Children's Place Inc (PLCE) 2009 Q2 法說會逐字稿

Good day, everyone, and welcome to today's program. At this time, all participants are in a listen-only mode. (Operator Instructions Please note today's call is being recorded.

It is now my pleasure to turn the conference over to Jane Singer. Please go ahead, ma'am.

Thank you, Lindy. Good morning, everyone, and thank you for joining us today for a review of The Children's Place Retail Stores, Inc. second quarter 2009 financial results. Participating on this morning's call are Chuck Crovitz, Interim Chief Executive Officer, and Sue Riley, Executive Vice President Finance and Administration. Dina Sweeney, Group Vice President of Merchandising is on hand to answer questions at the end of management's remarks. But I must warn you in advance that she has come down with a little bit of laryngitis, so if she has trouble talking later, Chuck or Sue may jump in to help her out.

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. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially. The Company undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date here of. Please also note that a reconciliation of certain non-GAAP financial measures discussed on this call is contained in this morning's press release, which can be found on our ChildrensPlace.com website. And now, I will turn the call over to Chuck for his opening remarks.

Thank You, Jane. Good morning, everyone, and thank you for joining us today. We continued to face a challenging retail environment in the second quarter of 2009, and at the same time, we were up against the best second quarter in the Company's history in 2008. We had a number of headwinds including the difficult economic environment, the negative impact of foreign exchange, and lower mall traffic. And these headwinds hampered our sales results during the second quarter. Nevertheless, we made significant headway in our e-commerce business, our cost cutting initiatives, and the roll-out of our new value-engineered store format.

To briefly highlight the second quarter of 2009 results, our net sales declined 7% compared to the second quarter of 2008 with comparable retail sales down 9%. Our loss from continuing operations, including(Sic-see press release) unusual and one-time items, was $12.4 million or $0.42 per share, compared to an adjusted loss of $0.03 per share last year. A couple of bright spots during the second quarter include the continued strong growth of our online business, which increased 24% this year on top of more than a 90% increase during the second quarter of last year, and our shoe business which delivered a solid increase in sales and margin.

To briefly update you on the progress we achieved on our three growth initiatives, I mentioned earlier that our Ecom business is continuing to thrive, that the move of the fulfillment center to Alabama which has enhanced our efficiency as well as increased levels of marketing support. During the second quarter of 2009, Ecom accounted for 6.5% of net sales, compared with less than 5% last year. Also, we remain on plan to open approximately 35 new stores in 2009, which will increase our fleet by a net of approximately 30 stores for the year. About half the new stores opened year to date are in the new Tech 2 format. This new format is easier to shop. It's been engineered to withstand higher traffic, and it costs 35% to 40% less to build than the previous prototype. And this gives us greater flexibility in the types of locations and markets where we can operate profitably. More than half of the new stores we have built year-to-date are located in value-oriented centers, primarily in strip malls.

Finally, we are ahead of schedule and realizing the planned $20 million in cost savings that we announced in February. Significant progress has been made across the organization to increase efficiencies and lower spending which Sue will review in a few minutes. As we enter the important back-to-school season, we are pleased with early customer response to our Fall One line, particularly the Wear Now product. Nevertheless, we are planning conservatively for the fall season due to ongoing weakness in the economic environment, cautious consumer sentiment, and significant volatility we continue to experience in our business. During the past year, we have observed customers shopping closer to need, shopping less frequently, and waiting for great deals before making a purchase. And we have no reason to believe that these behaviors will change significantly during the latter half of 2009.

Promotions are very important in this environment, and we are testing new ways to offer our customers even greater value. For example, in July, we offered a backpack promotion which required a minimum purchase of $30. And in August we offered a free graphic T-shirt with the purchase of two pairs of denim. In addition, we continue to focus on promoting the tremendous value that we have by highlighting our price points, both in stores and online. Looking ahead, while we manage our business prudently during this difficult period, we remain confident that strategic initiatives that we are pursuing combined with our trend right fashion and great value pricing, position us to achieve our longer term growth targets.

