Charlotte Russe Holding, Inc. Q1 2008 Earnings Call Transcript

Apr.24.08 | About: Charlotte Russe (CHIC)

Charlotte Russe Holding, Inc. (CHIC)

Q1 2008 Earnings Call

April 23, 2008 05:00 pm ET

Executives

Mark A. Hoffman - Chief Exec. Officer, Pres and Exec. Director

Patricia K. Johnson - Chief Financial Officer, Principal Accounting Officer, Exec. VP and Treasurer Edward Wong - Chief Supply Chain Officer and Exec. VP

Patricia A. Shields - Exec. VP and Gen. Merchandise Mang.

Jennifer L. Bolinger - Sec.

Analysts

Jeffrey Klinefelter - Piper Jaffray

Lauren Levitan - Cowen And Company

Robin Murchison - Suntrust Robinson Humphrey

Jeff Sinderen - B. Riley & Company, Inc.

Samantha Panella - Raymond James

Elizabeth Pierce - Roth Capital Partners LLCVan

Anna Andreeva - J.P. Morgan

Janet Kloppenburg of JJK Research

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Betty Chen - Wedbush Morgan Securities Inc.

Lyn Walther - Wachovia Capital Markets, Llc

Quinton Maynard of Morehead Capital

Operator

(Operator Instruction)

Welcome to the Charlotte Russe Second Quarter Results Conference Call. With us on today’s call are Mark Hoffman, President and Chief Executive Officer and Patty Johnson, Chief Financial Officer.

Certain statements made on this quarterly conference call herein, including without limitations, statements addressing the beliefs, plans, objective, estimates or expectations of Charlotte Russe Holding, Incorporated or future results or events constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements involve known or unknown risks, including but not limited to, general economic and business conditions and conditions in the specialty retail industry. There can be no assurance that the actual future results, performance, or achievements expressed or implied by such forward-looking statements will occur. Users of forward-looking statements are encouraged to review the company’s latest annual report on Form 10-K and its filings on Form 10-Q. Management discussion and analysis and the company’s latest annual report to stockholders, the company’s filings on Form 8-K and other federal securities law filings for a description of other important factors that may affect the company’s business results of operations and financial condition.

Once again, thank you for joining us on today’s call and now Mark Hoffman.

Mark Hoffman

Welcome to our conference call today to discuss our second quarter 2008 results and our guidance for our third quarter of fiscal 2008. Please note that Charlotte Russe is in the fourth week of the four-week month of April which will end this Saturday, April 26.

Now to the results that we reported this afternoon after the market closed, we are pleased with our reported positive, comparable store sales of a +2.5% as those results net our guidance that had been low single digit positive comps as well as our earnings per share of $0.17, which included the tax adjustment and therefore came in at the operand of the guidance range we gave on January 23.

We began our second quarter in the clearance month of January and on that last earnings call in January, we spoke to our confidence in our spring assortments with early read on spring selling. We pointed out then our belief that most visible sales benefits to our second quarter beyond our confidence in our product and our ability to execute would be the shift of Easter and the spring breaks out the third quarter and into the second quarter on a this year/last year comparison and such was the case and is reflected in this results.

I want to comment on the sales trends in the second quarter. When you remove the impact of the Easter break shift, we experienced the slowing trend across the board in our businesses in the back half of the second quarter. By reason, our business continued to be most soft in the West Coast and South West markets with our strongest performance on the East Coast and the Northeast markets.

During the second quarter, we saw strengths in the selling of oriented tops including stream keys, our refuge, long denim particularly in the skinny silhouette and our footwear specifically flaps and flip lops. We know its weaknesses in woven tops but we also know that up against some very strong numbers in those prints and solos of last year. We saw a shift out of the occasion or dressy dresses into the more casual dresses.

So, we ended the second quarter comparable store inventories up approximately 8.3%. You will remember we had guided to low single digit positive comparable store inventories. Now, while higher than our guidance, I would want everyone to know that we have taken our markdowns and managed our receipts flow such that as of this past Saturday, April 19th, our comparable store inventories are up approximately 4%.

Our inventory aging at the end of the quarter was better than the same period last year. And last year, we had strong sales quarter. The point is, we turn our inventories fast, we manage or open to buy carefully, we stay close to the management of our inventory on a weekly basis. I am confident that our inventories are at appropriate levels given this weak consumer environment and given that we have the speed and we have the flexibility to react to changes and trends. Be they up or be they down.

So let us look forward to the third quarter and let us talk about the merchandise assortments. Bright colors continue to be projected in our floor sets in our stores. Fashion and trend the right tops with feminine details and over and over-sized silhouettes, dresses for the important upcoming graduation and prom-time period, denim, more of the skinny silhouette, - shorts in casual fabrications and of course, lots of summer footwear.

We would project our third quarter end inventories to be down in high single-digit range by comparison, our comp store inventories were down about 4.7% for the same period last year. Up close my prepared comments with this.

