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The Gymboree Corporation (NASDAQ:GYMB)

F1Q08 Earnings Call

May 21, 2008 4:30 pm ET

Executives

Kip Garcia - President

Matthew McCauley – Chairman, Chief Executive Officer

Jeffrey Harris - Vice President of Finance

Blair Lambert – Chief Operating Officer, Chief Financial Officer

Analysts

Betty Chen – Wedbush Morgan

Adrienne Tennant – Friedman, Billings, Ramsey

Margaret Whitfield – Stern Agee

Dana Telsey – Telsey Advisory Group

Brian Tunick – J.P. Morgan

John Zolidis – Buckingham Research

Linda Tsai – MKM Partners LLC

Janet Kloppenberg - JJK Research

Lorraine Maikis - Merrill Lynch

Marni Shapiro – Retail Tracker

Operator

Welcome to the Gymboree first quarter 2008 earnings conference call. (Operator Instructions) Mr. Harris you may begin your conference.

Jeffrey Harris

Welcome to the Gymboree first quarter 2008 earnings call. I am Jeff Harris, Vice President of Finance for Gymboree. On the call with me today are Matthew McCauley, Chairman and CEO, Kip Garcia, President and Blair Lambert, COO and CFO.

Blair will first make a few comments about our first quarter financial performance and plans for the remainder of 2008. Kip will discuss product performance during the first quarter and update you on our product initiatives. Matt will then provide some additional background and update you on our strategic plans for the remainder of 2008 and beyond. After our presentation is finished we will all be happy to take your questions.

Before we get started, I want to point out that our presentation today contains forward-looking statements including statements about trends in operations, future sales expectations, and future financial performance. After results could differ materially from those forecast as a result of a number of factors including those set forth in our annual report on Form 10-K for the year ended February 2, 2008, filed with the SEC.

I would also like to point out that we intend to continue to comply with the SEC regulation FD. As such we will not be providing guidance or projections outside of public forums. You should also be aware that your participation in the Q&A session constitutes your permission to transcribe and re-broadcast any comments you may make.

Now here is Blair Lambert.

Blair Lambert

As reported in our press release net retail sales for the 13-week ended May 3, 2008 were $238.9 million a 16% increase over the $206.7 million in net sales from retail operations reported for the 13-week fiscal quarter last year. Other revenue for the quarter attributable to our Play and Music operations was $3.2 million compared to $2.6 million in the prior year.

In total, net sales for the quarter were $242.1 million versus $209.3 million for the prior year, an increase of 16%. As previously reported comparable store sales for the quarter increased 4%. During the quarter we saw increases in the total number of transactions and units per transaction offset by slightly lower average unit retail due to the growth of the outlet and Crazy 8 divisions. These changes were in line with our expectations.

The total number of stores open at the end of the quarter was 811 including 574 Gymboree stores in the U.S., 30 Gymboree stores in Canada, 96 Gymboree outlet stores, 95 Janie and Jack shops and 16 Crazy 8 stores. For the Gymboree brand for the quarter we opened 7 new stores and 14 new Gymboree outlet stores. We also opened 2 new Janie and Jack shops and two new Crazy 8 stores.

Total square footage under management at the end of the quarter was 1,570,000 square feet with our average store size at roughly 1,900 square feet.

Turning now to gross profit. Gross profit for the first quarter of 2008 increased 140 basis points to 51% compared to 49.6% for the same quarter of the prior year. The improvement was the result of the company’s continuing product cost reduction strategies, leveraging of buying costs partially offset by a lower AUR, increased occupancy costs and relatively lower Crazy 8 gross margin rates.

Looking at SG&A expense in the first quarter, SG&A as a percentage of sales increased roughly 30 basis points to 33.8% of sales versus 33.5% in the prior year. The increase is primarily driven by higher stock based and incentive compensation offset by lower professional fees, marketing, repairs and maintenance and store payroll. Notably, net of incremental non-cash stock based compensation expense SG&A fell by 30 basis points versus the first quarter of the prior year. Please keep in mind that the expense for performance based stock compensation is realized on an accelerated basis this year. As most of you know prior year costs were booked on a straight line basis in Q1 and adjusted in Q4 of 2007.

For the quarter operating income rose 24% to $41.6 million versus $33.6 million in the first quarter of the prior year. As a percent of sales operating income increased by 110 basis points to 17.2% of sales compared to 16.1% of sales in the prior year.

The tax rate for the first quarter was 40.2% versus 39.9% in the prior year. Net income was $25 million versus $20.9 million last year. Earnings per diluted share increased almost 30% to $0.86 per diluted share compared to the $0.67 reported in the prior year. These earnings include a loss of roughly $0.04 per diluted share associated with Crazy 8.

Let me now move to the balance sheet. Cash, cash equivalents, and investments at the end of the quarter were roughly $58 million with no short or long-term borrowings outstanding. Inventories at the end of the quarter increased to $95.6 million versus $85 million in the prior year. On a per square foot basis, inventories decreased 2% over the prior year. Gross capital expenditures for the quarter were $14.1 million. Depreciation expense for the quarter was roughly $8.4 million.