Before I turn to Sue for a review of operations, I'd like to briefly comment on the agreement with former Chairman and CEO Ezra Dabah. On August 3rd, the Company purchased 2.45 million shares, which is 50% of the shares owned by Ezra and his family for $28.88 per share. We have also agreed to file a registration statement to facilitate a one-time, marketed secondary offering of Ezra and his family's remaining shares. In connection with this transaction, Ezra and his father-in-law, Stanley Silverstein, have resigned from the Company's Board. The Board of Directors believes this development will create positive momentum in the CEO search and expects to name a permanent CEO before the end of the year. 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 discussion today will focus on continuing operations of the Children's Place business since the Disney Store business is classified as a discontinued operation. Net sales for the second quarter ended August 1, 2009 were $315.7 million, a 7% decline compared to last year's second quarter net sales of $338 million. The decline in the value of the Canadian dollar relative to the US dollar negatively impacted net sales by approximately $5.1 million compared to the second quarter of 2008. Comparable retail sales, which include online sales, declined 9% in the second quarter of 2009 following a 10% increase during the same period last year. The decline in comp sales was the result of a 7% decline in transactions and a 2% decrease in average transaction size. We ended the second quarter with a total of 937 stores this year compared to 902 stores last year.

Gross profit dollars declined 18% to $105.3 million, and gross margin decreased 460 basis points to 33.4% compared to a 38% -- excuse me -- compared to 38% in the second quarter of 2008. During our 2008 year-end conference call, we mentioned that we expected gross margin for the first half of 2009 to be significantly lower than the first half of last year. Our gross margin was negatively impacted by deleverage during the second quarter of 2009, in addition to more markdowns, higher shrink accrual, a lower IMU, and a lower Canadian exchange rate compared to last year.

During the second quarter of 2009, IMU will be stronger as merchandise purchases for the 2009 back-to-school and holiday seasons were made during a time period when the global retail demand was particularly weak, which is benefiting IMU for the back half of the year. In addition, we anniversaried the precipitous decline in the Canadian currency toward the end of the third quarter, assuming there is no further change in the Canadian to US dollar exchange rate. Offsetting this, we are continuing to see high levels of promotional activity from children's apparel retailers, and we expect we may sell a greater proportion of merchandise on promotion during the third quarter of 2009 than we did last year. Also, we may experience some deleverage during the quarter depending on comp sales. As a result, we now expect gross margin for fiscal 2009 to be approximately 50 basis points to 100 basis points last year. Again, depending on comp store sales.

SG&A as a percentage of sales was 33.6% in the second quarter of 2009, representing 230 basis points of deleverage, including several unusual or one-time items as follows. During the second quarter of this year, we had a $3.1 million accrual reversal in SG&A resulting from the favorable settlement of an IRS employment tax audit related to stock options which was offset by expenses associated with the recent proxy contest and 2009 restructuring costs. In the second quarter of last year, we had gains from transitional services income provided to Disney. and the sale of a store lease which were partially offset by one-time professional and legal fees. Excluding those one-time items which those items which we believe to be unusual or one-time in nature from both periods, SG&A expenditures were $106.7 million during the second quarter of 2009 compared to $111.9 million last year. As a percentage of sales, SG&A was 33.8% in the second quarter of 2009, representing 70 basis points of deleverage. The deleverage is due to lower top line sales. However, we were able to lower operating expenses on a dollar basis through our continued cost control initiatives, including lower administrative expenses, better management of store payroll and expenses primarily related to supplies, and lower professional and IT expenses. These savings were partially offset by higher pre-opening expenses as we opened more stores during the second quarter of 2009 and slightly higher marketing expenses to support our growing e-commerce business. As Chuck mentioned earlier, we are ahead of schedule in realizing savings from the restructuring program that was announced earlier this year. As such, we expect SG&A dollar spending for fiscal 2009 will be at least $10 million lower than in fiscal 2008.