We all know that business is tough out there for many. With that said, my optimism comes from how we react to that and we react with care and thought in order to stay fashion and trend right, support our competitive vantage businesses, focused on sales conversion in the store, keep our inventories fresh and measured very closely, control the product gross margin while in a promotional market place, tighten our expenses where it is right to do so for the business and take confidence from our growth. Like for example, our growth in our online business which completes its first full year of operation by mid-July, confidence with the growth of our fleet which will approach the 500-store mark at the end of this year.

Lastly, we continue our internal work focused on our goals to improve our sales productivity and profitability and we look forward to sharing the specifics of our progress in the future. At Charlotte Russe, our heads are up not down, we are focusing on our opportunities.

Okay, so now to my partner, our CFO Patty Johnson to give us her detailed review of the business.

Patty Johnson

Great, thank you Mark. I would like to take a few minutes to walk you through our performance for the second quarter and to re-iterate our guidance for the third quarter of fiscal 2008.

Net sales for the quarter, net sales increased to $185.1 million, a 14.9% increase over the second quarter last year. Comp store sales increased 2.5% for the quarter. In terms of comp store transaction metrics, average unit retail was around $11.00 for the quarter and down about 8% to last year. Comp store transactions were up approximately 6% and units per transaction were up about 4.5%. These metrics reflects the mix of promotional business driven by the shift of the Easter holiday time frame and the relative contribution of January clearance sales to the total quarter.

Here to date, net sales increased to $423.3 million, a 14.3% increase over the same period last year. Comp store sales increased 1.9% for the first six months of fiscal 2008. Operating income increased to $4.5 million for the second quarter, a 6.1% over the prior year. Operating margins of the second quarter declined slightly as compared to the prior year primarily due to the deleverage of fixed SG&A expenses for the quarter.

Let us take a look at the components of operating margins. Gross margin rate for the second quarter was 25.1% basically flat to last year. Product gross margin for the second quarter was up 36 basis points primarily driven by a reduced freight expense related to the new freight carrier implemented in the third quarter of fiscal 2007. Reduced freight expense accounted for about 130 basis points, a favorable impact for the quarter partially offset by lower IMU and a higher markdown rate than the prior year.

As we talked about our earnings guidance for Q3, I will remind you that in Q3, we will anniversary the new freight carrier implementation and therefore, we will not expect the positive year-over-year benefit we have seen for the last few quarters. We will talk about that more in a moment. The remaining factors impacting gross margin were down 34 basis points, primarily driven by the deleverage in rent and occupancy costs, which accounted for an unfavorable impact of about 50 basis points partially offset by improved distribution center productivity. SG&A expense as a percent of sales, deleveraged by 23 basis points for the second quarter as compared to a year ago. This was primarily due to an increase in professional fees and was partially offset by improved productivity in store operating expenses.

Diluted shares used to calculate earnings per share were 25.1 million shares for the second quarter and for the six months ended March 29, 2008. Diluted earnings per share were $0.17 for the second quarter compared to $0.15 a year ago. Included in the second quarter results is that favorable tax adjustment of approximately $800,000.00 or $0.03 share. I would refer you to our March 26th press release for further information.

For the second six months of fiscal 2008, diluted earnings per share worth $0.73 as compared to $0.70 last year. As discussed in our press release, we completed the repurchase of $4.8 million shares of our stock at a price of $18.00 per share. The reduction in shares was effective beginning April 3, 2008 and will impact third quarter.

We ended the quarter with a $125 million of cash on the balance sheet and no long-term debt. We funded the share we purchased with the existing cash, so that balance will be reduced beginning in Q3. As Mark mentioned comparable store inventories were up 8.3% at the end of the second quarter. From a store opening perspective during the second quarter, we opened 10 new stores bringing our total for the fiscal year to 18 new stores.

We continue to target opening approximately 60 new stores in fiscal 2008. Capital expenditures for the second quarter were $13.6 million. We continue to forecast full-year capital expenditures in the range of $70 million to $75 million. Depreciation expense was $10.8 million for the second quarter. As of March 29, 2008, we operated 448 stores in the United States and Puerto Rico. Total gross square footage was $3,180,000 square feet up from $2,797,000 at the end of the second quarter of last year.

In terms of third quarter earnings guidance, as Mark indicated in the press release, we are reaffirming our sales and earnings guidance for the third quarter as suggested for the change in share count due to the recent share we purchased. We are guiding to a flat to low single-digit decline in comparable store sales growth with diluted earnings per share in the range of $0.31 to $0.34 after adjustment for the share count change.

I would like to give you some additional information related to assumptions incorporated into our earnings guidance for the third quarter. As indicated in the press release, we estimate the impact of the share we purchased will favorably impact earnings per share by $0.04 for the third quarter. This is the net results of the reduction in shares outstanding and the reduced interest income on the lower cash balance. Our current guidance of $0.31 to $0.34 earnings per share includes the impact of the share we have purchased.

