Genesco Inc. F4Q08 (Qtr End 02/08/08) Earnings Call Transcript

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 |  About: Genesco Inc. (GCO)
by: SA Transcripts

Operator

Good day everyone and welcome to the Genesco Fourth Quarter Year End Fiscal Year 2008 Conference Call. (Operator Instructions) At this time, for opening remarks and introductions I’d like to turn the call over Mr. Hal Pennington, Chairman and Chief Executive Officer of Genesco.

Hal Pennington

Good morning and thank you for joining us for our Fourth Quarter Fiscal 2008 Conference Call. Participating with me on the call today are Bob Dennis our President and Chief Operating Officer, Jim Gulmi our Chief Financial Officer. As always, we will make some forward looking statements in this call that reflect our expectations as of today but actual results could be materially different. We refer you to our earnings release and to our recent SEC filings including the 10-K for Fiscal Year 2007 and the Third Quarter 10-Q for some of the factors that could cause differences from our expectations.

For those listening to the replay of this call on the internet some of these factors can be read on the opening screen. To begin let me address the settlement of our litigation with the Finish Line and UBS. As you know, last week just before the solvency trial in the southern district of New York was to begin we reached an agreement to settle all the litigation related to the merger for a cash payment of $175 million and a 12% equity stake in the Finish Line.

The value of the entire package will be taxable to Genesco so we expect to net about $95 to $100 million in cash in the transaction. The settlement agreement requires Finish Line to register the stock with the SEC and to list it on NASDAQ which will make it fully tradable. It also requires us to distribute the stock to shareholders once it is registered and listed. A record date for that dividend will be set promptly on completion of the registration process.

I thought it might be helpful to give some insight into our analysis of the settlement and why we think it was the best available alternative for the company. First, we believe that continued litigation was not sufficiently likely to yield a better outcome to justify the delay and risks associated with it. We had won a clear victory in Tennessee in December, Finish Line was subject to an order to complete the acquisition in accordance with the merger agreement but Finish Line didn’t have the cash to acquire us.

Their ability, and frankly their willingness to hold UBS to its commitment was increasingly open to question. While we had good arguments that the merged entity would have been solvent both Finish Line and UBS were in a position to argue the opposite, to a judge who was showing some signs of skepticism about the question. If there had been an insolvency finding our UBS would otherwise have succeeded in avoiding its commitment, we would have been left to pursue Finish Line for damages.

They were prepared to argue that we could only recover out of pocket losses from their breach not the merger premium based on one of the few cases addressing the question of damages for breach of a merger agreement, that being the Coned case from New York. We disagreed with that argument but saw it as a risk. Even if we won on that point we would have had another nice victory and an enormous claim against a bankrupt debtor.

In fact, we believe that Finish Line might file for Chapter 11 Bankruptcy rather than returning to court in Tennessee for a damages trial. Ultimately recovering damages from Finish Line in excess of this settlement seemed to us, at best, an uncertain possibility. It would have required months or even years of appeals with all the expense and distraction that litigation brings.

Second, we did not believe that a re-price transaction was a viable alternative. We had the clear sense that Finish Line’s management had reach the point that they did not want a transaction. Also, UBS was adamant that they were not required to fund a re-price deal under the commitment letter and it was not clear what the New York court would say on that question. Further, any re-price transaction would have been subject to delay or a renegotiated merger agreement, due diligence and new proxy statement likely SEC review and so forth. Because the UBS commitment letter would have expired on April 30 it was doubtful that we could have completed a transaction within the time remaining.

Finally, we frankly had no assurance that Finish Line or UBS would not once again be subject to buyers or lenders remorse before the new deal could close and that we wouldn’t find ourselves back in the same situation pretty much down the road. The settlement had at least two obvious benefits for Genesco and our shareholders. Most importantly it puts a long episode of distraction behind us and allows us to focus anew on executing our strategies.

While we will talk a little later about how current economic and market uncertainties have affected our recent performance we remain convinced that our long term prospects are strong. Fortunately we have managed to hold the core team together through these months of uncertainty. We have the same talented people executing the same long term strategies for the same industry leading businesses that we had a year ago. We look forward to working with renewed commitment to realize our potential.

The other benefit of the settlement is that it gives us some unexpected cash that allows us to do more than talk about our long term value. As we announced this morning our Board has authorized us to buy back up to $100 million of our common stock. This is a great opportunity to return settlement proceeds to the market to enhance our future earnings per share and to demonstrate our belief in this company’s inherent value.

Needless to say we view Genesco as a great investment especially at current prices and we expect to be an active buyer starting next Monday when our trading window opens. Now I’m going to ask Bob Dennis to discuss our operations in the fourth quarter.

Bob Dennis

Before discussing results let me emphasize that our operating teams, a very experienced group of merchants and field management let by Jim Estepa, Jon Caplan and Ken Kocher are all anxious to continue building their businesses absent the distractions of last year. We are fortunate not to have had significant losses of people as a result of the litigation. Now to our results.