Moving down the P&L, we had an asset impairment charge of $315,000 during the second quarter of 2009 for an underperforming store. Depreciation and amortization expense was $17.6 million during the second quarter, similar to last year, which resulted in approximately 40 basis points of deleverage. Operating loss from continuing operations before interest and tax was $18.7 million during the second quarter of 2009, compared to operating income of $4.9 million last year. Net interest expense was $1.5 million in the second quarter of this year, compared to $400,000 in 2008. We had a $38 million balance remaining on our term loan for the entire second quarter this year. Whereas last year we had minimal interest expense in the second quarter, as we did not close on the $85 million term loan until the end of July 2008.

During the second quarter of 2009, we had a couple of one-time items which impacted our interest expense. We incurred $1.5 million in accelerated, deferred financing fees and prepayment penalties associated with our decision to prepay the balance of our term loan on August 3, 2009. This was offset by a $1.5 million reversal in accrued interest as a result of the favorable settlement of the IRS employment tax audit related to stock options.

Going forward, net interest expense is expected to be approximately $600,000 per quarter, which includes seasonal short-term borrowings and fees related to our credit facility. Our effective tax rate for the quarter was 64%. The tax benefit for the quarter was increased due to a one-time tax benefit from excess foreign tax credits, resulting from the repatriation of cash from our Canadian subsidiaries. We expect our effective tax rate for 2009 for four, one-time items to be approximately 42%. Net loss from continuing operations after tax was $7.2 million, or a $0.24 loss per share in the second quarter of 2009, compared to net income of $2.7 million or $0.09 per share in the second quarter of last year.

Our basic weighted average share count for the quarter was 29.6 million. We expect our diluted weighted average share count to be approximately 27.8 million for the third and fourth quarters as a result of the Company's repurchase of 2.45 million shares from former chairman and CEO, Ezra Dabah, on August 3rd. Excluding the one-time items for both periods, second quarter adjusted loss from continuing operations net of tax was $12.4 million, or a $0.42 loss per share, compared to $900,000, or a $0.03 loss per share last year. Foreign exchange negatively impacted our second quarter 2009 EPS by approximately $0.05 per share. GAAP net loss for the second quarter, including the impact of discontinued operations, was $7.1 million or a $0.24 loss -- $0.24 per share net loss, compared to breakeven in the second quarter of 2008.

Moving onto the balance sheet, our quarter-ending cash balance was $152.2 million, compared to $146.7 million last year. As I mentioned earlier, we had $38 million of borrowings from our term loan this year, compared to borrowings of $85 million at the end of the second quarter last year. At the end of the second quarter of 2009, we had improved our cash position by approximately $52 million net of debt, compared to the second quarter of last year. As I mentioned earlier, following the second quarter on August 3, 2009, we took two actions which impacted our cash position for the third quarter. We closed on a transaction to repurchase half the shares owned by Ezra Dabah and his family for approximately $70 million. We also prepaid the $38 million balance on our term loan. We are comfortable with our cash position, coupled with our $200 million credit facility, and we expect to rebuild our cash position during the third and fourth quarters of 2009.

Total inventory including merchandise and transit at the end of the second quarter was up 13% per square foot, which is above our previous estimate. This increase is primarily due to timing, as in-store inventory was down in the low single digits at the end of July, and the level of prior season carryover inventory at the end of the quarter was comparable to last year on a dollar basis and slightly lower as a percentage of the total balance sheet inventory at 4.5% this year compared to 5.4% last year. The increase in inventory at the end of the quarter is attributable to higher levels in our DCs and in transit inventory at the end of July, 2009 compared to 2008, as we purposefully slowed shipments of some fallen holiday merchandise until they were required for August replenishment and September floor sets. So, we remain quite comfortable with the newness and overall level of our inventory. We expect to end the third quarter of 2009 with total inventory per square foot up low to mid single digits.

During the second quarter of 2009, we opened 15 stores. At the end of the second quarter, we operated 937 stores with a total of approximately 4.632 million square feet. During 2009, we plan to increase our net store count by approximately 30 stores with most of the new store openings occurring during the second and third quarters. Thank you, and now I'll turn the call back over to Chuck.

