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Gymboree Corporation (NASDAQ:GYMB)

F4Q07 Earnings Call

March 12, 2008 4:30 pm ET

Executives

Jeffrey P. Harris, Vice President of Finance.

Matthew K. McCauley, Chairman and CEO.

Kip Garcia, President.

Blair W. Lambert, COO and CFO.

Analysts

Paul Alexander – Unknown firm

Dana Telsey – Telsey Advisory Group

Marni Shapiro – Merrill Lynch

Margaret Whitfield – Stern Agee

Linda Tsai – MKM Partners LLC

Jody Yen – Buckingham Research Group

John Morris – Wachovia Securities

Brian Tunick – J.P. Morgan

Operator

Good evening. My name is Christy and I will be your conference operator today. At this time, we would like to welcome everyone to the Gymboree Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you have already done so, please press the pound sign now, then press star 1 again to ensure that your question is registered. Thank you.

Mr. Harris, you may begin your conference.

Jeffrey P. Harris

Thank you Christy. Welcome to the Gymboree Corporation’s Fourth Quarter Earnings Call. I am Jeff Harris, Vice President of Finance for Gymboree. On the call with me today are Matthew McCauley, Chairman and CEO; Kip Garcia, President; and Blair Lambert, COO and CFO. Blair will first make a few comments about our fourth quarter financial performance and plans for 2008. Kip will discuss product performance for the fourth quarter and our merchandizing initiatives for 2008. Matt will then provide some additional background about 2007 and discuss some of our strategic plans for 2008. After our presentation is finished, we will all be happy to take your questions. Before we get started, I want to point out that our presentation today contains forward-looking statements including statements about trends in operations, future sales expectations, and future financial performance. After results could differ materially from those forecast as a result of a number of factors including those set forth in our Form 10-K for the year ended February 3, 2008, filed with the SEC. I would also like to point out that we intend to continue to comply with the SEC regulation FD. As such we will not be providing guidance or projections outside of public forums. You should also be worthy of participation in the Q&A session, constitutes your permission to transcribe and re-broadcast any comments we may make. Now here is Blair Lambert.

Blair W. Lambert

Thanks Jeff. Let me just start out by saying that we got a great fourth quarter. With the backdrop of numerous concerns about the consumer and the financial markets, we were able to deliver a very strong fourth quarter. As reported in our press release, net sales from retail operations for the 13 weeks ended February 2, 2008, were $275.3 million, a 15% increase over the $238.5 million in net sales from retail operations for the 14-week fiscal quarter last year. Other revenue for the quarter attributable to our Play & Music operations was $3.2 million compared to $2.5 million in the prior year. In total, net sales for the quarter were $278.4 million versus $241 million for the prior year, an increase of 16%. As previously reported, comparable store sales for the fourth quarter increased 10%. During the quarter we saw an increase in the total number of transactions and a decrease in the average transaction value. Units per transaction were flat to the prior year. For the full fiscal year, the total net sales were $920.8 million, up 16% versus the prior year. Comparable store sales for the full fiscal year increased 7%. The total number of stores open at the end of the quarter was 786 including 565 Gymboree stores in the US, 30 Gymboree stores in Canada, 2 Gymboree stores in Puerto Rico, 82 Gymboree Outlet stores, 93 Janie and Jack shops, and 14 Crazy 8 stores. During the quarter, we opened a total of 16 new stores consisting of 8 new Gymboree stores, 5 Janie and Jack shops, 2 Gymboree Outlet stores, and 1 Crazy 8 store. Total square footage under management at the end of the quarter was 1,513,000 square feet with our average store size at roughly 1925 square feet.

Turning now to gross profit; as anticipated, gross profit for the fourth fiscal quarter of 2007 decreased 170 basis points to 48.2% compared to 49.9% for the same quarter the prior year. The reduction was due to lower average unit retail prices, the absence of an additional selling week in the current year, and lower margins from Crazy 8 offset by lower product costs and buying and occupancy expense leverage. In addition, in the prior year, favorable year-end inventory shrink results provided $2.1 million or 4 cents per share of incremental gross margin. Based on the success of the past few years, we have been accruing for shrinkage at a lower rate in the current year. Nonetheless, favorable year-end inventory shrink results provided approximately $1 million or 2 cents per share of incremental gross margin this year.

