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Executives

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

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

Michael Kaplan - Chief Financial Officer and Senior Vice President

Analysts

Dorothy S. Lakner - Caris & Company, Inc., Research Division

Jeffrey Wallin Van Sinderen - B. Riley & Co., LLC, Research Division

Marni Shapiro - The Retail Tracker

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

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

Alex Pham - Wedbush Securities Inc., Research Division

Travis Williams - Stephens Inc., Research Division

Janine M. Stichter - Telsey Advisory Group LLC

Pacific Sunwear of California (PSUN) Q4 2011 Earnings Call March 13, 2012 4:30 PM ET

Operator

Good afternoon. My name is Jamaria, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pacific Sunwear Q4 and Year End 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Mr. Craig Gosselin. Sir, you may begin your conference.

Craig E. Gosselin

Good afternoon, and welcome to the Pacific Sunwear of California Conference Call announcing our fiscal fourth quarter and year end 2011 financial results. My name is Craig Gosselin. I'm Senior Vice President, General Counsel and Head of Human Resources. This call is being recorded, and the playback will be available starting today, approximately 2 hours after the call through midnight on March 20, 2012. It can be accessed at (855) 859-2056 or (404) 567-3406, passcode 59622538. The call will also be archived on the PacSun website at www.pacsun.com through midnight on May 23, 2012.

Your speakers today are Gary Schoenfeld, Chief Executive Officer; and Michael Kaplan, Chief Financial Officer. [Operator Instructions] Before I turn the call over to Gary, I'd like to note the 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 uncertainty that could cause our business and financial results to differ materially from those in the forward-looking statements are included in our fiscal 2010 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 at pacsun.com. All information discussed on the call is as of today, March 13, 2012. Pacific Sunwear undertakes no duty to update this information to reflect future events or circumstances.

This call, the webcast and its replay are the property of PacSun. It is not for rebroadcast or use by any other party without the prior written consent of PacSun. With that said, I'll now turn the call over to Gary.

Gary H. Schoenfeld

Good afternoon, and thank you for joining us today. Michael's going to get into more detail on some of the accounting changes, but I'm going to speak to 2 things very briefly as a result of the December transactions. And the first of that being that we're now required to break out continuing operations versus discontinued operations as a result of the stores that we announced that we would be closing. So through the P&L, you'll hear us speak to discontinuing operations of ongoing stores.

The second is there now is derivative accounting, which Michael will explain that ties to the preferred stock that was issued to Golden Gate Capital and the transaction in December.

So as we look at the fourth quarter and the end of the year, sales from continuing operations were $234 million versus $238 million last year and for the total year were $834 million versus $837 million for 2010. As we stated in the press release, our overall business, which includes all stores opened during the fourth quarter, improved as we got further into the holiday-selling season, moving from a minus 3 comp store sales at the time of our last conference call to flat for the fourth quarter.

Given the highly promotional nature of the holiday season, we were also encouraged by our 150 basis point improvement in merchandise margins for continuing stores and the decline in non-GAAP net loss, which I will speak to in a moment.

GAAP net loss per share for the quarter was $0.56 as compared to $0.53 per share for the same period a year ago. On a non-GAAP basis, excluding store closure-related charges of $7 million and the loss on derivative liability, which Michael will explain as I said, and using the normalized annual income tax rate of approximately 37%, we reported a net loss of $0.19 per share as compared to a $0.31 loss on a comparable basis in the same period last year.

Comparable sales, which includes results for all stores opened during the fourth quarter, for Men's was a plus one, while the Women's side of the business was a minus one. Overall, the biggest shift we are seeing in our business is growth in our emerging and proprietary brands, offset by declines in some of our key heritage brands.

From a category perspective, denim and footwear had significant growth in both genders, while fleece, outerwear and Women's fashion tops fell short of our expectations.

Consistent with what we announced in December, we closed 119 stores during fiscal 2011, including 87 store closures during Q4 and ended the year with a store count of 733 stores. We continue to anticipate the closure of approximately 110 additional stores in 2012, with the vast majority of those closures taking place in the fourth quarter.