Overall our fourth quarter reflected a challenging economic and market environment as evidenced by the results that many retailers have reported for the holiday season. Comp store sales for the company were down 5% in Q4 compared to a 1% increase last year. Total sales were $467 million down 2% from last year and earnings from operations were $28.6 million including $8.8 million of merger related and restructuring expenses.

Looking ahead, we expect the consumer environment to remain challenging but we also believe we have some specific opportunities in several of our businesses as an offset during the year which I will call out as we review each segment. Also, we scaled back our store opening plans this year originally due to the Finish Line deal to a level we think is appropriate given the challenging environment. Now I will briefly review each segment.

Comps for the Journeys group were down 7% for the quarter with the Journeys stores also down 7% compared to a 6% increase last fourth quarter. The combination of a tough retail environment, the lack of a fashion driver in footwear and the continued effect of Heelys over distribution affected Journeys group during the quarter. Year over year Heelys revenue was off $13.5 million and gross profit was off $8.8 million in the fourth quarter. However, by the quarters end we had right sized the Heelys inventory and taken reserves that should allow us to sell the remaining shoes at a normalized profit margin.

Heelys strength in the first half of last year will continue to challenge Journeys comps but Heelys recent poor performance should create an opportunity for us in the back half of the year. As you may know PacSun is exiting a significant portion of their footwear business. We regard this move as a confirmation of Journeys position as the destination shoe store for the teen. As PacSun liquidates their inventories we might feel some short term impact in skate product. Longer term, of course, the exit of a significant competitor from this segment of our market should be a strong positive for Journeys.

Women’s casual shoes performed well in the quarter with particular strength in brands by Converse, UGG and Crocs. On the men’s side Vans, Nike and DC performed well. During fiscal 2008 we opened a total of 41 new Journeys stores and ended the year with 805 stores. We expect Journeys comps for the year to be positive low single digits with a stronger performance in the back half of the year than in the first half.

Turning briefly to Shi by Journeys, this business was also impacted by the weak retail environment but we remain convinced of its potential. In the fourth quarter we were especially successful with boots and other closed up footwear. We were pleased with the gross margins we achieved and the high multiples we are getting from our Shi customers. We see an opportunity to layer on a higher price line to what we currently offer and overall we continue to like what we see in this business. We opened 35 stores in fiscal 2008 and ended the year with 47 Shi stores.

Journeys Kidz had a comp decline of 3% in the quarter compared to an 8% increase last year. This was primarily due, again to weakness in Heelys. We expect comps to be challenged by Heelys in the first half but face comparisons that will be easier in the back half. Overall, we anticipate comps in the low single digits for the year. For the fiscal year we opened 42 stores and now have 115 Journeys Kidz stores in operation.

Turning now to Hat World, comps declined 4% for the fourth quarter on top of a 1% decline last year. The tough retail environment and weakness in fashion MLB and NCAA categories hurt sales. Major League Baseball remains our largest product category remains our largest product category. Core MLB product continues to be a significant part of the business while action brands such as DC, Fox and Hurley were strong once again. Recall that at this time last year we were depleted in the on field MLB hat due to the transition to a new SKU. This has made comparisons easier in January and February, a trend that should continue to April 1st.

Although it’s still a small part of the business we were very pleased with the performance of our Canadian stores as comps increased 9% for the quarter. We are especially ambitious to open more stores in Canada this year. During fiscal 2008 we opened a total of 98 new stores and ended the year with 862 stores in the Hat World group. Overall we expect comp for Hat World this year to be in the low single digits.

Underground Station group comps declined approximately 5% for the quarter again reflecting the general retail environment and the ongoing challenges in the urban market. Weakness in one of our major boot brands also hurt the quarterly comps. On the positive side we did see improvement in the comp trend during the quarter which has continue into the current quarter. We continue to make progress on our new merchandising strategy. Women’s footwear made up 42% of Underground Station’s footwear sales in the fourth quarter this year compared with 35% last year.

We are pleased with customer response and the increased effort many of the urban vendors are making in this category. We had real success with brands such as Baby Phat and Pastry and are adding several other key brands which will position Underground Station to be a true dual gender retailer and further different from other footwear concepts in the mall. The Kids business was also strong for Underground Station accounting for 9% of Q4 footwear sales.

We ended the fiscal year with 192 stores in the Underground Station group. Our previously announced program to close underperforming store is proceeding on track. We closed 33 stores in the group during fiscal 2008 and we will not open any new Underground stores in fiscal 2009. We expect comps in the high single digits for the year which we believe is achievable given Underground Station’s negative 16% comp in fiscal 2008 and our continued commitment to the repositioning of the business. We expect these comps to drive meaningful improvement to Underground Station’s gross margins and operating margins in the coming year.

The Johnston and Murphy group had another solid quarter despite the macro environment with sales of $54 million. Operating earnings were up 7.5% and operating margin increased 150 basis points to 13.6%. Same store sales declined approximately 1% in the Johnston and Murphy shops during the quarter after an increase of approximately 5% last year. Footwear comp asps at Johnston and Murphy shops were up 7% and unit comps were down 12% during the fourth quarter. Asps for all three footwear product categories; casual, dress and dress casual increased. This, along with fewer mark downs improved gross margins.