Thanks, Sue. Operator, I think we'd like to open up the call for questions.

(Operator Instructions) And we will take our first question today from Betty Chen from Wedbush Morgan. Your line is open.

Thank you. Good morning, everyone. Sue, I was wondering if we could speak a little bit about the cost savings. I think you have mentioned that we are on track to see about $10 million of SG&A decrease year-over-year. I think the plan was for about $20 million in total of cost savings. Could you walk us through maybe the timing of that? And whether we could potentially see more than the $10 million that you alluded to earlier?

Well, I did say at least $10 million more in savings. So, you know, given some -- just wanted to provide some cushion in that number, of course. But the goal -- the cost reduction program that we announced earlier this year was for $20 million, and we remain ahead of schedule to achieve that $20 million. The $10 million in SG&A savings that we expect to achieve this year is net -- it includes new store openings. And so bear in mind, we have got new store openings which drive SG&A somewhat. But all things being equal, we are on track to achieve the $20 million and then some of cost restructuring program savings.

Any color you can give us on how we should think about that between -- because I think we were already starting to see some of the savings in Q2. How much should we think about for the Q3 and Q4 time frame?

We had said that we expected to annualize the $20 million of savings in Qs 3 and 4. So expect about $5 million in each Q3 and 4 of those savings kicking in.

Okay. That's very helpful. And then just in terms of the inventory position. Just wanted to clarify, I think you said that the carryover inventory is actually down year-over-year? And then also, the plus 13% per square foot actually includes in transit.

That's correct.

How much of -- could you give us a sense of how much is in transit inventory? I know you also said that some of it is to help you position for August and September? And how much of that is -- so should we think that the in transit is primarily for the September floor set?

The in transit inventory, is primarily -- most of the in transit inventory is an actual inventory number -- is for holiday. There is a little bit of fall that's in transit. However, last year we had fall in transit. So we had more fall that was in transit as we were buying to replenish -- we delayed some shipments until they were just needed to replenish into the August floor set. Another way to look at it is, if you take in transit out -- it is a 13% increase per square foot including in transit. If you take in transit out, we are up about 8% per square foot and that includes DC inventory for fall. And then our prior season inventory, which is spring and summer, is about 4.5 % of the total inventory balance compared to -- I think I said 5.4% in the previous year.

Okay. And could you help us think about how that is positioned for e-commerce versus the retail stores? Because definitely it appears that the e-commerce business has been growing very nicely, and I know we had some capacity constraint earlier in the year. But now with the new DC and increased utilization, is there any sort of difference between your inventory position for online versus retail stores?

Yes. In fact, if you look at the retail stores on a per square foot basis, I said in my prepared remarks that the inventory was down in the -- was actually down per square foot in store. And it is, in fact, up in e-commerce.

Great. Thank you very much, and best of luck.

Thank you.

Thank you.

And we will take our next question from Rick [Batel] with Banc of America. Please go ahead.

Hi. Good morning.

Good morning, Rick.

Just a follow-up question. Can you just give us some color on how we should expect comparable inventories to trend during the holiday season both in dollars and in units? And if you had to, do you still have the ability to modify some of those orders for holiday?

Okay. Holiday, we are -- the holiday buy is up about 6% versus prior year, which we are actually very comfortable with. And again, that's consistent with our -- what we had been saying about inventories, that our in-store inventory would be down slightly versus prior year per square foot. And we are in fact buying more for e-commerce. So we -- and also bear in mind, just as background, last year we had changed our inventory policy. The first season that could really be impacted by that was back-to-school last year. We had significantly reduced our inventory buys versus the previous year. So back-to-school and holiday inventories had already been corrected for our new inventory policy. So we think about 6% increase in the overall buy -- and that's total buy not per square foot. So it's actually lower than that on a per square foot basis. It's about what we need in order to meet holiday demand.

