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rue21, inc. (NASDAQ:RUE)

Q2 2010 Earnings Call Transcript

August 25, 2010 4:30 pm ET

Executives

Joe Teklits – IR, ICR Inc.

Bob Fisch – President, CEO and Chairman

Kim Reynolds – SVP and General Merchandise Manager

Keith McDonough – SVP and CFO

Analysts

Brian Tunick – JPMorgan

Lorraine Hutchinson – Bank of America/Merrill Lynch

Michelle Tan – Goldman Sachs

Janet Kloppenburg – JJK Research

Sean Naughton – Piper Jaffray

Operator

Good day and welcome to the rue21 second quarter 2010 earnings conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Joe Teklits, rue21 Investor Relations. Please go ahead.

Joe Teklits

Thank you. Good afternoon, everybody. Thanks for joining us for rue21’s second quarter 2010 conference call. Hosting today’s call will be Bob Fisch, President and Chief Executive Officer. And after management made its formal remarks, we will open the call to questions.

As you know, quickly, some of the statements made on the call during the prepared remarks and in response to your questions may constitute forward-looking statements and are made pursuant and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements.

Those risks and uncertainties are described in the company’s annual report on Form 10-K filed on March 31st of 2010. Investors should not assume that the statements made during the conference call will remain operative at a later time, and rue21 undertakes no obligation to update any information discussed on the call.

And now, I will turn the call over to Bob Fisch, CEO.

Bob Fisch

Thank you, Joe. And thank you, everyone, for joining us for our second quarter conference call. Joining me today on the call is our CFO, Keith McDonough, and our Senior Vice President and General Merchandise Manager, Kim Reynolds. We are very pleased to be able to report earnings growth for the quarter that exceeded our guidance.

Our net sales increased 14.3% in the second quarter and we were able to drive net income growth of 20% even with incremental public company and share-based compensation costs. Year-to-date, net income increased 47%, and adjusting for incremental public company expenses and the share-based compensation costs, year-to-date net income increased 69%. See, we are coming off a very solid quarter and a terrific first half of the year.

Our management team has consistently delivered earnings growth in both strong and weak retail environments. The second quarter was a great example. While sales did not meet projections, but our earnings increase has certainly did. I think it is important to note that we have achieved 8.5 straight years or 34 straight quarters of substantial sales and profit growth. We believe that our business model would continue to deliver year-over-year profit gains.

Although today I will be highlighting some of our achievements for the second quarter and year-to-date, this team never loses sight of the future and executing to achieve the year-over-year growth targets we have set forth for this company. To deliver strong results this quarter, we focused on controlling inventory, running a tight operation, working with our vendors to maximize initial markups and managing promotions. Our gross margin increased 220 basis points to 38.2% from 36.0% in the second quarter of fiscal 2009, and we achieved a record merchandise margin this quarter.

Our ability to leverage our domestic base and domestic importer vendor network allows us improve initial markup through lowered cost of merchandise. Also, the control and flexibility we have in sourcing is an advantage to us when there are labor shortages or supply concerns in certain regions. We are not beholding to any one supplier, and we can maneuver around sourcing issues to avoid increases in costs. In fact, we can drive cost down by the fact that we are a growing retailer and a company that many vendors are eager to partner with right now.

We believe our promotional strategies for the short summer selling season were very effective. Although the second quarter is typically promotional in our retail demographic, we did hold price at many of our key seasonal items such as shorts and sandals. And we achieved our earning target by driving margin without taking a necessary markdown. We promoted where we felt it was right to do so and ended the quarter with controlled inventory levels that position us well for the back-to-school season.

While growing our top and bottom line, we also continued to grow our store base and position our company for the future. We opened 31 stores this quarter, bringing us to 62 new openings for the first half of the year. And we are very comfortable with our goal of 100 new stores for 2010. We have also continued to drive profits by converting our existing stores to our larger format etc! stores. Not only do these stores have more square footage, but they also highlight our higher margin accessory categories. And we are on plan to convert 30 stores to our etc! format in 2010.