Let me now turn to our plans for the remainder of the year. As noted in our press release for fiscal 2008 we are planning for diluted per share earnings in the range of $3.10 to $3.15 on 29 million diluted shares outstanding. These earnings targets anticipate a full-year net loss of $0.08 to $0.09 per diluted share. As has been our practice, we plan for a low single-digit comparable store sales increase for the year with modest increases in gross margin and operating income.

Looking more specifically at the second quarter of fiscal 2008, we are planning second quarter earnings to be in the range of $0.18 to $0.20 per diluted share on 29 million shares outstanding. This earnings estimate includes a loss of $0.04 per diluted share related to Crazy 8. In terms of real estate, we plan to open 24 new stores during the second quarter consisting of three new Gymboree stores, 8 new Gymboree outlets, 5 new Janie and Jack shops and 7 new Crazy 8 stores. We also plan to remodel, expand or relocate 8 Gymboree stores.

Turning to sales we are planning for a low single-digit comparable store sales increase for the quarter. In terms of gross margin we expect second quarter year-over-year gross margins to decrease slightly versus the prior year primarily due to the negative occupancy expense leverage associated with the large number of new store openings.

Looking at SG&A we expect slight SG&A leverage. On balance operating margins are expected to be consistent with those experienced in the prior year.

Now I’d like to turn it over to Kip for a discussion on our merchandising activity.

Kip Garcia

First we are very pleased to report that all brands positive comped both retail and gross margin dollars for the quarter. At Gymboree our sales increases were first and foremost driven by consistent strong line performance across the quarter.

Our merchandising and design teams have been relentlessly focused on developing product that emphasizes what makes our brand unique in the marketplace. That is outfit driven, mix-n-match, highly detailed and age appropriate and it is paying off. Our new lines for the spring season resonate with both our core customers and new customers just joining our family.

We are particularly pleased with the success of our Easter line which posted strong comps both across casual and dressy, boy and girl, baby and kid and family dressing. The Neapolitan ice cream theme and color palette for girls was fresh and unique for Easter timing and we were pleased there was nothing like it in the malls.

We felt that our Easter lines were differentiated from the competition’s sea of dresses offered at this time. Boys benefited from our color palette which tied to our girl assortment and our airplane icons worked for both dressy and casual Easter occasions. We also took a stand on swimwear and the success in this category helped drive comp for the quarter. We maximized our strength in head-to-toe dressing within our swim shops that offered outfit collections that mixed and matched for both boys and girls.

We launched UV blocking rash guards this spring which were incremental and new to Gymboree and we made them unique and our own by tying them into our mix-n-match swim collections. In support of our initiative to grow our newborn business we launched our brand new baby layout essentials line in conjunction with our baby event in February supported by new packaging, marketing, gift boxes and shopping bags. We are happy to report that this collection continues to perform above our original expectations and we will definitely be expanding this concept going forward.

Boy continues to be a key growth initiative for Gymboree and for Q1 our Boy departments posted the highest comp increases for the quarter. New, starting with our spring collections we have added authentic boy details and styling which included wash and detail for woven bottoms and woven shorts, pocket and collar details on woven shirts, and styling details on woven shorts including expanded length options and patterns.

We also offered a wider range of wardrobing options within every line so that any time our boys could find a range of outfitting from rugged play to casual dress up. We are very excited with the progress we continue to make towards filling our boy presence and there will be more to come for back-to-school so stay tuned.

Turning to Janie and Jack our boy accessories departments were our strongest comp performance for the quarter and as in Gymboree Easter was a strong delivery for Janie and Jack. As we said in our last call we are focused on ensuring that Janie and Jack continues to be the destination for best-dressed children by offering unique, timeless styling and heirloom quality details and Easter was our opportunity to raise the bar.

For girls we offered precious dresses with organza ribbons, hand embroidery, hand-stitched pin tucks and hand smocked details complete with the perfect Easter outfitting accessories including shoe and hair accessories with satin ribbon bow treatments and ponytail details.

For boys we offered our successful suit separates with dress shirts, ties and layering vests to create a little-gentleman look plus more casual options for a less dressy look. We also launched our special occasion, top of the line boy suites and girl’s dressy dresses this spring which were a customer favorite and positioned Janie and Jack as the special children’s apparel destination for times that will be recorded and remembered for years to come.

Finally, we narrowed our style counts across the lines in order to ensure that our assortments continue to feel special and elevated. The success of our very tightly assorted blue sky summer cap line supports this strategy going forward.

Turning to Gymboree outlets we continue to be pleased with our performance and as with Gymboree brand our boy departments were key drivers for the quarter. Additionally, we identified an opportunity for accessories for 2008 and found new sourcing opportunities to support drivers of this category. As a result, our accessories department achieved the highest increase for the quarter driven by shoes, hair accessories and underwear.

Turning to Crazy 8 our customers continue to respond positively to our boy and girl graphic tees and our best sellers continue to reflect the sense of humor that is iconic to the brand. Based upon the success of this program in our kid sizes we rolled out similar programs for both baby boy and baby girl this quarter. At the department level both baby boy and baby girl continue to out-perform our initial expectations for these departments.