As we discussed in December, we are very pleased to have the additional insight, experience and financial support of Golden Gate Capital, and the input that they have given us just in our first 90 days together. We remain committed to our turnaround strategy that includes a long-term focus on delivering trend-right product, working with great brands, optimizing our inventory management, pricing and promotional strategies, improving in-store experience for our customers and re-establishing PacSun's brand identity and relevance.

We know we still have a lot of work ahead to get to where we need to and fully recognize that the teen apparel market remains intensely competitive. Admittedly, our Women's business has started slower than we would like as we begin the year. Yet overall, we start the year with a team that is more aligned and with more talent and more passion that I believe this company has seen in quite some time, and I continue to believe we are taking the right steps to regain PacSun's prominence in the marketplace and look forward to sharing our progress with you as the year progresses.

I would now like to turn the call over to Michael who will speak more to our Q4 results and Q1 financial outlook.

Michael Kaplan

Thanks, Gary, and good afternoon, everyone. Before I provide an update on Q4 and full year 2011 results and Q1 2012 guidance, I wanted to take a minute and walk you through our GAAP versus non-GAAP reporting impacts and the 2 accounting matters, derivative liability and discontinued operations, which originated as a direct result of the financing and real estate restructuring that we communicated in December.

First, let me discuss the distinction between GAAP and non-GAAP reporting. Consistent with prior periods, we use a nominal tax rate for GAAP and normalized tax rate for non-GAAP reporting. We also adjust our financial results for non-GAAP to back out the direct costs associated with store closures.

Now let me transition in discussing an additional non-GAAP adjustment that was reflected beginning in fourth quarter 2011. In connection with the company's $60 million senior secured term loan financing with the affiliate of Golden Gate Capital, the company has recorded a derivative liability equal to approximately $15 million, which represents the fair value of the Series B Convertible Preferred Stock upon issuance. The company's stock price on each respective valuation date will be a key input when determining the fair value of this -- of the derivative and will tend to fluctuate based on movement in the fair market value of the company's underlying stock.

In accordance with applicable U.S. GAAP, the company has marked this derivative liability to market through earnings and will continue to do this on a quarterly basis until the Series B Preferred shares are either converted into PacSun common shares or until these conversion rights expire in December, 2021.

In Q4 2011, we recorded a $5 million non-cash loss on derivative liability. Our first fiscal quarter of 2012 earnings guidance excludes the quarterly impact of the change in the fair value of this derivative liability due to the inherently variable nature of this instrument.

Now let me shift gears and talk about discontinued operations. As a result of our real estate restructuring and store closures announced at our December earnings call, we had concluded that those closed stores met the criteria for discontinued operations. As required under applicable accounting rules, the results of operations of these store closures has been reclassified as discontinued operations for all periods presented herein. For fiscal 2011 and 2010, all of the company's store closures met the criteria for discontinued operations presentation.

I will now transition and discuss our Q4 2011 results, and then close with comments on our non-GAAP Q1 2012 financial outlook. Our fiscal 2011 fourth quarter financial results were as follows: total net sales from continuing operations were $234 million this year versus $238 million last year. Total net sales for all PacSun stores were $254 million this year versus $263 million last year. We ended the quarter with 733 stores versus 852 a year ago.

Gross margin from continuing operations as a percentage of net sales was approximately 19%, which marks an improvement of approximately 100 basis points as compared to the same period a year ago. Contributing to the improved margin was an approximately 150 basis point increase in merchandise margin and an approximately 30 basis point decrease in distribution and other related costs, which was partially offset by an approximately 80 basis point increase in occupancy costs as compared to the fourth quarter of 2010.

As of the end of Q4, total inventory was down approximately 7% compared to last year and was flat on a comparable basis. On a non-GAAP basis, excluding $4 million of charges related to future store closures, SG&A expenses from continuing operations as a percentage of net sales would have been 27% as compared to 31% a year ago. On a GAAP basis, SG&A expenses from continuing operations were 29% as compared to 31% as a percentage of net sales as compared to the same period a year ago. We are continuing to aggressively manage our SG&A expenses in light of our declining store base.

We recorded an income tax provision of $280,000 for the quarter, which reflects the continuing impact of the valuation allowance against our deferred tax assets.

