Children's Place Inc (PLCE) 2008 Q3 法說會逐字稿

Good day,everyone and welcome to The Children's Place third- quarter conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to answer questions during the question-and-answer session. (OPERATOR INSTRUCTIONS) It is now my pleasure to turn the program over to Ms. Jane Singer. Go ahead, ma'am.

Thank you, Austin.

Good morning, everyone, and thank you for joining us today for a review of The Children's Place Retail Stores, Inc third-quarter and year-to-date financial results.

Participating on this mornings call are Chuck Crovitz, Interim Chief Executive Officer and Sue Riley, Executive Vice President, Finance and Administration. Also, on hand to answer questions at the end of managements remarks are Richard Flaks, Senior Vice President, Planning Allocation and Information Technology, and Dina Sweeney, Group Vice President of Merchandising.

Before we begin, I would like to remind participants that any forward-looking remarks made today are subject to the Safe Harbor Statement found in this morning's press release, as well as in our SEC filings. And now, I will turn the call over to Chuck for his opening remarks.

Thank you, Jane. Good morning, everyone. Thank you for joining us today.

Earlier this morning, we reported our third-quarter 2008 financial results. We delivered positive top line and bottom line growth for the quarter, in spite of reduced shopper traffic in a more challenging macroeconomic environment. This speaks to the strength and resilience of The Children's Place brand.

To briefly review the highlights of our financial performance during the quarter, net sales increased by 5%. Comparable store sales increased by 2%. ECommerce sales increased by 40%, and excluding unusual and one-time items, income from continuing operations increased 28% to 24.9 million or $0.84 a share during the third quarter of 2008.

This compares to 19.4 million, or $0.66 a share in the third quarter of last year. During previous conference calls, I have talked to you about four significant actions that we undertook during the past year. In order to strengthen our business and ensure the long-term success of The Children's Place.

Looking back, I can tell you that we are very glad that we took those actions when we did because they have significantly contributed to the solid results that we are reporting today.

Our first action was reducing inventory levels, which we believe were too high during 2007. At the time of our decision last year, we were able to partially impact the summer 2008 buy and fully impact the back-to-school and holiday buys.

With lower inventories, we were able to better manage our markdown levels, significantly improve our gross margins, enhance the shopability of our stores and at the same time, deliver modest increase in comp sales.

Second, we identified a number of opportunities to reduce our cost structure. We implemented a work force reduction in our shared services department. We have also instituted a disciplined focus on expense and cost management that is becoming an integral part of our culture in order to get our cost structure to a level that is consistent with that of a value-oriented retailer.

Third, we have focused on strengthening our balance sheet and cash flow by reducing the number of new store openings and delaying capital spending. We finalized an $85 million term loan at the end of the second quarter of 2008 to ensure the Company would have adequate liquidity in the event the economy continued to worsen, which, of course, it has.

With many retailers struggling to fund their businesses, I am pleased to report that our balance sheet to date is strong and healthy. And fourth, as part of a broader review of strategic alternatives undertaken by the Board, we have decided to exit the Disney Store North American business and focus all of our efforts on The Children's Place brand.

In this economy, we're pleased to be focusing exclusively on the value price driven apparel market.

I would like to spend a few minutes talking about some of the broad trends that we are seeing in this market this year. Based on NPD data, fiscal year to date through August of 2008, the unit sales of children's apparel has increased 3%, more than double the growth rate of the adult apparel market.

We believe this indicates that many parents are choosing to buy clothing for their children instead of themselves this year. Not surprisingly, NPD also reports that the average unit retail sales price for children's apparel has declined 4% year to date.

AUR across all income levels, including among those households making more than $100,000 per year, which confirms that on average, all consumers, even those, the most affluent consumers, have begun trading down and looking for greater value in purchasing their children's clothing.

The Children's Place is uniquely well positioned for this current climate. Our high quality, trend-right fashion and value pricing have always appealed to a broad spectrum of parents, from low to high income and across racial and cultural groups.

In the current macroeconomic environment, all consumers are looking for greater value and we believe The Children's Place provides an ideal solution.

Fiscal year to date, The Children's Place market share on a dollar basis as measured by NPD has expanded 40 basis points to 3.9% of all children's apparel sold in the United States. Our market share among households with incomes above 50,000 has increased 70 basis points to 4.8%.

We believe this share gain is the result of some higher income consumers choosing the better value offered by our brand. We also believe our improved merchandising assortment and enhanced marketing efforts have added to our success for the fall season.

Here are a few examples of the marketing enhancements.

We moved the timing of our back-to-school mailing to coincide more closely with the peak shopping weeks in the third quarter, as we know that consumers are shopping closer to need this year.

We also expanded our direct mail events for the back-to-school and holiday to target infrequent and non-shoppers of The Children's Place. Initial results from our August mailing indicate that new and infrequent customers, who redeem specially coded coupons tended to spend more transaction than current customers. Finally, we redesigned our eCommerce site.