Finally, looking forward to second quarter across our brands we are better positioned with the right balance of value and fashion assortments in order to maximize the price sensitive summer selling period as well as offering motional, must have fashion items within each brand targeted to our regular price customers.

For example, Gymboree just launched its summer vacation line which last year was very weighted to our opening price points. We are pleased that this year we are selling a good balance of both full-price fashion and key item opening price point cap deals. We are looking forward to our July kick up office back-to-school and have exciting product marketing strategies to share with you on the next call.

Now I would like to turn it over to Matt.

Matthew McCauley

We accomplished a lot during the first quarter. Total sales increased 16% for the quarter. Comp store sales grew another 4% on top of last year’s 3% and we opened 25 new stores. We also increased gross margin another 140 basis points on top of last year’s 100 basis point increase.

Operating margins grew 110 basis points from 16.1% in 2007 to 17.2% this year. Most importantly we grew our earnings per share nearly 30% on top of a 20% increase last year. Though we are pleased with these accomplishments we still see opportunities to improve top line sales as well as comp store sales.

Our fiscal 2008 strategies have been discussed at length on previous calls. Let me take this time to update you on a few of them. First looking at Gymboree our focus continues to be on acquiring new customers, holding on to customers longer and reducing expenses. I’d like to give a brief update on the progress in Q1 on each of these.

As we mentioned previously our major initiatives under customer acquisition are products category growth, direct marketing and the Play and Music integration. Out of the product category we have called out boys as one of the largest growth opportunities. With an expanded assortment and increased inventory the boy department again continued its trend as the leader in comp store growth and we are confident we are on the right track. The two key growth categories for boy were polos and woven bottoms.

Now for direct marketing our goal is to reach more potential customers and drive more sales while leveraging marketing expenses. For Q1 we achieved this goal. By improving our list productivity, adjusting the mix of direct mail and print advertising and through improved production costs we were able to leverage marketing expenses. Although it is early we are encouraged by the first quarter results.

Finally, the Play and Music integration. As you know Play and Music is the leader in early childhood development. We operate over 580 sites in 30 countries around the world. The objective of the Play and Music integration is to enhance the customer experience and increase the overall customer base. We are doing this through more concise communication and with real incentives and benefits for being part of the Gymboree family.

During Q1 we reached out to Play and Music customers with welcome kits to encourage customers to shop any of the Gymboree of brand and we invited the Play and Music customers to Gymboree retail circle of friends events.

We also drove new customers into the Play and Music sites with a shared direct mail piece during our baby sale and through a shared email in May. We are also re-designing our Play and Music website to better serve the franchisees and customers. The new site will go live in the fall of 2008.

Turning now to our efforts aimed at holding on to customers longer. The two major initiatives in this bucket are CRM and size extensions. CRM launched in April last year and since then we have been able to improve our list management, get better, faster, more accurate test readings and improve our customer segmentation capabilities. With the roll out of the new Key West system we will be able to associate customer information with transaction data and begin to test a more formal loyalty program. The new Key West system will be fully rolled out in the third quarter and our loyalty program will begin testing in 2009.

Now moving to size extensions. We introduced size 10 for boy, 10-12 for girl and 5T in baby in all stores during back-to-school last year. In addition, plus and slim sizes were introduced in all but small stores during the same time. These expanded size ranges have added incremental sales and they are contributing to our comp store sales growth.

In summary, we are pleased with the progress we are making with these key initiatives and continue to see opportunities within the core Gymboree business that will support growth in the second quarter and beyond.

Turning to the Gymboree outlet business, Gymboree outlet also continues to perform very well. The every day low price is driving solid regular price sales while the increased volume is bringing down our product costs. These factors combined with the lower operating expenses incurred in these malls are allowing us to generate our highest four-wall contributions. We currently operate 97 outlet stores with the ultimate goal of growing to a total of 150 Gymboree outlets.

Looking at Janie and Jack, the combination of increasing sales and margins coupled with the improvements of store efficiencies is improving the four-wall contributions of these stores. We continue to believe there is an opportunity to operate a total of 200 stores in this concept.

In addition to the store growth and sales growth strategies we also discussed in our last call several opportunities to improve efficiencies and reduce costs. Some of these opportunities are in store operations, communications, shipping costs, proprietary expenses and product costs. We are making progress in all of these areas and anticipate additional savings throughout the year and continue to execute these strategies.

Now let me take just a minute to give an update on Crazy 8. As we discussed previously our strategy with Crazy 8 was to target moms who want cool, wholesome clothes for kids at a price. Our approach was to impress moms with an elevated shopping experience, great service, entertainment for her kids and quality gift packaging all while offering impressive values throughout the entire store such as $6 graphic tees and $14 denim.

Crazy 8 also offers an expanded size range compared to Gymboree and Janie and Jack. Crazy 8 goes from size 0 to size 14 and as planned is capturing a slightly older customer. To date we are hitting our budgeted sales driven by slightly higher than expected boy sales and slightly lower than expected girl sales. Our margins are lower than expected due to a combination of a more promotional environment and higher cost of goods. To date, however, our percent of sales at regular price is similar to our outlet business and we expect gross margin rates to improve as our cost of goods reduces over time.