On a GAAP basis, our net loss for the quarter was approximately $38 million or a loss of $0.56 per share versus our guidance of a loss of between $0.44 and $0.58 per share. While our GAAP net loss this time is the high end of our range, it is important to note that the loss includes a non-cash charge of approximately $5 million or $0.08 per share related to a derivative liability that was not contemplated in the Q4 financial outlook. This was the matter I discussed earlier.

On a non-GAAP basis, excluding store closure-related charges of $7 million and a loss on derivative liability of $5 million net of tax effects and using a normalized annual tax rate of approximately 37%, our net loss for the quarter was $13 million or a loss of $0.19 per share versus our non-GAAP guidance of a loss of $0.18 to $0.27 per share.

I will now shift gears and provide comments on our full year fiscal 2011 results. Total net sales from continuing operations were $834 million versus net sales of $837 million for fiscal 2010. Total net sales for all PacSun stores were $896 million versus $930 million for fiscal 2010.

Total company same-store sales, which includes all stores opened during the year, were a minus 1%. On a GAAP basis, we reported a net loss of $106 million or $1.60 per share compared to a net loss of $97 million or $1.46 per share for the prior year. On a non-GAAP basis, excluding store closure charges of $12 million and a loss on derivative of $5 million, and using a normalized annual income tax rate of approximately 37%, our net loss for fiscal 2011 would have been $51 million or $0.77 per share as compared to a net loss of $58 million or $0.88 per share for fiscal 2010.

As of year end, we had approximately $59 million of cash, including $9 million of restricted cash. Overall, we have closed a significant number of underperforming stores, made progress in more effectively managing inventory, continued to reduce our SG&A costs in line with store closures and significantly enhanced our liquidity position.

I will now shift gears and talk about the financial outlook for our first fiscal quarter of 2012. Our sales comp guidance for Q1 is negative 4% to plus 1%. We are targeting our gross margin rate, including buy-in occupancy and distribution costs, to be in the range of 17% to 20% versus 19% in Q1 of last year. We expect SG&A expenses to be in the range of $59 million to $61 million.

Assuming a normalized annual income tax rate of approximately 37%, this translates to a non-GAAP net loss from continuing operations of $0.26 to $0.34 per share for the quarter compared with a net loss for continuing operations of $0.26 per share last year.

Our non-GAAP loss from continuing operations per share guidance also excludes the quarterly impact of any change in the fair value of the derivative liability due to the inherently variable nature of this financial instrument.

Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question will come from the line of Edward Yruma with KeyBanc Capital Markets.

[Technical Difficulty]

Operator

And we'll move on to the next question. Your next question will come from the line of Dorothy Lakner with Caris & Company.

Dorothy S. Lakner - Caris & Company, Inc., Research Division

A couple of questions. I guess first, for Gary. Just a little bit more color, if you would, on what you were saying about, I think, strengthening in the emerging brands performance and some falloff in the heritage brands and what your process is, I guess, going forward in terms of balancing those out. And then secondly, just a little bit of comment on Juniors and the things that you think you're doing right and what you need -- the other things that you need to do to continue to improve that business.

Gary H. Schoenfeld

Sure. So the first part is when I came in 2 years ago, we had very little pipeline of emerging brands. And over time, I think, we're regaining our credibility with that group of smaller brands. As you know, Dorothy, years ago, PacSun was the retailer that emerging brands wanted to get into. I remember being one of those brands. So importantly, we've made progress, and we're adding some very good brands that are performing very well, and we look forward to continuing to do so. And candidly, it's in both genders of the business. So it certainly is a very substantial and critical part of the Men's business. But in the Women's business as well, we're expanding the universe of brands that we think fit our California lifestyle. And I think you'll continue to see that unfold as we move forward in the year. In terms of the heritage brands, probably the biggest challenge we have is, I think, over the prior couple of years, a couple of our key heritage brands did some exciting things in terms of energy during collaborations, and that was a very substantial business for a couple of those brands and translated into substantial business for us at PacSun. That energy during collaboration has declined rather dramatically, and a couple of those brands that had a pretty strong run with that are feeling the effects of that going the other direction, and those numbers aren't easily offset. But net-net, I like where we're headed with our brand portfolio and with what, I think, that means for us going forward.