Looking at SG&A in the fourth quarter, SG&A as a percentage of sales decreased roughly 170 basis points to 32.4% of sales compared to 34.1% in the prior year. As noted in our press release, SG&A includes a non-cash catch-up charge related to performance based stock grants. During the first three quarters of fiscal 2007, the company expensed the 2007 performance based stock grants on a straight-line basis in a manner consistent with how the grants will vest to employees. The company has determined that under generally accepted accounting principals, these grants are to be amortized on an accelerated basis. Since the charge is not material to any individual quarter, we recorded the additional expense in the fourth quarter. The net impact to the fourth quarter is to increase SG&A by approximately $3 million. Net of this catch-up charge for the first three quarters, SG&A for the fourth quarter fell by 280 basis points to 31.3%. These SG&A expense decreases were driven by leveraging store compensation, lower in-store marketing costs, reduced travel expenses, and numerous smaller savings throughout the organization. In addition, the prior year SG&A included a $1.3 million charge arising from the settlement of a wage an hour class action suit. For the quarter, operating income rose to $43.8 million or 15.7% of sales including the net impact of the stock-based compensation charge just discussed. Excluding the catch-up charge for the first three quarters, operating income would have been $46.8 million or 16.8% of sales compared to 15.8% in the prior year. Income from continuing operations after tax was $26.8 million or 93 cents per diluted share compared to 82 cents per diluted share in the prior year. Excluding the 6-cent charge – a stock-based compensation adjustment – and the 2-cent benefit resulting from the company’s year-end inventory shrink results, income from continuing operations increased to 97 cents per diluted share. As a reminder, there were also a number of items included in the prior year’s fourth quarter earnings which should be considered when evaluating our year-over-year performance. Specifically, prior year earnings included the following: First, a 5-cent benefit associated with the 53rd week of fiscal 2006. As you are aware, fiscal 2007 had 52 weeks. Second, a 4-cent benefit arising from a favorable inventory shrink result compared to the 2-cent benefit as a result of our fiscal count this year. And lastly, the prior year fourth quarter earnings included a 5-cent benefit associated with the recognition of various state net operating loss carry-forwards. You will note that the fourth quarter tax rate in fiscal 2006 was just 34.1% due to this item versus this year’s more typical tax rate of 39.8%. Please refer to the table included in our press release titled “Reconciliation of Certain Items Affecting Comparability” for a tabular summary of these items.

Let me now move to the balance sheet. Cash, cash equivalents, and investments at the end of the quarter were roughly $33 million with no short or long-term borrowings outstanding. As a side-note, the company does not currently hold any auction rate securities in its investment portfolio. Inventories at the end of the quarter increased to $119.5 million from $104.3 million in the prior year. On a per square foot basis, inventories decreased roughly 1% due to lower product cost. Gross capital expenditures for the quarter were $11 million. For the full year, gross capital expenditures were $68.8 million. Depreciation expense for the quarter was roughly $8.5 million. For the full year, depreciation was $31.2 million.

Let me now turn to our plans for fiscal 2008. As noted in our press release for fiscal 2008, we are planning for diluted per share earnings in the range of $3 to $3.05 on 29 million diluted shares outstanding. These earnings targets include a net loss of 7 to 9 cents per diluted share associated with our new Crazy 8 concept. As has been our practice, we have taken a reasonable but cautious approach in developing our plans for 2008. Looking at sales, we will plan for low single-digit comparable store sales increases for each quarter of fiscal 2008. In terms of new store openings, we plan to open 100 new stores consisting of 20 Gymboree stores, 40 Gymboree Outlets stores, 20 Janie and Jack shops, and 20 Crazy 8 stores.

Turning to margins and expenses, we expect modest improvement in year-over-year merchandize margins as we continue to focus on our product cost reduction initiatives. We anticipate that year-over-year merchandize margins will improve by roughly 100 basis points as a result of these efforts. These product cost reductions will be offset to some degree by higher occupancy costs associated with re-negotiated leases and new store openings. In developing our plans, we anticipate modest year-over-year SG&A leverage before the impact of any incremental direct marketing expense. As a result of the above, we planned for increased year-over-year operating margins for fiscal 2008. Capital expenditures for the year are planned at roughly $60 million. These expenditures will support new store openings, re-models and re-locations, along with targeted investments in our distribution center, new point of sales system, and other information technology systems and infrastructure investments in support of our various initiatives. Depreciation for the year is planned at $35 million.

Let me now turn more specifically to the first quarter of fiscal 2008. We are planning for first quarter earnings from continued operations to be in the range of 73 to 75 cents per diluted share. This first quarter earning adjustments include the loss of roughly 2 cents per diluted share associated with Crazy 8. We built these plans based on low single digit comparable store sales increases for the quarter. In terms of real estate, we plan to open 25 new stores during the first quarter consisting of 7 new Gymboree stores, 14 new Gymboree Outlets, 2 new Janie and Jack shops, and 2 Crazy 8 stores. We also plan to re-model, expand, or relocate 6 Gymboree stores. In terms of gross margin and SG&A performance for the first quarter, we continue to anticipate modest improvements versus the prior year.

Now I would like to turn it over to Kip for discussion of our merchandizing activities.