In the third quarter as I mentioned earlier, we will anniversary the implementation of the new freight carrier. We will no longer see the favorable variance to last year for this expenditure on the gross profit line. As I mentioned earlier in the second quarter, the favorable freight cost comparison contributed about a 130 basis points of margin rate improvement.

In addition, we are beginning to feel the effect of higher gas prices in the form of a fuel surcharge which we expect to impact Q3 and Q4 putting further pressure on freight cost. And finally, the revised effective tax rate as indicated in our recent press release is 38.3% for the remainder of the year.

That concludes our prepared comments for this conference call and now we would like to open it up for any questions.

Question-and-Answer Session

Operator

Thank you. The call is now open for questions.

(Operator instructions)

Our first question is coming from Jeff Klinefelter of Piper Jaffray. Please go ahead.

Jeffrey Klinefelter - Piper Jaffray

Yes, thank you. A couple of questions for you Mark and Patty, just starting with the inventory having been up 8% and then now down to close to that 4% range. Two questions, one, where did the inventory build or happened, was there particularly a category slow down or a change in your receipt flow that resulted in that increase and then secondly, as you have gotten more I guess, aggressive or proactive in getting that down with your promotions in your markdowns, is there now a slightly higher markdown rate implied in your guidance? And are you offsetting that somehow or just give us a sense or how you have managed that within the same guidance for the quarter.

Mark Hoffman

Yes, I would I say, I point to category slow down referred to primarily in the woven tops categories and I think everything else is pretty much across the board as a result of the slowing trend which we had indicated had begun in February. The team obviously worked very closely then to identify how we maintain the balance of fresh new goods. Slow but based upon the slowdown in any category, how we begin to pair back on our receipts flow. I think they have done that very effectively, I think they continue a practice of doing that very effectively.

On the subject of the markdown rate, I would say it is probably wise to assume that there will be a continued pressure on gross margin as we proceeded in the third quarter in the light of the slowing of the business trends and the increased competitive pressure to move product and cashier share of wallet.

Jeffrey Klinefelter - Piper Jaffray

Okay. I know you do not like to talk about business on a weekly and monthly basis but you know, a lot of people are talking about business trends, the weather impact on trends having improved or accelerated in the last couple of weeks. Do you care to share anything about the cadence of your business at this point or more specifically, any regional differences in the business?

Mark Hoffman

Well I think it is fair to say that what we feel began in February continued in April and I am not going to comment on week-to-week business. I do not think that is indicative. A lot of folks talk about the importance of the warning of the weather patterns as we move further in the spring, I would say, “Yes I think that is probably a good thing for business.” We refrain from weather comments and so as we are looking in our business, we think that we are appropriately adjusted and have the ability to react to changes and trends on a very quick basis.

Jeffrey Klinefelter - Piper Jaffray

Okay. Last question for me as on the inflation, on the cost of goods line, a lot of discussion about that or the fob China product but given its effect on the entire supply chain and in some of your domestic manufacturers, can you address that at all and what you are factoring in for the balance of the year?

Mark Hoffman

Yes. I think you are right on or continued to be pressured from a post standpoint given the devaluation of the dollar, given what is going on in China with pressures on quota and production there which impacted us not only in our direct import program but it does impact us across our domestic resource structure because that is where the majority of the product is sourced from.

Having said that, we work very closely with our business partners, I think everyone is aware of this increase cost pressure and we have to manage with them in partnership to reduce the impact on our business. All that said in summary, there will be increased pressure continuing for the next several quarters as we project on our gross margin.

Operator

Thank you. Our next question is coming from Lauren Levitan of Cowen and Company. Please go ahead.

Lauren Levitan - Cowen and Company

Thanks, good afternoon. Mark, I was wondering if you could give us an update with your thoughts on the potential store base of the company and your thoughts as to the pace of store openings. Your 60 stores, certainly are faster equipped and the majority of your peers at this point. So I just wanted to give us some thoughts on the approach and how those new stores are performing and whether you think that or I guess maybe how many years of growth of this concept at this kind of pace you think are available to you? Thanks a lot.

Mark Hoffman

Thanks Lauren. On the subject of our store base, I think that we have followed a historic practice of speaking to the next year’s new store opening schedule on our July conference call. And in discussions with our Board just this last week, we expect to continue that process and talk in the July earnings conference call as to what our decision is.

As regards to the pace, we began fiscal 2008 planning last summer and hence, we have committed to because we leaped so far in advance the 60 new store program that Patty spoke to in her comments and we are on track for that targeted 60 stores by the end of the year, again, those leases being largely done, significantly in advanced timing and opening.

So, as we are looking outward, we are taking all of that in consideration, the current market conditions and at the direction of our board, we will make I think the appropriate business decision as we look out to 2009 and beyond. As concerns with our new store performance, we continue to enjoy very strong first year cash-on-cash returns, carefully monitoring those by class on an on-going basis so we should also feel good about that.