Our real estate growth strategy has given us the ability to partner with our landlords and lock in lowered occupancy costs in our leases, which not only helps today but will benefit us for the next 10 years. We continue to focus on small and medium size markets in strip centers and in malls that attract customers start for fashion at a great value. We consistently see strong results and return on investments within one year on our new store openings.

In the second quarter, we were proud to launch our 11th exclusive fragrance called twentyone black, which we kicked off with a huge Facebook promotion during the first 21 days of July. We remain committed to strengthening our vital marketing tools that create excitement and pull customers into our stores, as we continue to build our brand. We have seen our customers react positively to our social media pages and to the email blast we send out weekly to our RUE community.

While we are coming off an excellent spring season, I know many of you are looking forward to fall and holiday. It is too early to speak to back-to-school results, but I will say that we feel well positioned for the third quarter and we are looking forward to a strong fall. There are exciting fashion opportunities for the back half of the year that we intend to capitalize on. Giving newness to our customers at a great value is one of the keys to our consistent growth.

We will continue with planning and allocation initiatives that we highlighted in our last call and will manage inventory flow while growing square footage. We feel confident that we are positioned to deliver again in the third quarter on top of three straight years of impressive third quarter increase. And we expect to achieve our initial guidance of $1.14 to $1.19 earnings per share in 2010.

In closing, we believe our solid second quarter and year-to-date performance exemplifies our ability to drive profit even in challenging retail environments. Our sustained growth is a product of core initiatives that I discussed with you today, a flexible sourcing model that allows us to drive margins, disciplined store growth in strips, malls and outlets, a focus on execution and controlling costs while driving sales, and most important, a fierce commitment to provide fashion and quality at tremendous values for our customers.

Now, I’d like to turn this over to Kim Reynolds to provide an update on our merchandise performance in the quarter as well as on how our team is focused on fashion trends we see developing for the fall season. Kim?

Kim Reynolds

Thank you, Bob. As Bob mentioned earlier, we achieved great margin growth in this quarter. We were able to achieve this result by not getting overly promotional early in the season and maximizing business. RUE has always been about quality and value, and we offer a great deal to our customers even in our opening price points.

Our fast fashion model allows us to flexibility and control to adapt our assortments to trends that are happening now. Capri sandals and dresses performed well for us in the quarter, as did shrugs, cardigans and cocoons, which continue to gain momentum going into fall. We have noticed that there was little price resistance when it is the right fashion at a great value.

We promote strategically throughout the quarter as planned and ended in a comfortable inventory position as we entered back-to-school. There is a lot of conversion in the retail marketplace about sourcing challenges. Control and flexibility in sourcing is a real advantage to us now.

We don’t own any manufacturing facilities. We purchase all of our merchandise from a network of domestic and domestic importers based here in the US. We have a very collaborative working relationship with many of our longstanding vendors, and we have also been growing our vendor base though we have not been affected by cost increases. We can maneuver so that our merchandise is produced in areas that offer us the most competitive pricing, quickest delivery at a great day-in day-out value.

I’d like to share that we have just returned from Los Angeles this week and the Magic trade show in Las Vegas last week. My team is excited about our current assortments and jazzed by the trends we see as we enter into the holiday season. We know we will deliver newness in trends in many key categories, including sweaters, outerwear and footwear, as we focus and build our successful beauty and fragrance brands going into holiday.

And again, our fast fashion flexible sourcing model allows us to jump on a trend and deliver to our stores very quickly. From our shopping and trade shows, there were some great trends that will be in our stores over the next few weeks.

I’ll now turn it over to Keith McDonough, our CFO.

Keith McDonough

Thanks, Kim. I will review the details for the quarter and then provide an update on our outlook for 2010. Overall, our quarterly results were very strong with operating profit margin expansion and up 17% from last year. When adjusted for incremental public company and stock comp expenses, operating income was up 31%. Net income grew by 20% in the quarter, and adjusted for incremental costs, was up 34%.

Net sales for the quarter were $143 million, up 14.3% from $125 million in the second quarter of 2009. The increase was driven by square footage increase of 22%. Comparable store sales declined 1.6% for the quarter, which was primarily a result of a pricing as comp transactions were relatively flat for the quarter. Overall, transactions were up 16.2%.