Within our Women's business, it's been an enormous amount of change in organization and strategy. Looking back over 2011, I think we did some things well. I think over the course of the year, importantly, we started to get stability with the team. I think in some of our key categories like denim in particular and overall in bottoms, we've seen consistent strength. And I think our challenge has been really identifying what we're going to stand for in tops, making that clear to the customer and then really doing a great job in style, fashion, fit, fabrication. And we haven't gotten it all right. I think that going into the first quarter, I don't think we had enough diversity in our fits on tops, and I think we got a bit ahead of ourselves in terms of thinking about warmer weather and crop bodies and versus appropriately transitioning tops. And I think we've also not given enough attention to essentials. But I can tell you the team is responding to that with a high degree of urgency. And we're hopeful that we'll see those trends improve as we progress, hopefully, through this first quarter and as we progress further into the year.

Dorothy S. Lakner - Caris & Company, Inc., Research Division

But do you think you can get that back, kind of, where you want it to be in time for back-to-school at this point or is it...

Gary H. Schoenfeld

Yes.

Operator

Your next question will come from the line of Jeff Van Sinderen with B. Riley.

Jeffrey Wallin Van Sinderen - B. Riley & Co., LLC, Research Division

I wonder if you could give us a sense of how many of the total plant store closures are completed at this point and maybe give us -- just kind of update us on the timeframe to close the remaining stores. And then also if you could talk about the 4-wall contribution of the stores that you plan to keep open, kind of, were those are running, those are in the fleet that you have not indicated you plan to close. Just trying to get a sense of what the operating margin would be running currently if all the, let's say, the bad stores were closed at this point. And then maybe you can just give us a little more on how you're thinking about that. And what do you feel is really feasible this year in terms of EBITDA for the whole year?

Gary H. Schoenfeld

So, Jeff, consistent with how we've been for some time, we're not going to give guidance beyond the current quarter. With respect to your questions on real estate, as we said, we closed 87 stores in the fourth quarter. Those stores are closed and behind us. And a total of 119 stores closed during fiscal 2011. The performance of those stores is removed from the P&L, but for the single line item of discontinued ops. So you can see what the impact of those stores are in that one line item towards the bottom of the P&L. As I said, we anticipate closing about 110 stores, consistent with what we said back in December, and we expect those stores to happen towards the end of the year in the fourth quarter, the vast majority of those stores.

Jeffrey Wallin Van Sinderen - B. Riley & Co., LLC, Research Division

Okay. And then as a follow-up. Any more color you can give us on your business in February and March and, kind of, how you're thinking about spring break. Also, how should we think about comp inventory. I know obviously, there's a lot of stores that have closed, but how should we think about that? And then how is footwear trending? I think you said that, that was a bright spot. And then anything else you can give us on the same-store sales metric for Q4, what was driving that? And then also what you're experiencing and looking for in terms of the Q1 same-store sales guidance you gave, whether you're looking for AUR, UPT, transaction count. What do you see, kind of, getting into that number?

Gary H. Schoenfeld

Well, I didn't jot all that down, but I'll try and speak to at least a few things. So in terms of fourth quarter progression, we were hopeful that we would see a pickup in the business just based on shopping patterns, as we got closer to holiday, and we were pleased to see the improvement from the minus 3% run rate that we were at to get to an overall flat rate. As that relates to where we are in Q1, we are currently sitting at the lower end of our guidance, and it is our hope that we will see that run rate improve, in part because of what we believe is a strengthening assortment as we get closer into spring break and see that as a significant part, in particular, hopefully improving the run rate of our Women's business, which was softer in February than what we would've liked. Footwear has performed well and continues to perform well. And I think the customer is recognizing that we're back in that business. I think the assortment is strengthening, and I think the team that we have managing that business in both genders is now getting the experience back underneath us to understand what it takes to run a good footwear business. So we continue to believe in that category for both genders. And in terms of drivers, in terms of transactions, we do look at AURs as continuing to be an important part of driving top line rather than seeing a dramatic increase in transactions.