Kip Garcia

Thanks Blair. I will highlight performance for Q4 and then speak about our key merchandizing initiatives for 2008. First, we are pleased that all brands positive comparisons for sales and gross margin dollars for the quarter. At Gymboree, the high level of planning and execution of our key holiday and gift initiatives definitely moved the needle to a successful quarter. First, we elevated our holiday in-store environment – new this year with three-dimensional trees decorated with festive multi-color lights and we surrounded them with decorated gift boxes to create a festive gift-giving experience for our customers. Our customers were also treated with special red holiday plaid shopping bags and gift boxes which completed the experience. Secondly, our increased investments in key holiday classification paid off this year exemplified by the success of dresses, outerwear, sleepwear, and polar fleece. We ramped up our execution of our tried-and-true holiday events for Q4 and launched new incremental campaigns for the season. For example, Jingle Deals – a campaign that was in its third year double-digit cost over last year as a result of fine-tuning our offerings and price points based upon key learnings from the prior year. New this year was our stocking stuffer headquarters which offered accessory gift items packaged in our holiday plaid complete with to and from tags. We gave gift cards more exposure this year by including them in our stocking stuffer headquarters and made them more giftable by printing them in our holiday plaids and added value by offering a special knitted mitten gift cardholder free with purchase. The stocking stuffer collection became a popular easy pick-up gift destination and as a result the program exceeded plan. Next, we maximized Black Friday by offering special door buster items in addition to our additional percent off. And finally, we had consistently strong product concept and themes throughout the quarter which increased regular priced sales.

Turning to Janie and Jack, we were pleased that all departments positive comparisons with Accessories and Boy departments leading the pack. A key initiative for Q4 was to increase our gift offerings across the departments and giftable sweaters were a key classification driver. In addition, dresses were particularly strong and our shoe business continues to grow at Janie and Jack. In fact, shoes were a major comparison contributor in the quarter. Turning to Crazy 8, strong performance came from our Baby departments where fashion outfits and denim were the key drivers. At the class level, we were pleased that graphic jean denim categories performed well across all departments and boy fashion hoodies were also particularly strong. And finally, $8 sleepwear door busters successfully drove traffic in sales for the quarter.

Turning to Gymboree Outlet, our strongest performance came from Boy and Accessories. Jolly Deals continued to be a customer favorite and we are pleased with performance of our Jolly Deals promotions with strong selling coming from polar fleece and sleepwear. Finally, we maximized Midnight Madness and Black Friday with a successful door buster promotion.

Now looking forward to 2008, at Gymboree, we continue to focus on acquiring new customers and holding on to our customers longer. We have experienced great progress reporting our initiatives to grow the boy business, increase our newborn market share, and maximize extended sizes, and we feel that there is still incremental opportunity in 2008.

We are committed to be the destination for shower baby gifts and have targeted 2008 as the year that we maximize newborn. In support of this initiative, we raised the curtain on our new comprehensive newborn strategy during our February baby event. We heard from our customers that it was hard to find essential layette pieces within our ever-changing fast new collection, and to address that void in our service, we launched a brand new concept which addresses the customer who wants classic essentials for brand new babies that are available every day in our stores. Key to the collection are super-soft knit fabrics, adorable icons, and classic styling for the littlest one. We also have provided pre-selected shower gift options for easy gifting at every price point, from opening price point classics to the ultimate collection, perfect for a wild individual gift or the big from the office gift. We’ve also created a shower gift destination within our stores and online, offering new adorable packaging, gift wrap, shopping bags, and gift cards. For the customer who wants an even more special gift, we are offering a diaper tote to present their gift in complete with organza wrap, ribbon bow, and boy-girl gift toppers.

To continue the momentum for newborns, we have developed specific email, direct mail, celebrity showers, and advertising to support the strategy throughout the year. Additionally, we will be launching an extension of brand new with organics in the fall.

Regarding Boy, our boy initiative in 2007 was successful, and we are continuing on our long-range plan to gain market share in this category. We are pleased with the efforts that we have made in styling supported by overwhelming customer comments to offer an even broader assortment. As a result, we have expanded our assortments to support more outfitting and layering as well as increasing our offering as key boy classifications, as denim, shorts, polos, and woven shirts. We are also continuing to ensure that our product fields are tested by adding masculine details and finishes for our woven shirts, polos, rugbys, denim, and woven bottoms.

To acquire new boy customers, we have added boy-only direct mail, press kits, emails, and in-store marketing to our calendar during key selling seasons, and we are ensuring that boy is prominent in all store sets and visual merchandising throughout the year.

Finally, we have been pleased with the performance of our extended sizes and plan to continue and fine-tune the strategy in ’08.

Turning to Janie and Jack, we are focused on ensuring that Janie and Jack continues to be the destination for best-dressed children by offering timeless styling, heirloom quality and details. In support of this initiative for 2008, this last February, we launched Special Occasion, which includes top-of-the-line dresses and boy suiting. For the February launch, this product was only offered on line and in a very select store group. This very special product resonated with our Janie and Jack customers, and based up on the success of this launch, we will offer the assortment year around and expand our store count.

Finally, we were pleased with our launch of extended sizes to 6 and 8, and we will continue to offer this size range to keep our customer longer.

Turning to Crazy 8, we learned a lot in 2007 and are consistently tweaking and fine-tuning our assortments based upon our key learnings. First, our graphic tees imagings across the departments have been a big win. Our customers have responded positively to our unique graphic tee art work, themes, sense of humour, as well as our fit detailed styling for denim jeans. We feel that we have growth potential within these categories and will continue to position ourselves as the headquarters for jeans and graphic tees. We underestimated the potential of our baby departments in ’07 and see baby as the great opportunity in ’08 by providing unique fashion outfitting as well as key denim and graphic tee presentations styled specifically for that age range.