As Bob said, we opened 31 stores in the quarter versus opening 25 in the second quarter of 2009. Importantly, in the last two weeks of the quarter and the first week of the third quarter, we opened 14 new stores versus eight in the same three-week period last year. So the expense impact of these stores exceeded the sales lift relative to last year. Year-to-date, we have opened 62 stores compared to 56 in the first half of last year, and we are ahead of our plan to open 100 in 2010.

We operated 595 stores at the end of the quarter, consisting of 469 comparable stores and 126 non-comparable stores or about 21% of the total, versus last year’s Q2 total store count of 505, which included 362 comparable stores and 143 non-comparable stores or approximately 28% of total stores.

Gross profit for the quarter increased by 21.2% to $54.5 million, and gross margin expanded by 220 basis points to 38.2%. The gross margin expansion was driven by 270 basis point expansion of our merchandise margin, somewhat offset by deleverage of store occupancy, freight and buying. We did leverage our distribution center cost versus last year due to the upgrades completed in January. We are pleased that since the upgrade, all costs per unit handled metrics in our DC are down record levels compared to any other years prior.

The Q2 gross margin increase was well above our guidance for the quarter. Although we said last quarter that our strong merchandise margin gains would not continue at the same pace through the efforts of Kim Reynolds and her collaboration with our vendors along with our focus on gross profit dollars, we were able to again achieve strong merchandise margin increases in the quarter.

Selling, general and administrative expenses increased 21.3% to $38.7 million. Included in this expense in the quarter were public company costs of $703,000 and stock option expense of $628,000. Combined, these expenses totaling $1.3 million added 90 basis points in expense margin. Total SG&A expenses increased by 160 basis points to 27.1% versus 25.5% last year. But excluding these incremental expenses, SG&A would have deleveraged by only 70 basis points in Q2.

Depreciation and amortization totaled $5.3 million and increased 29.5% over a year ago. This expense increased 40 basis points. Increases on this line continue to be driven by previous investments in CapEx for new and conversion stores as well as our IT and DC systems. As discussed last quarter, we continue to plan 2010 CapEx to be roughly $32 million net.

Operating income for the second quarter was $10.5 million versus $8.9 million a year ago, a 17.3% increase. Our operating margin expanded by 20 basis points to 7.3% of sales. Without the incremental expenses I have described earlier related to being public company, operating margin would have expanded by 110 basis points and growth would have been 31%.

Finally, net income increased by 20% to $6.4 million for the quarter, up from $5.3 million a year ago. Fully diluted earnings per share were above our guidance at $0.26 versus $0.23 a year ago on a fully diluted share count of $25.0 million versus $23.0 million last year. And again, this year’s Q2 net income includes public company expenses that equated to $0.03 of earnings per share.

Turning to the first half results, sales increased by 20.4% to $281 million, reflecting square footage growth and sales growth per square foot. Comp store sales growth is 2.8 year-to-date. Operating income year-to-date is up 45.7%, with operating margin expanding 130 basis points to 7.3% despite expenses from the first quarter secondary offering and incremental cost associated with being a public company. Excluding all these costs, our operating margin would have expanded by 220 basis points for the first half.

Net income year-to-date is up 47% to $12.2 million, and margin has expanded to 4.4% from 3.6%, including all incremental public company costs. Our balance sheet at the end of the quarter remained strong. Cash was $16.7 million. Inventory remains controlled. It totaled $109.6 million, up 17.9% from last year, but down 3.6% on a square footage basis. We have no long-term debt on the balance sheet, with $85 million in availability, but no plans to borrow.

Now turning to our outlook, we plan for 100 new stores opening in 2010 and can comfortably reaffirm that guidance, especially given we have opened 62 in the first half. We anticipate meeting our goal of 38 new stores in the second half by opening at least 25 in Q3, with the remainder in the fourth quarter.

We also may close a handful of stores in the second half of the year, all of which that had leases that are expiring. Consistent with our long-term guidance, we are planning for low-single digit same-store sales increases in both the third and the fourth quarter with square footage growth in the mid-to-high teens.

We expect gross margin for both quarters in the second half to exceed prior year by at least 50 basis points and operating margin for the full second half to expand by approximately 20 basis points, incorporating the impact of the additional public company cost and stock option expenses.

