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Pier 1 Imports, Inc. (NYSE:PIR)

F2Q09 Earnings Call

September 18, 2008 11:00 am ET

Executives

[Nancy Benson] - Assistant Treasurer, Director of Investor Relations

Alexander W. Smith - President, Chief Executive Officer, Director

Charles H. Turner - Chief Financial Officer, Executive Vice President

Analysts

Michael Baker - Deutsche Bank Securities

Brian Nagel - UBS

Budd Bugatch - Raymond James

Neely Tamminga - Piper Jaffray

Colin McGranahan - Bernstein

Analyst for Matthew Fassler - Goldman Sachs

Crystal Kallik - D.A. Davidson & Co.

David Magee - SunTrust Robinson Humphrey

Operator

Welcome to the Pier 1 Imports quarterly conference call. (Operator Instructions) I would now like to introduce Nancy Benson, Assistant Treasurer and Director of Investor Relations for Pier 1 Imports.

Nancy Benson

Today we will hear from our President and Chief Executive, Alex Smith, and Executive Vice President and Chief Financial Officer, Cary Turner. The agenda for today’s call will be to hear opening remarks followed by a brief discussion of our second quarter results that were reported earlier today. We will provide an update on our business followed by a question and answer period.

Before we begin I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of Section 21(e) of the Securities Exchange Act of 1934 and can be identified by the use of words such as may, will, expect, anticipate, believe and other similar words and phrases. Our actual results and future financial conditions may differ materially from those expressed in any such forward-looking statements as the result of many factors that may be outside of our control. Please refer to our SEC filings including our annual report filed on Form 10K for a complete discussion of the major risks and uncertainties that may affect our business. The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update our forward-looking statements.

If you do not have a copy of this morning’s press release, you may obtain one on the Investor Relations page of our website located at www.pier1.com.

Now for an update on our business I would like to turn the call over to Alex.

Alexander W. Smith

Let me start by saying that our second quarter results were not what we had hoped, in part because of the challenging economic environment and in part because of our own errors. There is nothing we can do to affect the economy but we can impact the position of our execution and all parts of our business. And we are focused on that as we return our company to profitability and beyond.

Cary, take them through the numbers.

Charles H. Turner

Earlier today we reported a net loss of $0.34 per share for the second quarter compared to a loss of $0.49 per share for the year ago period. For the first six months we reported a net loss of $0.71 per share compared to $1.14 for this period last year.

Total sales for the second fiscal quarter declined to $320 million from $345 million in the year ago quarter primarily as a result of decreased store count as well as the elimination of ancillary businesses. Comp store sales for the quarter declined 1.7% and 3.9% for the year-to-date period. Comparable store sales during the quarter were impacted by increases in conversion rates and units per transaction as well as a reduction in average ticket. Comparable store sales were further negatively impacted by a reduction in marketing expenses in the second quarter of $4 million or 29% less than the same period last year.

As previously indicated, the company has repositioned the use of its marketing dollars to coincide with the critical holiday season. $2 million in marketing expense has been moved into the third quarter and $6 million has been added to December compared to last year. For the first six months marketing expenditures were $12 million or 35% less than last year.

Merchandise margins for the second quarter were 49.3% compared to 47.0% last year. Merchandise margins during the quarter were impacted by the semi-annual clearance that occurred in July as well as the deeper-than-anticipated markdowns on outdoor furniture and gardening accessories. The impact on margin was especially evident in markets experiencing greater economic difficulties such as Phoenix, Las Vegas, Florida and Atlanta. Excluding the categories of gardening accessories and outdoor furniture, our merchandise margins for the quarter would have been 100 basis points better and more in line with our expectations. On a comparable store basis merchandise margin dollars increased approximately 1% over last year.

Store occupancy costs in the quarter were $72 million compared to $75 million last year. Overall gross profit dollars were $86 million compared to approximately $87 million last year.

During the second quarter selling, general and administrative expenses were $107 million a decline of $10.4 million when compared to the year ago quarter. SG&A during the quarter included special charges of $5 million compared to $7.4 million in the second quarter last year. Special charges included the one-time costs related to the withdrawn offer to acquire Cost Plus of $1.7 million, lease termination charges of $2.4 million primarily related to the exit of distribution warehouse space, and $900,000 in severance and other charges. Excluding these charges, ongoing SG&A expenses declined $8 million from the year ago period. The primary decrease in costs were savings of approximately $4 million in marketing expense, $1 million in store payroll, and $3 million in other general costs.