For kids, we feel that we are on track targeting an 8-year-old who wants cool fashion and easy outfitting with all-American age-appropriate style and details. At Crazy 8, we will continue to offer key categories at opening price points to go head to head with our competition as well as offering competitive priced fashion collection.

Turning to Gymboree Outlet, we have been pleased with out performance and will continue to offer Gymboree’s styling, outfitting, and fashion details at value prices. To support our value equation for Outlet, we have fine-tuned our in-store and window communication packages including window banners and signage in order to ensure that we are clearly communicating value on a consistent basis in all of our stores.

In closing, amid doom and gloom economic news and seasonal calendar shifts, we are very encouraged by our February performance. Our new spring lines have been well received by our customers, and our Easter collections have been a big hit. Our merchants and designers worked diligently to ensure that our Easter assortments are differentiated, and we have been happy to hear from our customers that there isn’t anything comparable in the mall. Easter dresses are the strongest performers across the brands, and plaids are key driving trends for both boys and girls in all size ranges. Both Janie and Jack and Gymboree recently delivered our new spring break and swim lines, and the success of those concepts gives us optimism for the post-Easter selling season and looking forward. We are confident our 2008 initiatives across the brands will set us up for success for the balance of the year.

Now, I’d like to turn it over to Matt.

Matthew McCauley

Before outlining the opportunities for 2008, I want to take just a minute to recap the progress we’ve made over the last few years. Our strategy has been relatively simple in that we’ve focused every department in the company to set clear quantifiable goals in one of three categories – acquiring new customers, holding on to customers longer, or reducing expenses. In order to accomplish our goals and creating clarity, we divided the company into two teams – offense and defense. The offense or obsessed sales drivers are naturally setting goals in the first two buckets of new acquiring new customers and holding on to customers longer. The defense, or masters of efficiency, sets goals around reducing expenses or finding more efficient ways of operation. Both teams have delivered. Since fiscal 2004, sales have grown over $330 million, up 56% percent; operating margins have grown from 4% to 14.1%. Over the same period, net income and earnings per share have grown at a compound annual rate of 55% and 57% respectively. Every department in the company has and continues to contribute to the top and/or bottom line growth.

The designers and merchants are creating products that customers just have to have. The production team, factories, and agents are working tirelessly to produce the best quality kids clothes in the mall at better and better prices every year. The real estate and construction teams negotiated and built more stores in the last two years than the company has in the previous 7 years combined. Our field teams are some of the most passionate and committed people I’ve ever seen, and they thrive on remarkable customer service. By the end of this year, our IT team will have replaced virtually every piece of technology in the company with almost no disruption to the business. We nearly doubled the units going through our distribution center in the last few years, added several new concepts, and expanded the warehouse, and this team took it all in stride. Our marketing team has reinvented itself and now drives new customers in the doors in a way that has never been done in the long history of Gymboree, and we opened our world’s leading play and music classes in South Africa and Portugal establishing the Gymboree brand now in 30 countries around the world.

The point is that every department sets seemingly impossible goals for themselves and delivers. As happy as we are, however, with the last 3 years, we have adjusted our ambitions about the future. We not only aim to reach every mom in America through our multi-brand strategy, but we want to reach moms around the world with our leading play and music classes and e-commerce. To give an idea of where we see the opportunities that can move the needle for us in 2008 and beyond, let me walk through each brand. Within each brand, I will start with the topline growth opportunities followed by the efficiency or margin opportunities.

Starting with Gymboree, the opportunities are still in growing boy market share, newborn market share, customer acquisition through direct marketing, loyalty, integrating play and music, and finally 40+ additional stores in US and Canada. As discussed before, the boy opportunity is worth low single-digit comp growth for Gymboree if all other departments hold constant. We are on the right track with boy as it has led the way in comp store growth the last 2-1/2 years. The demand continues to grow, and we are supporting the demand with increased assortments and inventory. The newborn strategy targets customers at a time when they are still formulating opinions about brands for their kids. In February, we delivered an enhanced layette assortment, elevated our packaging for gifting, and launched the first of several targeted baby mailers. This combined with quality that stands out among the competition, we plan to increase the number of customers in the pipeline leading to compound growth.

Our direct marketing efforts continue to be profitable, and we anticipate growing this effort methodically as the ROI merits. We also expect to have all stores upgraded to the new POS system by the end of the third quarter, and we will be able to test a more formal loyalty program by the end of ’08 or early 2009.

We have increased our efforts to integrate the message from play and music and retail. We have also leveraged the marketing efforts at retail to drive customers into play and music. Through combined direct mail, shared e-mail lists, and improved incentives, we have seen significant increases in the average site sales. We have also seen stronger turns and redemption rates on the retail incentives for play and music customers. In short, the integration of retail and play and music is providing tangible benefits for the customer and ultimately driving profitable growth in both divisions of the company. In 2008, we will step up the integration with additional combined marketing efforts.