Operator

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

Marni Shapiro - The Retail Tracker

I had a couple of quick questions for you. If you can give us any update on your direct business versus your stores business, if there's any difference there in terms of traffic direct on the direct side held up a little bit better? And any indications about the traffic store-wise versus just your general sales trends, if the traffic was different. And then if you could also follow up, last year, you guys hit the spring season with a very impactful swim line that blew me away as I recall. And I see that you have some swim in the store, but it's pretty moderate compared to what I remember last year. And I'm just trying to figure out what the timing was last year, and if it's still on the comp this year?

Gary H. Schoenfeld

So yes, you'll see a stronger swim assortment hitting the stores in the not-too-distant future and certainly in advance of the peak of spring break in both genders. And we don't have traffic counters so I can't comment on traffic in stores. But I can tell you that we are pleased with both traffic and sales that we're seeing in the online business so far here in the first quarter that is performing significantly above what we've seen in terms of comp store performance in the stores so far.

Marni Shapiro - The Retail Tracker

Is there any difference in what you're seeing selling online versus what's selling in stores?

Gary H. Schoenfeld

I'd say the big difference is actually the performance in Women's. It is very encouraging online, which is different from some disappointment that we've seen in store. And I think it speaks to a bit of a broader assortment that we're able to represent online and some diversity, and it's part of what is encouraging to us as we look at the assortment that'll be hitting the stores in the next couple of weeks in Women's and compare that to what's selling online is part of what gives us some confidence that we think we'll see some improvement in the in-store comp as we progress through the quarter. And we hope that, that proves to be the case.

Marni Shapiro - The Retail Tracker

Can I ask one more follow-up on those heritage brands versus your own brands? Away from the energy drink tie-in part of it, at least from what I'm seeing in the stores on the Junior side, I don't think some of the brands have brought their A game over the last couple of months, and I think your own product looks much better. Is it that those brands just look a little stale or is it really just this whole energy drink, they hit a trend and it's over? Or can you not answer this, and we'll take it off-line?

Gary H. Schoenfeld

No, I mean, again, the energy drink is pretty specific to Men's, so different comments as it relates to women's. I'm sure our design team down the hall appreciates the feedback in terms of the women's line. I share that, I think you're going to see even more compelling design in what hits the stores here in the next couple of weeks. Still, I think that our heritage brands on the Women's side of the business would acknowledge that, that's been a challenging business for several of them. At the same time, we do continue to have confidence and believe there's a role for them. But at the same time, as I said, I think it hasn't been as strong as it was probably back in the heyday. And you will see us add some additional brands beyond our heritage brands on the women's side just as we've been able to on the men's side.

Operator

Your next question will come from the line of Andrew Burns with D.A. Davidson.

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

Could you talk about the store closures, how the sales went on those 87 stores? Did they meet your expectations? And maybe would you do it differently next time around?

Gary H. Schoenfeld

No, I think the firm we worked with was actually the firm the company previously worked with when closing the demo division. At net-net, I would say that we're satisfied with that. The team's doing some hindsighting, but at least at this point, I don't anticipate dramatic changes as we exit the remaining stores at the end of this year.

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

Okay. And then secondly, can you speak to the quality of inventory just in terms of the levels of fall merchandise that requires closeout or any lingering inventory from those store closures that had to be pulled into existing ones?

Gary H. Schoenfeld

No, we exited that in inventory, and so there's not liability in -- from those closed stores sitting in our inventory today.

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

And in terms of fall merchandise, is that where you expect it to be or is there some clearance required to move that inventory?

Gary H. Schoenfeld

We always have some clearance, but I would say it is in line with where we would've expected it to be. And we look at freshness of inventory as I'd imagine, and it's in line with what we would expect and slightly above where it was a year ago.

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

Great. Last question just in terms of the proprietary brands and the growth that you saw there. Just wondering if you could update us on Modern Amusement and the plans there.

Gary H. Schoenfeld

Yes, I think more to come. I think we started off with some good items with Modern Amusement. We enjoyed the partnership that we have with that brand, and we think that there is an opportunity for that brand to become more important, along with some of the other emerging brands that we work with. So I think over the next 12 months, you will see more from Modern Amusement.