The new site is faster and easier to shop. It also has a stronger focus on outfitting and highlights two-for- pricing and other promotions to ensure that online customers are able to take full advantage of the same great values we offer in store.

Since launching the redesign site in September, online orders have been strong and we expect the site will continue to draw significant traffic throughout the holiday season.

In summary, we're gratified that management's actions taken earlier this year have helped to improve the overall health of our business and we're pleased with our sales and earnings growth during the quarter.

But this year is far from over and we're facing a very sobering macroeconomic environment this holiday season. One of the worst we have ever seen. As well as, significant volatility in both shopping traffic and sales.

As a result, there's a great deal of uncertainty going forward, which causes us to remain conscious and conservative in our approach to both the fourth quarter and 2009.

Our entire team is now focused on maximizing our performance during the important holiday season in order to satisfy our customers and deliver the strongest possible results.

In addition to our strong merchandising assortment and sharp value pricing, our store associates will be focused on providing the same great customer experience this holiday season for which The Children's Place has always been known.

We expect shoppers to be making fewer trips to the mall and we want to ensure that each of their visits is as pleasant and productive as possible. We believe, we are well poised to handle the record high order volumes we are expecting through our eCommerce site during the holiday.

Our holiday one line resonated well with consumers and we are cautiously optimistic that we'll get similar response to our holiday two line, which set this week.

And finally, we expect the competition will be as intense as many retailers use deep promotions to entice customers into their stores to move excess inventory.

As we have all year, we are planning fewer markdowns this quarter than last year. Yet we still have very exciting promotions planned for Black Friday, which begins before Thanksgiving and will continue throughout the weekend.

In addition, our teams will remain vigilant and prepared and react nimbly to the changing business conditions over the weeks and months ahead.

As you well know, the current retail environment is one of the worst we have ever seen. Looking forward to 2009, we will continue to conservatively manage our business and carefully navigate through this difficult retail environment.

Longer term, we are fully committed to restoring the Company to its historic levels of profitability, as the economy returns to a more stable footing.

With that, let me turn the call over to Sue, who will review the financials.

Thank you, Chuck, and good morning, everyone. Most of my discussions today will focus on continuing operations, which is The Children's Place business only.

As previously disclosed, we have classified the Disney Store business as continued operations in accordance with generally accepted accounting principles, given our decision to exit that business.

Net sales from The Children's Place business for the third quarter ended November 1, 2008 increased 5% to $450.6 million from $430.6 million last year. Contributing factors to the sales growth were comparable store sales, which increased 2% on top of a 1% increase last year. ECommerce sales, which grew more than 40% for the quarter, and growth in our store base. At the end of the third quarter 2008, our store count was 920 compared to 907 stores at the end of the third quarter last year.

During the quarter, sales were negatively impacted by the decline in the Canadian exchange rate relative to the US dollar. The currency swing negatively impacted our top line sales by approximately $3.6 million compared to the third quarter of 2007.

Our 2% comp, increase in comp sales for the quarter was the result of a 4% decline in store transactions, consistent with the 3.4% decline in mall traffic, offset by a 6% increase in average transaction size. Units per transaction decreased in the mid-single digits. This was offset by a low double-digit increase in average unit retail, as a result of our lower markdown rate.

Our strongest regions were metro New York, northeast, Mid-Atlantic, New Jersey, Pennsylvania and the Southwest. The west was the weakest region. Gross profit dollars increased 14% to $196.4 million. Gross margin increased 360 basis points to 43.6% from 40% in the third quarter of fiscal 2007. The increase is the result of fewer markdowns.

Partially offsetting the impact -- partially offset, excuse me, by the impact of the lower Canadian exchange rate, a lower initial markup, and slight deleverage of our occupancy expense during the quarter. SG&A as a percentage of sales was 28.1% in the quarter, representing 230 basis points of leverage.

I want to point out several one-time items that impacted our results during the third quarters of 2008 and 2007.

This year, we realized income for transition services, which we provided to Disney, as we finalized our exit from the business and we had a modest benefit from the recovery of some -- of some accrued legal expenses.

Last year, we incurred a large severance charge, professional and legal fees related to the Company's stock option investigation and related restatements, stock option tooling expense and fees for the review of strategic alternatives.

Excluding those items, which we deem to be unusual or one-time in nature from both periods, SG&A as a percentage of sales for the third quarter of 2008 was 29.4%, representing approximately 60 basis points of deleverage due to higher accruals from management bonuses and an increased charge for equity awards in the third quarter of 2008 resulting from the Company's significantly improved performance this year versus last year, which accounted for approximately 90 basis points of deleverage.

A translation adjustment for the Canadian dollar, which accounted for approximately 60 basis points of deleverage, and the timing of marketing expenses, which accounted for approximately 20 basis points of deleverage, as we shifted the bulk of our Mag log mailing from the second to the third quarter to be more closely aligned with our peak full price back-to-school selling period.

