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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 W. Kaplan - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

Chris Armbruster - B. Riley & Co., LLC, Research Division

Dana Lauren Telsey - Telsey Advisory Group LLC

Travis Williams - Stephens Inc., Research Division

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

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Pacific Sunwear of California (PSUN) Q1 2012 Earnings Call May 17, 2012 4:30 PM ET

Operator

Good afternoon. My name is Allie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q1 2012 earnings conference call. [Operator Instructions] Thank you. Mr. Gosselin, you may begin your conference.

Craig E. Gosselin

Thank you. Good afternoon, everyone, and welcome to the Pacific Sunwear of California Conference Call announcing our Fiscal First Quarter 2012 Financial Results. I'm 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 2 hours after the call through midnight on May 24, 2012. It can be accessed at (855) 859-2056 or (404) 537-3406, passcode 78167566. The call will also be archived on our website at pacsun.com through midnight on August 22, 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 uncertainties that could cause our business and financial results to differ materially from those in the forward-looking statements are included in our Fiscal 2011 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 be found in the Investor Relations website -- section on our website at pacsun.com. All information discussed on the call is as of today, May 17, 2012. PacSun undertakes no duty to update this information to reflect future events or circumstances.

This call, the webcast and its replay are the property of Pacific Sunwear. 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

Thank you, Craig. Good afternoon, and thank you all for joining us today. I'm pleased to say that we experienced a significant improvement in our business since the time of our last conference call, which resulted in sales for the first quarter at the high end of our guidance and gross margins and non-GAAP EPS that exceeded the high end of our range.

Sales from continuing operations for the first quarter were $174 million this year versus $172 million last year, and our first quarter operating loss was reduced by nearly $10 million compared to a year ago.

Specific highlights for the quarter included: positive comp of 1% in both men's and women's; 160 basis point improvement in merchandise margins; lower occupancy costs and SG&A expenses, both at absolute dollars and as a percentage of sales; and lower inventory compared to a year ago.

At the time of our last release on March 13, we indicated that sales for the quarter were running at the low end of our guidance -- of our Q1 guidance of a minus 4 comp, but that we were hopeful this would improve with deliveries of new product and as we got into more of the peak spring selling season.

Over the next 6 weeks, through the end of the quarter, we had an 8-point swing to a positive 4 comp, resulting in a positive 1 comp for the quarter as a whole.

Shorts and denim, including chinos and casual pants, were among our strongest categories, as both genders achieved a positive comp for the first time since fiscal 2005.

Our reentering into footwear and accessories continues to be a growth opportunity for us. And for the first time, Nike has become the top-selling footwear brand at PacSun.

One of our merchandising objectives is to broaden our range of price points across different categories. Oakley has led the way with our relaunch of branded sunglasses at price points in excess of $150. And as Nike continues to drive its brand toward performance and innovation, we look forward to adding higher price point Nike signature products for back-to-school to further propel this part of our business.

Another important step for us in the first quarter was the launch of our Golden State of Mind brand positioning. Regrettably, over the past several years, PacSun lost some of its identity as a brand and its relevance among target consumers, yet an important part of why I joined PacSun is that this brand has a great 30-year heritage tied to action sports as a core element of California lifestyle. And with this new Golden State of Mind platform, I believe we can reestablish the emotional connection and leadership position that PacSun enjoyed for so many years across all 50 states.

So I will wrap up by saying that it has been a total team effort in driving these improvements in the first quarter. And while we are pleased with our start to the fiscal year, we also know there is still much more to be done.

We remain committed to our turnaround strategy that includes being a destination for great brands, passionately focusing on delivering trend-right products, improving the in-store experience for our customers and cultivating deeper connections to our PacSun brand through our unique lens, tied to action sports and California lifestyle.

I will now turn the call over to Michael, who will speak more specifically to our Q1 results and Q2 outlook.

Michael W. Kaplan

Thanks, Gary, and good afternoon, everyone. Today, I will be providing an update on our Q1 2012 operating results and then close with comments on our Q2 2012 financial outlook.

Our fiscal 2012 first quarter financial results were as follows, total net sales from continuing operations were $174 million this year versus $172 million last year, primarily driven by our plus 1% same-store sales increase in the current quarter.