And then lastly, your question as I mentioned, we will be approaching the 500-store mark by the end of this fiscal year. We still have a high degree of confidence that our fleet population growth can be as much as 700 plus stores. With that said, that gives us a lot of headroom for new store growth. We will talk in July as to the pace that we would envision accomplishing that.

Lauren Levitan - Cowen and Company

Mark, can you give us any update on what you are seeing in terms of real estate availability and pricing of that real estate?

Mark Hoffman

Yes, a lot of talk on that Lauren and I hope to get an update and one at the ICSC next month. The fleet portfolio reviews that we do an annual basis have recently been completed with our largest landlord partners. And I would say there seems to be more and more indication of an awareness of the impact of those troubled retailers and have either aggressively slowed their new store openings or those unfortunate retailers that have been faced with shut down and we all know the list. That said, it is my sense, it is our real estate team sense that there is a shift underway from a seller’s market to a buyer’s market. I cannot quote any specific economics at this point, but I am optimistic that we have reason to believe that the trend is in that direction.

Lauren Levitan - Cowen And Company

Great. Thank you and good luck.

Mark Hoffman

Thank you.

Operator

Thank you. Our next question is coming from Robin Murchison with Suntrust Robinson Humphrey. Please go ahead.

Robin Murchison - Suntrust Robinson Humphrey

Hi, thanks. Mark and Patty, I have two questions. One is if you can address any particular trends and bottoms, I know you did say the skinny, is there anything going on with crops, is there anything going on with prom, good, better and different? Color we know as good, what about silhouette? And then I have a follow up question.

Mark Hoffman

Sure, thanks Robin. A significant penetration in our bottoms business is our wonderful refuge by the label denim. And that wall program continues to build in customer loyalty so we are very pleased within in the basic washes. The skinny silhouette is without question, probably the most talked about and the most fashionable of silhouettes and we see that continuing. I spoke to that from Patty Shields’ comments. We see that continuing into the third quarter very nicely.

This is the time of year when we present our crops assortment and we are very pleased with the inventory levels of our crops and presentation in, in store now and also in casual fabrications. As concerns, the prom period that is coming upon us quickly, we believe that we are very well positioned with our dress assortment. We continue to keep a lot of attention and focus on the dress penetration opportunity to Charlotte Russe. I think that Patty is very pleased with progress made and the belief that our dress cycle, the dress cycle we are all in, is something for us to continue to take advantage of.

So I think we will be talking about the impact of our success for the graduation and prom season that we are coming into and your last comment, I think on color, we had a lot of feedback and I appreciate that. Positive feedback about the impact of the coordination of our spring breaks color presentation on our store from our apparel through our accessories and into our foot wares, so all of that is good reason for the confidence that even in this difficult retail consumer environment, we will continue to do our best.

Robin Murchison - Suntrust Robinson Humphrey

I have got a follow up and I am going to try with you. When you think about February and March, I mean how much of it do you think is your one time versus weather slash environment or maybe addressed in another way, is there any help that you might tell us how the comps ranged during the – not with time period but with the height of low or how negative you got and how high you got?

Mark Hoffman

I thought I knew you well Robin. Somebody can pass on that, there is always an element of “us” in our performance regardless of the level, there is always an element of “us” and the beauty of that is that there are always opportunities identified to improve upon that next-go round. And so there are clearly is an element of “us” in our second quarter because we did not beat guidance. We did not surprise on the upside which is always I believe any retailer’s goal. So we believe we have identified those elements within our product assortments and within our execution and we will focus on that.

As concerns of the weather and the economic environment, the weather I do not want to comment on it, that to me is that is regional and that is problematic, nothing we can do so you put your assortments out with your best effort in that regard. The economic environment is that, which I think is so many people have talked about and we spoke to regarding the slowing of trends in our pre-announcement that we saw beginning February. So I would think that you are drawing the conclusion that we had a strong January and business then continued to slow after January allowing for the adjustment of the Easter shift, which clearly was up this year. That begins no Easter last year, but you take it out, you align it. I believe we have said, we saw a slowing in trends across all our business categories in that period.

Robin Murchison - Suntrust Robinson Humphrey

Okay, that is clear. And just one more if I can. California, any comment on how California has turned in?

Mark Hoffman

Yes, in my prepared comments, I intended to refer to where we see our business most challenged at the store level is on the West Coast and in the Southwest so definitely California where we see our business actually the strongest on a year-over-year basis is on the East Coast and the Northeast.

Robin Murchison - Suntrust Robinson Humphrey

Thank you very much.

Mark Hoffman

You are welcome Robin.

Operator

Thank you. Our next question is coming from Jeff Sinderen with B. Riley. Please go ahead.

Jeff Sinderen - B. Riley & Company, Inc.

Hi! A couple of questions, actually when you look overall was there anywhere specifically that you feel you are missing terms of the merchandise assortments that has significant impact on your business during the quarter and then as you look at the quarter you are in now, do you feel that you are equally or better positioned overall in terms of the merchandise assortment?