During the quarter the company’s semi-annual sale was targeted at clearing seasonal and discontinued inventory. In addition, the company continued its efforts to receive merchandise closer to the actual need. As a result inventory at the end of the quarter was $379 million approximately $20 million below the previous projection. Inventory levels will build throughout the third quarter as the holiday season approaches and the company now expends to end the third quarter with inventory levels of $410 million, $20 million below last year. We anticipate continued reductions in inventory when compared on a year-over-year basis and now expect year-end inventory levels of $350 million to $360 million compared to $412 million last year.

In terms of liquidity, as of the end of the second quarter cash and cash equivalents were $191 million. At the beginning of the second quarter we completed the sale of our corporate headquarters and received net cash proceeds of approximately $102 million. Net cash provided by operating activities for the first six months was approximately $1 million versus the usage of approximately $53 million over the same period last year.

In addition, as of the end of the second quarter we had $104 million in outstanding letters of credit compared to $166 million last year. The usage of our line of credit has decreased significantly over last year as we have negotiated better terms with a large percentage of our merchandise vendors moving more of them to open account and therefore reducing our reliance on documentary letters of credit.

Year-to-date capital expenditures totaled approximately $7.2 million and were primarily spent on the existing stores and fixtures. Capital expenditures for the year are now expected to be in the range of $15 million to $17 million.

Currently our tax net operating loss carry forward is over $200 million. During the quarter we closed four Pier 1 Import stores. We ended the quarter with 1,112 Pier 1 Import stores with 1,030 stores in the US and 82 stores in Canada. Closings for the year are now expected to be approximately 20 stores.

Given the difficulties and uncertainties surrounding the macroeconomic environment we will not provide guidance for the remainder of this fiscal year and are withdrawing the previous guidance. We believe that the success of our turnaround will be best measured by two key metrics: Merchandise margin and operating profit.

Year-over-year comparisons of these metrics will provide better insight into our progress in this challenging retail environment. Results for the second half of the year will depend on maintaining current traffic levels. Assuming traffic levels similar to those seen in the second quarter, modest improvements over last year in the key metrics are expected throughout the second half of this year.

Now I’d like to turn it back over to Alex.

Alexander W. Smith

What we find most frustrating about our second quarter results is they should have been better. We started the quarter with a nice gross margin dollar improvement in June and July but had a disappointing August. As we told you in our release, there were two things we should have done better.

Firstly, we miscalculated the markdown cadence required to clear our outdoor furniture and garden accessories by the end of Labor Day weekend, which we needed to do so that the stores would be ready to receive our fall and harvest assortment. In the end we sold more than we had planned at 50% and 75% off and less at 25% and 30% off. Thus we took our medicine, cleaned house, and our merchandise margin percentage has rebounded well.

The second thing we did wrong was to have a flawed back-to-school strategy. The emphasis in our marketing and in our stores was primarily on lower ticket items to the detriment of our furniture business. Consequently we saw a bigger decrease in average ticket than planned. Frankly, we did a better job last year in terms of store setup and execution for back-to-school.

Having said all of that, we are now ready for the important fall and holiday selling seasons. For the balance of the year we will as always focus on our business priorities which we’ve talked about on previous occasions. These priorities speak to great merchandise, great stores and a cost-efficient and effective infrastructure. We are pleased with the look and feel of our holiday merchandise assortment which we know are stronger than last year.

We have returned to our historically successful market positioning, updated and reinterpreted for today’s customer. Our expanded and revitalized merchant team is growing more experienced and each season more and more of our products are on target and resonating with our customers. We are confident going forward that their selection decisions will continue to get closer to the bull’s-eye.

The units and repeat business driving departments such as gifts, jewelry and stationery which we introduced last fall continue to do well. We are expanding both of these areas as we move into this fall. Our tabletops which as you know has been disappointing is now trading well and showing sales and margin dollar improvement.