As a comparison, Janie and Jack took three years to break even and we anticipate a similar break-even point if not sooner. We now plan to open 25 stores in 2008 representing a 5 store increase bringing the total store count to 39. We feel this is a large enough base to properly evaluate and size the opportunity.

In summary, we are continuing our focus on long-term growth. With a multi-brand strategy reaching every mom in America, significant store growth and current proven concepts and major market share opportunities we are on tack for solid growth for the next several years. We look forward to sharing our progress with you in the future.

Now we’re happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Betty Chen – Wedbush Morgan.

Betty Chen – Wedbush Morgan

I was wondering could you clarify a little bit about your commentary on SG&A being slightly higher in the second quarter. I think you mentioned it was for new stores. Then in terms of the Crazy 8 plan for this year could you talk a little bit about the rationale of why you have increased the store opening plan? Is it perhaps that real estate became available or perhaps some increased confidence in the progression of that concept?

Blair Lambert

In Q2 we said gross margin would be down a little bit due to higher occupancy costs and that is really the result of the large number of renegotiated deals we have done over the last few years and the fact we have 23 to 25 stores that will open up in the second quarter so we are ending up with a fair amount of rent expense when we don’t even have revenue in the stores yet because we have to start charging off that rent expense a couple of months prior to the opening.

We charged it off as we start to take possession of the store. So that is what the occupancy comment was. SG&A we think will be slightly leveraged in the second quarter allowing us to get back to an operating margin that is consistent with the prior year.

Matthew McCauley

Crazy 8 is a combination of both of those things. We are feeling good about the sales we are seeing right now, are happy with the direction it is going and feel confident of the opportunities and things that we can improve on and a combination of having the right deal coming up and finding the right locations. So both of those.

Betty Chen – Wedbush Morgan

Could you speak to the merchandise margin plans? I think in the past you had talked about I think perhaps 100 for this year. I wonder if that was still on track and if you could remind us the buys you had completed for this year. I think it was already done close to the very end of this year.

Blair Lambert

Really no change on that guidance for the full year. We are expecting about 100 basis points of gross margin improvement. Everything else remaining equal based on getting lower product costs for the full-year period. We have purchased, at this point most of the year is done so we feel pretty good about those expectations.

Operator

Your next question comes from Adrienne Tennant – Friedman, Billings, Ramsey.

Adrienne Tennant – Friedman, Billings, Ramsey

My first question is on the boy penetration at Gymboree. I know you don’t give numbers but what inning are we in? How much more penetration do you see that you can drive the comp with that?

Matthew McCauley

Adrienne how did I know you were going to ask what inning we were in? We’ve heard that before. The response to that is we still have a long ways to go and what we have said and continue to feel is that if we do stay on this track we are on with boy we should continue to see low single-digit comps for the entire company, holding everything else constant. So there is still several more years of growth for us to get out of boy.

Adrienne Tennant – Friedman, Billings, Ramsey

On the Crazy 8 side of things thus far what have you learned with 16 stores open? What have you learned as you go to open the next several stores? Are you making any tweaks or are you pretty happy with where things are?

Matthew McCauley

We are learning all the time. We are still learning things in Gymboree. On Crazy 8 the things we have learned on the real estate side is we continue to feel good about opening in high traffic malls and prominent malls and we’re trying to build a brand so that is exciting for us going forward.

Learning a lot about the balance of boy and girl and kid to baby and feeling pretty good about the direction we are going and still see opportunities for us to improve the girl business. We’re really happy with the boy strength and the baby girl strength and the kid girl opportunities where we’re seeing a little bit more growth and we’re pretty excited about all of those things we have learned there.

One other thing that we’ve learned in terms of where the customer is coming from is seeing a lot of the customers coming from Target, Old Navy and certainly a lot coming from Children’s Place. I think the thing that surprised us the most was how many of them were coming from Target.

Adrienne Tennant – Friedman, Billings, Ramsey

Are the category strengths pretty similar? Do they mirror those of Gymboree’s core business? Actually I should say the penetration.

Matthew McCauley

The penetration is much higher in boy right off the bat in terms of departmental selling. So we are very, very happy with that. But that is the opportunity for Gymboree to increase boy and the opportunity for Crazy 8 is to increase girl.

Adrienne Tennant – Friedman, Billings, Ramsey

My last question is on cost inflation. Minimum wage, freight, cotton prices, we are hearing all these things. Are you seeing any of that?

Matthew McCauley

Obviously we are under the same pressures everybody is feeling particularly around production, cost of fuel, cost of labor, all of those things are putting pressure on us. The good news is we are still, in terms of Gymboree, we are still in the early stages of finding new opportunities for sourcing.

We are still looking at new countries we can go to and that is still an opportunity for the Gymboree side even though the costing is plateauing a little bit there. It is offset by the fact we have Crazy 8, Janie and Jack and outlet that still have lots of room just based on the sheer quantity of the orders increasing that is helping the cost of goods.

Operator

Your next question comes from Margaret Whitfield – Stern Agee.

Margaret Whitfield – Stern Agee

I guess a question on Crazy 8. I was surprised the loss was higher than I thought in first and second quarter but now I guess break-even is planned for the back half or close. Was that in your original thought? Apart from seasonality what would lead to that?