We were able to offset much, but not all of the impact of these items through better management of store expenses, as well as, administrative expense reductions, which represented 120 basis points of leverage in the third quarter of 2008 compared to last year.

Moving down the P&L, depreciation and amortization expense as a percentage of sales was 4%, comparable to last year. We had a store impairment charge of approximately $1 million this year compared to $900,000 last year. Income from continuing operations before interest and tax increased 118% to $50.9 million compared to $23.3 million in the third quarter of last year.

Net interest expense was $1.9 million this quarter compared to 800,000 in 2007, as a result of the term loan which we closed just prior to the end of the second quarter of 2008. Our effective tax rate for the quarter was 42%.

Income from continuing operations net of tax increased 91% to 28.4 million, or $0.96 per diluted share compared to 14.9 million, or $0.51 per diluted share in the third quarter of last year. Our diluted share count for the quarter was 29.7 million.

Excluding the one-time items from both periods, third quarter adjusted income from continuing operations net of tax increased 28% to $24.9 million, or $0.84 per share compared to $19.4 million, or $0.66 per share in the prior year quarter.

Foreign exchange negatively impacted our third quarter 2008 earnings per share by approximately $0.05. GAAP net income for the third quarter, including the impact of discontinued operations was $24.1 million, or $0.81 per share compared to $12.3 million, or $0.42 per share last year.

Moving on to the balance sheet, our quarter ending cash balance was $186 million compared to $108.3 million last year. We have $85 million of borrowings from our term loan this year compared to borrowings of 108.9 million on our credit facility last year.

Our net cash position for the quarter reflects the funds received from the term loans, as well as our strong business performance. The Company continues to have some cash costs associated with the Disney Store exit, which we expect to come in at the low end of the estimated range.

Net-net at the end of the third quarter of 2008, we improved our cash position by $100 million net of debt versus 2007. Total inventory at cost at the end of the quarter was down 12%, or 14% per square foot, due to lower inventory on hand and lower inventory in transit than last year. Carry-over inventory was 3.1% of total inventory versus 2.8% last year. We expect to end the year with inventory per square foot down in the low single digits.

Inventory levels at year end are expected to be impacted by higher in-transit inventory, as the earlier Chinese New Year in 2009 will result in early shipment of a portion of our Summer goods, coupled with additional inventory investment to support our eCommerce growth.

During the third quarter, we opened 19 stores and closed one. Year to date, we have opened 22 stores and closed six. As of November 1, 2008, we operated a total of 920 stores, with a total of approximately 4.4 million square feet.

Planned fourth quarter opening of four to five stores will be offset by some planned closings, so we expect to end the year with approximately 920 stores.

In summary, The Children's Place is ending the third quarter on solid footing as a result of our sales growth, lower levels of inventory, and cost containment efforts throughout 2008.

While we remain cautious about the fourth quarter given the highly volatile retail environment, we are pleased with the progress we have made in strengthening of positioning our Company for the current environment and for the long-term. Thanks. And now I'll turn the call back over to Chuck.

Thanks, Sue. To wrap up, we are encouraged by our performance for the fiscal year to date, but remain cautious due to the current economic environment. Thanks. With that, operator, we would like to open it up for questions.

(OPERATOR INSTRUCTIONS) We will take our first question John [Salitas] with Buckingham Research. Please go ahead, sir.

Hi, good morning.

Good morning.

Good morning, John.

Question, two questions. The first one, you laid out at the beginning of the call the four strategic actions that you embarked upon at the beginning of the year and certainly in retrospect or in hindsight, those appear to have been very prudent decisions.

Was wondering, is there a part two to this strategic approach to running the business? In other words, now that we've accomplished a number of the things that you laid out at that time, what is the -- what's the next step to improving profitability of the business and really streamlining things going forward? Thanks.

You know, I think that we're going to continue with these strategies that we have laid out because I don't think we've finished with them.

Certainly, the inventory levels, we're going to have to keep pressure on in this economic environment. And I think that, in terms of the cost structure, we've begun that and we definitely instilled in the culture but we have to continue to drive these costs out of the Company and we are going to continue to support the business through growth in our stores and our eCom growth.

So I do think that the strategies that we've laid out are going to continue here for the foreseeable future. You know, as we begin to recover out of this economy.

Okay, thanks. And my second question, thank you for sharing that data on the kids business with the unit sales up 3%, average unit retail down 4%.

Can you remind us of the demographic data that may be supporting increases in unit sales for children? I believe in the past, the Company had shared some demographic data. Is there any update on what's going on with the number of kids out there and so on?

Yes, in terms of the demographics, they are very favorable for our business. I think we're now in a new baby boom, which we've had a number of births this last year, actually exceeded the number of births in the '50s. And we see just dramatic growth in the children's population that are in our core markets.

So from a demographic standpoint, I think we're doing quite well. We also see -- faster growth of minority populations in the the economy and we've performed very well with those groups as well. So from a demographic standpoint, I think things are moving towards us.