Johnston and Murphy’s strategic push to expand the brands reach beyond footwear continues successfully. Non footwear in shops accounted for 38% of sales for the quarter compared to 33% last year. Our wholesale business also remained strong despite overall weakness from many of our major accounts. In fiscal 2008 we opened 11 stores, eight Johnston and Murphy shops and three Johnston and Murphy factory stores and we ended the year with 154 stores. We anticipate comps for fiscal 2009 in the low single digits.

Finally, turning to licensed brands, sales increased 3% and operating income increased 29% in the quarter. The Dockers footwear business continued to benefit from gross margin expansion during the quarter. Docker’s products styling comfort and value equation continues to resonate with its core customer. Our product team continues to find ways to add newer technologies that differentiate the brand. Despite the challenging retail environment Dockers order backlog is currently above last year’s comparison.

Hal Pennington

It’s obvious that our performance in the second half of last year reflected general economic conditions and the lack of must have products in the footwear market. While we are expecting a continuation of these trends in the first half of this year as Bob points out we do have a comparison playing in our favor in some of our businesses even in the first half. Even while we plan prudently for this year we are focused on opportunities to make process improvements that we believe will have multi year benefits for us.

To offer just one potentially significant example, as Bob has mentioned, and as Jim will discuss in more detail, we are planning to reduce our face of store openings across the board for this year only. We will take advantage of this brief breathing space to analyze our store opening process focusing first on how we build and picture stores. We believe that a more systematic approach to these processes can yield potentially significant long term savings and capital expenditures.

We would also be able to be much more selective and much stronger on negotiations for new space this year given our temporary lower demand. By turning external challenges into internal opportunities in this way we believe we will be able to emerge from this cycle stronger and better prepared to resume and sustain the face of growth we are accustomed to. Now I’ll ask Jim to discuss the financial results for the quarter and our outlook for the year.

Jim Gulmi

I will now run through the P&L for the quarter starting at the top. Fourth quarter sales declined 2% to $467 million compared to $477 million last year. Comp store sales decreased 5% in total. We estimate the extra week in last years final quarter added about $25 million in sales. Without the extra week last year sales would have increased about 3%. Journeys group sales decreased 3% to $227 million and comps were down 7% for the quarter. Adjusting for the extra week, sales would have been up 2%.

Hat World group sales rose 5% to $122 million. Adjusting for the extra week sales rose 10%. Comp sales for the quarter declined 4%. The Underground Station group sales were down 13% to $43 million. Adjusting for the extra week sales declined 7%. Comps were down 5% for the quarter.

Johnston and Murphy group sales decreased 4% to $54 million. The Johnston and Murphy wholesale sales were down for the quarter but up about 4% for the full year. Adjusting for the extra week, total Johnston and Murphy sales for the quarter increased about 2%. Comps sales for the Johnston and Murphy shops declined 1% and factory stores were down 2%. Licensed brand sales increased 3% to $21 million on top of a 51% increase last year. Adjusting for the extra week, sales increased by 7% in the quarter.

Now turning to gross margin, total gross margin for Genesco was 48.8% compared to 49.2% last year. The gross margin decrease reflected generally conserved posture on year end inventory reserves due to the sales weakness in the fourth quarter. Journeys group gross margins for the quarter were down due primarily to heavier mark down reserves.

Underground Station group’s gross margin was down about 60 basis points which was due primarily to lower discounts from vendors as mark down and reserves were close to last years levels. Hat World’s gross margin improved 100 basis points in the quarter. This was good to see as we had been trending down in the previous three quarters of the fiscal year. Licensed brands strong gross margin of 290 basis points on top of a 50 basis point increase in last years fourth quarter. Johnston and Murphy’s gross margin continued to show a good improvement of 140 basis points. This was on top of 190 basis point improvement last year in the fourth quarter.

Turning to SG&A, total SG&A as a percentage of sales increased 42% compared to 36.7% last year. Included in this expense percent is about $15.1 million or 323 basis points of costs associated with the merger litigation. Total expense dollars excluding merger costs were lower than our earlier internal forecast. Much of the remaining increase of SG&A as a percent of sales reflects lower than expected sales in a relatively fixed nature of SG&A expenses particularly in our retail business and incremental expenses associated with store growth.

This was essentially true each of our retail concepts in the quarter due to a weaker comps and the square footage in the Journeys group and Hat World group. The Johnston and Murphy group was able to improve leverage in the quarter even with the sales decrease. Licensed brands were not able to leverage SG&A due primarily to higher bonus accruals. For the quarter operating income was $28.6 million and operating margin was 6.1% compared to 12.6% last year. The current quarter included $15.1 million of merger related litigation expenses and $3.7 million in store closing and impairment charges that reduced operating margins by 400 basis points.

Last year we had a net restructuring gain of almost $600,000 which added 12 basis points to operating margin. Operating margin declined to 10.6% in Journeys, 14.2% in Hat World, 5.3% in Underground Station and rose to 13.6% in Johnston and Murphy and 8.4% in Licensed brands. In addition, corporate expenses excluding merger related litigation expenses were $1.00 as a percent of sales from last year.