Operator

Your next question will come from the line of Jeff Klinefelter with Piper Jaffray.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Gary, I just wanted to ask you about your, kind of, lease structure occupancy levels at this point when you look at your run rate coming out of this year with the store closures. And then if it's possible to even look forward into the end of this year with the projected closures. What does the occupancy structure look like? What sort of leverage point do you now have in the business? And I'm wondering how we think about the gross margin rates stepping back up over time. Is there any way to think about adding low single-digit comp you have some level of margin recapture potential on that mid-single-digit comp that elevates from there?

Gary H. Schoenfeld

I don't think I can give you a clear answer to that. But importantly, exiting these underperforming stores has to help us directionally. And as we get through these remaining anticipated closures, we would then like to think we're in a position where if we can get back to top line growth and merch margin growth, that we'd like to think that the deleveraging or the negative leveraging, whatever would be the right way to describe it, that we'd experienced in real estate in the last couple of years, we'd like to think that, that would be coming to an end. Do I think it will flip and go the other direction? I probably wouldn't be anticipating that now. I wouldn't get bullish in terms of it flipping the other way. But at least in terms of it working against us, I would like to think that we're getting to a point where it's going to stop working against us.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Okay, maybe asked a slightly different way. If you think about where your, kind of, merch margin levels are at this point, how much of a deleveraging effect have you been experiencing with those underperforming stores? Is there any way to quantify that in basis points roughly?

Gary H. Schoenfeld

Yes. I think...

Michael Kaplan

For the first set, it's about 0.5 point. The stores that have closed, look at it at about 0.5 point.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

About 0.5 basis point -- 0.5 percentage point rather?

Michael Kaplan

0.5 percentage point drag on merch margins. Yes. And the mid to higher end of our guidance probably got a little bit of margin upside from a leverage standpoint. On the low end of the guidance is where, kind of, the breakpoint is.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Okay. And remind us where your -- what's your current run rate in terms of the balance of private label exclusive versus branded?

Gary H. Schoenfeld

It tends to run pretty close to 50/50. It slips a little bit from one quarter to another in the fourth quarter. The proprietary part was a little bit more. And within the Women's business, we're seeing proprietary become a bigger part. But as I talked about starting to think a bit differently about emerging brands and what they can mean on the Women's side, we'd still like to think that there's an important role for brands on the Women's side. So net-net, we still continue to think that we're in the 50/50-ish range. But whether that's 55/45 one way or another, we don't try and manage the business very specifically in that regard.

Jeffrey P. Klinefelter - Piper Jaffray Companies, Research Division

Okay. One other question on the expense structure. As you've closed these stores, are you able to fairly quickly make commensurate reductions in your, sort of, field organization? I recognize that closing stores across different districts or regions, you oftentimes can't keep your expense structure right in lockstep with those closures, but give us a sense for how that's flowing through your income statement as you closed this last year and as you anticipate closing this year.

Gary H. Schoenfeld

Yes, Paula, who's our head of the retail team, she's done a great job of frankly staying ahead of this. One of the things that she felt strongly about that I really supported her on was the notion of we'd hate to have to let go DMs and other key positions as we closed things down. So we've got to manage the business the other way where we stretch some people in anticipation of those closures. But at a high level, I can just remind you, when I joined and we were, I think, 932 stores, we had a field organization that had 3 zone vice presidents, 9 regional directors and I think we were 93 or 94 district managers. As we've closed 200 stores during that timeframe, we've eliminated all 3 zone vice president positions. We've shrunk from 9 to 6 regional directors, and we've shrunk from the low to mid-90s in DMs to below 60s in DMs. So she's done a great job, and the team's done a great job of, kind of, staying ahead of the anticipated closures and, as I say, stretching people a little bit to stay in line with that. So feel good about the way we've been able to manage people, as well as the expense in anticipation of those closures. And I think that as that organization structure that I just outlined is pretty consistent with where we would expect to be a year from now and I think is well suited to support kind of a 600-ish store chain.

Operator

Your next question will come from the line of Pamela Quintiliano with Oppenheimer.

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

So I just had a few questions for you. Just your thoughts on the competitive landscape overall and how you're planning the business in terms of buying into promotions, any change in the timing of flows, you're open to buy inventory commitments, just any type of color you could give surrounding that.