We have maintained our furniture business at around the magical 40% but as I previously mentioned we did not optimize our sales of that shelving and casual seating for back-to-school. We are however very pleased by the number of new furniture introductions that have made it to our best-seller reports over the last few weeks.

We will also continue to test new product areas that speak to the Pier 1 Imports customer. This holiday season you will see a selection of new categories. One example, kitchen tools and gadgets is a natural expansion of our storage and serving assortment.

Other retailers closing down has also created some new opportunities. One of them is nutcrackers. Pier 1 Imports has never had a nutcracker assortment and we expect them to be a good addition to our Christmas décor. Additionally, we are going to be offering customers a national brand for the first time as we introduce Yankee candles to our assortment.

Obviously in this environment inventory control gains an even bigger emphasis than in normal times and I am pleased to tell you that our inventory levels are slightly lower than we had originally planned. Of course it is very important to continue to balance inventory levels with the flow of new SKUs, and we will constantly re-evaluate and readjust to achieve and maintain this balance.

Going into the back half of this year we feel confident that we’ll be able to achieve the merchandise margin percentage we expect. We are also confident that we will be able to hold or improve our conversion rates as well as units per transaction.

What we cannot say with any certainty is what will happen to traffic. We believe that the improvement to traffic we saw in the second quarter is due to both effective marketing and word of mouth. The marketing decisions we have made will support traffic in the second half. We have a solid plan which includes retail mailers with larger circulations than last year, newspaper inserts also with greater circulations than last year, robust email and web advertising, credit card promotions as well as the reintroduction of television advertising. Our television advertising will begin mid-November and will carry through December 22. Our ads will air on cable and satellite channels; not on network television. The only celebrity they will feature is our merchandise.

Having said all of this, we are obviously concerned that all of the external negative influences on traffic may negate all the positive ones that we have created internally.

We’ve continued our dedication to making our company more efficient and cost efficient in every way. Our company is leaner and more efficient in every part of our business than it was 12 months ago. G&A and supply chain savings have provided direct improvements to our bottom line and are helping to protect initial markups in spite of cost pressures. Ongoing additional cost savings opportunities exist within our supply chain. These savings will primarily help us to continue to offset any increase in merchandise costs resulting from increased fuel costs and general inflationary pressures.

In terms of real estate, the downturn in the retail environment has provided opportunity for us and we have been able to negotiate with some of our landlords more favorable lease renewal rates. We will continue to review opportunities for us to enter new and growing markets while keeping a watchful eye on those locations where continuing to operate may not make financial sense.

Earlier this week we had around 60 stores that were closed and many more affected by Hurricane Ike. 10 stores remain closed today. Additionally, many of these markets remain without power. We have of course seen an immediate short-term impact on our September sales but we anticipate that most of the closed stores will be reopened within the next few weeks. And I’d just like to take a moment to send a word of appreciation to all of our employees affected by this storm and to offer a word of support as they work hard to restore our stores as well as their own lives to some sense of normality.

As we announced yesterday, my senior team continues to get stronger as we combine our premier talents with new talent. Michael Benkel has joined us as Senior Vice President of Planning & Allocations. He brings with him solid retail experience, most recently 11 years of experience with Pottery Barn.

In closing I want to reiterate that we are happy with our merchandise assortment, conversion rate and unit sales growth. Our costs are buttoned down. We have a strong balance sheet. Our profitability in the second half of the year is going to be a function of customer traffic between now and Christmas. We have a dedicated team and we are working smarter all the time. We know what great execution looks like and we are striving to achieve it. The economic headwinds have certainly slowed down our turnaround and may continue to do so, but they will not blow us off course and we have not changed our strategy: Great merchandise, great stores and a cost-efficient and effective infrastructure.

We are now happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Michael Baker - Deutsche Bank Securities.

Michael Baker - Deutsche Bank Securities

So you now have I’d say almost more than half your market cap is cash. I understand you have some debt but a lot of cash sitting there. Any plans or can you share with us what you might do with that? Second question, your accounts payable ratio looks better almost even with last year. How should we think about that going forward and how does that help the cash? And then my last question, the traffic you say if you’re able to maintain the level that you’re at now, I guess without quantifying it, does that imply that your sort of happy with where the traffic is now? Is that in line with where you would have expected it to be earlier in the year as you head into the fall season?