Johnston and Murphy’s 150 basis point improvement in operating margin reflected expense leverage and a better gross margin. Obviously the strong turn around at Johnston and Murphy continues a 3% increase in sales for the year and a 29% increase in operating income. Operating margin is 10.3% for the fiscal year as compared with 2.6% four years ago.

Licensed brands operating margin also increased once again by 170 basis points due to gross margin expansion. Licensed brands sales increased 18% and operating earnings increased 62% for the fiscal year. Operating margin was a record 11.8% of sales for the year.

Net interest expense during the quarter increased to $3.5 million from $2.9 million last year due to increased borrowings. Earnings before discontinued operations of $4.5 million or $0.19 per diluted share compared with $1.36 last year in the fourth quarter. Included in this years fourth quarter earnings are merger and impairment charges of $18.8 million pre tax and a higher tax rate primarily due to the non-tax deductibility of merger related fees.

As we have talked about before merger related fees are not tax deductible unless the transaction should not be completed. We estimate those items caused EPS to be lower by about $0.81. Last year’s EPS for the quarter included a gain of approximately $0.01 per share net primarily from the recognition of gift card related income and a favorable litigation settlement. For the full year, earnings before discontinued operations were $9.4 million or $0.40 per diluted share compared with $68.2 million last year or $2.61 per diluted share.

Included in this years earnings are merger and impairment costs of $37.3 million pre tax and a higher tax rate due primarily to the non-tax deductible merger related fees I mentioned earlier. We estimate that those items reduced EPS for the year by about $1.26. Last year EPS for the 12 months included a loss of $0.03 per share net primarily from impairment charges.

Now turning to the balance sheet, we ended the quarter with $69 million of bank debt compared to $23 million last year. This increase in bank debt is due to a variety of factors including the lower than anticipated net earnings in part due to the merger related non-tax deductibility costs of $27 million and the higher than anticipated inventory levels at year end. Our inventory levels increased 15% from the same period last year and our square footage increased 11% for the year. We are comfortable with the quality of our year end inventory and have plans to bring the overall inventory level in line with sales expectations in the first half of the year.

Now turning to capital expenditures, for the quarter capital expenditures were $12 million and depreciation was $12 million. For the 12 months capital expenditures were $81 million and depreciation was $45 million. We ended the quarter with 2,175 store compared with 2,009 last year. This represented a net new store increase of 166 stores or 8.3% year over year. While square footage increased 11% to three million square feet.

In the fourth quarter we opened 41 stores and closed 38 of which 23 were in the Underground Station group. In the fourth quarter last year we opened 49 stores and closed 14. All together for the fiscal year we opened 229 new stores and closed 63 of which 33 closed store were in Underground Station group. As Hal and Bob have mentioned we are planning a slower than usual phase of store openings this year in response to economic conditions. Reflecting this we are planning capital expenditures for FY09 to be in the $61 million range about $20 million below last years levels.

Depreciation for the full year is expected to be about $47 million. Here is the breakdown of our new store plans or FY09. We expect to open about 28 Journeys stores and to close three. We expect to open 24 Journeys Kidz stores and about 13 Shi by Journeys stores. Hat World expects to open about 40 stores and to close all together 13 for the year. We expect to close about six Jarman and 22 Underground Station stores. We expect to open six Johnston and Murphy shops and to close two and to open four Johnston and Murphy factory stores.

Altogether we expect to open up about 115 stores and to close 46 this year. We expect an FY09 with 830 Journeys stores, 139 Journeys Kidz stores, 60 Shi by Journeys stores, 889 Hat World stores including 15 Lids Kids stores and 44 stores in Canada, 164 Underground Station stores, 117 Johnston and Murphy shops, 45 Johnston and Murphy factory stores. This is a total 2,244 stores or an increase of 3%. We also expect retail square footage to increase about 3%.

Now let me discuss our outlook for the current fiscal year. We expect sales for the year in the range of approximately $1.6 billion, operating income in the range of $92 to $96 million not including items I will mention in a moment. Our EPS guidance for the fiscal year is in the range of $1.83 to $1.91. Non of our earnings guidance reflects any merger related litigation expenses, any restructuring charges and any positive tax adjustments from the deduction of FY08 merger related costs or the gain of merger related litigation settlement. It also assumes current share outstanding and thus does not reflect a benefit of our planned share repurchase.

We estimate restructuring charges primarily in connection with our previously announced plans of a total of 57 Underground Station and Hat World stores and asset impairments to be in the range of $10 to $12 million pre-tax in FY09. In addition, we are expecting merger related litigation fees of about $5 to $6 million pre-tax in quarter one and a tax benefit of approximately $10 million in quarter one from the tax deduction of merger related fees FY08.

In addition, we will be reporting a merger related settlement gain in the first quarter of the fiscal year. Again, none of this is included in the guidance. Comps are expected to be in the low single digit range for the fiscal year. We are expecting a modest decline in our comps in the first quarter as we are going against tough comparisons in the first quarter. We expect to improve comps as we move in the back half of the year.