As far as margins for Gymboree, we anticipate continued expansion through 2008 as a result of reduced cost of goods already sourced in 2007. As we are in the fourth year of this initiative for Gymboree, we are planning the rate of reductions to slow in 2009 and an increased emphasis to be placed on the cost of goods reductions in Janie and Jack, Outlet, and Crazy 8 as the store counts grow in these concepts. We also see opportunities to improve our store operations with the use of a more sophisticated payroll tool, better processes for store tasks, and improved technology.

Regarding Gymboree Outlets, the Outlets are our strongest of our four-wall contributors, and we still have 60 more stores to open, which will bring the store count to roughly 150. We also plan gross margin expansions as the order sizes increase with the store growth. Janie and Jack has become the ultimate place to shop for luxury European-inspired baby clothes. Our average store growth has been strong year after year since we opened the doors in 2002, and we expect this trend to continue as brand awareness increases and as we capitalize on the larger sizes in stores now. We also have roughly 100 stores still to open bringing the total store count to 200.

Gross margins should also expand in 2008 and beyond as the order sizes continue to go up, and just as we identified operational efficiencies in Gymboree, we also see these opportunities in Janie and Jack stores which will help drive higher four-wall contributions. We also see opportunities in the market particularly in the kids fashion at a price space. We believe we can capitalize on this opportunity in a unique way through Crazy 8. We opened our first store at the beginning of August and currently operate 14 Crazy 8 stores. This concept is targeting moms who want cool wholesome clothes for kids at a price. Our strategy is to impress moms with an elevated shopping experience, great service, beautiful store, entertainment for her kids, quality gift packaging, and then blow her away with value; $7 graphic tees and $14 denim are just two examples of the impressive value in a Crazy 8. We are targeting customers who choose to spend less on kids’ clothes regardless of income. Our strategy also includes an expanded size range compared to Gymboree and Janie and Jack. Crazy 8 offers sizes 0 to 14, allowing us to reach the older customer that Gymboree is graduating. At this point, we are seeing a nice relationship of kid-to-baby selling as well as a more balanced boy-to-girl selling ratio.

Today, we are hitting our budgeted average store and web sales; however, our budget has an aggressive ramp up assumption for the first several years as brand awareness increases and customer loyalty builds. While our assumptions pattern what we have seen in other new concepts, it’s just too early to say whether or not these assumptions will hold true for Crazy 8.

Our gross margins are lower than expected for two reasons: Lower than anticipated initial markups and larger-than-planned marked downs driven by a highly promotional environment in the fourth quarter. Current trends show our percent of sales at regular price is consistent with our outlet business, and we expect gross margin rate to increase as our IMUs grow over time. At this point, we plan to open at least 20 stores in 2008 bringing our total store count to a minimum of 34. We feel this is a big enough base to properly evaluate and size the opportunity.

In summary, store growth in our proven concepts, market share in boy, market share in newborn, margin expansion in all brands, as well as operational efficiencies throughout the entire organization support a solid growth strategy for 2008 and beyond. With a focused and diligent team, we look forward to sharing our progress with you throughout the year.

Now, we’d be happy to answer any questions that you have.

Question-and-Answer Session

Operator

Thank you. At this time, if you would like to ask a question, press star, then the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q and A roster. Our first question comes from Lorraine Malchus.

Matthew McCauley

Hi Lorraine.

Paul Alexander

This is actually Paul Alexander calling for Lorraine. Hi. What kind of macroeconomic assumptions are you building into your guidance?

Matthew McCauley

We’ve basically taken the same approach even when times are good that we want to make sure that we are cautious and make sure that we are prepared, and so we’ve tried to focus on things that we can control and make sure that we don’t get too far ahead of ourselves, and our approach has been to have a very broad strategy – that we’re not hanging our hat on one strategy. So, certainly we’re aware of what’s going on out there, paying attention to the fact that it seems to be dooming gloom. Fortunately for us we’ve always kind of taken the same approach that we will make sure that we’re very cautious. So, not much has changed from there for us.

Paul Alexander

Thank you.

Operator

Your next question comes from Dana Telsey.

Dana Telsey - Telsey Advisory Group

Good afternoon everyone.

Matthew McCauley

Hi Dana.

Dana Telsey - Telsey Advisory Group

Hi. How are you? Can you talk a little bit about your learnings from Crazy 8 and what’s applicable or not applicable about your plans from Gymboree. What’s the integration of the concepts? What do you benefit from in terms of processes? What will make that new concept ramp quickly for you guys? Thank you.