And then in terms of the ability to change, you can only change things really on the margin at this point. So we can get a few things in because we have been -- we have a program -- a new program called Fast Fashion that enables us to make some commitments closer into the market. But the bulk of the inventory is already set.

Okay. And then a question on your product costs. Some retailers out there have mentioned a mid-single digit decline in sourcing costs out of China for the back half of this year. I'm just wondering if that level makes sense to you? And do you see these product costs reductions continuing into early 2010 as well?

It actually does make sense to us. That's about the range that our product costs are down. They are down for both back-to-school and then down even more for holiday. And we do expect that to some extent to carry into spring for next year.

Great. Thank you very much.

Thanks.

And we will take our next question from Kimberly Greenberger from Citigroup. Your line is open.

Great. Thank you. Good morning. I wanted to just follow up on the inventory discussion. Sue, it sounds like there's a lot of timing issue involved with the balance sheet cutoff. Maybe you could step back and just tell us for the third quarter, approximately how much did you buy total inventory up? And I don't know if there is a way to disaggregate the piece that you bought for Ecom versus the stores? For example, if you bought the stores flat? In Ecom, up significantly for a blended of X. Maybe that would be helpful.

Sure. First, in terms of the total -- the total buy. I think I said -- fall we did buy up slightly versus prior year, consistent with our goal of having the in-store inventory down somewhat. And then we did, in fact, buy up for e-commerce . So the increase in the buys -- result of our having allocated more inventory to e-commerce. And then again, slightly less in-store at any given point in time because we are also holding back inventory in the DC so that we are replenishing into inventory that's in fact selling in the store so that we don't end up with inventory in the wrong stores. And again, consistent with our flow strategy of shipping it once as opposed to into the stores and then into DCs. Our holiday buy, I think I mentioned, was up 6% consistent with that strategy. Fall was up year-on-year about -- total fall buy is up about 4%, which again is what we are very comfortable with. It just so happens this year that we have more of that 4% buy shifting into the second quarter than what we had last year where we had more of it in the third quarter. We also set fall a week later. So again, just some shifts in timing, but overall we are very comfortable with our

Great. Thanks. And just a follow-up on your 2009 gross margin expectation. I think the range you gave was 50 to 100 basis points. But I didn't hear if that was up or down to last year for the full year?

We expect -- we actually were -- we said 50 to 100 basis points gross margin decline versus prior year. And Kimberly that's a function of our having moderated our view on top line. The IMU that we are expecting, we are still -- we have made the buys. So we absolutely expect to get the IMU. It's really a function of deleverage at this point in time.

Oh, that's helpful. Thanks.

Yes.

And then one last thing, Sue. The deleverage in the second quarter? Could you just help us understand the relative magnitude of the deleveraging piece of the 460 basis point decline in gross margin? Thanks.

Yes. Deleverage was significant with the first item mentioned it was the over -- the most -- the most significant cause of that decline.

Okay.

Representing almost half of that.

Almost half of it. Okay. Thanks so much.

And our next question comes from Brian Tunick from JPMorgan. Your line is open.

Thanks. Good morning. Just a couple more questions on some details. So you talked about the IMUs a couple of times so far, and we are just trying to understand how much pressure on the IMU did you see in the first half? And how many basis points of upside do you see in the back half? We are just trying to understand that versus the markdowns. And then the second piece on the occupancy opportunity in the back half, you look at your two-year, comp comparisons. Are you thinking with the inventories you have that same store sales should be flattish versus the down 9% in Q2?

We don't give -- we don't give guidance on same store sales. But on IMU -- we knew that IMU was going to be down, and we had said that IMU would be down. And it, in fact, was down in both the first and second quarters. Driven down by two things. Firstly, the cost of the buy, as you know, we were -- again, spring and summer were bought before the decline -- before the economy really declined. And as such, so there were higher product costs for both spring and summer. And then IMU was also impacted by the Canadian dollar where we are buying product for Canada with a weakened dollar.

Right. How much IMU growth are you expecting in the back half?