From an earning standpoint we expect a decline in the first quarter which is by far our strongest quarter last year due to general economic environment. Our current outlook is for EPS in the range of $0.08 to $0.10 for the first quarter. Again, excluding all the non-operating items we mentioned in connection with annual guidance. We expect to see some improvement as the year progresses as the comparisons become easier and we hope the economy begins to show some improvement.

We are also expecting a nice positive cash flow in FY09 with a lower capital expenditures, lower inventory levels and improved earnings. As Hal has said we expect to resume to higher new store growth levels in the following year. Now I’ll turn the call back to Hal.

Hal Pennington

After all the distractions in the past 13 months it feels good to be able to focus exclusively on the business once again. I hope that you can also tell that we are excited about the opportunities ahead of us. Despite an uncertain economic environment we are confident of our position and our plans and we look forward to reengaging with our investors. As I’ve already mentioned we are excited about the change to sharpen up some of our key processes.

If we are right about that we should see tangible benefits from this work in future years. We also know from experience that strong companies like ours emerge from these periods of uncertainty even stronger and better positioned as competitors leave the field. We are prudent in our near term plans and outlook but we are bullish as ever on Genesco’s long term haul. With that let’s open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to John Shanley with Susquehanna Financial.

John Shanley – Susquehanna Financial

Jim, the 15% increase in inventory, can you give us an idea of what components of the business that inventory is heavily concentrated in and how much of it may be dated inventory versus current season goods?

Jim Gulmi

The increase is primarily in Journeys and Hat World. I’ll start with Hat World, from the standpoint of dated the fashion risk there is not as great as it might be in some of the other businesses and Bob might want to talk about that some in a minute. We feel definitely there is value; there is no risk from the standpoint of obsolescence or fashion. In the case of Journeys we looked at the Journeys inventory very closely at year end and we feel very comfortable that what we have on hand that we will be able to sell in the first half of the year without taking any meaningful mark downs we think we’ve got the inventory valued properly and we don’t feel like we have much inventory risk going forward because we’ve looked at it, we feel we can sell it though in the first half and we’ve been pretty conservative we think in our year end inventory reserves.

Bob Dennis

On Hat World what we have done is right size the fashion Major League Baseball, the Hip Hop inspired inventory and that is not bigger than we want it to be. It is much more in stock hats and as you know we can manage our inventories down on stock hats with just receipts.

Jim Gulmi

Another point is that you also have to remember that our square footage is up 11%. I know sales and inventories are the key metric here but also we’ve got more stores, more square footage and we obviously need more inventory in those stores or they look empty. Some of that is square footage growth but we do have more inventory than we need but we do believe we can right size in the first half of the year.

John Shanley – Susquehanna Financial

Can you comment on whether or not the company has set up any reserves for any pending litigation coming up down the road? Are there any special provisions that you’ve made for litigation expenses?

Hal Pennington

No we haven’t. We will have to address that when it happens. There is not reserve that is set up for it.

John Shanley – Susquehanna Financial

The last question I have is on Underground Station. You are down to 192 stores, you are going to close another 28 or so this year. Why not just shut that division down rather than have a slow bleed like you have been doing the last couple years?

Bob Dennis

We still believe in the promise of Underground Station. As we said on the call the most recent results have been very encouraging. This is a very different business today than what it was just a year ago in terms of the commitment to the women’s side of the business, the corresponding reduction and our exposure on the men’s side, kid’s is planning an important role there. We’ve modeled it out and we believe that it’s a better outcome to stick with the plan we’ve got. Needless to say if this plan doesn’t pan out we will take another look at it. We’ve been committed to this strategy and we knew it was going to take a little time for it to take hold and right now we really like what we are seeing.

John Shanley – Susquehanna Financial

Is the division making you money?

Bob Dennis

It didn’t make money last year. Jim can give you the numbers. We expect it to make really good progress this year and to be making money next year. The issue with these kinds of businesses is you can’t shut these things down for nothing and when you look at the over under on it we think the strategy we’ve got is viable and so it’s much better to stick with it.

Operator

We’ll go next to Scott Krasik with C.L. King.

Scott Krasik – C.L. King

Thanks for the first quarter guidance. I wanted to dig a little further, second quarter last year you were essentially break even. Are you thinking you are going to make money in the second quarter this year?

Bob Dennis

I’ll answer that in a minute but we really aren’t giving guidance going forward but we do obviously believe we are going to make money in the second quarter.

Scott Krasik – C.L. King

Hal, maybe talk a little bit about Journeys, I know the last time you reported the third quarter the Heelys ASP was $62 a pair. I’m sure that came down a lot in the fourth quarter. Maybe talk about where that sits now and maybe some of the other brands, what your expectations are.