Gary H. Schoenfeld

I'm not going to give away too much, but I think I can probably speak to some of the fundamentals that you would want to know about. So number one is we think the marketplace is intensely competitive, that there's quite a vast range of choices. And yet at the same time, I think within the building, I think we all believe that if we can execute it right, there's a real future for PacSun. A lot of the branded business is done across department stores, and we think that as a specialty retailer, we have the opportunity to offer something different than what a department store offers. And similarly, when we look at how much business is done through vertical retailers, we think our brand assortment gives us a really compelling point of difference if we execute it right.

So we are cautious in terms of how much competition is out there, how promotional it has become and the reality of there's probably more choice than the customer needs, and yet at the same time believe we have a path ahead of us that can get us back to where we have a real reason for being in the marketplace. In terms of how we're managing inventory and thinking about the business getting from here to there, we're going to continue to be quite disciplined in inventory. And I'm not sure if I fully answered this in somebody's earlier question, but in terms of overall on the balance sheet, I think our inventory is down 7%. On a comp base, it works out, too. It's about a flat inventory, and we're going to continue to be pretty diligent in how we manage inventory. Michael has taken over responsibility for that area. He's developed, I think, very good relationships with the merchants. The open-to-buy visibility is given a lot of careful consideration. So net-net, we're not going to get ahead of ourselves as best -- or we're going to try our very best not to from an inventory perspective, let the business start to come back. And then if we leave a little bit of sales on the table, then we'll chase it as best we can.

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

Great. And then if I could just follow up a few more other questions. One is do you think there could be the opportunity to close more stores in 2013 as we look ahead? And then also your comment to Marni on Juniors' online performance versus in stores, so do you have a greater ability to leverage your online performance than you have historically? And just, I guess, how are you viewing that differently, and what are you doing differently?

And then the last question is with the guidance that you provided, the 1Q guidance being so broad, is that fully reflective of that Juniors comment you made or is there something else there as well that we should be aware of that can be an impact in the next 1.5 months?

Gary H. Schoenfeld

So relative to the guidance, it really is largely about the Juniors business that was soft in February, which we're hopeful we'll see some improvement on in the second half of the quarter and with new merchandise hitting in about 10 days, but that's the bigger variable. I think the Men's business continues to perform in line with our expectations and in line with kind of its run rate as of late, so that's that piece. As to your question about additional store closures, we've indicated previously that probably somewhere in the 550 to 600 range is probably where we see ourselves aiming towards. And so yes, we would anticipate some additional closures in 2013, but nothing of the magnitude of 2011 or 2012.

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

And then just in terms of the ability to leverage what your learnings online into the store and whether you have a greater ability to do that than you have in the past?

Gary H. Schoenfeld

Yes. I think the short answer is yes, we do. And that -- in the context of everything else that we were doing in 2011 starting with myself, I don't think we gave enough attention to the online world, both in terms of from an e-commerce perspective, as well as just how important it obviously has become from a marketing and customer-connection standpoint. So we have absolutely committed ourselves internally to stepping up our game and in many respects online. And we are encouraged by just some of the things we've started to do and how that's beginning to translate to that business relatively early into the year.

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

And just a very last one with that. Any -- so is there any additional SG&A commitments to that or...

Gary H. Schoenfeld

To the extent there is, it's within the total SG&A guidance that we've given, and I think you've seen we've continued to be very mindful of, as the store base is declining, finding ways to further reduce SG&A, so that we're not experiencing negative leverage as the store base is declining. So have we moved some dollars from other areas into digital? The answer is yes, but it still is with a pretty disciplined eye towards overall SG&A.

Operator

Your next question will come from the line of Betty Chen with Wedbush Securities.

Alex Pham - Wedbush Securities Inc., Research Division

It's Alex Pham on for Betty. I was wondering if you could just give some additional color on product costs for spring and maybe into the second half for fall.

Gary H. Schoenfeld

I think it's obviously well recognized. This is when the year-ago cotton prices were starting to move up and become challenging, so we are seeing some benefit from that. We also did say last year that we were making changes to our assortment, that we didn't -- we weren't expecting to incur the kinds of increases that others were experiencing. So we might not have as much to gain back this year versus others who maybe didn't make changes and absorb bigger increases. So net-net, we are seeing improvements in terms of material costs. Having said that, there are other increases in terms of wage rates and currency that certainly are affecting costs out of China. And part of offsetting that is broadening the countries that we're sourcing from. So net-net, we're seeing in some categories improvements in product costs, but there's a myriad of factors playing into that.