Okay, great. Thanks a lot, and best of luck for the remainder of the year.

Thank you, John.

Thanks, John.

We will take our next question from Kimberly Greenberger with CitiGroup. Go ahead, ma'am.

Great, thank you. Good morning, and congratulations on a nice quarter.

Thank you, Kimberly.

I'm wondering, I know you're not providing any guidance today for fourth quarter, but just for planning purposes, can we assume SG&A dollars in the fourth quarter would be similar to the SG&A dollars during the third quarter, or are you looking at them to be up slightly?

About similar, Kimberly. Take out the one-time items because the Disney transitional income is winding down.

Right. So if I use the base in the third quarter of 133.6 million in SG&A, is that the right base to use?

Yes.

Okay, and you've got a nice build of cash on your balance sheet. I noticed, obviously, for the last couple of quarters, you've had the -- a piece of that term loan in short-term debt, the $30 million. When are you anticipating paying that down?

That's correct, Kimberly. The $30 million is characterized as short-term debt and the reason for that is because as part of the term loan agreement. We're required to pay down a portion of our end closing cash balance. And so we expect at this point in time that we'll pay down 30 million as we exit this fiscal year and then the same provisions would apply to the end of fiscal 2009.

Okay, and the end of '09, would -- is it the same dollar amount, another $30 million next year, or does it depend on your ending '09 cash balance?

Depends on the ending '09 cash balance but I would say for planning purposes, order of magnitude, I would use that amount, roughly 30 million.

So I guess any other uses for that cash on your balance sheet other than the sort of gradual paydown of that debt?

At this point in time, I think we just want to hold tight with the cash on the balance sheet and weather the next few quarters and then make some decisions as to whether or not we, you know, what we want to do with it.

Okay, and then, sorry, one last question on the balance sheet. Sue, there's a $104 million other current asset. Could you just talk about the composition there and if there's an opportunity to turn any of that into cash any time soon?

Not, not really, I would say at this point. Other current assets are -- just give me a second. I would say that, you know, basically as you look at the balance sheet, I would make the assumption that we can turn the inventory -- inventory will result in cash. We'll of course reinvest back in inventory. The other current assets, I would expect to continue to be in the range of about 100 or so million dollars through 2009.

Okay, terrific. Thanks so much and good luck here for holiday.

We will take our next question from Betty Chen with Wedbush Morgan. Go ahead, ma'am.

Thank you. Good morning, everyone, and congratulations on a great quarter.

Thank you.

Sue, I know you mentioned earlier, if I got the numbers right, looked like the carry-over inventory was a little high at the end of the third quarter, at least higher than last year. Could you speak to that a little bit, please.

It's a little bit higher -- Richard, did you want to answer that?

Yes, it's up 0.3, to 3.1% versus 2.8%. Part of the function of that is that total inventory is lower. So actually on a dollar basis, there's less carry-over inventory.

We feel really comfortable with having 3% of our inventory in prior season, not current season goods. So anything under 5% is a comfortable pace for us and we have no concern that we can clear that inventory out during this holiday time period.

Betty, may I also just add to that, that last year, recall, we had a bad fall season and so we were marking down just to basically get rid of merchandise.

So the disparity in the two numbers is more a function of us having been a little bit lower last year. If you go back to 2006, we're right in line. And as Richard said, we're very comfortable that we can liquidate that inventory.

Okay, that's terrific. And then when we think about merchandise plans for the first half, I know you mention that there will be some timing differences because of the Chinese New Year. But currently, as we stand and as we think about the buy for first half, are we planning them to be down so far year-over-year or kind of what are the thoughts there?

So we really don't give inventory guidance specifically out beyond one quarter, but directionally, we are continuing to plan the inventory conservatively next year to support a conservative sales growth.

The only area that we are investing a little bit more aggressively in is eCommerce because we do see some upside growth from an eCommerce perspective.

So pretty much directionally, we're expecting inventory to be anywhere between flattish to down a little bit, but not -- so we're going to remain conservative.

Okay. That's terrific. And on that front, are we seeing any sort of product cost pressure? It seems like that's now dissipating. So are we able to see some favorable terms for product costs next year?

Yes, I think that this is probably more of a complicated story here. The sourcing is definitely one of our core competencies and we did note earlier calls that the IMU would be down slightly this year. Although, so far, we thought we would be able to sort of largely mitigate the pressures we have in Asia.

And this has proven true. Although, the IMU has sort of gone up and down as we've gone through the different quarters. During the first half of the year, we really benefited from a mix standpoint. Particularly, because we have less denim and that helped the IMU.

But in the second half, we are experiencing a bit more of the IMU pressure due to the lower Canadian exchange rate primarily and the mix because we're tending to get into more basics. And as I mentioned, more trading down that we're seeing from the consumer side.

We also are continuing to see cost increases as a result of commodity and fuel prices compared to earlier this year. Now, we are starting to see some moderation of those commodities but they are still not down below a level that they were a year ago.