Hal Pennington

On Heelys, as Bob pointed out, we have right sized that inventory down to a price that is acceptable in the market, which obviously is lower than it was at the time. We feel pretty good about that. Where we are, we are well positioned with that, we are still selling Heelys, albeit we are not selling as many as we were nor at the prices we were. As far as the other brands there hasn’t been a great deal of movement in pricing at this point. Bob pointed out one of our major boot brands had some down turn this past fourth quarter than affected us. I think pricing with the exception of Heelys is relatively stable.

Scott Krasik – C.L. King

So your back half, assuming positive comps, are you expecting ASP increases in the back half of the year, or is it units?

Hal Pennington

At this point it’s a little early to tell on that. Remember on the back half is when we get out from under the Heelys umbrella of the higher prices for the first half. It’s going to be mix as much as anything. There’s not a great deal of movement there but we are feeling more positive about that back half as you always know the back half is our stronger part of the year.

Scott Krasik – C.L. King

How to the Journeys guys feel, obviously PacSun getting out is a big positive for you but at the same time the family footwear channel seems to be a bigger player and skate with access to brands. How do you balance those things?

Hal Pennington

If you look at the breadth and the depth of the brands that Journeys has and the newness they are really first to market with whatever comes. We still believe that Journeys is the destination shop for the teen and especially for skate footwear. Some of the family chains, if you will, may have some of it. It may not be as fresh or the most recent releases. We are still confident about Journeys position and feel very strongly as they do.

Operator

We go next to Stephanie Wissink with Piper Jaffray.

Stephanie Wissink – Piper Jaffray

I can sense there is a sense of relief to have this past you. A couple of questions, first can you talk about inventory, I know the question was already asked but are you getting increased support from your vendors particularly at Journeys and then any initiatives in systems or IT that will enable you to tighten your working inventory levels going forward?

Bob Dennis

In terms of the system support, the management of the inventories is just a matter of managing sales and buying to your sales plan and then reacting. What happens, as you can be aware, in the fourth quarter it all happens so very quickly over Christmas that if you are missing your sales plan you run the risk of being a little bit heavy and then you have to right size it. I don’t think that our systems, in terms of managing the inventory are in any way a real problem. We know what we need to do; our merchants are very tuned in to sell throughs. I think they are really on top of that so I’m not looking for a systems solution in that space.

In terms of vendors working with us, most of our vendors do recognize the importance of Journeys in their retail strategy. They generally work with us as needed.

Stephanie Wissink – Piper Jaffray

My second question is on your level of confidence in your comp guidance should the environment remain challenging through the year. Is it easier compares or are there merchandise initiatives that you are seeing down the road that give you that increased confidence?

Bob Dennis

You have to almost go by banner. Hat World, as you know, is going to get a lot of help in the beginning of the year because they were depleted in the on field hat. They also spent a lot of the year trying to right size that hip hop inventory and therefore took some hits there in terms of the pricing that they went through to right size it.

In the case of Journeys the big event they’ve got is Heelys and so we had committed, it was going to be our number one vendor in terms of dollar commitment for the back half of the year. That turned out to be a problem for us. As we look forward we have the opportunity to take a significant chunk of our inventory commitment that was not productive last year and it will be productive this year. We think that eases up the comparison.

On Underground Station where we are most bullish in terms of the comps that are definitely tied to last years comps. Underground was in the negative 20% in the first three quarters of last year because we were off the Nike strategy, we were only testing the women’s strategy and working our way into re-fixturing the stores and this is the point at which we can make the full blown commitment to the strategy and we think that’s going to make an enormous difference.

Operator

(Operator Instructions) Up next is Jill Caruthers with Johnson Rice.

Jill Caruthers – Johnson Rice

Could you take the valuation you did on Heelys and how big of an impact that was and as you relate it to the Crocs brand I know that’s been an important brand in the Journeys division, how important is that and is there a risk if the Crocs brand does stay, does it have the impact like Heelys has in the back half of ’07?

Bob Dennis

First of all, Crocs continues to be a solid brand for us. They certainly are widely distributed but our commitment and our exposure to Crocs is very different from what it is to Heelys in terms of magnitude. We bet on Heelys and a percent to sale basis we are a lot less dependent on Crocs. We really don’t have that same kind of exposure.

Jill Caruthers – Johnson Rice

Any way to can quantify that percentage of cost in your mix?

Bob Dennis

No, I don’t think we are going to call that, what percent we are doing in Crocs.

Hal Pennington

Remember that we have no brand that’s higher than single digit share within Journeys. While Heelys was certainly a tremendous impact it was done in such a short period of time it had a strong negative impact. Our other brands have been more tempered than that as their ebb and flow.

Jill Caruthers – Johnson Rice

To reiterate, I know you touched on it earlier in the call, given all these uncertainties over the past few months with the pending merger and what not. Could you talk about your merchant teams, particularly in the Journeys division if that was held in tact and your feelings there?

Bob Dennis

We are delighted and feel very fortunate that our teams are largely kept in place. Certainly on the operations side, meaning the people that work within our divisions, very lucky to have virtually no disruption there. We lost a few key people in more of our support infrastructure and so we are going to have to do a small amount of rebuilding there. It’s nothing that causes us to lose any momentum and we feel very fortunate in that way.