During the first quarter, we closed 5 stores and opened 1 store and ended the quarter with a total of 729 core and outlet stores versus 827 a year ago. We still expect to close approximately 100 additional stores in 2012, with most of these occurring in Q4 after the peak holiday selling season.

Certainly, one of the highlights of the quarter was delivering gross margin from continuing operations as a percentage of net sales at approximately 24%, which marks a 430 basis point improvement over the same period a year ago.

Contributing to the improved margin was an approximately 160 basis point increase in merchandise margin and a combination of other factors, including lower rent and repairs and maintenance expense and greater efficiencies within our supply chain.

As of the end of Q1, total inventory was down approximately 10% compared to last year, which translates to a minus 3% on a comparable store basis. SG&A expenses from continuing operations were approximately $59 million, or 34% of net sales for Q1, as compared to 61 -- approximately $61 million or 35% as a percentage of net sales for the same period a year ago.

We continue to actively manage our overhead costs and remain pleased with how these trends align with our declining store count.

We recorded an income tax provision of $0.4 million for the quarter, which reflects the continuing impact of the valuation allowance against our deferred tax assets.

On a GAAP basis, our loss from continuing operations for the quarter was $16 million or a loss of $0.23 per share. Excluding store-related charges of approximately $0.1 million and a current period gain on our derivative liability of approximately $6 million and using a normalized annual income tax rate of approximately 37%, our loss from continuing operations for the quarter, on a non-GAAP basis, was approximately $14 million or, a loss of $0.20 per share versus our non-GAAP loss of $0.27 per share last year. This favorability is a direct result of delivering comparable sales at the high end of our guidance range, improved gross margins and reductions in our managed spent.

I will now shift gears and talk about the financial outlook for the second quarter. Our sales comp guidance for Q2 is a negative 1% to a plus 4%. We are targeting our gross margin rate, including buying, occupancy and distribution costs to be in the range of 24% to 26% versus 24% in Q2 of last year.

We expect SG&A expenses to be in the range of $62 million to $64 million. Assuming a normalized annual income tax rate of approximately 37%, this translates to a non-GAAP net loss from continuing operations of $0.11 to $0.16 per share for the quarter, compared with a net loss from continuing operations of $0.17 per share last year.

Our non-GAAP net 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 up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Jane Thorn Leeson with KeyBanc Capital Markets.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

I was curious how you were thinking about products and pricing in Q2 and also for the back half of the -- of this year?

Gary H. Schoenfeld

Can you be more specific in -- product and pricing? It's...

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

Yes, as it relates to AUR versus units. Or just how you're thinking of costing.

Gary H. Schoenfeld

So AUR, we saw AUR increase in the first quarter, and we look for that to continue in the second quarter.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

And then for the back half of the year?

Gary H. Schoenfeld

I'm not going to make a lot of comments about the back half of the year beyond just what we're seeing right now.

Jane Thorn Leeson - KeyBanc Capital Markets Inc., Research Division

And then, as it relates to just your turnaround improvement, what -- how was the -- what drove the comps, if you could give more color, during the quarter?

Gary H. Schoenfeld

Yes, I mean, I think, at a broad level, when we were on the last call, it was our genuine hope that -- February had been a challenging transitional month, but we really felt like we had a compelling assortment for spring, both with products we had in the stores and then, in particular, some of the newer women's products that was about to hit the stores. And as we got into the peak spring selling season, I think clarity of message, prominence of key brands, reduced SKU count, that I think supported execution in the stores. And then, just the product itself, as I said, led by shorts was, in both categories, denim broadly defined, including chinos and casual pants, and then also footwear and accessories. Altogether, when spring kicked in, we had a very nice back half of the quarter.

Operator

[Operator Instructions] Your next question comes from Jeff Van Sinderen with B. Riley & Co.

Chris Armbruster - B. Riley & Co., LLC, Research Division

This is Chris Armbruster calling in for Jeff. Do you -- how much of an impact do you think weather had in the quarter? And how much did the calendar shift help March? And do you have any color on the comps in April?