So we've got kind of a balance of kind of favorable and unfavorable factors but I think, the net of it is that we'll probably mitigate most, but not all of these cost pressures in overseas sourcing. The favorable factors are that we've got lower retail demand globally and these, as I mentioned, these recent reduction in oil and commodity price, lower, but not lower than a year ago.

Unfavorably, we have negative exchange rates in Canada. We have less supply, as many of the factories, particularly those in southern China, have closed or suspended their operations. We have some higher labor costs in China due to new labor laws. We have some higher costs of environmental initiatives and higher cost of capital financing for some of these factories.

So, again, net-net, I think we're going to be able to offset much, though not all of the cost pressures going forward.

And, Chuck, I know that we've been trying to diversify sourcing away from China, which I think at one point was close to 50% of the merchandise buy. What is kind of the update there and the progress?

We're continuing to do that. China's down a little bit lower than that now and we're continuing to look at some of these other economies, particularly Bangladesh and India and in Africa and exploring some of the other southeastern Asian economies as well. But definitely, China is starting to come down and these other -- we're focusing more on other economies.

And then lastly, if I could, Sue. When we think about the fourth quarter and maybe some of the one-time items so far this year, should we still expect a potential gain for the Disney Store services and also store impairment charge. As well as, how should we think about the Canadian dollar impact?

Okay. Basically we -- generally we don't forecast -- I'll take the last part of your question first. We generally don't forecast exchange rates, so internally we're planning for the Canadian dollar to be about where it is now. So I would expect roughly the same, roughly the same impact. Although, some of that will depend on how -- the Canadian balance sheet and how that gets translated back.

But I think you should prepare for roughly the same Canadian dollar as what we're seeing now. With regard to -- I'm sorry, I just drew a blank. What was your second question?

In terms of store impairment and Disney Stores?

Impairment charges we evaluate quarterly. We'll basically look at the profitability of each store in our fleet at the end of the quarter and make a decision as to whether or not we need to take any impairment charges.

We generally don't provide guidance on impairments because it will really depend on how each store does at this important quarter.

And then what about any gains for the Disney Store?

That's winding down, so we're just about out of that. You're likely to see a very small net profit, but it will be diminimus.

Terrific. Well, best of luck for the holidays.

Thank you.

Thank you. We will take our next question from Brian Tunick with JPMorgan. Go ahead, sir.

Hi, thanks. One for Chuck and then one for sue. I guess, first for Chuck. Just curious, how you think about your value message. Whether that's in stores or in marketing and your tier pricing strategy.

How does that flex, I guess when everyone in the mall is screaming value at the customer. And then for Sue, maybe just talk on the SG&A side, Maybe when we think about the buckets of opportunities for 2009 and beyond, besides corporate overhead, is there also store payroll, marketing, processes, things like that, that we can look for more SG&A to come out of the model? Thanks very much.

Yeah, no, I think in terms of our value messaging, I mean we -- first of all, we have very low prices, very good value prices relative to most of our mall competitors and I think our customers recognize that.

And as I mentioned, we are running aggressive promotions and Black Friday, will continue to take markdowns. We just won't have to take nearly the level that we did last year, but I think given our overall price level being so much more favorable than most of our competition and coupled with the strong promotions that we're planning through the holiday season, I think we're going to be fine.

And then on SG&A, Brian, I would expect you're going to see a continuation. It's going to be more of the same because bear in mind, you didn't get the full year impact this year of some of the actions that we had taken.

And then you asked specifically about marketing and our marketing, just constantly honing in on the marketing spend to get sharper and sharper. An example of that is what was done in the second quarter, where they didn't drop the bulk of the Mag logs and at the time when a large percentage of the store was on sale.

So we're really just trying to focus that marketing in on when we have the most full price merchandise available in the store and that's resulting from some leverage of marketing this year and again next year.

And if I could just ask one more, have you said what the total liabilities could be for the bankrupt estate of Hoop.

We haven't stated -- the liabilities are stated on the balance sheet. So you can see them and they are still carried on the balance sheet.

But we have said that we expect the cash costs to The Children's Place of exiting that business to be approximately $50 million. We're -- basically that number has not changed. Most of that has been paid out but there is a small amount that we expect to be paid out between now and the final liquidation of the estate.

Okay, terrific. Good luck.

Thanks.

Thank you.

We'll take our next question from Linda Tsai with Mkm Partners. Go ahead, ma'am. It appears she dropped off the line, unfortunately. We'll take our next question from Janet Kloppenburg with JJK Research. Go ahead. I'm sorry. Go ahead.

Hi, it's Janet.

Hi, Janet.

Hi, congratulations. Nice quarter.

Thank you.

Sue and Chuck, I was just wondering if we should expect the, the impact from the Canadian currency to continue to be a detriment to the earnings results at the same level for the fourth quarter and what's the outlook for the first half of '09 as well?