Operator

Up next is Heather Boksen with Sidoti & Company.

Heather Boksen – Sidoti & Company

A quick housekeeping question, can you tell us how much of the $0.81 in charges in the fourth quarter was store closure costs and how much was the merger and the litigation costs?

Jim Gulmi

In the first quarter?

Heather Boksen – Sidoti & Company

In the fourth.

Jim Gulmi

The restructuring costs were about $3.7 million in the fourth quarter and the merger related costs were about $15 million.

Heather Boksen – Sidoti & Company

With respect to Heelys did I hear you correctly when you said in the prepared remarks that you took the appropriate right downs for it in the fourth quarter. Going forward, even though it’s going to be a comp issue in the first half it won’t really be a margin one?

Jim Gulmi

That’s correct.

Operator

We’ll go next to Mitch Kummetz – Robert Baird.

Mitch Kummetz – Robert Baird

Just something to get a little more color on the comps. For the fourth quarter you mentioned Journeys negative 7% comps, Heelys was a drag on the top line at $13.5 million. How does that translate in terms of the comp. What was the comp on Journeys in Q4 excluding Heelys?

Hal Pennington

I don’t think we’ve calculated that.

Jim Gulmi

I think it’s a pretty easy calculation. I think Bob called out $13 million impact on the fourth quarter. Just take that off the sales and you can get a pretty good sense for it.

Mitch Kummetz – Robert Baird

Obviously the expectation of the Heelys was a drag on the first half and then that eases up in the back half of fiscal ’09. It wouldn’t be this big of drag because usually Q4 is a better quarter than Q1 or Q2. In terms of its comp impact do you expect a similar comp impact in the first half of ’09 from Heelys as you saw in the fourth quarter ’08?

Jim Gulmi

I’d have to go back and look at it by quarter; we haven’t quantified it that way.

Bob Dennis

The first quarter is bigger than the second quarter. We began to see it in mid second quarter and it eased off in July. It was really heavy in the first quarter and it began to ease off in the second quarter so it wasn’t as great in the second quarter as it was in the first quarter.

Mitch Kummetz – Robert Baird

On Underground you mentioned that you saw improvement in the comp performance of that business over the course of the fourth quarter. Were you at a positive comp in January, even if you could speak to February seeing how that the comp trend has improved beyond just the fourth quarter? Are you at a positive comp yet on a monthly basis in that business?

Bob Dennis

We aren’t going to disclose what’s going on in the current quarter. We saw nice improvement throughout the fourth quarter, it gave us a lot of confidence that we are trending in the right direction. The customer is recognizing what the store is all about now. We aren’t going to give any numbers beyond what we just provided.

It’s gone from the third to the fourth quarter in Underground we saw a nice improvement right there going from 18% down to 4% or 5%. We saw a big improvement, all along last year, as we were talking about the new strategy we said that we’d begin to see some impact of that in the fourth quarter because that’s when the Nike comparisons began to drop off in a material way. Plus, some of the new product was going to hit the stores. We did see a nice improvement in the fourth quarter and now we just need to continue that momentum.

Mitch Kummetz – Robert Baird

What are some of the merchandize trends that you are seeing at retail right now? We transitioned into the spring season, although its obviously early has it flip flopped, what’s going on in Journeys and Underground right now on the merchandise side, what’s working?

Hal Pennington

It’s too early to tell at this point, there’s nothing that, as I mentioned, there is nothing that is a must have and new emerging on the market to take the market by storm. At the same time, you are moving into what is an earlier Easter. We will see how that works out. I would say there has not been any big shift in this whole merchandising strategy at this point.

Mitch Kummetz – Robert Baird

I have a couple housekeeping items for Jim. Obviously not assuming any share repurchase in your guidance. What kind of share count tax rate interest expense is embedded in that ’09 outlook?

Jim Gulmi

Tax rate, when I gave the guidance I excluded many, many things but if you look at the pure tax rate on the ongoing business, probably around 39.8%. Interest expense will, all these numbers do not take into consideration the settlement. Based on where we were we obviously started the year with higher debt level, $69 million versus $23 million in the previous year. Based on that you can get some sense for what interest expense will be for the whole year.

Mitch Kummetz – Robert Baird

What was the pro-forma tax rate in the fourth quarter? I haven’t calculated that yet.

Jim Gulmi

Backing out everything, all the stuff that I talked about it was about 40.2%. It was a very high rate from a GAAP standpoint as you notice because the merger related costs were not deductible 70% or so. If you talk about pure rate it was about 40.2%.

Operator

We’ll go next to Brad Cragin with Goldman Sachs.

Brad Cragin – Goldman Sachs

With respect to your store growth as you think about potentially ramping up the following year. Can you talk about what you need to see to be able to pursue that? Do you have to see the improvement in comps in the second half to commit to that?

Hal Pennington

The biggest driver of that will be the economic environment that we are in. We will be looking to see how that plays out. We will have the time during the back half of the year to plan for the following year. Certainly the comps are going to reflect what’s in the market place. Its probably a broader question than that.