Gary H. Schoenfeld

So again, April is included, obviously, in the quarter. So any calendar shift is not really particularly material from our perspective in terms of how the quarter played out. And weather, I think weather helped the season get off to a good start in certain regions, and that's always a good thing. But in general, I think looking at how others have performed, we feel real good about how we ended up and obviously, are looking forward to hopefully continuing here in the second quarter.

Chris Armbruster - B. Riley & Co., LLC, Research Division

And do you have any of the comp metrics for Q1 available as far as maybe the transaction count and how you're thinking about that? And do you see any potential triggers to really get that transaction count running positive in the near-term?

Gary H. Schoenfeld

Don't have a strong comment in terms of that at the moment. We do think that AUR is going to be the bigger driver for us, and it's kind of reflected in, hopefully, driving within the guidance that we outlined.

Chris Armbruster - B. Riley & Co., LLC, Research Division

Okay. And just real -- one more quick one, really. Merchandise margins versus last year, and how are you thinking about merchandise margins for the rest of the year?

Gary H. Schoenfeld

As I said before, we're going to keep our comments just to Q2. And as we reflected in the guidance, we anticipate being at or above last year's overall gross margin. And within that, we look to merchandise margins to help contribute to that.

Operator

Your next question comes from Dana Telsey with Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

I want to touch base on as you see the Girls and the Guys business, and I don't know if you touched on this before, but how are you seeing pricing differences, brand versus private label in each of the businesses? And as you look towards Q2, is there any differences in terms of products that you're going to be introducing that could move the needle in either way?

Gary H. Schoenfeld

Yes, as we've spoken before, and you certainly see it in the stores, brands continue to be the dominant driver in Men's. In Women's, brands are a nice complement. But I think we're becoming more and more consistent about recognizing that first and foremost for her is about trends, styles, fit, fabrication, color, price and brands than get folded into that competitive mix. What we do see from our brands is, when they nail it in terms of a style or a fit or a certain print or design that's new and fresh, it performs very well, and we don't see a lot of price resistance. When it's more in line with other products that's in the market, then price is obviously an important factor for her. And unlike the Guys business, where on a T-shirt or a hoodie or a hat or their sneakers, it's quite clear what brand they're wearing. In the Women's side of the business, brands externally just are not as prominent. So that's where we see the biggest distinction between Men's versus Women's. As to changes or something different in Q2, the honest answer is we hope to build, to see this responding well to our spring assortment. And we think that, hopefully, will continue to be trend right and build on that as we go into the summer. So we look at summer as an extension of spring rather than thinking that we need to do something dramatically different.

Operator

Your next question comes from Travis Williams with Stephens.

Travis Williams - Stephens Inc., Research Division

I was just wondering if maybe you might comment on the comp performance between Men and Women's. Were they very similar? Or any big discrepancy there? And then I got a few follow-ups.

Gary H. Schoenfeld

Both came in at a plus 1 comp.

Travis Williams - Stephens Inc., Research Division

Okay. And then, I guess, Gary, if you could comment maybe on the performance of board shorts, just given the real early spring this year and how was this year compared to last year in that -- within that category? I know it's important for you guys. And then, my last question really is just could you comment on what the promotional level at PacSun looked like 1Q this year versus 1Q last year?

Gary H. Schoenfeld

Yes, I think, importantly, one of our objectives was to elevate the PacSun brands as we moved into this year. And I think feedback we've been getting from customers and others is feeling much more of a brand statement and the windows and also, as they get into the stores, and the promotional history that PacSun has been on for quite some time, I think, is becoming more muted and the overall experience, more elevated. So that's one of the qualitative things that we're quite pleased within the first quarter. As to the other part of your question, so just board shorts. Board shorts and swim in general in both genders has only been okay. I think that when technical story of board shorts really hit the market 2 years ago, that was kind of our high watermark in terms of board shorts. And so yes, it certainly is an important category. We love the brands that we get to represent through our board short assortment. But it's not been a growth category for this year.

Operator

And your final question is a follow-up from the line of Jeff Van Sinderen with B. Riley & Co.

Chris Armbruster - B. Riley & Co., LLC, Research Division

Would you consider Q1 less promotional than Q1 of last year? And what are the promotional -- promotions look like for Q2?