Matthew McCauley

It is mostly seasonality. That was pretty much our expectation. Obviously Q2 is challenging for most retailers especially for kids in shorts, tees and tanks at lower price points and then obviously we are building the business and increasing the store count over time it helps offset some of the fixed costs here at the home office.

Margaret Whitfield – Stern Agee

On the stock based compensation would we see a similar increase year-over-year in Q2 and Q3 as was reported in Q1?

Blair Lambert

You would see similar types of numbers, yes. I think that is a reasonable expectation and then it turns around a little bit as you get into the fourth quarter.

Margaret Whitfield – Stern Agee

And the product cost benefits that we had in the first quarter would we see similar benefits in Q2 and beyond?

Matthew McCauley

Essentially it is a target in the 100 basis point forecast we have given for the year are pretty consistent throughout the year and we have pretty much baked those purchases.

Margaret Whitfield – Stern Agee

Interested in that organic baby line. Will that be in all doors? What percent of baby will it comprise?

Kip Garcia

Organics actually is a test for us. So we will be launching it online. Our press kits are just now coming out. So more to come on that. We think it is something we have to do and we just want to see how much our customer responds to it. But it is really cute. It is not just organic it is actually very well styled.

Margaret Whitfield – Stern Agee

How many stores now have that special occasion line at Janie and Jack?

Kip Garcia

Janie and Jack is only in a handful of stores right now and it is also online and we’re going to expand it. It is in less than ten stores I think in Janie and Jack but we are expanding it as we go forward because it has been so strong and we have been looking for space opportunities in our stores to see where we can put it.

Margaret Whitfield – Stern Agee

With Talbot Kids going out of business does that represent an opportunity later in the year?

Matthew McCauley

Looking at it, we look at the big landscape and certainly with a lot of the retailers struggling it presents a lot of opportunity but at the same time there is a lot of competition with promotional pricing competition so certainly that could be an opportunity grab a little bit more market share, certainly offset by a lot of the other challenges with people being more promotional and dropping prices.

Margaret Whitfield – Stern Agee

Can I ask, thus far in May your comps are in line with your plan for the quarter?

Matthew McCauley

Yes, we feel very good about the guidance we have given for the quarter and May is certainly supporting the guidance we have given. We feel very good about that.

Operator

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

Dana Telsey – Telsey Advisory Group

Can you talk a little bit more about the outlet business? What you are seeing there traffic wise, product wise and what you are seeing from the real estate conference that is being held this week. Then lastly on the gross margin which went up so much can you tell us a little bit about the opportunities there? Are you seeing it in IMU, merchant or product costs and how does it vary by concept?

Matthew McCauley

Your first question about outlets what we are seeing in terms of the opportunity there is we continue to be thrilled with the sales growth we are seeing there. Still a lot of opportunity in terms of store growth. We feel really good about the direction we are headed with Gymboree. Four-wall contributions continue to be very, very strong. Percent of rev is still very strong. We are really happy with that opportunity.

When we talk about merchandise margins and where that came from in the first quarter I won’t break that out by department but I will tell you that we did have positive regular priced sales comp which we are very happy about in the first quarter even though we were offset a little bit by lower averaging at retail a lot of that is driven by a larger mix of Crazy 8 and outlet selling which is at the lower average unit retail. So, the combination of our regular priced sales comp in addition to our cost of goods reduction that is what is driving a lot of margin growth there.

Blair Lambert

On the real estate conference I’d say I was down there on Monday and it is a little bit less attended than in prior years. I don’t think there is a lot of movement in the real estate world though. There was a little bit more on the fringe in terms of spaces becoming available in some of the better malls. That’s not to say that in the best malls the prices are going to come down because frankly there is a big demand to be in those best malls. There may be some opportunities on renewals in some of the B malls and C centers there may be some opportunities there although we don’t think they are going to be dramatic and frankly we don’t have that many renewals coming up compared to the base so I don’t think it is going to impact us a lot but we are certainly going to be pushing on that.

I would say on the fringe though it was probably a little more positive from our perspective than maybe some of the prior years where there was so much competition for space.

Dana Telsey – Telsey Advisory Group

On the gross margin Blair, any commentary on the margin improvements?

Blair Lambert

In addition to what Matt said we had some pretty good buying leverage in terms of leveraging some of the corporate costs. So that was on the positive side. We had some downward pressure from Crazy 8 just the impact of having a new business with a lower margin impacting the mix. But those are really kind of the key components as Matt said. You have better average cost but offset or in addition to that a little bit better full price selling offset by the Crazy 8 piece and a little bit of negative occupancy expense leverage.

Operator

Your next question comes from Brian Tunick – J.P. Morgan.

Brian Tunick – J.P. Morgan

I guess is it more because of the number of openings in the second quarter that it sounds like you need to get 3% to 4% comps to get occupancy leverage or is that going to continue for the rest of the year?

Second question is the inventory plans for the end of the second quarter and maybe what categories you think are the biggest opportunities for back-to-school that you might have missed out on last year?

Finally with the increased number of Crazy 8’s even though CapEx might go up a little more you are still going to obviously be generating free cash and have cash. So can we look for a new buyback program? What are you waiting for on that leg?