Blair W. Lambert

I have to say it’s a great thing to be in a business that we know something about. It’s a lot of fun to come in and look at sales and get reads on things that we have a lot of experience in, and so I feel like we’ve been very prepared looking at the 20+ year history of Gymboree. We get a good read on what classification contribution should be – boy-to-girl ratios – what the opportunity is there – Baby-to-Kid ratios – all of those things really helped us in the beginning to set pretty strong goals, but we’ve had a few surprises in there; for example, the relationship of Baby-to-Kid that we talked about. We’ve also been really impressed with the relationship of boy and girl – boy to girl. We planned it aggressively on boy’s side and we’re hitting it. So, we’re happy with that. And obviously we have a lot of opportunity in the leverage and the infrastructure across the organization. We don’t have a separate president for each division. We have a president that oversees all of merchandizing and design for all brands, the same thing with planning and allocation, as well as production. So, we have huge opportunities to leverage the entire organization in addition to sourcing. Let’s say one of the biggest things that has been helpful for us is having Outlet be the forerunner for Crazy 8 because we have a really good idea of what we should be paying in average costs by class and by item. So, I think we probably learned more from Outlet than we have from anything else to prepare us for Crazy 8.

Dana Telsey - Telsey Advisory Group

Does it have the potential to have the same operating margin as Gymboree?

Blair W. Lambert

We have a higher operating margin in Outlet. Obviously we’ve got a very different model there. We had very aggressive goals on what we expect it to be, but it’s a little early to say whether or not it can be higher or lower, but we have very aggressive expectations for it.

Dana Telsey - Telsey Advisory Group

Thank you.

Operator

Your next question comes from Marni Shapiro.

Matthew McCauley

Hi Marni.

Marni Shapiro - Merrill Lynch

Hey guys. Congratulations.

Matthew McCauley

Thank you.

Marni Shapiro - Merrill Lynch

Must be nice to be in a baby boom and have customers that don’t care what the stock market does. I’d like to say first on Gymboree and then I have a followup question as well. I’ve been in stores very frequently and I’ve been online very frequently, and the one disconnect I find is that the product sometimes looks – for the older kids – cooler and more pulled together online whereas sometimes in the stores they are very messy and a little bit hard to shop. It feels a little disjointed. So I guess if you could address that issue and if it’s maybe just the stores I am seeing, then I am sorry because I got the manager in trouble, but…but I don’t know if this is something that you are seeing across the board or if – because online you could click on a specific age, it just feels very different and cooler online than it does in a store. And then my second question is – internationally, you talked about play and group, you talked about selling internationally, but if you could just remind us – are you selling internationally with just Gymboree or is it Janie and Jack as well? How many countries are you shipping and what percentage of your direct sales is international?

Matthew McCauley

Okay. Great. First of all, great feedback on what you are seeing in the stores. That’s not something we’re seeing across the board, but always want to hear feedback where we can improve. That’s certainly not our plan and not the strategy and we’re not seeing it across the board – would like to look into that where you are. Secondly, the opportunity for us internationally, yes we are selling in Janie and Jack internationally. We’re shipping it online, and at this point we are in about 30 countries with the play and music and certainly see that as creating a lot of brand presence for us and continue to educate ourselves on what the opportunity is to expand international growth.

Marni Shapiro - Merrill Lynch

Where is direct today internationally – about what percentage of sales?

Unknown Male Voice

We haven’t broken that out because we don’t break out what sales, but it’s a nice chunk and the exciting thing is it is growing quite well.

Marni Shapiro - Merrill Lynch

Great. And then just one followup on Crazy 8 – is there a more fashion bend to Crazy 8 than there is to Gymboree?

Matthew McCauley

There is a little bit more of a fashion bend because we’re reaching out to a slightly older customer there on the kids’ side, but still the focus is really all about “coolsome” – as we call it cool and wholesome.

Marni Shapiro - Merrill Lynch

Great. Thanks guys and good luck with the spring season.

Matthew McCauley

Thank you Marni.

Operator

(Operator Instructions) Again, as a reminder, to ask a question press star 1.

Our next question comes from Margaret Whitfield.

Margaret Whitfield - Stern Agee

Good afternoon everyone. I also visit stores and they are two Crazy 8’s near me, and my neighbors who have children in that age are very unaware of this concept. One of the stores is in the mall with the Gymboree – I wondered at what your seeing when you have that kind of a location, what the cannibalization rate is, and I wonder what your plans are to market the concept; I think you are opening several additional stores in New Jersey, are you going to still focus the store openings in select areas, and what kind of marketing will you support the concept with so that the traffic will build and hopefully the mark-downs will be fewer.

Matthew McCauley

A couple of things – what we are seeing in terms of cannibalization, your first question, is – we had a number out there that we had planned and it looks like it is going to be right around that, maybe a little bit less at this point – so far we are pretty pleased with the amount of cannibalization that we have seen. Secondly, we have done several direct mail campaigns around the launch. We’ve done grand openings and doing mall-based marketing as well trying to capitalize on the mall traffic. Certainly, there are opportunities for us to expand that and we are launching some ambassador programs with some of our employees to get the word out and we’ve also done some radio and we’ve basically kind of learned as we tried several of these things in what is the most productive. We’ve also done some, what we call, Crazy Cash in the malls which significantly increased conversion. So, it sounds like there is still opportunity to reach a whole lot more customers – love to hear that – and we’ve also tried to leverage a lot of the list that we already have in-house as well. So, going forward we will continue to increase direct mail and try to reach out to an even broader customer base.

