do two flights of TV this year, one in the early fall and one in holiday. The holiday one is the same as previous years. The fall one is new. So that is additional. Then underneath that are specific activities which go towards either our Pier 1 Rewards Cardholders or we have programs for new movers and things like that. Then the final layer is all the electronic marketing we do on top. So it is pretty multi-layered.

Bradley Thomas – Keybanc Capital Markets

I know a number of other people have asked questions about performance among different categories. Is there a great difference in terms of the magnitude of sales growth between furniture versus decorative accessories? Does the price point matter in terms of the rate of sales growth we are seeing?

Alexander Smith

Well, within each broad merchandise category, there are obviously a number of departments and the departments within the categories, there are fluctuations. I was talking to the broad categories. The broad categories are pretty similar in truth, although as I say there are fluctuations at the department level. So what was the second part of that?

Bradley Thomas – Keybanc Capital Markets

First of all, any difference between furniture versus decorative?

Alexander Smith

Not really. As you know, furniture is 40% of our business and it continues to be 40% of our business. I think the big news on furniture and I would make this point is historically the merchandise margins of our furniture dragged the average down because they were quite significantly below the non-furniture. We have worked very hard to even that out. What you see now is a much closer fit between our merchandise margins on furniture and non-furniture. That is good news because we don’t have to try and manipulate the mix. We can just follow the customer and whatever she wants we will supply without it having a detriment on our margin.

Bradley Thomas – Keybanc Capital Markets

Anything geographically that seems different or anything you would call out?

Alexander Smith

Yes. Some of the parts of the country have come back from the dead which is terrific. We have seen an uptick in business in Florida which we are pleased with. We have seen an uptick in business in California and the west coast generally which we are very pleased with. Again a much more even performance across the country than you were seeing in the last fiscal year.

Operator

The next question comes from the line of Anthony Chukumba – BB&T Capital Markets.

Anthony Chukumba – BB&T Capital Markets

A quick question on capital expenditures. You mentioned you are planning to spend about $25 million on CapEx which is a significant increase from the $5 million you spent last year but you are only planning to open 3-5 stores. If you could just give us some color in terms of where you are going to spend that CapEx? I know you mentioned 50 store remodels as well as making some changes to the website. Just some color on that?

Charles Turner

When I take a look at CapEx, I would say half is going to be for stores and the other half is going to be for IT projects. As I said, the IT projects are going to be primarily to improve efficiency and to improve the customer experience. The fixtures is just a subset of the CapEx for the stores. A smaller amount is for the new stores. We are looking at wanting to touch a significant number of the stores over the next three years just to, if nothing else, give them a fresh set of paint and to refresh them. When I take a look at the CapEx of $25 million, if you look at the last couple of years it has really been de minimis and we have done a good job controlling that expense but we feel the $25 million is the right number.

Anthony Chukumba – BB&T Capital Markets

Given the fact you have cut back on your CapEx is some of the CapEx spending on the stores going to be almost like catching up?

Charles Turner

No, it is really the intent is to drive sales and sales per square foot and show the product off a little bit better.

Alexander Smith

Thanks for joining us today. Thanks for your questions. We will talk to you in three months.

Operator

Ladies and gentlemen, thank you for participating in today’s conference call. You may now disconnect.

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Source: Pier 1 Imports, Inc. F4Q10 (Qtr End 02/27/10) Earnings Call Transcript

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