Mark Hoffman

Yes. I do not think we can point to any specific area where we would say, “My gosh, that is a big mess.” And I say that in the context the breath of our assortment, apparel, accessories and foot ware. I comment it on the definite decline on the year-over-year basis in the woven tops category which is a significant percent of our tops business. And that I think is reflective of the trends in the industry and its decline is also in perspective of the strength you have recorded last year, when the trends in the soilage of woven tops versus strong.

I think that our denim business continues to be strong. We have many categories I have spoken to in terms of strength but in light of all of that, in the context of the slowing business trend we have spoken to. As I look into the third quarter and have been updated and reviewed with Patty Shields and the merchant team and the support from that flying and allocation team, I think there is high confidence that we are well positioned, but we area well positioned in perspective of the soft economic environment. Hence, our guidance for the third quarter.

Jeff Sinderen - B. Riley & Company, Inc.

Okay, fair enough. And then let me ask you in terms of, obviously, environment is challenging right now but maybe you can talk a little more about some of the things you mentioned in your prepared comments in terms of what other potential catalyst could be for your business to improve assuming that the environment does not change much from how it is currently.

Mark Hoffman

I am not sure what you are referring to Jeff in terms of…

Jeff Sinderen - B. Riley & Company, Inc.

Okay. Well I think you talked about a couple of things in your prepared comments just in terms of your focus to improve your business versus obviously you cannot do anything about the environment.

Mark Hoffman

Well our focus on our opportunities within sales productivity and profitability, we intend to speak to in the future. If there was something of substance that I would draw your attention to, please respect I will do that now. But we are in process in that area and mindful that as we have specifics to share, we will do so.

Jeff Sinderen - B. Riley & Company, Inc.

Okay, fair enough. Thanks very much and good luck.

Mark Hoffman

Thank you Jeff.

Operator

Thank you. Our next question is coming from Sam Panella of Raymond James. Please go ahead.

Sam Panella of Raymond James

Okay, good afternoon. I was wondering if you could break out the store openings for the remaining two quarters? And then I have a couple of follow ups.

Mark Hoffman

The store openings by quarter?

Sam Panella of Raymond James

Yes for the third and the fourth quarter.

Patty Johnson

Now the cadence, we have not typically shared that Sam. The cadence is pretty similar to last year if you want to model it off of last year. There is just going to be a little bit higher store opening count in the third quarter proportionately than last year. We were more back loaded last year into the fourth quarter. I just have not shared those details publicly so I am hesitant to do so but I will with you that if you model it of off last year and push a little bit more new store openings into the third quarter, you will be in good shape.

Sam Panella of Raymond James

Okay. And then looking at SG&A line, you put new systems into place last year, the POS system and I believe a new payroll management system. I am just wondering what the benefits that you are seeing now from those system enhancements and the also how long is your contract with the consultant and how much did this impact the SG&A line in the second quarter? Thank you.

Mark Hoffman

For the last one of your question with regard to our consultant is referring to our discussions I think that on January third’s conference call that we had engaged one.

And as we continue our work process, we will be able to share with you where we see that process ending and what are the measurable results that we are focused upon to deliver from our business so stay tuned for our future updates on that.

Sam Panella - Raymond James

Okay, and then how about the benefits that you are realizing with the new POS system and the payroll management system?

Mark Hoffman

Well the POS system, saying that we have completed it, the installation on end of last May beginning of June, we continue to be very pleased with this. We are able to generate benefits through our stores organization in to servicing our customer for throughput at the cash wrap as well as through the overall analysis of the business and the detailed information that this system provides setting us up for implementation of CRM this year and setting us up for implementation of the work force management system. Both of which have been targeted to be completed in the third quarter order that we are entering.

However, I would tell you at this time as a result of implementation processes as well as the overall business climate, I would project that those two system’s implementations will likely fall into the back half of the fourth quarter of 2008. So we will then be in a position to talk more about the benefits that we are able to extract from our CRM capabilities and the impact on our payroll control and productivity control from our work force management system.

Sam Panella - Raymond James

Okay great, thank you.

Mark Hoffman

Thank you.

Operator

Thank you. Our next question is coming from Liz Pierce of Roth Capital Partners. Please go ahead.

Elizabeth Pierce - Roth Capital Partners LLCVan

Thanks. Mark, just a follow up on that question, I just want to make sure. So, you are juts stretching out the implementation of the workforce managements?

Mark Hoffman

I would not say that we are stretching it up Liz. I would tell you that as we are looking at the implementation process for workforce management and as we meet on that on a regular basis, the team is now adjusting its implementation dates to be more toward the end of the fourth quarter. Stretching, sound like it is something that we have chosen to do. This is a very complex enriched system that we began testing fist in our distribution center and then have began to implement it in selected stores.

So as we move that forward, we have come to the realization that the full implementation chain laud is more likely now to occur by the end of the fourth quarter.

