Good afternoon. My name is Jamica, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Craig Gosselin. You may begin your conference.
Good afternoon, everyone. Welcome to the Pacific Sunwear of California conference call announcing our fiscal first quarter 2010 financial results. This is Craig Gosselin, Senior Vice President, General Counsel and Head of Human Resources.
This call is being recorded and the playback will be available starting today approximately two hours after the call through midnight on May 27, 2010. It can be accessed at (800)642-1687 or (706)645-9291, pass code 74311650. The call will also be archived on the PacSun website at www.pacsun.com through midnight on August 18, 2010.
Your speakers today are Gary Schoenfeld, President and Chief Executive Officer; and Mike Henry, Senior Vice President, Chief Financial Officer. Today's call will be limited to one hour, and questions will be limited to one per participant.
Before I turn the call over to 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 in the Investor Relations section on our website, www.pacsun.com. All information discussed on the call is as of today, May 20, 2010. Pacific Sunwear undertakes no duty to update this information to reflect future events or circumstances. This call, the webcast and this replay are the property of PacSun. It is not for rebroadcast or use by any other party without the prior written consent of PacSun. With that said, I'll now turn the call over to Gary.
Thank you, Craig. Good afternoon, and thank you all for joining us. I will start with a few comments about our Q1 results and then update you on a couple of other topics. Michael will then provide you with more of the first quarter financial details and our guidance for the second quarter of 2010. On our last earnings call, we shared our goals for how we would hope to progress through 2010, targeting sequential improvement in our comp sales results from quarter to quarter with the goal of returning to positive comps by Q4 of this year.
Our first quarter results and second quarter guidance are both in line with our expectations when we started the year, so we feel we are off to a good start and continue to be optimistic about the prospects for further improvements as we progress.
Turning to some specifics on Q1. Total sales for the first quarter were $190 million. Our comp decline of 15% was consistent with our expectations and the 16% reduction in inventory with which we entered the quarter.
Highlights during the quarter were the continued improvement in the trending of our Young Men's business, favorable reaction to some of our initial newer women's products and merchandise margins above our expectations. The stronger-than-expected merchandise margins, together with expenses coming in as planned, results in us in exceeding our earnings guidance for the first quarter.
Leading our Young Men's business was our shift in strategy to embrace our heritage brands, which included leading the market with the best assortment of boardshorts. We aggressively went after the higher end and more technical products led by Hurley, Volcom, O'Neill and Billabong and eliminated any private label products from this category.
Additionally, we tested our first shop in shops with Hurley and Benz as we move to reestablish PacSun as the destination for great brands. Overall, our Young Men's business continued to improve with an almost flat comp for the first quarter compared to a low double-digit negative comp in Q4 of 2009.
With respect to our Juniors business, on our last call, I said that we had made the decision to dramatically cut back our Juniors inventory, having concluded last November that we do not have the right leadership or strategy in place, and that we were going to fix those things and then build the business back up as the year progressed. I felt that we were skewing too young, too basic and increasingly dependent upon promotionally priced proprietary products. Consequently for the first quarter, our Juniors comps were down in the high 20s on a more than 30% decrease in average store inventory and in line with our expectations.
Historically, I'm not sure that PacSun has ever had a sustainable year-round Girls business. Certainly, there was a time when brands like Roxy and Billabong new and hot in the market place resulting in a lot of hoodies and tees and bathing suits being sold at PacSun. And then more recently, a couple of years ago, we've gotten out in front of the new trend for skinny denim. Yet in neither case did PacSun establish the kind of foundation and destination like we have in Young Men's. So with our Young Men's strategy and execution soundly in place, we look to create a similar sustainable Girls business at PacSun based upon four key elements.
First is about strategy, and I believe that customers are beginning to notice the difference in our Juniors product as we target an older teen girl in a more fashionable aesthetic. This will become even more evident as we progress through the summer and reach back to school, and we have had some encouraging initial sell-throughs with more fashionable tops, shorts, dresses and sweaters.