Margaret Whitfield - Stern Agee

And the openings – the geographic locations you are planning this year?

Matthew McCauley

Yeah, we haven’t laid all those out yet, but we probably won’t cluster as much as we have this last year. Basically, the key to success is being in the right malls and start with the high traffic very successful malls and then we will expand from there, and we have seen a lot of success with being in the same locations as a Gymboree actually.

Margaret Whitfield - Stern Agee

Okay. Baby is at the back of the store in the case of Crazy 8. I’m surprised you are seeing a better sales there than you planned. How much of the floor is Baby, and roughly speaking, what percent of the sales is coming from Baby?

Matthew McCauley

We don’t break out the sales per se, but in terms of the floor, roughly 20% to 25% of the floor is dedicated to Baby.

Margaret Whitfield - Stern Agee

Okay. And over to the Newborn focus for Gymboree – has Newborn been fairly small up until now, and how quickly could you get it to a much bigger number?

Matthew McCauley

Really the opportunity on Newborn is to increase the pipeline, more customers coming in and hold on to them longer. It is not necessary that it has been really, but I would say it has been a little less consistent than we want it to be. Kip touched on the fact that the customers – they kind of come and go with the fashion – and they really need a little bit more of a stable business, more of the layette business that they count on us for, and that’s really what we are enhancing, and our expectation is that yes we can grow the Newborn area, but the real growth is going to come from increasing the pipeline, holding on to those customers longer, and we expect it to kind of move through in the Toddler and the Baby area.

Margaret Whitfield - Stern Agee

Okay. And for Blair, could you get us the four wall numbers overall, and by concept, I think you said that was at the top.

Blair W. Lambert

Yeah, we haven’t been talking about four walls across the board, but definitely Outlet is the highest performing four wall, then Gymboree, then Janie and Jack. So, I guess what we’ve always pointed back to is – and especially store businesses – if you get beyond about a 20% four wall, you usually have a very good return on investment – on your invested capital. So, we start to look at hurdles like that – although we look at it very specifically and each individual store – and we are very happy with all those concepts and where they are currently sitting and where they’ve been moving up to.

Margaret Whitfield - Stern Agee

And finally, the trend in average selling prices, of course, had pressured Q4. Is that something we should consider as a factor in the first half of this year at least?

Matthew McCauley

It’s hard to say at this point but we’ve been happy with the way that we started off this year – February looks good – and hope it continues that way but hard to say at this point.

Matthew McCauley

Do keep in mind that a little bit of the factor on AURs going down is that we have more store growth in the Outlets and in Crazy 8 which are a little more price point sensitive, so it going to put some downward pressure on AURs.

Margaret Whitfield - Stern Agee

Okay. Thank you.

Operator

Your next question comes from Linda Tsai.

Linda Tsai - MKM Partners LLC

What kind of gross margin contribution are you working towards for Crazy 8 and how does that compare to Gymboree’s gross margin?

Matthew McCauley

We are not breaking out the margin rate, but in terms of a comparison to Gymboree, there is no reason that we shouldn’t be expecting margins to be very similar in a Gymboree or Janie and Jack for that matter.

Linda Tsai - MKM Partners LLC

Is that over the next – like a – 2-year time horizon or is there any kind of….

Matthew McCauley

It definitely takes a few years because we need to get enough girth that you can have some buying power to get those average costs down and we’re nowhere near that now.

Linda Tsai - MKM Partners LLC

Is there an approximate number of stores that you need for Crazy in order for that to happen?

Matthew McCauley

Not necessarily. We think that it should continue to happen over time, but at this point, we feel like 30 plus stores is a good chunk for us to get a read on and be able to at least kind of project what our average cost should be and our average unit retail should be.

Linda Tsai - MKM Partners LLC

Great. Thank you.

Matthew McCauley

Thank you.

Operator

(Operator Instructions) Again, to ask a question, press star 1 on your telephone keypad. Your next question comes from John Zolidis.

Matthew McCauley

Hey John.

Jody Yen – Buckingham Research Group

Hi. This is actually Jody Yen calling on behalf of John Zolidis.

Matthew McCauley

Hi Jody.

Jody Yen – Buckingham Research Group

Hi. I’m sorry. Actually, my question is already answered.

Matthew McCauley

Alright.

Operator

Your next question is from John Morris.

John Morris - Wachovia Securities

Hey. Let me add my congratulations on the quarter and the year.

Matthew McCauley

Thank you.

John Morris - Wachovia Securities

Blair, I think the first one is for you. If you can, give us the approximate impact in basis points from the absence of the extra week on gross margin and also on SG&A.

Blair W. Lambert

The total number is 5 cents from last year. We haven’t really broken it out, but a large percentage of that is in the occupancy cost certainly, so it is in the gross margin line.

John Morris - Wachovia Securities

Okay. What I’m trying to get to is if there is a way to look at – just look at gross margin, apples-to-apples, ax the shrink, and any other one-time adjustments, can you give us color on that?