It is important to note, the impact of those incremental expenses are unfavorable in Q3 as they have been in Q1 and Q2, but become favorable to last year in Q4 due to the APAC’s management termination fee that we expensed in last year’s Q4. Depreciation and amortization grew by 30% in the second quarter, and we are using that as our expected growth rate in both quarters of the second half.

So for the full year 2010, incorporating the store growth and same-store sales increases I have already mentioned, we expect sales to increase by just under 20%, net income to grow by over 25%, and we are reaffirming the EPS guidance issued last quarter to be in the range of $1.14 to $1.19 per share. Fully diluted share count is expected to be 25.0 million versus 23.1 million for 2009, the difference affecting our IPO last November.

For the third quarter of 2010, we expect diluted earnings per share in the range of $0.25 to $0.27. This guidance assumes total sales growth in the mid-to-high teens. As a reminder, our long-term forecast includes square footage growth totaled in the mid-to-high teens, low-single digit comp growth, and annual net income growth of between 20% and 25%.

That concludes my prepared remarks. I’ll turn this call back over to Bob.

Bob Fisch

Thank you, Keith. And now we’re ready for any questions if anybody would like to ask them.

Question-and-Answer Session

Operator

(Operator instructions) And the first question today will be from Brian Tunick with JPMorgan. Please go ahead.

Brian Tunick – JPMorgan

Thanks. Good afternoon, guys.

Bob Fisch

Hi, Brian.

Brian Tunick – JPMorgan

I was hoping – first really around the comp decline, you are up against the fairly easy compare and it certainly gets tougher as we go through the back half. But just trying to understand if you can give us some idea of how the comps were trending either by month or by the class of store base, strip, regional or outlets. Just trying to get some color, more about the comp decline. We know you are obviously not competing directly in the malls, but how do you think about your average selling prices in the back half when the competition is running 20% to 40% below last year in some categories? And then the final question, I guess, on the Analyst Day, I think you guys highlighted a double-digit EBIT margin goal potential. So what, Keith, is your comp leverage point next year as you sort of put these public company cost behind you?

Bob Fisch

I think there are about three questions there, Brian.

Brian Tunick – JPMorgan

Yes. Yes, absolutely.

Bob Fisch

And I want to make sure we try to answer this right because I know you are putting your fall top ten list together. So we better be careful. As far as the comps, and I’ve mentioned this before in last call, I think that in the second quarter, I think it’s very promotional timing. It seems to be something that happened last year in the second quarter/ And then from the second quarter last year, we ended up having strong increases that – I think that there wasn’t as many as exciting new trends that I swear, and I think that that’s why, as a company, we positioned our inventory in the right place and we weren’t as promotional. And I look at it, and just like last quarter – just to let you know, last year when we were basically up against almost 1% increase, part of that was because that year before that year last year that the Labor Day was later and the tax-free days were moved into August. It probably would have been a 3% or 4% comp just to verify that. But I look very positively to what I mentioned, what Kim mentioned, that going into third quarter, which is back-to-school, and further that I see stronger trends and I maintain our guidance of what we said in our comp increases.

Brian Tunick – JPMorgan

Were there any differences between the strips, the regional, the outlets? Just trying to understand that.

Bob Fisch

I would say marginally different. I would say marginally different and probably not big enough to say that there was something that overcame. Our strip centers remain strong, as do our malls, and our outlets have been fine. So it hasn’t been that big a difference of – that we would make a comment right now. As far as – I don’t want to get into classifications or by month and things like that. We had a strong business. I think one thing that I should tell you though, because as I’ve always said on these calls and with the analyst investors that this be very straightforward of what’s been going on.

I think that our men’s business took a little hit, and I don’t think it had anything to do with the economy. I don’t think it has anything to do with the promotions and anything to do with the environment. I think we had a few missteps in some graphic Tees and in some of our pants and the bottom pants where we were very strong last year in the skinnies. And I think that’s something that Kim is correcting for the third quarter. But what I’m very proud of is maintaining strength of our junior business, which obviously many people had ups and downs. And I think very important is our accessory business, and that we look to see that continuing to strengthen in all the major categories of accessories. So we see that, as we said, as we have a three three-pronged strategy. So it’s girls, guys and etc!