Second is the team. Christine has now been on board for 90 days, and I'm quite pleased with the merchandising direction that she is providing as well as the talent that she is adding both in merchandising and design. Additionally, Kelly Bladow who has been with PacSun for five years and until six months ago was our Vice President of Juniors Value and Outlet Merchandising, has now taken on a new position of VP and General Manager for Juniors and Outlet. I think valuable experience to Christine's team and leading the cross functional execution required for both Juniors and Outlet business.
Third is speed and freshness. I just returned from Hong Kong last night and clearly, the rules have changed as the world is getting smaller and moving faster. The days of shopping in Europe for trends and then delivering a whole new collection 12 months later are pretty much behind us, thus, requiring a revamping of our internal timelines and processes. As aggressively as we have been working on redefining our design and merchandising and being crystal clear on who our target customer is, we have simultaneously been developing different ways of working with existing and new factories to give us the necessary agility to move quickly. Our product development team has done a great job leading this effort, and I'm increasingly optimistic about our ability to move from a high 20s negative comp in Q1 to hopefully a positive comp in Juniors by Q4.
Fourth, we need to create an in-store experience that makes PacSun a fun place to shop for her and her friends and a brand that she connects with and have to either Twitter her friends about or go home and post something on Facebook. Through our filter of California optimism, confidence, sunshine and individuality, engaging customer service and a unique mix of third-party and proprietary brands, we believe we can create this kind of passionate connection with our female customer in line with what we enjoyed on the guy side of our business.
Let me now add a few comments regarding marketing, real estate and the further development of our executive team, and then I will turn the call over to Mike. There are some exciting things on the horizon as we look to reconnect with teams across the country and build momentum towards back to school. I still don't want to give specifics today, but we're going to be doing some things differently from a marketing and branding perspective that we feel will begin to reestablish an emotional connection between our customers, PacSun and our important brands. If you have any 15 to 20 year olds at home or 22 year olds, tell them to keep an eye out for PacSun in the weeks and months ahead.
Turning to real estate. Over the past several months, we've been working to right size our store base and reduce the occupancy costs within our stores where possible. We are close to completing the bulk of these negotiations of more than 150 leases that covered lease actions from 2009, 2010 and some extend beyond that time. Included in these negotiations are short-term renewals of approximately 100 stores at reduced rates and longer-term renewals of approximately 60 stores with increases in top stores that still reflect the reality of our current business.
With respect to our executive team, in addition to Craig Gosselin as General Counsel, Robert Cameron as Head of Marketing and Christine Lee, as Head of Juniors who joined us in December, January February, respectively, another highlight for the first quarter was the addition of Paula Lentini who joined us last month in the critical role of Senior Vice President for Retail. I believe Paula will be a great leader of our more than 10,000 brand reps, managers and district managers who touch customers every day. Paula brings a wealth of experience having been a Zone vice president for seven years, split between GAP and Victoria's Secret, and then for the past three years was head of retail for T-Mobile, leading a $7 billion business with 15,000 associates and 2,000 stores. Like Christine, Robert and Craig, Paula has hit the ground running, and I'm excited about our potential to meaningfully improve our customer engagement and in-store experience, which is a nice way of saying getting a lot better at driving sales.
So to sum up, we know we still have a lot to do yet we continue to believe 2010 can be an exciting year for PacSun and the beginning of our transformation. I remain hopeful that our combination of great brands, coupled with meaningful proprietary products, efforts to improve our store environments, new methods of marketing PacSun and improvements in how we manage our assortments will begin to show progress in 2010 as we work to reestablish our leadership position in the mall.
I'll now turn the call over to Mike.
Thank you, Gary, and good afternoon, everyone. Our fiscal 2010 first quarter financial results were as follows: Total sales were $190 million this year versus $223 million last year; same-store sales declined 15%; we ended the quarter with 883 stores versus 927 a year ago; gross margin including buying, distribution and occupancy costs was $42.5 million or 22.3% of sales this year versus $61 million or 27.4% of sales last year; occupancy costs were roughly equal to last year in dollars, but deleveraged 380 basis points on a lower sales base; merchandise margins were 130 basis points below last year, but were significantly better than we were anticipating entering the quarter; buying and distribution costs were reduced by over $1 million and were flat as a percent of sales.