Charles H. Turner

I’ll take the first two Mike. On cash I think right now it probably would just be prudent, let’s get through the holiday season and it’s a subject matter for the Board to discuss. In terms of accounts payable, I mentioned to you that we have gotten better terms with our vendors and I think we’re continuing to work towards that and you’re going to continue to see an improvement there.

Alexander W. Smith

In terms of traffic, first of all we’re never happy with traffic. I mean it doesn’t matter how good it is, we’ll not be happy with it. But what we’re trying to say to you is if the traffic levels continue slightly around last year or slightly above, then we’ll feel pretty comfortable going through the balance of the year. So that’s really all we’re saying. In absolute numbers obviously the traffic will go up as we move into October and November.

Michael Baker - Deutsche Bank Securities

Sure. But on a year-over-year basis it sounds like it’s about where it was then in the second quarter, at or slightly above in that range?

Alexander W. Smith

No. What we’re saying is that’s what we needed to be.

Charles H. Turner

We told you we got hurt by the hurricanes.

Michael Baker - Deutsche Bank Securities

Right. But in the release when it says maintain at current level, I guess that refers to the second quarter, not necessarily early third quarter.

Charles H. Turner

Correct.

Alexander W. Smith

That’s a good way of putting it.

Operator

Our next question comes from Brian Nagel - UBS.

Brian Nagel - UBS

First off, with respect to the clearance activity and I know we discussed this a little bit after your pre-announcement, but any updated thoughts on the impact upon sales and gross margins in the quarter just from the clearance?

Alexander W. Smith

Not really, no. I think we took our hit, I think we said at the Goldman’s conference that it impacted our merchandise margin by about 1%, and that’s what it was.

Brian Nagel - UBS

Second question Alex on that same topic. With the benefit of hindsight, you laid out your prepared remarks on what you think happened, but what would you have done differently with respect to the clearance or is it just simply a function of a tougher macro environment?

Alexander W. Smith

No. I think what we would do if we did this again, we would do far more regional markdowns rather than doing national markdowns. We did actually do some regional markdowns but we came to that decision too late in the process. And what we’ve found now is that it’s not the easiest thing in the world for us to do, but we can take regional markdowns. And that’s what we would have done differently.

Charles H. Turner

Hindsight is always 20/20 but we probably would have sent more up to the Northeast where we know we had a sell-out.

Operator

Our next question comes from Budd Bugatch - Raymond James.

Budd Bugatch - Raymond James

We calculated inventory per square foot at about $43.67 at the end of the quarter, almost the same as it was at the first. Is that number right or wrong?

Charles H. Turner

About $43.23.

Budd Bugatch - Raymond James

I know you’ve talked about better terms with suppliers. How should we model accounts payable going forward either as a percentage of inventory or days, cost of sales, what’s kind of a good bogey to use?

Charles H. Turner

Let me follow up with you on that. We’re just starting to look at all that.

Budd Bugatch - Raymond James

Just lastly, quickly can you give us the number of store days closed by the hurricane or what you think it’s going to be in the quarter?

Charles H. Turner

We can probably adjust that for comps.

Nancy Benson

It’s a little over 240 total.

Budd Bugatch - Raymond James

240 store days?

Nancy Benson

Yes.

Operator

Our next question comes from Neely Tamminga - Piper Jaffray.

Neely Tamminga - Piper Jaffray

Following up a little bit, I just want to confirm. Mall traffic has fallen off about 400 basis points in August and September from the June and July trend. Is that on par with what you guys have experienced from an off-mall perspective?

Alexander W. Smith

No.

Neely Tamminga - Piper Jaffray

Is it not as big of a magnitude?

Alexander W. Smith

No. Our august traffic was okay actually.

Charles H. Turner

It’s closer to flattish.

Neely Tamminga - Piper Jaffray

So it’s September that’s really fallen off more? Is that the implication?

Charles H. Turner

It was more of a factor for the short-term impact from the hurricane more than anything else.

Neely Tamminga - Piper Jaffray

So ex-hurricane you would be seeing similar trends?