Keith McDonough

To your expense question, Brian, it’s – I would say that I maintain – it’s between 2% and 3%. It started to deleverage expenses. I think importantly in the second quarter when you exclude the incremental costs, we only deleverage that admin expenses by 10 basis points. Store expenses deleveraged by 50 basis points. But that’s something that I’ve said in the past as well. And as our footprint gets a little bit bigger, we are seeing more operating expenses in our store P&Ls. But as you can see, the gross profit is more than paying for those additional expenses. So we see increased operating margin expansion.

Brian Tunick – JPMorgan

All right. Sounds good. Good luck for the back half. Thanks, guys.

Bob Fisch

Thanks, Brian.

Operator

And we’ll take the next question from Lorraine Hutchinson with Bank of America/Merrill Lynch. Please go ahead.

Lorraine Hutchinson – Bank of America/Merrill Lynch

Thanks. Good afternoon.

Bob Fisch

Hi, Lorraine.

Lorraine Hutchinson – Bank of America/Merrill Lynch

Just wanted to get a few more thoughts on the comp performance. I guess you had been guiding to a low-single digit. What was the real surprise factor is that occurred during the quarter?

Bob Fisch

I don’t think that was surprise factor. I think I did mention that the guys may be (inaudible) a little, which I don’t think is a long-term thing and especially with our model. So – but the thing that I think is important to bring up is that we didn’t push the pedal promotionally as other companies did. And I know if we did push it harder, I think – I’m sure that we would have achieved 2%, 3% or higher comp. And I’m not so sure that’s the right thing to do when you’re really looking to build the brand. And you’re building it for the long-term. And I think too many companies – and we discussed this on the second quarter that a lot of people would be very promotional, and all of a sudden, that could hurt your margins.

And I think that if we have the strength of our gross margin and we manage the gross profits and we have a great collaborative relationship with our vendors that I’m kind of pleased that with – even though we had a little over 1% drop comp that we were able to have record profit increases on top of strong profit increases last year, Lorraine. And I think that I’m looking to build the brand for the future and then I want to be able to go into third and fourth quarter and not have to be so promotional all the time that I’m going to hurt my business. Wouldn’t you?

Lorraine Hutchinson – Bank of America/Merrill Lynch

Yes, I would. Any comments on August to date?

Bob Fisch

No, except that I commented that we are pleased with our guidance in what our comp store increases are and our profit would be. So – and even though we are up against back to back to back strong businesses, we feel comfortable in mentioning that.

Lorraine Hutchinson – Bank of America/Merrill Lynch

Great. And then just finally, the class of 2010 store performance, have you been pleased with your new locations?

Bob Fisch

Yes, very much. That’s why, believe me, this is – we know what it’s like to sit there and say opening 100 stores, and that makes people nervous. And we are very careful about that. And if there was some reason that we did not feel comfortable with that, we do not have to live to a plan. We live to the plan or the projection because we feel comfortable that we can achieve the profits to that plan and the sale to that plan.

Lorraine Hutchinson – Bank of America/Merrill Lynch

Okay. Thanks a lot and good luck.

Bob Fisch

Thank you, Lorraine.

Operator

We will move along to Michelle Tan from Goldman Sachs. Please go ahead.

Michelle Tan – Goldman Sachs

Great, thanks. Hey, guys.

Bob Fisch

Hey, Michelle.

Michelle Tan – Goldman Sachs

I was wondering if you could give us, just on the comp question, maybe a little perspective on why it seems like historically second quarter has been a tougher quarter for you guys to deliver comp in. I know third quarter you are up against tougher comparisons, but it’s historically been a stronger quarter. So, some perspective on kind of how you can drive comp in the different quarters and why maybe second quarter is tougher. And then also just following up on the new class of stores, it looks like the new store productivity number was a little lower than it has been. I know – I think you mentioned some timing changes with when the stores were opening. So I was wondering if you can give us any specific metrics on how the new stores are performing. Thank you.