Well, I would -- I would say that right now I'm not an economist, as you well know. But I think -- I'm not reading anything that says that the Canadian dollar is going to strengthen markedly, as, again, as you know, it's a currency that's dependent -- seems to fluctuate depending on oil pricing.

Right.

But at this point in time, we are planning for the Canadian dollar to remain pretty much as it is for the fourth quarter and for the first half of next year.

Okay. So we should factor that into our estimates and that could also sort of constrain the reported comp level, but you usually break it out for us anyway, isn't that right?

That's right. We'll break it out for you.

Okay, and on the SG&A fund, I think one of the reasons why the wait was up beyond bonus accrual in the third quarter may have had to do with a shift in marketing spend, out of Q2 into Q3.

And I'm wondering if -- what is happening specifically on marketing spend for the fourth quarter versus last year's fourth quarter?

You know, that's correct, Janet. I think I had said in my prepared remarks that there was a 20-basis point impact to SG&A from that shift in marketing from Q2 into Q3.

Right.

At this point, Q4, to be about comparable as a percentage of sales to last year.

Okay, great. And then I just wanted to address your inventory planning for the end of the year.

It looks like it will still be very lean, but down, down considerably less than it is now and I'm just thinking about the economy and the outlook for a tough first half next year. And I'm just wondering, if this is where you want to be at minus low-single digits year end.

Yes, Janet, let me try to explain that one. First of all, a couple of other data points on end of year inventory. We do expect to be down in the low-single digits, as I said. One of the things that impacting that I am not quoting that to be even lower than that is the fact that we made an investment in eCommerce. So there's a chunk of eCommerce inventory over last year that gets added into the inventory. But obviously, eCommerce doesn't add to the square footage.

So we're actually increasing square footage inventory per square foot because of eCommerce. If you look at just the stores piece of it, we're probably projecting down in the mid,closer to the mid-single digits negative.

That's obviously, not down by as much as the double digits that we're seeing now. But if you look at what we're up against, a year ago, inventory per square foot was reported up 24% at the end of the third quarter and up 9% at the end of the fourth quarter.

So the two-year comparisons are very different. Part of the reduction at the end of this third quarter is because we were just so high last year. So to answer your question in total, is we are very comfortable with are we are ending the inventory and it's right in line with where we planned.

Okay, good. And I think, Chuck, you said that you're cautiously optimistic on the new holiday line that's been in the stores for about a week now.

It's been actually a couple of days.

Oh, okay. I thought I had seen some over the weekend. I thought it looked very good.

Some has dribbled in early, but the full set was up this week.

Right, and I recently got the circular that came in the mail offering, the regular discounts that you usually do. And I'm wondering what your cirque rate is on that versus last year.

Yes, we don't provide that information. Sorry.

Okay. Well, I want to wish you all the best for a great holiday season.

Thanks, Janet. Take care.

All right. We will take our next question from Linda Tsai from Mkm Partners.

Good morning. Sorry about that earlier.

That's okay.

Any color on mall and off-mall performance during the quarter?

Yes, I mean what we've seen is that the malls have definitely been weaker than the off-malls in terms of what's been going on in traffic.

And then in terms of store payroll, what are you doing -- what are you doing there specifically to drive more efficient practices?

Well, we've done -- we've had quite a bit of re-engineering in that area over the last couple of years, where we've had initiatives to try and make our merchandise much more floor ready when it comes from overseas.

We've also changed a lot of our flow patterns to reduce some of the initial inventory we put in the store and replenish more frequently changing those kind of balances. So that we get a lot more -- doing a lot more in terms of labeling and staging the cartons in a way that make it much more efficient for the stores. So that has been a big effort for the Company over the last several years and will continue.

What parts of that are kind of driving the savings that you were able to see in the quarter?

I think that we can specifically figure out how much of the savings we've seen have come from those kinds of savings versus just adopting a more conservative posture with respect to our labor given this environment.

I think what we've recognized is that the -- there's a lot more volatility in terms of when customers come in. They shop much closer to need. So what we tried to do is to plan very conservatively and watch our sales mix. We've got the sales associates there when we have the volume and not, not other times.

Are you training your sales associates any differently to interact with the customer?

No, we have not made any changes in those policies.

And then just one final question. In terms of the marketing that you're doing in magazines, what are you doing there specifically and are you seeing better conversion from those incentives you were talking about?

A lot of our marketing is in direct mail and that's the area we can measure very effectively. Most of the magazine is not as measurable as the direct mail.

I think in this environment, we've tended to put more of our emphasis on the direct mail, where we're getting good returns and on the margins, slightly deemphasized some of the magazines.

Great. Thank you, and good luck.

Thank you.

All right. We will take our next question from John Morris with Wachovia. Go ahead, sir.

Thanks. Hello, everyone.

Hi, John.

And congrats on really a great quarter in a tough environment.

Thank you.