We are expecting IMU -- we haven't disclosed specific amounts but we do expect IMU to be favorable in the third quarter. And then again, more favorable in the fourth quarter. Again, as a result of the product -- the buys that were done for back-to-school and holiday.

Okay. And then as far as the store base goes, I know strip center growth has been a lot of your growth in margin talk of the future. Can you just talk about how the first half trended in the strip or lifestyle centers versus your mall stores?

Yes. I think that in general the -- we had less -- I should say less negative comp in the strip centers and in some of the value-oriented centers than we did in some of the A and B malls. I think everything was down. But those were down less. We also, in general, saw outlets being a little softer as I guess people were not willing to drive out that far for outlets. So that's basically what -- how it came out. Relative strength in strips and value centers.

Okay. And finally my third question is on the marketing side. Is there anything we should expect from any marketing -- direct, magazine -- here in the back-to-school period versus last year?

No, I don't think major changes in that. I guess versus a year ago, we probably invested a little bit more money in business -- direct business driving, which is of more investments into the direct mail pieces and incrementally less in magazine advertising. But the circulation of direct mail is pretty much comparable to where it was last year. The only real difference is just a lot more experimentation on promotional -- in-store promotion -- promotional pricing to try and react to this economy.

Okay. Thanks and good luck.

Thank you.

And our next question comes from Richard Jaffe from Stifel Nicolaus. Please go ahead.

Thanks very much. Two quick questions. One would be did -- to follow up on your comments about customer response to back-to-school. I'm wondering how you see that breaking out? Whether it's the product is right, and that there's not a lot of resistance to price? Or it's really that magic price point, the promos you talked about earlier, and the price points that are driving that business? And then a follow-on question regarding the shoe business, how that's developing as a percent to total? And how it's represented in stores. I know all stores don't have the full assortment, but wondering what the outlook for that is.

So we are seeing -- I'm going to actually start with the shoe piece first. Chuck had mentioned that the shoe sales were strong in the first half. We are continuing to make progress on the design [shoe cannon] in the margins, allowing the inventories living longer on the floor. And seeing that we are getting a lot of positive returns on those strategies that we have put in place, we are still experimenting with shoes. So we aren't seeing a tremendous significant roll-out plan yet. But we are -- as we continue to experiment, we will continue to elaborate on that. Then in regard to the product, what we are seeing the customer -- the customer is continuing to respond to what we have talked about earlier on in the year, the key items and the basics are the major contributors. However, where we are offering unique fashion products, customers are responding to that in -- at full price level. So we are excited to -- with that, and we are seeing that continuing now -- excuse me -- into the early back-to-school time period.

Just a couple of additions there. I think that we are feeling good about fall in terms of the early -- particularly, the Wear Now product as I was mentioning before. I think the bigger issue is just the overall traffic and the propensity to shop in the mall. I think that's the bigger level of concern there. And then just a specific question, shoes is, I think, around 5% of our total mix at this point.

Yes. That's great. And I guess while you can't make traffic happen, do you have more irons in the fire? Or more tricks up your sleeve, if you will, in terms of key items, promotion, gift with purchase, like the backpack or those kinds of things for later in back-to-school and the holiday season?

Yes, I would say that's right. I think we are in constant experimentation there trying a lot of different things that we haven't tried in the past because I think that's what's required in this environment.

I couldn't agree more. The more clever you can be, and it sounds like you've got the margin and the units to make something happen. Thanks very much.

Thank you.

And we will take our next question from John Zolidis from Buckingham Research. Please go ahead.

Hi. Good morning.

Hi, John.

Hi. Two quick questions. One, I think I heard you say that you were committed to bringing in a permanent CEO by the end of the year? And I just want to help -- ask you to clarify -- had you previous committed to bringing in someone in the next 90 days? Is that correct? And if so, what's changed?

Yes. I don't think there's any change there. I think we are just hedging things. That still is our expectation -- that time frame.

Okay. So I guess the end of the year would include the next 90 days. And then, on the full-year guidance for gross margin to be down approximately 100 bps? As I recall, the last guidance you had said was similar to the previous year. Can you just clarify what's changed relative to that previous outlook? Thank you.