Elizabeth Pierce - Roth Capital Partners LLCVan

Okay, alright, that is good. And in terms of store remodels, could you tell us how many that you did in the second quarter and what the plans are for the third quarter?

Patty Johnson

Yes, we have completed two remodels actually in the second quarter and we do not share our cadence by quarter, but again we targeted a total of 20 remodels this year. They are typically back loaded in the back half of the year and there is always a possibility that a couple of those will flip based on deal negotiation, timing, et cetera. So, we targeted 20, we remodeled two this quarter. It came to probably begin, to be pretty similar to last year probably back a little bit.

Elizabeth Pierce - Roth Capital Partners LLCVan

Okay, and Patty, I do not think you did any in Q1 right?

Mark Hoffman

We did not. I would just come back and say on the subject of remodels, I appreciate that that negotiation with the landlord and then you need to be able to able to continue and protect your business by having a temporary space. So it is subject to a lot of shifts to the advantage of the business which like kind of difficult to say, “Oh no, we are definitely going to have this one a year from now on such and such a month.” So I appreciate your understanding of the good sound business reasons why they came to shift and change.

Elizabeth Pierce - Roth Capital Partners LLCVan

Now that is fair enough. Mark, in terms of the feedbacks that you are getting from the stores in terms of their customer, are they seeing and I know it is hard to tell, a vastly different customer profile, has the age gap or the age range widened and I think what Patty was trying to say in her comments on transaction metrics in terms of the AUR being down influenced by the January clearance but I am also wondering if you are noticing that they area just looking for that lower ticket items, that graphic tee or something versus the dress or but then you said that refuge denim line is good so maybe not.

Mark Hoffman

Okay, Liz, let us go slow. Clearly, the pressure on the AUR is driven by mix, and mix determined by what the customer chooses to purchase at this time. I think that you are absolutely right that we have many indicators suggesting she is reducing her overall spend. Not in absolute purchase transactions but in number of transactions as she is under the pressure we perceived of increased gasoline prices and that ultimately every customer even ours becomes impacted by real or perceived issues in the economy.

So to your question in terms of how we see our target customer changing, we have not seen any material change in our target customer. We still believe that our target customer on is late teens to early 20’s but we know that bell-shaped curve includes a wider spread of age that starts younger and can be considerably older.

It is really in that context not so much age driven as it is fashion and attitude and lifestyle driven. So I am not sure, if I answered that question, we have no indicators at this time that we have a material change in our customer shifting to younger or older.

Elizabeth Pierce - Roth Capital Partners LLCVan

Okay. And then, Patty, I think you said on the comment about gross margins, given what is happening in freight, your anniversarying that benefit that you said for the next several quarters we ought to be thinking about gross margins being under pressure?

Patty Johnson

Yes, okay, so two sides, so one, because we are anniversarying the freight implementation, the new freight carrier from last year, each of the last several quarters we have been celebrating the benefits of that new freight carrier. Well now we are going to lap ourselves. So we continue to get the benefit of the new carrier but the year over year benefit is not going to be there from a comparison standpoint. So I just wanted to make sure you knew that as you are developing your model.

But yes, the second question about do we continue to see pressure on IMU from the things that Mark talked about earlier. The source thing environment et cetera, and on the marked down line, in terms of the promotional pressures that maybe out there in this tough environment. So all the more reason why we have to be very, very good and continue to focus on our execution to manage our marked downs, manage our store allocations, our inventory levels et cetera. That is going to be sort of a hard work of getting to these things, a couple of quarters because there are lots of cost pressures out there right now.

Elizabeth Pierce - Roth Capital Partners LLCVan

Okay. And I think on the last conference call you kind of ended the call by talking about SG&A being up and I just really want to clarify that because I think it is going to point a confusion into that 17% to 18% kind of year-over-year increase still hold even kind of under different circumstances.

Patty Johnson

Good question. So that was like to a point in time when we were talking about low single digit comp store growth because remember, in our SG&A are things like store payroll. So, I would moderate that a little if we are now talking flat to down low single digit comp. You are not going to see the same kind of SG&A increase as you might see in a low single digit comp increase. So that percentage growth is going to be slightly lower in that range.

Elizabeth Pierce - Roth Capital Partners LLCVan

All right. That is really helpful. Thank you guys and good luck.

Operator

Thank you. Our next question is coming from Anna Andreeva of J.P. Morgan. Please go ahead.

Anna Andreeva - J.P. Morgan

Thank you so much. Good afternoon guys. Mark, you mentioned that you guys were able to get better productivity of in-store expenses during the quarter. I was just hoping to follow up on that and if you could give us some better visibility on what is driving that. I am assuming that some of the systems that you guys installed last year.