Blair W. Lambert

Gross margin for the quarter is down 170 basis points. About a third of that is related to Crazy 8 involvement – so that is a big component of it. I would imagine that the other probably 53rd week net of occ is pretty close to the same number – actually 53rd week in and of itself – I am looking at some notes here. So then the remainder is kind of a blend of a lot of things, less favorable shrink is certainly a big component of it – we had 2 cents of benefit this year, 4 cents last year, but then there is a lot of other things – lower average unit cost and then on the other side we’ve got lower AURs, so those kind of net together a little bit. And then finding occupancy leverage just from having a higher comp gives us a little upside. So a lot of different components to it, but probably the two biggest ones are the 53rd week and the Crazy 8 component.

John Morris - Wachovia Securities

Okay. That’s very helpful. That’s what I was trying to get at. And also, unless I missed it, did you talk about the inventory plan for the spring season.

Blair W. Lambert

Basically, we were with a day left in the year down about 1%. We anticipate being up slightly in the low single digits by the end of the quarter.

John Morris - Wachovia Securities

And on Crazy 8, the gross margin pressure that you noted – were you seeing that pretty much evenly spread across the units or was there any kind of an insight that you would have had based upon geographic performance or specific real estate performance.

Blair W. Lambert

Well, where we’re seeing the spread is obviously on the sales across the real estate and what we’re seeing is really great performance in those top malls particularly where we’ve got a Gymboree already which naturally coincides with stronger malls, and so that’s really what we’re seeing as the spread and basically helping us know what kind of malls we should be starting with. It doesn’t mean that we can’t expand to those malls long-term – that’s the plan – but we really need to start with malls that have a lot of traffic when you’re trying to build a brand and get that brand awareness out there.

John Morris - Wachovia Securities

Okay. That’s really helpful. And finally for Kip, I think. A really terrific job really on the whole organization and executing a holiday as we noted. Was there anything that you would have, looking in hindsight now, you would have liked to have done better? Where would the opportunity be for next year’s holiday?

Matthew McCauley

There is one classification that we’re a little bit disappointed in and it had a slow start in the quarter – that was sweaters. The customers definitely voted for dresses this year as the fashion items. So we’re doing the deep dive in that category across all the brands actually – it’s a little bit surprising – but other than that, we were pretty happy.

John Morris - Wachovia Securities

Great. Thanks guys.

Matthew McCauley

Thank you.

Operator

Your next question comes from Brian Tunick.

Brian Tunick – J.P Morgan

Thanks. Hey guys.

Kip Garcia and Blair W. Lambert

Hey Brian.

Brian Tunick – J.P Morgan

Alright. So, I guess the first one is – you talked a lot about direct marketing being the huge customer acquisition opportunity. Can you give us any dollars, or percentages, either growth, or of sales that you guys have spent in 2007 versus the prior years or what we could expect for 2008 and what are you guys doing there?

Matthew McCauley

I’ll just repeat the total marketing dollars – last year we were around 1.7% of total sales, this year we’re a little over 2%. So, a nice increase in the investment – the vast majority of that is in direct marketing. And as we said, for 2008, we plan to kind of methodically grow that as we continue to see the ROIs on it.

Brian Tunick – J.P Morgan

Okay. Second question I guess is the cash cushion that you guys feel comfortable running with – obviously you’ve got these 100 stores. How do you guys view the buyback program opportunity versus how much cash you want to sit with?

Blair W. Lambert

Well, we certainly always look at the cash position, always looking for the best utilization of cash. Obviously, right now we don’t have any new buybacks authorized. We will continue to talk with the board about that on a regular basis. In this environment, everybody likes to have a little bit of cash and we’ve also got a few assets that are unencumbered that are available to us. We own our distribution center for example – so, we feel pretty good about where we are sitting with the balance sheet right now, but we will work with the board and come up with appropriate strategies throughout the year as things progress.

Brian Tunick – J.P Morgan

Okay. And just finally on the 100 basis points of IMU opportunity for this year, we’re starting to obviously hear about cost pressures potentially in the back half. I mean, is all your business bought already and manufactured these contracts, so if are very comfortable with that?

Blair W. Lambert

We’ve bought the vast majority of 2008. We still have one development period to wrap up the year, but it is something that we are paying an attention to seeing a lot of pressure across the market, but a lot of it is really impacting China and we’re trying very very hard to diversify and have a lot of other countries that we’ve entered into over the last few years that have helped us out.

Brian Tunick - J.P. Morgan

That’s terrific. Good Luck guys.

Blair W. Lambert

Thank you.

Kip Garcia

Thanks.

Operator

At this time, there are no further questions. Are there any closing remarks?

Kip Garcia

I want to thank everyone for participating in our call. If anyone has any questions, please call our investor relations hotline at 415-278-7933. Thank you very much.

Operator

Thank you for participating in today’s conference call. You may now disconnect.

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Source: Gymboree Corporation F4Q07 (Qtr End 02/03/08) Earnings Call Transcript
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