Sue, I think in your prepared remarks, you talked about 120 basis points. On the SG&A discussion, about 120 basis points of leverage that you were getting specifically to some of the cost initiatives you've been taking and better store expense and administrative expense reduction, which is pretty impressive.

When did those specific initiatives start? Just reminds us, or did they begin in the current quarter? Maybe dive a little bit deeper.

I know you kind of touched on some of the responses, or Chuck did, with Linda's question, but maybe dive a little bit deeper on some of the other areas. So we can kind of get a sense of the benefit going forward. And then a couple follow-ups.

Okay. So on SG&A, I would say you saw the full impact of our reductions really in the second quarter. This is a carry-over from the second quarter with then some, because it's a constant -- as Chuck said in his remarks, it's just changing the culture to one of cost containment, which is happening, we expect to continue to happen through 2009.

In terms of specifics, I mean basically we've just gone through every single department in the Company. The store's organization did take a layer out of store management. They had an assistant manager position that they did in fact take out and that was effective in May of 2008. And then through 2009, I think you can just expect to see more of the same.

We'll be annualizing it and then just chipping away at our overall cost structure. Specific initiatives are things like pooling all of our paper -- you know, basic blocking and tackling, pooling all of our paper buy so we realize more of a quantity discount.

Renegotiating freight rates.

Yes, telephone.

Telephone rates.

Just going back out there to vendors and renegotiating in a very tough, very tough environment.

I think it's a lot, too, just trying to hold our cost, growth and costs very conservatively as we grow our top line and I think that dynamic is going to pay great dividends over the long run for the Company.

And what happens is the culture starts to change. You find the people, rather than coming forward to try to sell a new position -- fill this immediately when someone leaves, what happens is they come forward and they say, you know, I think I can hang on a few months. Let's see how it goes and really it's just a change in the mindset.

Great. That's very helpful. And then also from a merchandising perspective, where do you see the opportunity for the holiday merchandise assortment this year versus last year, just talking about product a little more for Q4?

So we are actually standing behind the glacier fleece, micro fleece we have in the stores and the fleece hoodies. We also believe that sweaters will perform strongly for holiday. And the coordinating accessories that go with that, we really believe are going to be the drivers this season.

Okay, great. Good luck. Thank you.

Thank you.

Thank you.

We will take our next question from Thomas Filandro with SIG. Go ahead, sir.

Thank you, and I would like to add my congratulations. Nice job.

Thanks, Tom.

Two questions. One question is you had double-digit increase in AUR during the quarter, a function of the inventory levels in much better shape, better full price selling and the like.

Should we anticipate a similar trend in AUR in the fourth quarter, first question?

Yes, Tom, first of all, it is better full price selling, but it's also on the markdown selling, we're getting a much higher AUR because we're not strong go as deep, even on the markdowns.

Directionally, we expect that to continue into the fourth quarter and then start mitigating as we get into the first half of next year.

Okay, thanks, Richard. I guess the related question to that is maybe the markdown rate as it stands currently, how is that relative to historic norms?

I know, obviously, you had a lot more inventory in the pipeline last year. You cut back significantly.

Is there still room to improve the markdown rate significantly or the regular price selling rate?

So, again, we see similar type of markdown rate improvements in Q4 as to what we've seen. Maybe a little bit less but similar to what we've seen in the last couple of quarters. There's a little bit of room for improvement in the first half of next year further.

We are not planning for any meaningful improvement in the back half of next year at this stage.

Okay, great. And just, first of all, quick question to Chuck, Sue, are you guys still in a strategic review, or is that over?

No, we're still in the strategic review. Things we've talked about before are still ongoing. The Board is still reviewing strategic alternatives. Our CEO search is still ongoing.

In the strategic review, who is the -- is there a consulting firm behind that? Wasn't it Lehman originally?

Yes, we announced that sometime ago Lehman Brothers was helping us, now Barclays.

Okay, okay, check on that. And shoes, any update there?

Shoes, we're continuing to make progress on shoes. The consumer acceptance continues to be very strong. We've made a lot of adjustments out of our first year of learning, with the SKU counts and the mix between the various different classifications of shoes. And basically, then allowing inventory to live longer in the store.

I think, we're pleased with the progress that we're making on shoes and we're doing a lot of testing in terms of improving some of the operating issues in the store and have made good progress.

We're still not to the point where we want to aggressively roll it out but we're pleased with the progress we're making.

And great job. And the best to all of you professionally and personally for the holiday season.

Thank you, Tom.

Thanks, Tom.

We'll take our next question from Marney Shapiro with the Retail Tracker.

Hi, guys. Congratulations, great quarter.

Thank you.

I have a couple of questions. Can you update us on any shrink issues that your seeing, hearing or accounting for?

And then on the product side. Can you just talk a little bit about how newborn is doing and some of your one-offsets, like Halloween, for example, and your most recent pajama and robe set looked very, very good and have made quite a presence in the store. So I was curious how those capsules are doing.