Jeffrey Harris

On occupancy in the second quarter you just get lower volume levels when you are selling t-shirts and shorts at lower prices as Matt was referring to so that occupancy cost you have a little bit less room. It is just a bigger nut relative to the total PNL. It is relatively a fixed cost. We don’t have a lot of stores that go into the percentage rent world. So going forward we have said we expect a little bit of downward pressure from occupancy throughout the year. We said that I think coming into the year and we expect that for the full year.

Kip Garcia

Your question about inventory, looking at the quarter we purchased inventory slightly down to last year. If you remember last year we made some pretty large investments going into back-to-school and felt really good about that but we were also a little bit more promotional last year. So we tightened that up a little bit and feel great about where we are headed.

The big opportunities are going to be in denim, backpacks, polos, woven bottoms and dresses, all really around buying up for that back-to-school time period at the end of the quarter. In terms of cash and whether or not you can expect a buy back we are always looking at shareholder value and continue to assess all of the opportunities that are out there and buy back is certainly one of them and we are constantly evaluating what the best return on the investment is for the shareholder. Nothing in the near-term plans but rest assured we are constantly looking at the best use of that cash.

Brian Tunick – J.P. Morgan

Do you have a new CapEx number we should be using?

Blair Lambert

We haven’t planned on anything new Brian. I think we are still going to be around 60.

Operator

Your next question comes from John Zolidis – Buckingham Research.

John Zolidis – Buckingham Research

We have drilled in on the gross margin pretty good which I think is the real positive surprise in the quarter. I was wondering if you could talk about the Crazy 8 and what you think the ultimate longer-term potential is for that store base if it is successful. Especially in light of the fact you have over 700 Gymboree stores going forward.

Blair Lambert

Basically what we said on that obviously we are reaching a much broader demographic, it should be a much larger customer base and if we do this thing right and it works it should be bigger than Gymboree. We should have more stores than Gymboree and that is what we have said and we continue to feel pretty good about that.

John Zolidis – Buckingham Research

You have already talked a bit about the costing and having purchased most of the goods for the balance of the year. At some point do you expect upward pressure on cost coming out of China and where you source your goods?

Blair Lambert

Absolutely. There is already that pressure…upward pressure, particularly in China. As I mentioned earlier we have to constantly look at ways to offset that. We’re looking at new sourcing opportunities. We actually have reduced the amount that we have in China already and looking at new countries and fortunately we are kind of at the front end of opportunities of getting into new countries so yes there is pressure there. We move very slowly when we look at going into new countries and factories because of our quality standards and our social accountability expectations but that is real. We are experiencing that.

John Zolidis – Buckingham Research

I guess looking out to 2009 at this point it may be somewhat speculative but if you had to guess how this is most likely to play out in terms of your income statement if there is slight increase in costs that you could no longer offset through the maneuvers you have already been utilizing would you try to pass those costs on to your customer? Would you expect that to be a positive for comps? Would you expect it to be a negative for gross margins? Do you have any sense of that you can create a framework for us to think about it as we get closer?

Blair Lambert

Obviously we are thinking about 2009 and 2010 as well. The good news is for 2009 we have several strategies already that we feel great about that continue to give us growth, long-term growth in earnings and margin growth. I’m just going to frame this a little bit. If you think about Gymboree where it is getting closer to those kind of more modest cost of goods reductions and might even be plateauing when you start to get out to 2009.

You have that offset by the fact you have Crazy 8, Janie and Jack and outlet which are all growing businesses, larger store counts, larger contribution to the total pie and at the same time they are significantly reducing their cost of goods just with the sheer order sizes growing. So that offsets it to some degree. In addition to the additional strategies we will be sharing with you at the end of the year about what we are doing in 2008 to offset it. So we still feel good about the growth in 2009.

Your question about would we pass on costs to the customer, at this point we are still feeling really good about our pricing strategy and we don’t have any plans to make any major changes to pricing. We are always looking at pricing to make sure we are competitive in the marketplace and making sure we are managing our margins but at this point we don’t have a major pricing strategy to pass on costs.

Operator

Your next question comes from Linda Tsai – MKM Partners LLC.

Linda Tsai – MKM Partners LLC

I realize it might be still a little early to tell but what do you think are some of the differences or similarities between the Gymboree outlets and Crazy 8 customer? And are you seeing any increased price sensitivity as it relates to the Janie and Jack customers?

Matthew McCauley

In terms of the similarity on the customer the fact that most moms are shopping the malls they are hitting everybody who is in the mall; Gymboree, Children’s Place, Gap, Baby Gap, Crazy 8. The similarities are that they want value. They want cute clothes. They want it to be age appropriate. So those are our core strengths. So we feel like we have that in terms of similarity.

The biggest and I guess the most important thing is there is a big differentiation in the customer. So the similarities are that everybody wants high end, they want great quality and they want cute clothes in an age appropriate, wholesome style. The differentiation is certainly for the vast majority a pretty big differentiation in household income, price is much more sensitive to price in the Crazy 8 customer and those things are obviously what we have anticipated.