Gary H. Schoenfeld

So yes, as we just talked about, yes, we do view that as a positive step in Q1. Not going to talk about promotional strategies for Q2. But what I said a moment ago, in terms of overall objective of making an elevated presentation about the PacSun brand and the brands we carry, making that a stronger part of the message and promotions, not as bigger part of the message, that does continue to be one of our strategies for the year.

Chris Armbruster - B. Riley & Co., LLC, Research Division

Got it. And then, can you give us any additional color maybe on the footwear segment? How you're kind of evolving penetration to new stores or larger stores and the plan for adding SKUs in brands?

Gary H. Schoenfeld

So yes, footwear continues to be a growth category for us, led by Nike and Vans, in particular. We're over 400 stores in Men's. And so that's getting to just about the right number of stores that really can support the inventory that's required to be impactful. So we feel like we're at the right mix there. And on the Women's side, we've started to add sneakers, but it's in a smaller door count. Pleased with the early start with Roxy and some of the other products that we have there. So I think over time, we'll see the Women's store count expand. But more to come on that as we move forward.

Chris Armbruster - B. Riley & Co., LLC, Research Division

And how much is remaining on your line of credit? Or your line of credit availability?

Gary H. Schoenfeld

We don't have anything drawn on the line of credit.

Chris Armbruster - B. Riley & Co., LLC, Research Division

What's the availability?

Gary H. Schoenfeld

I don't know that number off the top of my head.

Michael W. Kaplan

Is that about Q1, Q2?

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

Yes, I was looking for the availability at Q1.

Gary H. Schoenfeld

We can get back to you on that.

Operator

You're next question comes from Adrienne Tennant with Janney Capital Market (sic) [Janney Montgomery Scott LLC].

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

I have a couple of questions, and I apologize I've been hopping around. So I'll just ask them. If you've already addressed them, I can go back and read the transcript. The first is, average unit cost impact. I'm wondering if you can help us out, sort of what if any, you had in Q1 and then as we go into the back half of the year. Number two, branded versus private label. Any changes, material changes or just changes within Men's or Women's that's happening there. And then number three, Mike, for you, the back half plan in terms of inventory units. You've been very good since the back half of last year in controlling that inventory. So if you can just talk to us in terms of units for the fall season, I would appreciate it.

Gary H. Schoenfeld

Sure. So I've -- just to tackle all 3. As we said earlier, not really going to speak to back half of the year other than we'll say, "Remaining disciplined around inventory and driving inventory productivity continues to be a priority for us." As to the first 2 things you asked about in terms of AUC and brands. As you recall last year, we did a pretty good job, I think, relative to what others experienced in terms of mitigating AUC increases. So that's not a big swing factor for us in terms of how we look at 2012. But certainly, the continued reduction in cotton prices is a good thing, as we look out towards the back half of the year. That may be not as big of a swing for us as it might be for others, but still something we're pleased with. From a brand perspective, as we spoke earlier, brands continue to dominate our Men's assortment and play a smaller role in the Women's part of the business.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Okay, great. And then, did you -- your earlier comment on sort of quarter-to-date trends says it all? And then, secondly, your quarter seemed very different versus the cadence of almost every other retailer out there. I hazard to say that the first person you had said that the second half of the quarter and as you meant it includes April, was actually the better part of the quarter. So does that include the shift component? Can you just help us get some more color on sort of, do you mean April? Did April drop off in the back 2 weeks like everybody else saw? Did it pick up in May? If you can help us out, anything there, because it's so different from sort of everything else that we've heard.

Gary H. Schoenfeld

Sure. So the March, April combined was a positive comp. And as you said, we went into the beginning of March. And at the time we did our call, we are running at minus 4. So the bulk of that was obviously the peak of spring break and Easter week. So those next 3, 4 weeks and obviously, anniversarying at the end of April against Easter, we didn't match that. But as a whole, I think the key takeaway in terms of us, I can't comment for others, is we had a slow start in the transitional month of February, but when we got into spring, we had a good spring. That really would be the takeaway. And as to your question about this quarter, we're early in the quarter, but we are seeing positive comps continue so far into this quarter.

Operator

And sir, there are no further questions at this time.

Gary H. Schoenfeld

Well, great. Appreciate everybody's interest, and we look forward to giving you our next update in August. Thank you very much.

Operator

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

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