Patty Johnson

It was really kind of across the board. We saw some productivity improvements in in-store payroll, in some of our benefits in workers comp line, supplies, debit card usage, one of the benefits of installing our new POS system with our ability to accept debit cards so that penetration was up slightly, which drove some improvements in our tender fees. So, it was a little bit of several things to be honest with you. There was not one big item that sort of heads off to the field team because I think that they did a terrific job of managing expenses during the quarter.

Anna Andreeva - J.P. Morgan

Okay. Is that something that we can expect of to see continuing helping your SG&A over the next couple of quarters?

Patty Johnson

Well it helps, when we have a 2 ½ comp, when we started getting into something like flat to slightly down, you have an opposing pressure which is some of the deleverage that we get on some of the fixed cost. To the extent, yes, they will continue to focus on those improvements and yes we should see that. But, it will be somewhat offset if you will buy a deleverage that we would see on some of the fixed cost in our system.

Anna Andreeva - J.P. Morgan

Okay. That makes sense. Just looking at your balance sheet, how should we think about your cash position over the next couple of quarters? Is there just a minimum cash cushion that you guys need to maintain to operate this business? If you could remind us, what is your revolver availability right now?

Patty Johnson

The maximum revolver availability is $40 million. As you know, we have not drawn against that revolver. We do use it for letter of credit facility from time to time. So, there is a maximum of $40 million available. It is an asset backed facility. In terms of our cash flow forecast, in fact, we just went through our cash flow forecast with the board last week. We are comfortable with our cash flow forecast. You know that we ended the second quarter with $125 million in cash then of course, a couple of weeks later, turned around and wrote a pretty large check for the share we purchased. But even after the share we purchased, we are comfortable with our cash flow forecast and where we will be for the year. I do not anticipate any issues.

Anna Andreeva - J.P. Morgan

Okay. That is definitely helpful. And just finally, circling back on one of the previous questions, you still were able to get a pretty nice increase in transactions during the quarter and I know that you do not have traffic counters at stores. But just anecdotally, do you think that you were getting better traffic or was it more coming from conversion?

Patty Johnson

That is a great question. I do not know because we do not have traffic counters. In looking at how the quarter played out, because we started the quarter very strong as Mark talked about on the January conference call, so I would say that it was probably footsteps in the stores, in the front half of the quarter somewhat moderated with trends in the back half of the quarter.

Mark Hoffman

And, we also benefited from continued focus on UPTs in store with some modest improvement there but credit where credits do.

Anna Andreeva - J.P. Morgan

Great, thanks. Good luck for the third quarter.

Operator

Our next question coming from Janet Kloppenburg of JJK Research, please go ahead.

Janet Kloppenburg – JJK Research

I have a couple of questions for Patty first. And then Mark, I have a couple of questions for you.

Patty, what is the expected share count at the end of Q3?

Patty Johnson

Like 2011.

Janet Kloppenburg – JJK Research

Did you guys quantify what the benefit of the Easter shift was going into Q2 from Q3 so when we analyze the next shift of Q2 depending on the timing, will we still have an idea of that?

Patty Johnson

What we talked about when we were giving our Q2 guidance, we talked about that at that point in time, we estimated that there would be a shift of about a point and a half of comp out of Q3 into Q2. That was kind of our rough way of estimating the impact. I think that as we get through Q3, we might be able to look back with some high in sight and validate that but that was our expectation.

Janet Kloppenburg – JJK Research

A point to a point and a half a comp. So, you cannot translate that into an earnings number for me?

Patty Johnson

No. But you could put a flow through on that.

Janet Kloppenburg – JJK Research

You want me to just flow it through a regular way.

Patty Johnson

Yes. I do not know a better way to tell you to think about it.

Janet Kloppenburg – JJK Research

Okay. The cash balance, we should just assume the cost of those shares and think about your cash left at that level.

Patty Johnson

Yes and a couple million for fees, expenses, et cetera as well. So, yes.

Janet Kloppenburg – JJK Research

Any option with security exposure?

Patty Johnson

No.

Janet Kloppenburg – JJK Research

Good. Okay. Mark, so just going back to the inventories so I can better understand it, I guess that it is mostly in the top area and you work that down to this quarter, is that the idea?

Mark Hoffman

Well Janet, if you look at the overall penetration by business category, the largest group being on tops, I suppose if that is your point, it would be across the product assortments, number one. Number two, we obviously were planning for the Easter shift and then we spoke to this office in business trends, when extracting Easter, hence, the previous comments.

Janet Kloppenburg – JJK Research

But then, I just want to understand how you work it down. Is it at the expense of newness which could hurt comps here in this month or next month? In other words, sometimes, when you are trying to bring inventories down, you have to pull some receipts flow that you have previously planned. Is that is what is happening? Maybe you could help me understand a little bit better.

Mark Hoffman

The answer is that you have to aggressively review your receipts flow and manage the cancellation of those product categories with the highest week on hand that are not turning it faster, balanced it against the benefit of those product categories, those items that are selling the strongest while managing your marked bound cadence to reduce your inventory ownership. And, I believe that the team did that very effectively through this transition period and I think that that is what I am wanting the numbers to say.