SG&A expenses declined to $73 million this year from $77 million last year. The $4 million reduction in SG&A was led by store payroll and depreciation savings. Non-cash asset impairments were $5 million this year versus $2 million last year. Although SG&A was lower than last year in dollars, SG&A deleveraged by 400 basis points on a lower sales base to 38.4% this year versus 34.4% last year.
Income tax expense was $338,000 for the quarter as a result of the continuing impact of the valuation allowance against our deferred tax assets. Our net loss for the quarter was $31 million or $0.47 per share versus our guidance of a loss of $0.50 to $0.60 per share. On a non-GAAP basis, using a normalized income tax rate of 36.4%, our net loss for the quarter was $20 million or $0.30 per share versus our non-GAAP guidance of a loss of $0.32 to $0.38 per share. We ended the quarter with $57 million in cash and no borrowing-based debt.
Given our performance in the first quarter, we continue to track with the targets for the year that we outlined on our last call, starting with sequential improvement in our comp sales results from quarter to quarter. Secondly, gross margin as a percentage of sales, is targeted to improve by approximately 50 to 100 basis points for the year based upon anticipated improvements in merchandise margins, offsetting higher occupancy costs as a percentage of sales. Lastly, SG&A expenses are estimated to be in the range of $310 million to $320 million versus $340 million in fiscal 2009.
More specifically to Q2 guidance, we're anticipating a same-store sales decline of 9% to 14% compared to a decline of 15% in Q1. We currently expect our gross margin rate to be in the range of 21% to 24%, with merchandise margins equal to or slightly better than last year. SG&A is expected to be in the range of $72 million to $75 million. This translates to a net loss in the range of $0.35 to $0.45 per share for the second quarter, including the continuing impact of having a very low tax rate. On a non-GAAP basis, using a normalized income tax rate of approximately 36% to 37%, we would expect to report a net loss of $0.22 to $0.28 per share for the second quarter.
Operator, we'll now take questions.
[Operator Instructions] Your first question comes from Jeff Van Sinderen from B.Riley & Co.
Ali Mogharabi - B. Riley
Ali calling in for Jeff. Just wanted to ask you guys what have you experienced in April and May versus March in terms of comps and traffic?
With regards to April, I mean I think everybody recognizes the Easter shift contributed to a flux in comps. We do not historically talked about month-to-month variations or the first couple of weeks of the new quarter. So I can't give you a lot of specifics on what you're asking for.
Ali Mogharabi - B. Riley
Have you seen any differences by region? Or has maybe weather been a factor at all?
I mean weather plays a few days here and there and differences by region. There tends to be some fluctuations, but I think relative to the big picture of what we're setting out to accomplish, no, I wouldn't say either is materially affecting our outlook on the business.
Ali Mogharabi - B. Riley
Regarding brands, are you seeing any new and up-and-coming brands or anything that it's worth mentioning that you've brought in or in the process of bringing in?
Yes, in a sense, we continue to be excited about what we're doing with the heritage brands, but some of the newer brands that we've added in terms of RVCA and WeSC are an important part of the business. We do have some additional brands that will be coming on at back to school, but I'm not, at this point, going to say just which those are. So as I said when I came on, one of the objectives is to reestablish PacSun as a place for newer brands. We still got some work to do in that regard, but we're making some progress.
Your next question comes from Stacy Pak from CPResearch.
Stacy Pak - Prudential
One is I'm hoping you can discuss your feeling about your positioning for denim for back to school? Two is just some more information on how you think footwear went? Three, Swim. There's been some questions about weather out there and some other retailers have broke price, so I'm wondering if you could address that? And then lastly, could you update us on how you're beginning to use the systems now for what stores like particular brands, et cetera? And also kind of where you think you can go with regard to speed on the sourcing.