Bob Fisch

I’ll answer the first, Michelle. There is an anomaly I think about second quarter. I think that – to me, again, it’s not economy. I will never say things like that. I think it’s our performance is our key. And I think that it is a more promotional short-term environment out there in the second quarter that I see even though people are promoting now. But I find it’s really a promotional short time period. And I don’t know if that – between that, I think that’s part of it. And also I think that it’s harder to get a quick read on trends and then the season is over. So we get into the third quarter like right now, we see some very explosive trends in back-to-school that will help us not only for back-to-school but for the holiday season into early spring. And I don’t know if it’s anything else with that that I can see, and I’m sure we felt like missed some category, but it’s something that happened in the last two or three years. And then we seem to really bounce back strong. And I believe everything that I just said that we will again.

Keith McDonough

And to the new store productivity, Michelle, just reaffirming, we are extremely pleased with the family of 2010 stores. The ROI rate in excess of 100% is still there. The maturity levels of sales opening are still there. One thing that I did mention in my prepared remarks about the last few weeks being heavy with new stores is our weighted average store count in the second quarter was only up 17%. So I know we had a quarter ending growth of 22% square footage and something like that for new stores, but the weighted average was 17%. So that compares a little bit better with the total sales growth of over 14%.

Michelle Tan – Goldman Sachs

Great. Thanks. Good luck, guys.

Bob Fisch

Thanks, Michelle.

Operator

The next question will be from Janet Kloppenburg with JJK Research. Please go ahead.

Janet Kloppenburg – JJK Research

Hi, everybody. Congratulations on a good quarter.

Bob Fisch

Thank you, Janet.

Janet Kloppenburg – JJK Research

I just had a couple of questions. As far as the comp goes for this quarter, you are up against a double-digit gain. Are you planning to be more promotional than you were in the second quarter or will the same margin preservation objectives be in place? Second of all, I missed how much the inventory per square foot was up going in for the third quarter. And I was just wondering if you could share that with us. And I was also just wondering about the comps during the second quarter if they were stronger at the beginning and maybe tailed off in July when we heard that business conditions worsened for the industry. Thanks.

Keith McDonough

The inventory per square foot to open the third quarter was actually down 3.4%, Janet.

Janet Kloppenburg – JJK Research

Okay. And Bob, did you say something about – go ahead. Go ahead.

Bob Fisch

And as far as the comps for the third quarter, I do not see us being more promotional. I do not believe we have to. We certainly are promotional because that’s part of our game and we’d be silly not to be.

Janet Kloppenburg – JJK Research

Right. We can see that in the stores, but –

Bob Fisch

Absolutely. But – and we are a promotional store. And it’s part of it to get value, but I am not looking to add more promotions. I am not nervous about that. I see better trends out there. And to me, that whether your promotional business not the key to success for us or any other retailer, but let’s talk about us, is to go after strong regular price trends. And that’s what we see. And that has some promotions around it. And so I am not (inaudible) what we want. I am not looking to take a much bigger markdown rate or anything like that. And I think that as a fashion, we have that fashionability to jump into things, and I think that that’s what we see right now. I feel good about that, and I feel good, as Kim said when she came out – when we came out to Magic that that will roll right into the fourth quarter. So I feel good about that.

Janet Kloppenburg – JJK Research

Okay. And any comment on the comp trend during the quarter? And also –

Bob Fisch

It was pretty consistent. It was not – we did not see – absolutely did not see a fall off in July. All of a sudden, we got hurt in July versus May and June. It was really fairly consistent. But again I want to reiterate I’m sure, to me, I look to say that I’d rather have a 1.5% drop comp, pick up the strong double-digit sales growth, and have an adjusted over-30% profit growth for the quarter, which is good and builds me for the year that have to pick up 3% or 4%, have a lower margin and maybe make a 10% kind of profit. I always signed up, I believe, and our company has that we are not going to always have the strongest comps all the time. I think what we’re signing up that we want to be consistent and we will achieve the profit that we expect and you expect.

Kim Reynolds

Janet, just to add to that – it's Kim. I just wanted to point out also that for the first half of the year, all three categories of business, girls, guys and accessories, are plus comp.