So yes to all of your points. You got to do that in a balanced way. And before anyone could conclude that we have cancelled new receipts at the risk of business, I would say that the answer to that is a clear cut no.

Janet Kloppenburg – JJK Research

Right. Only in the areas where it has been difficult in turning that desirable way.

Mark Hoffman

That is correct.

Janet Kloppenburg – JJK Research

Right. So, going forward then, you will invest in these categories that you talked about, the dresses the shorts, the shoes, where the performance has been the strongest.

Mark Hoffman

Well said Janet.

Janet Kloppenburg – JJK Research

I just wanted to make sure that as you bring the inventories down which I think that you think there would be at -5 single digit levels at the end of the third quarter, is that right?

Mark Hoffman

Correct. As we project our business trends or sales on inventory ownership by week through to the end of the third quarter, we are currently targeting ending at a decrease of high single digit that is based upon our sales assumptions or if you will, our burn through rate.

Janet Kloppenburg – JJK Research

Patty, maybe you can help me with this with the marked down levels going into Q3, would they be higher than last year going into Q3? And, how do you think about them coming out of Q3?

Patty Johnson

I think that it is a fair assumption that we continue to see and it is not so much about this clearing into this inventory as it is. It is just overall promotional pressure on the quarter as well. I think that that is the bigger factor here.

Mark Hoffman

It would be wrong to conclude that, we have just now incurred some significant increase in markdowns that are going to, in this period of time, that which is behind us the first three weeks of April that are going to reduce our gross margin on a year-over-year basis rather than it is as we view the entire quarter and we look at our promotional cadence this year to last year and we respond to the competitive pressures that we are currently experiencing and that we foresee in this economic environment that those would be the assumptions in our guidance.

Janet Kloppenburg – JJK Research

Okay good, thanks very much you guys, I will talk to you later.

Operator

Thank you, our final question is coming from Quinton Maynard of Morehead Capital.

Quinton Maynard of Morehead Capital

Just a couple of quick things, when you were talking about new store performance, if you do not mind, I was hoping to get a comparative feel for that against 2007 mini-stores versus 2006 or the most recent open stores versus last year, are you willing to give us that kind of detail?

Patty Johnson

You know Quinton, it is hard. I could tell you that we look at the stores by class. So we have a full year of operation for the stores we opened in 2006. We do not have them because so many of our stores are backfloated in the fiscal year. We only have four or five stores that opened in our 2007 class that has actually been open a full year. We like to wait until they are open a full year to really evaluate because of seasonal differences in timing et cetera.

I can tell you, we continue to be pleased with our new store openings, but I cannot tell you about the class of 2007 yet because so many of them have an anniversary at their opening day yet.

Quinton Maynard of Morehead Capital

That makes sense, as far as the new openings you are looking at in the back half of the year, can you give us a feel for the regional mix there?

Mark Hoffman

Yes, the biggest geographical impact, Quinton, would be in the Northwest and as you would look across the country, the rest are basically fill-ins. There really would not be a particular geographic region where you would say, “Oh my, there are lots of openings there beyond the Northwest.”

Quinton Maynard of Morehead Capital

Mark, as far as the “got to have” product, is there something right now that you are looking at, saying, “Man, my customer really wants this.”

Mark Hoffman

Aside from the strength and the categories previously mentioned, I do not think there are any key items in our sector right now that would be in the context of what I think you are saying or I have got to have that, I am coming to the store and specifically asking for that.

At this time of year, there is no question of the strength of our green teas. There is no question to the strength of our cross business and our denim business in general but to point out any single item, I mean, I am missing on a number of our flip-flops, our sandals, et cetera. But to call out a single key item, I could not do that.

Quinton Maynard of Morehead Capital

Okay, sure that is fair. And last thing I have got for you. Starting on the calls about a year ago, you had targeted a specific operating margin guidance and then as we got into this tougher economic cycle, obviously that had to be given up a little bit. As you kind of look down that road and think about all the things that are kind of coming into play here, are you getting a feel for where we should be heading with operating margins over two, three, four quarter viewpoint?

Mark Hoffman

Quinton, you are talking about coming on a 2006 and our focus on our belief in our consistent deliverance of positive cost or sales on a quarterly basis having come off of double digit quarterly increases. And it is tough to speak to that in the environment that we just completed and what we projected for the third quarter. I say, it is tough to speak to because we know that the sale environment we are in is a very challenging and soft one. Hence, save way from there than to our operating margin goals.

We are mindful of our need to continue to improve our overall performance or achieving best practice, margin statistics in the industry, we see headroom and upside and we will be talking about that in coming conference calls.

Quinton Maynard of Morehead Capital

Great, well good luck guys, thanks so much.

Operator

Thank you I would like to turn the floor back over to – for their final remarks.

Mark Hoffman

Well, thank you for attending today’s conference call and we will look forward to speaking again this July. Have a great day.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

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