I'll try and touch on much of that. I may not hit all of it, but first off with regards to denim, we see denim as a obviously really important part of our business as we head into back to school, and look forward to reestablishing our denim assortment in July in anticipation of building up for August. So quite looking forward to denim and what we think we have coming both in terms of guys and girls. With regards to Swim, as I mentioned, we've been very pleased with the performance of Swim on the guys side of the business, and both the sales that we've achieved through the boardshorts, but also just the brand projection and kind of statement it's made that we think customers have responded very well to. On the Juniors aside, I'd say it's been a bit of a mixed bag and somewhat anticipated that way. When I came on last summer, my sense was that the price of branded swim was still too high relative to where more competition was coming in with the number of the vertical retailers. And we agreed that 2010 would be a year to test that with the brands and the optimists were hoping that as we came out of recession that, that business would return back to its historical sales and price points. Candidly, that wasn't our expectation and is part of why we anticipated lower margins, and I'd say the performance to date has been mixed. Great styles with great brands are still able to command that premium pricing but the brand and styling really has got to be spot on. So as we look ahead to 2011, we anticipate some fairly meaningful reduction in price points that will either come from the brands adjusting to what I think are the realities of the market or else an increase in our proprietary brands as a portion of our Juniors Swim. And I think it's that flexibility between brands and our proprietary brands that is a key differentiator of PacSun that we're going to continue to leverage as we go forward. With regards to speed to market, that's a topic that is near and dear to my heart, having just gotten back from Hong Kong late last night. I don't think that there's any question that there's a new way of doing business with factories as sourcing partners. And I'm quite excited about what we're going to begin to tap into for the back half of the year on Juniors and even more importantly, probably going into 2011. So I think that, that is a critical piece, again, particularly on the Juniors aside. And I think we're beginning to take the steps to set ourselves up to operate fairly differently than how PacSun has operated in the past, and set us up to have a much more sustainable Juniors business going forward. So quite excited about some of the things that we discussed in our beginning to put in place, as I say. So I don't think I covered everything you asked about but hopefully, that is the bulk of the things you are wondering about.
Stacy Pak - Prudential
The other two things I asked there, how you feel about how went and then just how are you using the systems currently in terms of the information you have for what stores, like what brands, et cetera?
So Footwear was just okay so far, and I think that the clear learning and that reinforced some have always believed as -- if you're going to be in a category, you need to be in it. And as we've been developing our internal capability, our buyers for Footwear in Juniors and Young Men's both joined us in the last 30 days, so wanted to get started, and we had people from the apparel teams taking a start at that. But I think that we'll have a better presentation and more depth in our Young Men's business as we head in to back to school. And as importantly is also that we give that enough presentation that people realize we're really back in the business. So I think we're off to an okay start, I think there have been some good learnings and I think that business will continue to progress for us in the back half of the year and further into 2011 as we learn. Knowing that the company had struggled two years ago, it was not my desire to just completely jump in and be overly aggressive in how deep buy footwear. So for me, 2010 is a learning and building year, and I think it'll become even more meaningful in 2011. On the systems side, I have spoken previously about the importance of localization, which I think you're referring to. The real implementation of that starts with Q3 and back to school. So I feel good about the work and the methodology that we've put in place, and I think we'll begin to see the benefit of that, as I say, as we go into the back half of the year the year and better able to comment more at that time.
Your next question comes from Dana Telsey from Telsey Advisory Group.
Dana Telsey - Telsey Advisory Group
Can you talk a little bit about private label? And you mentioned before in terms of as you see speed to market changing, what's changing in the landscape out there? How do you see the assortment changing for private label in Guys and Juniors? And what does it mean for the margin?
Sure, I mean it's a bigger conversation obviously than just the speed-to-market component, and the Guys presentation that you see in stores is going to continue to be pretty indicative, which is we expect the Guys business to lead with the branded portion. But we do have some important private label segments within our Guys business, certainly Bullhead denim and also with our fashion knits and wovens, with our On The Byas brand and some of the other private label products. So it is an important complement, and quite pleased with how that business continues to perform on the Guys side, but still expect that the branded business will be the bigger portion of that. On the Juniors side, as I've said previously, continue to expect the private label piece and where speed to market directly plays into this to lead as -- in contrast, the Guys that brands is as important as with fashion style, I think on the Girls market it's clear that, that it starts with fashion and style and then brand and price round out the criteria for where she shops and where she buys. So the speed-to-market component of driving our proprietary business on the Juniors piece, I think, is going to be a very important piece to our success. And as I alluded to, with a clear sense of the older teen girl being our customer, a real embracing of fashion, I think the direction that Christina and the team are taking our Juniors business. Yes, I'm excited to have back to school come and start to get reaction from that older teen customer, because I think we're going to make a good showing and I think we've got a real business to build.