It is also very, very early and we are seeing that these customers are, as we mentioned earlier with Crazy 8, they are Target customers. They are Old Navy customers. They are Children’s Place customers. Whereas the Gymboree customer is very brand sensitive, brand conscious, high quality and they want clothes that are going to last forever and they can hand down from generation to generation. So there are some differentiations there, similarities on the things that I said earlier.

Linda Tsai – MKM Partners LLC

With the average unit retail is there a certain number you are targeting for Crazy 8?

Matthew McCauley

Around 25% to 30% off of Gymboree is roughly what it is.

Linda Tsai – MKM Partners LLC

Are you seeing any increased price sensitivity as it relates to Janie and Jack customers?

Matthew McCauley

We’re not. That customer seems to be a little bit less price sensitive and even with these times has been pretty resilient so we haven’t seen it yet.

Operator

Your next question comes from Janet Kloppenberg with JJK Research.

Janet Kloppenberg - JJK Research

I just want to clarify is the loss for Crazy 8 greater in the first quarter and second quarter greater than expected but going to be lower than expected in the back half to come out the same? Is that how you want us to think about it?

Matthew McCauley

In the first quarter it is a little bit more than what we expected. Pretty much what we have anticipated in the second. Obviously it will get a little bit better in the back half which is our expectation because we haven’t changed the total year. So yes that is how I would think about it.

Having said that I just drove out…keep in mind it is a relatively small number we are talking about. $3.15 earnings for the year. We’re talking about $0.08 to $0.09 for the year and yes could there be another penny here or there up or down? Absolutely. There are a lot of unknowns in a new business like this and we’ll see how it plays out but directionally I think we are in the right area.

Janet Kloppenberg - JJK Research

Matt, you talked about opening more Crazy 8’s this year than expected. Maybe you could tell us what takes your growth rate up to this year and can you maintain that growth rate for this year or maybe you open more Crazy 8’s next year and it goes higher? Perhaps you could help a little bit with that?

Matthew McCauley

I’ll answer the second question about whether or not we can maintain that growth rate for next year. We’ve always said that we will continue to evaluate and asses it and if things continue to go the way that we want to certainly we would want to keep that growth rate up if not accelerate it. At this point we feel really good with close to 40 store count to be able to size the opportunity, assess the types of markets we need to be in, the size of stores and those kinds of things.

Blair Lambert

We are just going from 100 stores to 105 so it is not a huge jump in the total and you are not going to be open for the full year so we only have a few months so it is an incremental lift in the total square footage, not a huge difference. It is really more a function of opportunities come up, they look good, we have the right location in the mall, we have the right economics on the deal and we just don’t see a reason to pass on good opportunities.

Janet Kloppenberg - JJK Research

Matt you talked about some cost opportunities in shipping and store operations, etc. Did those opportunities decelerate as the year goes along or can they be as beneficial as we go through the remainder of this year?

Matthew McCauley

They can be as beneficial as we go through the remainder of the year. Some of them started last year and obviously as you go through it you start to learn a little bit more and learn what you can expand on and what things are working and what aren’t. You can expect that through the rest of the year.

Blair Lambert

I think when you look at a couple of things that we leveraged on year-over-year, things we traditionally had de-leveraged with marketing and as Matt highlighted we are efficient from that standpoint. We also mentioned store compensation as an area where we are leveraging. That is another initiative we talked about in terms of expense opportunity. I think we are starting to see some of that flow through the numbers in the leverage so we’re happy about how it is going.

Janet Kloppenberg - JJK Research

I think you said Matt that you think Crazy 8 can be break-even in three years and that was pretty much the totality of the outlet business. Or was that the profile of the Janie and Jack business?

Matthew McCauley

Janie and Jack. Actually out broke even in six months. Janie and Jack were three years.

Janet Kloppenberg - JJK Research

So did outlet remain the brand or the business that has the highest store contribution or over time can Crazy 8 move up to that level? What is the outlook?

Matthew McCauley

Outlet definitely has the highest and there are a lot of things contributing to that. A lot of the occupancy costs there make it much easier for us to have the higher four walls. It has a high percent at rev because of the everyday low price which will be similar to Crazy 8. But I think more of the occupancy will make it a little bit more challenging. We have very aggressive and high expectations for four walls in all of our concepts. To be honest there is not a huge spread now between Gymboree, retail and the outlet business because of our margins in Gymboree retail. The goal is to get it close. Whether or not it can actually eclipse the outlets I’m not sure that could happen. But we could get it very close.

Janet Kloppenberg - JJK Research

If you could just talk a little bit about the content, mark down inventory levels versus last year going into Q2? Secondly, I think you are looking for low single digit positive comps; inventory is down 2% on a comparable basis. Should we look for that to continue inventory at those levels? Or will it move back up to the level that the comp trend is expected to come in at?

Matthew McCauley

Our markdowns are actually down a little bit going into Q2. We are very clean and very happy with the mix of inventory. We feel very comfortable with the comp guidance we have given with the inventory we have got.

Blair Lambert

The only thing I would add, Janet, is on a per store basis I think inventories are really flat year-over-year and keep in mind we have product cost reductions we have been incurring so actually on a unit basis we are probably up a little on a per store basis. So we are feeling pretty good about where we are and fairly consistent with what you would expect given the comp guidance.