Alexander W. Smith

In truth, we’re only now in the beginning of the third week and the weather started to impact at the end of the first week Neely, so Friday, Saturday, Sunday, Monday, Tuesday, Wednesday. It was horrible. What I can tell you is it’s recovered a little bit every day. But we still have stores closed; there’s still a lot of people in this country who’ve got no electricity; etc.

Neely Tamminga - Piper Jaffray

Just a housekeeping question on this one for you Cary. It would seem to me most retailers have got four consecutive store days closed. Do you actually exclude that from comps? Is that similar to you guys? Obviously it’ll have a financial impact but from a reported comp perspective?

Charles H. Turner

For a reported space, unless the store’s closed more than three weeks we keep it in the comps.

Neely Tamminga - Piper Jaffray

You guys are doing an awesome job with these real estate guys out there and taking advantage of this and I think you’re unusual in your sector in doing so. Could you give us some guidance as to how we should be thinking about occupancy expense at the end of this year?

Charles H. Turner

I think you saw what the number was for the first quarter and saw what it was for the second quarter, and for the third and fourth I’d just bring it down a little bit.

Alexander W. Smith

Don’t forget Neely, when we’re renegotiating sometimes you’re actually bringing rental per square foot down. For the most part you’re stopping at going up.

Charles H. Turner

And that’s over the next five years as opposed to a short-term impact.

Neely Tamminga - Piper Jaffray

Alex, from your perspective in planning and allocation I don’t think I zoned out when you were talking about your new hire here but what more specifically hasn’t been done in the past that you now expect to be done with this hiring?

Alexander W. Smith

If you go back to when we really started on this turnaround and we had our second priority to have a best-in-class planning and allocation group, really that function has to work hand-in-hand with the buyers and bring a great quantitative judgment to their qualitative judgment. And it speaks to how much we buy, when we buy it, which DCs we put it in, what the inventory levels in store are like, how much we’re bought out at any one time, I could go on and on. Although we’ve made some improvement, we haven’t done that to the level of sophistication that we need.

Neely Tamminga - Piper Jaffray

A change like this, are we talking 10s and 20s of basis points to margin or is this 100s and 200s?

Alexander W. Smith

Michael’s in the room with us now. I’m just going to look at him and ask him how many basis points [inaudible] merchandise margins. He’s going paler by the second. It all goes into the mix. When we think about going forward and we want to over time improve our inventory turns, have less merchandise in the DC, get back to those historically high merchandise margins in the mid-50s. It all speaks to that.

Operator

Our next question comes from Colin McGranahan - Bernstein.

Colin McGranahan - Bernstein

I want to focus on merchandise margins. I know you’re not giving official guidance but you did say that was a key metric. As I think about last year the merchandise margins in the third quarter were quite strong excluding the clearance from the Pier 1 Kids clothes. I think it was up in the 40% or 54%?

Alexander W. Smith

It was very strong in the third quarter last year?

Colin McGranahan - Bernstein

But then in the fourth quarter last year, I think post-Christmas you had a little bit more clearance activity than planned, and you said modestly up if traffic - the big if - if traffic is consistent. Should we expect margins to be kind of against a very tough, very successful third quarter to be down but then a nice improvement as we think about better execution in the fourth quarter and what does modestly up mean, because I would think there’d be more opportunity? It sounds like you’re more comfortable with the product on the merchandise margin line.

Alexander W. Smith

I think your thought on the opportunities percentage-wise in the third quarter are not nearly as great as the percentage improvement that we would hope to get in the fourth quarter. Because you’re right, we had a ton too much clearance last year.

Charles H. Turner

I would also say, and we’ve said this before, that it’s clearly predicated on the sales.

Colin McGranahan - Bernstein

In terms of mix is there anything we should be thinking about in mix this year relative to last year that would move that merchandise margin in either direction?

Alexander W. Smith

No. As we’ve said on many of these occasions, and I just want to reiterate, our business model works well when we have the same input margins in pretty much every department that we have and the spread between our achieved margins in terms of furniture and shelf goods, while there is some it’s not very significant. And we’re working all the time to sort of close that delta so that basically we achieve pretty much the same merchandise margin rates on all our categories.

Operator

Our next question comes from Analyst for Matthew Fassler - Goldman Sachs.