Dana Telsey - Telsey Advisory Group
Just on the real estate side, what are you seeing from the real estate developers and either existing leases or leases coming up for renewal, how is that working in the cost structure?
Yes, as I alluded to, we're close to completing negotiations that will involve over 150 leases. And I would say roughly 100 of those are shorter-term leases for not great real estate. And the result of those discussions has been some reduction in rental rate to reflect the reality of those stores. And then there's probably a 50 or 60 renegotiations for longer-term leases that are stronger-performing stores in better malls around the country. And as you would imagine, at the end of the tenures, the landlords are still looking for some increases. But I think we've been able to have thoughtful and pretty comprehensive discussions with our key landlords on kind of a total portfolio perspective and a bit of a trade off of keeping open some stores for a while longer that we would otherwise probably elect to close. And in return for that, getting long-term renewals with some increases but increases that probably aren't as high as they otherwise would be.
[Operator Instructions] Your next question comes from Paula Torch from Needham & Company.
Paula Torch - Needham & Company, LLC
I was wondering if you could further comment on the target age of your customers? You mentioned that you were getting a younger customer on the Juniors side. Is the sweet spot still about 15 to 17 years old for the Junior? Or are you still targeting an older customer, older than the 17-year old? And also if you could comment, have you noted any changes on the Men's side perhaps?
I think starting with our Men's business, our customer really is kind of 15 to 22, somewhere in that range. And we've got a pretty good mix of customers both older and younger than kind of that sweet spot. We'd say that prior to three to six months ago on the Juniors side, it was probably more 12 to 15, and a fair bit of imbalance between the two. So that same 15 to 22 that we believe is really our current Young Men's customer, that's the same direction where we want to be on the Juniors side. And the products that you'll start to see flowing into those stores more and more as the summer unfolds, and we get closer to back to school, I think really reflects that.
Paula Torch - Needham & Company, LLC
You spoke that the Junior customers began to respond more favorably to fashion. What percent of the Juniors assortment is fashion versus basics currently? And where would you like to ideally see that mix going forward?
It isn't as black and white as fashion and basic, but I'll take a simple category like tank tops or bare where we were doing pretty basic kind of two silhouettes of bare driving a good bit of our business, pretty vibrant colors and pretty simple stripes. And there's so much more going on in there with lace and different back treatments. So I'm not sure that we're moving from basic to fashion. I think we're just becoming much more relevant to what's really happening in the market, and also recognizing the kind of aesthetic that's appropriate to a girl who's a senior in high school or in college that's different to a girl that's in middle school.
Your next question comes from Liz Dunn with Thomas Weisel.
Lizabeth Dunn - Thomas Weisel Partners Equity Research
We saw, and when I say we, I mean my associates saw on MTV last night some advertisements and it seems like you're directing people via these advertisements and on the website to the store on May 29. Is that part of the new marketing approach that you're talking about? And if you could just give us as much detail as you're comfortable with there. And then I just had one question of clarification. So are we to assume that you're still comfortable with all the full-year guidance that you've previously provided in terms of gross margin being up modestly and SG&A being in the range that you've previously guided to?
So yes to the second part that we do continue to feel comfortable with the guidance that we had given before. And as the first part, good for you, your associate's doing some good work. And yes, that is kind of the beginning. Well, not the only one and there are others. So yes, we're excited about kind of elevating PacSun and getting back in the conversation, if you will. Secondly, about reestablishing our connection with our brands and thirdly, we are going to have a little bit of fun over Memorial Day weekend, and we've been working closely with our brands to do that. And we think we've got some real reason for customers to want to come spend some time with us over the weekend. And I'm being still a little bit guarded in what I say since it isn't just Wall Street that listens to these calls. But yes, we're looking forward to Memorial Day and looking forward to summer.
Lizabeth Dunn - Thomas Weisel Partners Equity Research
Will you be doing more TV as we move through the year?
Yes, we will, and I think we've got some fun and creative plans as we do that.
[Operator Instructions] There are no further questions.
All right. Well, I thank you all for tuning in, and this concludes our conference call for our first quarter results, and we look forward to updating you on our progress on the next call. Thank you very much.
Thank you for participating in today's conference call. You may now disconnect.
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