Janet Kloppenberg - JJK Research

Then it should run along this level? This rate of inventory for the end of the second quarter as well?

Matthew McCauley

We said we bought down a little bit going into this quarter so you can expect it to be down slightly.

Janet Kloppenberg - JJK Research

Coming out of the quarter?

Matthew McCauley

Yes.

Janet Kloppenberg - JJK Research

I would expect we might see some back-to-school receipts or something that might take it higher? What I’m getting at Matt is last year going into back-to-school you beefed them up because I think your uniform or your basic programs you wanted to be more key item focused. So you are following that again this year?

Matthew McCauley

Exactly. The big opportunities I mentioned before would be going after denim, backpacks, polos, woven bottoms and dresses. Those are the big categories we are continuing to go after. Since you saw a big increase last year obviously we are anniversarying that and the big wildcard always is the in-transit because we are looking at the inventory a snapshot in time. I think the best way to think about this is our purchases for the selling time period going into back-to-school are down slightly still with major investments in denim, backpacks, polos and woven bottoms as I mentioned.

Operator

Your next question comes from Lorraine Maikis with Merrill Lynch.

Lorraine Maikis - Merrill Lynch

Things have been very promotional around you. Are you planning any direct mail pieces or incremental marketing for the summer and fall timeframe?

Matthew McCauley

Let me start with our promotional strategy. It is very similar to last year. As you saw in the first quarter in some cases we may have gone a couple of extra days or started a little bit earlier. That may happen in the second quarter as well. In terms of direct mail you heard me talk about earlier how we had a change in our mix between direct mail and print advertising and using call-to-actions in our print. So we are pretty much flat in terms of the direct mail piece but you may see an increase in some of our other marketing like print with calls-to-action.

Lorraine Maikis - Merrill Lynch

Have you seen any evidence of your mom customers trading down within the store or even from Gymboree down to the outlet or Crazy 8?

Matthew McCauley

That is something that has come up actually for the last couple of years it is a question that has come up. It certainly would make sense for that to happen. We just haven’t seen it happening at this stage. Not to say it won’t in the future. We just haven’t seen it happen yet.

Operator

Your next question comes from Marni Shapiro – Retail Tracker.

Marni Shapiro – Retail Tracker

I also have a question or two on Crazy 8 but I promise to make them short ones. You mentioned Children’s Place, Old Navy and Target all within the same commentary on Crazy 8. If you could talk a little bit about your retail real estate strategy for Crazy 8. Do you prefer mall, off mall, which are your favored adjacencies?

If you could also talk about on the product side I noticed the last group particularly on the girls side is much more fashion forward. I would call it more tween friendly than I have seen from you guys prior. How do you think about Crazy 8 as you go forward because you have a very different customer in Crazy 8? The older customer that crosses with some of the tween type of brands in the department stores and then your younger customer who crosses more with the Gymboree type of customer.

Matthew McCauley

First of all your question about real estate the opportunity, as we said earlier, we want to really start with the high-volume, high traffic malls and then expand out from there. Kind of the hub and spoke type of approach where we will start with the high-volume, high traffic malls, build the brand and then expand out from there.

In terms of the product, yes you are right. The line in there right now is skewed a little bit older. What we really see is the opportunity to not be in the tweens business. I want to make sure that is clear. We are really seeing the sweet spot more as the 6-8 year old. We’re not really trying to get into the tween business. As you heard me mention we are slightly above our plan on boy, slightly below in girl and we probably have skewed a little bit too old particularly on this line. You’ll see us actually skewing a little bit younger, a little sweeter and that is the opportunity that I spoke of earlier to expand the girl business.

Marni Shapiro – Retail Tracker

What is the thought behind that? To me 7-8 is tween. I guess what is the thought behind that and couldn’t you execute (audio breaks) a lot less competition for that 7-9 year old girl versus the 4-6 year old girl or even the 6-7 year old girl. Couldn’t you execute both within the box?

Matthew McCauley

We are actually. We actually have a much larger percent of those sales in the 7-9 and the larger sizes than we do in Gymboree so as you heard me say earlier we are really happy we are capturing that older customer. The key is we have to be very sensitive to the sweet spot on making sure we are wholesome, making sure we are sweet and that is really what resonates with our customers and allows us to capture the older customer as well as the younger customer. That is our core strength. Gymboree has about 3% of a $30+ billion market and so the opportunity for us to gather more market share at great price points that are age appropriate and wholesome fashion is just so much larger than what we have really tapped into.

Marni Shapiro – Retail Tracker

You said you are selling more sizes 7-9. Are you selling more of that size because the customer is that size or because she is that age? I have to ask that question because the demographic makeup might be different as well.

Matthew McCauley

I’m glad you asked that because we have been studying that ourselves and actually we have been able to assess from our customers the age we are actually hitting the sweet spot is that 6 and 7 and the sizes they are actually buying up a little bit.

Operator

There are no further questions at this time.

Matthew McCauley

No. Heather thank you very much for hosting the call. If anybody has any questions or follow-ups they can call us at (415) 278-7933. Thank you very much.

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Source: The Gymboree Corporation F1Q08 (Qtr End 05/03/08) Earnings Call Transcript
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