Operator

Your next question will come from the line of Travis Williams with Stephens.

Travis Williams - Stephens Inc., Research Division

I guess first off, Gary, I think it was 3Q that you talked about rent and CAM expense getting up around 20% of sales. I'm not sure if you can share this with us, but it would be great to have an update on that, what that looks like now with the store closures. And then I've got a couple of follow-ups.

Gary H. Schoenfeld

That number is improving, but I don't think we're prepared to be specific as to what that number is. Maybe once we're through all of the closures in 2012, probably this time next year, that would be a fair number to comment on.

Travis Williams - Stephens Inc., Research Division

Okay. And then my next question is just looking at the full year, I know you guys don't provide a capital expenditures guidance, but I think given the cash flow use of the business right now, and then everything going on with the changes in the store closures and the refinancing, it might be helpful for us to kind of know your plans there in some sort of fashion, whether it includes some sort of store remodels or any type of IT you've got to spend on this year, anything that you could help -- could offer would be helpful.

Gary H. Schoenfeld

So I think what I can say is we're -- in terms of turning the business, our focus is: number one, on product and merchandising; number two, in-store experience; and number three, as it relates to digital. So within those things, it's not contemplated. Huge capital expenditures beyond recent levels is probably as much as I think is probably appropriate to say at this point.

Travis Williams - Stephens Inc., Research Division

Could you at least -- I mean, I guess do you expect it to be lower than this year or you think in line with recent levels is somewhere in the ballpark?

Gary H. Schoenfeld

I'd probably take what I just said that's probably as much as...

Travis Williams - Stephens Inc., Research Division

And the last question just the -- could you maybe update us on the penetration of footwear? How many doors are you in now? Any plans to increase that? Sounds like it's been going pretty nicely so far.

Gary H. Schoenfeld

Yes. It's -- in terms of Men's, we're between 350 and 400 doors. That's where we're going to keep most of the Men's footwear. The remaining doors are lower-volume doors that then make it tough for footwear to really be productive. Hanging footwear is an exception to that, so we do anticipate having hanging footwear in Men's in a broader door talent. And in Women's, we've got, I think, the opportunity to and have had footwear in all doors, and I think that will continue.

Operator

Your next question will come from the line of Janine Stichter with Telsey Advisory Group.

Janine M. Stichter - Telsey Advisory Group LLC

Just 2 quick things. First on denim, I think you mentioned that had been a category of strength. I'm just wondering what you're seeing there. Anything you thought maybe you could pinpoint that you're doing right. I know there had been a promotional category on around back-to-school. And then with the outerwear and the fleece showing some weakness, how much of that do you think was weather? And then any adjustments you'll make going forward to those categories?

Gary H. Schoenfeld

So I think weather was a factor, but I don't think these businesses are ever solely about weather. So there's things in our assortment in both genders with regards to fleece and outerwear that we definitely can improve upon and do differently next year and fully intend to. And having just reviewed this morning our back-to-school fleece assortment in Men's, I like where we're headed in that regard. In terms of denim, I think we've got a loyal customer in denim that recognizes us for fit and value and washes, and we need to continue to build on that. While I say they're loyal, they're also happy to shop other retailers as well, so it's loyalty with an asterisk. But we think that's a critically important business for us in both genders, and we need to continue to stay ahead of that marketplace. I think we did a very good job this year in Men's in anticipating shifts beyond indigo denim. And I think on the Women's side, I think we did some things right. I think that our color palette for the beginning of spring was not as strong as some others in the marketplace. And I think it was the team, we acknowledge that, and, yes, you'll see some changes there forthcoming relatively soon as well.

Operator

And at this time, there are no further questions. So I would now like to turn the conference over to the panel for closing remarks.

Gary H. Schoenfeld

Great. Just appreciate everybody's interest. And thank you to Michael and the team walking through and working on all the accounting complexity, but mostly appreciate everybody's continued interest. Appreciate the hard work of the team across the country, and we look forward to sharing our progress with you on our next call. Thanks very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference call. You may now disconnect.

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