Janet Kloppenburg – JJK Research

A what, Kim?

Kim Reynolds

All three categories of business, girls, guys and accessories, are positive comp.

Janet Kloppenburg – JJK Research

Okay, great. For the first six months of the year?

Kim Reynolds

That’s correct.

Janet Kloppenburg – JJK Research

Great. And Bob, did you mention something about a comp trend of 3% to 4% excluding something or was that the first six months trend?

Bob Fisch

No, that was the first six months.

Janet Kloppenburg – JJK Research

Okay. Great. Thanks so much and good luck this quarter.

Bob Fisch

Thanks, Janet.

Operator

(Operator instructions) We will now move along to Sean Naughton with Piper Jaffray. Please go ahead.

Sean Naughton – Piper Jaffray

Hi, thanks for taking my question. First, on the real estate environment, we continue to hear about some other specialty retailers in A and B malls that are talking about closing or rationalizing some of their real estate portfolio. And you’ve described a desire to actually move up into some of those locations. Can you give us just an idea of what the environment currently looks like out there?

Bob Fisch

It’s hurdle. It’s the first word that came to my head. It’s such an opportunity. I am not looking to go into A malls. I believe that the (inaudible) there and that’s not what our business is all about. It would be silly for me to do that. But I am telling you that we have gotten to B malls, and we are going into B malls strength with our major mall developers because we are getting very advantageous lower occupancy costs that are even better than last year. So unfortunately, for the industry, I do not see this getting better out there in malls. And I think you’re right that we’re seeing store closures again. It gives us an opportunity though to really be able to take advantage of what that situation is. And I do not see the developer community getting stronger in the next year.

Sean Naughton – Piper Jaffray

Okay, got it. And then secondly, is there anything on regional dynamics that you would be able to share with us in terms of how you performed during the quarter? Was there any different strength throughout the country geographically? And then secondly, maybe you could remind us of any other gross margin dynamics from the third quarter last year where you guys posted a very nice 13.5% comp, but the merchandise margin came up a little bit short year-over-year. If you could just remind us on that number from last year. Thanks.

Bob Fisch

Keith, do you want to –?

Keith McDonough

The gross profit in the last year, we did see – we were a little bit more promotional last year in the third quarter. And so when we looked at it year-to-year a year ago, we certainly had 13.5% comps, but we did get back some of that in the merchandise margin line. I don’t think regionally, Bob, if there is anything that –

Bob Fisch

It’s not – you know, there is nothing that stands out really more than 1% or 2% differences that would be a real standout that would say – that would make me nervous and be concerned about something. But what – is something else that’s important? Just like we are speed to market in fast-paced fashion, we are speed to market, as we’ve discussed before, in our real estate pickings of stores and that we can open up stores within six weeks of taking possession. So we react like the merchandise to – if areas or states or whatever are little slower, we can react on that. So I’m very comfortable with our guidance of that 100 stores and having them to be profitable to what we see last year or better. So I feel good about it.

Sean Naughton – Piper Jaffray

Okay. So, nothing on the accounting last year that was a bit of an anomaly in terms of capitalization of distribution costs of inventory or anything like that?

Bob Fisch

We –

Keith McDonough

We do have an accounting mechanism that we capitalize our distribution costs. And that did move against us last year. Last year was a – last third quarter was an amazing quarter for us. Not only did we produce 39% comp growth, but we also ended the quarter with inventory down from the end of the second quarter. That very rarely happens. But when that does happen, those distribution costs peel back out of inventory and go to the P&L. That did move against us. I think the overall movement in margin was down 170 basis points. Just under half of that was the distribution cost capitalization calculation. So it did impact the quarter there.

Sean Naughton – Piper Jaffray

Okay. All right. Thanks. Best of luck in the third quarter, guys.

Bob Fisch

Thank you very much.

Keith McDonough

Thank you.

Operator

And at this time, we have no further questions in the queue. I will turn things back over to our host for any additional or closing remarks.

Bob Fisch

Thank you. I want to thank everybody for being on the call today, and I look forward to the fall season and talking to you again in the next quarter. Thank you very much.

Operator

And again, this does conclude today’s conference call. Thank you for your participation.

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