Analyst for Matthew Fassler - Goldman Sachs

To start with, your comments on marketing spend. I want to make sure that I understand the numbers that you called out that you spoke to, the $2 million shift into Q3 and the $6 million shift into Q4. Should I interpret those as year-over-year numbers?

Charles H. Turner

Yes, that’s what I said.

Analyst for Matthew Fassler - Goldman Sachs

Has something changed at all in the way that you’re thinking about marketing relative to sales? I mean as you look at today’s or 2Q’s results you ended up with marketing spend being a 3%-ish of sales kind of number below your annual rate. And it looks like the third quarter we end up something above 5% and the fourth quarter closer to the targeted annual rate. Whereas before you had kind of talked to having a consistent quarterly level of marketing spend?

Alexander W. Smith

I don’t think we ever talked about having a consistent quarterly level. We in fact had a consistent quarterly level so we were spending effectively the same dollars quarter-by-quarter for different sales numbers. So what we’ve done this year is frankly what we should have done last year but didn’t, which is to back end your marketing spend so it’s supporting the time when people have their highest propensity to spend. So what we’ve done this year is pretty good in my book.

Analyst for Matthew Fassler - Goldman Sachs

Sure. I actually meant the marketing spend relative to sales as stable through the quarters. But I understand that. I just wanted to clarify that nothing had changed there in the thought process.

In terms of inventory levels, you guys are coming in well below your plan for the quarter. How should we think about that in terms of how that might play into your expectations for sales for the rest of the year?

Charles H. Turner

I think it’s playing in as we expected. I think the best thing is we cleared out the merchandise we need to and the merchandise for the holiday is coming. And as I said by the end of the third quarter it’ll decline but it’ll be about $20 million less than last year. So the inventory will be more efficient and then at the end of the year we’ll be some $50 million below last year.

Alexander W. Smith

Don’t forget that one of the things that we’ve talked about a lot is how this company used to buy a very, very large number of months of supply on the initial orders and that resulted in extremely high DC inventories and if we didn’t get a home run, very high markdowns as well. What we’ve done is make smaller buys as we’ve moved through the last year or so. And that effectively reduces DC inventory and allows us to buy more frequently and to follow our winners. If you look at our store inventories, our store inventories are up from last year. The savings all come out of the DC.

Analyst for Matthew Fassler - Goldman Sachs

One last question on the merchandise margins, you attributed 100 bits to the cadence of markdowns in the outdoor and garden category. You fell short to the first quarter which you had initially said you expected to keep pace with by about 200 basis points. Could you help us with where the other 100 bits of shortfall relative to Q1 came from?

Alexander W. Smith

Not really.

Charles H. Turner

It’s really through all the other categories. Just need to take more markdowns than we had first anticipated. But it was really across the board.

Analyst for Matthew Fassler - Goldman Sachs

In other words, the same may be being a bit slow to begin the markdown process?

Alexander W. Smith

No. Please don’t read into things that we’re not saying. What we tried to give you is to just try and let you see the broad brush of what happened. And the broad brush of what happened is we screwed up on the markdown cadence on garden accessories and outdoor furniture. If you strip those out and look at the other sort of 38 departments that we have, you get the usual spread that you’d expect to see. Some had fantastic gross margins for the quarter. Some had okay gross margins for the quarter. Some had not so good. So it was pretty much the typical curve.

Charles H. Turner

And as we said earlier, the thing we’re most pleased about is the fact that our [I&U] is holding up.

Operator

Our next question comes from Crystal Kallik - D.A. Davidson & Co.

Crystal Kallik - D.A. Davidson & Co.

As you look at the distribution center warehouse, and you’re obviously very closely monitoring your inventory levels and I think with the new planning and allocation hire, is there opportunity for you to lower the warehouse space that you have allocated at this point or are you where you need to be?

Charles H. Turner

Crystal, I think that’s a longer-term view. We were able to get out of all the excess space. If you go back to where we were last august, we’ve probably gotten rid of some million square feet. And we’re down to about 4 million square feet and we’re going to continue to analyze that. Because the key to us I think is to ensure that more and more of the costs that we spend on the supply chain are variable in nature.

Crystal Kallik - D.A. Davidson & Co.

Cary, are you still feeling comfortable with $160 million savings this year?

Charles H. Turner

Yes.

Crystal Kallik - D.A. Davidson & Co.