Okay. I'll take the shrink question first. We're not seeing a meaningful change in shrink at this point in time. Shrink for this Company has historically been very, very low.

Even at times when we see slight increases, the impact to our overall financials are not -- is generally not that great. But we're not seeing a market change in shrink at this point. Now, Dina will answer your product questions.

In terms of newborn, we did have a bit of a tough third quarter for newborn, along with baby boy and girl. We are seeing that change as we go to the dressy lines for holidays. So we did see a shift with holiday and we are continuing to see that right now.

In terms of Halloween, Halloween actually we were very pleased with. We reduced the inventory levels that we had compared to last year and the sales were extremely productive. We were actually able to comp that holiday -- with that less inventory.

In regards to the PJs, we -- it did start out a bit slower than we had anticipated, but we've seen that change over the past week and a half. So we are feeling good about where the PJs are sitting right now.

Is there opportunity heading into next year to do more capsules like that, that are very targeted and encompass more of the store? Because it goes from almost newborn straight up.

Yes, we're looking at that as we're focusing on fall and holiday of next year. So we are positioning things like that.

Great. Good luck, guys, for holiday.

Thank you.

Thank you.

All right. We will now take a question from Dana Telsey with the Telsey Advisory. Go ahead, ma'am.

Good morning, everyone.

Hi, Dana.

Hi. Can you talk a little bit about what would be the stair steps to achieving the higher operating margin in terms of the levers on gross margin and SG&A. Are there any infrastructure elements that allows you to get there in terms of returning to that?

And also, what do you see on the penetration of lower price product and that impact on margin?

And just lastly, the online business has been enhanced lately. How are the learnings of that relative to the store? What's the same and what's different? Thank you.

Yes, I think in terms of getting the operating margins up, I think what the drivers there are going to be to continue -- one of the big drivers will be continuing to hold our costs reasonably flat relative to the growth of the sales and that's going to leverage it a great deal.

And the second thing that really helps to drive that is placing a lot more emphasis on the growth of eCom where the margins are much stronger. I think those are things that will help that.

Yes, that's really it. It's basically curtailing the growth in SG&A to less than the growth in sales and planning -- you know, planning for relative -- if you run the math, you can plan for relatively modest sales growth driven by new stores and eCom, as Chuck said, and then as we really manage that SG&A and hold the line on SG&A growth, you recall do see the leverage over time. It's not really margin expansion. You know, a little bit of margin expansion, but not a lot.

And then lower price product, how is that doing in the margin impact?

We're definitely seeing this shift into -- we always look at our business in terms of good, better, best and we definitely are seeing the shift in this economy to more, more good and less better and best. Do you have anything to add on that?

We are seeing that and we're seeing a lot of the two-for items that we have within the store really resonating well with the customer.

Thank you.

Thank you.

Thanks, Dana.

We will now take our final question, a follow-up from John Salitas with Buckingham Research. Go ahead, sir.

Hi, thank you. Two quick questions.

On the gross margin, when we think about the fourth quarter -- is the potential for gross margin improvement more akin to what we saw in the third quarter, or -- can you say, is it greater than what we saw in the third quarter, or about the same?

I assume not similar to the standout performance that happened in the second quarter.

And then my second question is -- obviously, you had a 2% comp in the third quarter, which was significantly better than the vast majority of retail. Many retailers have talked about how they have seen sales really fall off a cliff here in November. But clearly your business has been more resilient year to date and you obviously, have the demographic tail wind.

Could you -- is it safe to say that you're not seeing that same kind of significant deceleration as we head into November? Thank you.

Go ahead.

Okay. On the gross margin, yes, we had said, even when we announced the second quarter, that the second quarter was a real standout quarter.

I would expect to see gross margin at this point in time, with of course a lot of variables, in Q4 pretty much comparable to Q3. Not Q2.

And then in terms of comments about November, I'm really leary to make those because of tremendous variability that you see week to week. And so it's -- I can't get myself to the point of being able to say. We see some days going up and some days going down. It's just -- you just don't--

There's a shift.

John, can I maybe jump in. We're finding it's difficult to read November from a comp perspective versus last year and even translating to December. Because of the shift of Thanksgiving into the last week or five days later in November, we shifted our holiday two floor set this week out by corresponding week as well.

We just didn't want to set the floor set another week out pre-Black Friday and because we shifted the floor set out a week, we shifted the corresponding marketing out a week as well.

So we've gone through a week or so of non-comp from a calendar perspective, non-comp from a floor set perspective and non-comp from a marketing perspective.

So it's not easy for us to translate the last week or so of November into our true run rate. We're doing a whole lot of stuff to figure that out, but there's a lot of variability that we're seeing.

Okay, great. Well, I appreciate getting the second question. Thanks a lot, guys.

Thanks, John.

All right. This concludes today's question and answer session. It is now my pleasure to turn the program back to Chuck Crovita.

Thanks for joining us today, and thanks for your interest in our Company. Have a great day.

And this does conclude today's conference. You may disconnect at any time.