Bob Dennis

The other thing to keep in mind we are still opening stores and we constantly do a look back and make sure we are comfortable with how the new stores are performing. It will be a little based on what we see in terms of the newer store we put out there. That all gets decided on banner by banner basis, we won’t really be making a company decision; we’ll do it by brand.

Brad Cragin – Goldman Sachs

With respect to some of the process review that you alluded to, will you be looking at some of the formats for new stores at all? I’m trying to get a sense, I don’t want to misinterpret that, does that have any implications for the long term store potentials for each of your concepts that you have talked about in the past?

Bob Dennis

We’re not really referencing any big changes in the format of the stores. What we’ve done is we’ve a look back at our construction costs and we’ve looked at the growth of the cost per square foot and a lot of our concepts and its made us see that there’s an opportunity there to bring that down a bit. We’ve had a lot of pressure to get our store open on time and that sometimes becomes a trade off with some of the decisions you make. We’ve recognized that if we buckle down on the construction process just by executing better, some design elements might be in this. Things that would probably not be visible to the customer that we can find ways to bring the cost of our stores down.

Brad Cragin – Goldman Sachs

No change in any view on your store potentials?

Bob Dennis

No, the store format is still the same. We are, as you probably know, ambitious to do a bigger footprint on Journeys which we’ve been doing recently than we had in the past because of the volumes and ditto for Johnston and Murphy. We’ll continue to pursue those slightly larger stores. No different from what we’ve been doing in the past year.

Operator

We’ll go next to Steven Martin with Slater Capital Management.

Steven Martin – Slater Capital Management

As everyone else has commented, it sounds like you are much relieved over the situation.

Hal Pennington

We are looking forward to the future and executing those strategies, closing the chapter on this particular episode and looking ahead.

Steven Martin – Slater Capital Management

Just a couple of follow ups. In malls where you’ve closed Underground Station what impact have you seen on the Journeys store in that mall?

Bob Dennis

We’d have to go back and look at it but a large number of those Underground stores, most of them don’t have Journeys, I think its most of them. In some instances we’ve seen an opportunity, we’ve closed Underground and our deal with the landlord is to open a Journeys in some instances in that space. If you are going to say, is there an additional benefit to closing Underground by seeing a pick up in Journeys we are not expecting that. The SKU overlap between Underground and Journeys is very small so you really don’t expect to close one store and get a big pick up in the other.

Steven Martin – Slater Capital Management

In terms of corporate overhead staffing restructuring one of the comments you made during the trial was that you lost a number of people who were fearful of not having a job under the newer company. What are you going to do about replacing that and right sizing your corporate staff?

Hal Pennington

With reference to that we lost a few key people in the support areas as Bob had mentioned earlier, a couple in our tax area, a couple in finance. We will be looking for replacements for those. These we will be careful about because we want to have the best that we can find out there. There is no wholesale restructuring going on.

Steven Martin – Slater Capital Management

Back to somebody’s question on the Heelys impact on Journeys. If Heelys was down $13.5 million for the fourth quarter and Journeys last year was $235 million wouldn’t the simplistic answer be that it was roughly 6% of the comp decline? Or am I not doing the math correctly?

Jim Gulmi

That’s roughly right. That’s the way to think about it.

Operator

We’ll go next to Adam Comora with Entrust Capital.

Adam Comora – Entrust Capital

A quick question on the PacSun exiting, where are we in that process? Have you seen them exit footwear and what kind of overlap do you have with their stores?

Bob Dennis

Our overlap is tremendous, the overlap between Journeys and PacSun in malls. Not only are we in the same malls but we typically co-locate. We across the hall or next door in many cases. We are not privy to exactly how they are going about the liquidation and we only know what they’ve said publicly so you can pick up what we’ve picked up. Thus far we haven’t seen anything that’s been any very aggressive liquidation that’s affected us much.

Adam Comora – Entrust Capital

What other color can you give us on Shi, are there any metrics. What can you tell us about why you are pleased and when you said you were moving up average price points there is that higher priced private label stuff or are you moving more branded, any other color you could give us around Shi, maybe how the new store openings when?

Bob Dennis

At Shi what we see is an opportunity to do a layer of better shoes. Its going to be both branded and our own brands both in that space. The average price for Shi this year was about $40 it was in the high $30’s in the first half of the year, the low $40’s in the back half of the year which is when the boot business picks up. Our guys recognize that there was a customer coming in who would have an appetite for an even higher priced shoe and we were walking that opportunity.

We are going to be able to go out there with another layer of shoes. Overall the business, we like what we see, the customer love this concept. As you know the women’s business has been difficult so we are weighing that in as we observe the results and project out what we think the potential is for it. We are still pretty excited.

Operator

At this time I would like to turn the conference back over to Mr. Pennington for any closing or additional remarks.

Hal Pennington

Thank you all for joining us this morning. We look forward to seeing you along the way, seeing more of you and we’ll be talking with you. Take care, have a good day.

Operator

That does conclude today’s conference, we appreciate your participation your may disconnect at this time.

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