I just want to verify, for the Yankee Candle when do we expect that in-store? And then you had talked about margins remaining pretty stable across all categories but I’m assuming that probably doesn’t include a branded product, or could you walk us through the thought process and any implications Yankee Candle would have to the merchandise margins?

Alexander W. Smith

As I was driving in this morning, I thought, who’s going to ask me the question about the margins on branded merchandise? So congratulations on that. You’re absolutely right. The input margin on Yankee Candle will not be as great as the input margin on our own candles. We have to see this as incremental business. Clearly if all it does is move sales from our proprietary candles to a branded candle, that has not achieved anything for us. So we’ll be watching that really carefully.

Charles H. Turner

And also remember, that’s just a small amount of our total inventory.

Crystal Kallik - D.A. Davidson & Co.

So it’s supplementing the existing? It’s not replacing it? And you’re essentially testing it to see how large the business can become?

Alexander W. Smith

Yes. Yankee Candle has an incredible franchise on their fill products and our business is based on pillar candles, and the price points on Yankee Candle are higher than on our core programs. So it’s a good best-of-best strategy. You can sort of put the Yankee Candle as the best. So it’s a higher price point and it is a different product.

Charles H. Turner

And it is only 1% of the inventory.

Crystal Kallik - D.A. Davidson & Co.

And finally Cary, I just want to verify. Now that the headquarters transaction has been completed, in Q3 I think we had talked about this before where you’re looking for higher interest income, lower depreciation and then the higher rent offsetting the lower G&A. Is that about correct for the formula?

Charles H. Turner

It’s really all in the second quarter as well.

Alexander W. Smith

I think we’ve got just time for one more question.

Operator

Our next question comes from David Magee - SunTrust Robinson Humphrey.

David Magee - SunTrust Robinson Humphrey

As you think about next year and the prospects for having perhaps more of an inflationary environment overseas with the sourcing, would that be a plus or a minus for your margin visibility if you’re able to source perhaps a little more efficiently from China?

Alexander W. Smith

Are you asking whether our margins will go up or I wasn’t quite sure what you’re getting at?

David Magee - SunTrust Robinson Humphrey

Yes. The last couple of years there have been hyper-inflation over in China and it seems like that’s slowing down now. I’m just curious whether that’s something that you could see as a benefit or a risk to your margin visibility next year?

Alexander W. Smith

A couple of things. Firstly, the inflationary pressures out of you mentioned China specifically have really not hit us until in terms of our FOB prices until really the last few months and particularly for merchandise that we’re going to take delivery of next year. As we talked about earlier, a couple of things we won’t compromise on. One of them is our initial mark-on and another is the quality of our products. So what our merchants have to do is they have to work smart with our vendors and they have to come up with products that speak to our customers and get the appropriate retail. Now the good news for us is because pretty much everything we do is proprietary, there is some elasticity in our pricing. Where we have to take price from the vendor, we will be passing that price through.

David Magee - SunTrust Robinson Humphrey

But it would make it a lot easier for you would it not if the pricing were to ease overseas?

Alexander W. Smith

Sure. But frankly we haven’t seen any sign of that yet.

David Magee - SunTrust Robinson Humphrey

I was wondering to what extent consolidation may be impacting your business in a positive way this year as well as, it seems like there’s a lot of pain in your category, probably a lot of smaller players going by the wayside. Are you seeing anything of note that would be helping your business this year?

Alexander W. Smith

There are so many variables and so many things that impact our business day-to-day, it’s kind of hard to separate out any one factor. What I can tell you and I referred to it in the prepared remarks this morning, we did see an opportunity where one of our competitors went out of business and they’d been very strong in a particular merchandise category. So we went to their principal vendors and bought merchandise and hence the whole nutcracker story. We do look for those and to some extent the opportunity to put Yankee Candle into our stores is a function of a reduction of their doors with some of their other customers. So there absolutely is an impact. In terms of just customer flow, it’s really hard to measure it frankly.

Operator

And there are no further questions at this time.

Alexander W. Smith

I think we’re finished for today. Thank you very much one and all. We’ll talk to you in a few months.

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Source: Pier 1 Imports, Inc. F2Q09 (Qtr End 08/30/08) Earnings Call Transcript
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