John, the only change of that previous outlook is that we have moderated our view of the top line. So we have just taken the top line down somewhat relative to how we had them thinking about it before. So from the last guidance that we gave to this now, it's really just a function of deleverage.

Okay. So it doesn't have anything to do with increased markdowns related to the inventory or anything like that?

Well, the lower top line, if you think -- it does not have anything to do with decreased -- increased markdowns having to do with inventory. But if you lower your top line and you have the units, by definition, you're selling those units at a lower price. So it does -- it is a function of moderating our view of the top line in part because of higher markdowns, particularly in the third quarter. We did say that we expected markdowns could be higher in the third quarter of 2009 relative to 2008. Chuck mentioned earlier that we are experimenting with some new promotions.

Okay. Great. Good luck with back-to-school and, Dina, I hope you feel better soon.

Thanks.

And our next question comes from Janet Kloppenburg from JJK Research. Please go ahead.

Hi, everyone.

Hi, Janet.

I just wanted to elaborate on that for a minute, Sue, then. What do you think about the fourth quarter? Do you think the easier comparison, then, will give you an opportunity for gross margin improvement in the fourth quarter? And perhaps a better performance on the top line vis-a-vis the third line -- the third quarter? Excuse me.

Sure. Fourth quarter, we do have an easier comparison. And in fact, fourth quarter we did see higher markdowns than what we had gone into the quarter expecting. So I do think we kind of anniversary the markdown cadence in Q4. I think that there is some opportunity given that stronger IMU in Q4 to see margin expansion. But I just want to be cautious that this -- at this point in time, again, just because we have moderated our view of the top line a little. It's not a huge change, but we have just moderated our view of the top line just given the current environment.

Just to talk about the inventories for a second. If I have it right, it's up a little higher than maybe we expected because the in transit is higher, and most of that's associated with the fourth quarter receipts. I think that's the way you want us to be thinking about it. So I'm just wondering if that is correct? And if you're comfortable with where your third quarter inventories are right now in light of your more conservative outlook for the top line.

We actually are. We have taken a conservative stance on our buys. Again as I said earlier, total fall is up about 4% -- that's base, that's everything and bear in mind we have more stores this year than we had last year. So we are comfortable with our inventory buys. The in transit was up significantly, and to be honest, we should have done a better job of forecasting it. But it was up over 30% year-on-year. With the lion's share of that being earlier receipts than last year of holiday. So we are very comfortable with our inventory position. We are also very comfortable with the newness of our inventory, in that, we are not carrying -- we are carrying less as a percentage of total inventory of prior season, which again is spring and summer into the third quarter. So we are overall pretty comfortable with where we are.

Okay. And just lastly, can you comment on any product sourcing advantages you might be gaining for the first and second quarter of next year? Because I know there was something that you didn't have the advantage of here in the first half of '09. I'm wondering what the outlook is for 2010 because I think you're probably placing those orders right now?

We are. I expect them to be favorable. Go ahead, Chuck.

No. It's the same thing. When the demand is weak in the United States, the costs are better in Asia. And it's the basic opposition. So, as we continue to experience this weak business here, we are going to continue to see favorable costs over in Asia.

Okay. Great. Thanks and good luck.

Thanks, Janet.

And we will take our next question from John Morris from BMO Capital Markets. Your line is open.

Thanks. Good morning, everyone. Sue, question for you -- one more inventory question. I apologize.

No problem.

But I think maybe here's how I want to ask it. I think it would help to understand a little bit better. When you had talked about purposefully slowing shipment of inventories. I think I'm hearing that you say that that's partially due to the new flow strategy and setting fall later. I think with the -- with the calendar shifts, maybe we would have expected it to be kind of the opposite. So a little bit more clarification on why you would have purposefully slowed those shipments of inventory?

Let me apologize if I was not clear on that. We have slowed the shipment of inventory last year because we had to make decisions on when we wanted inventory to come in last year -- you're making those decisions months in advance. And recall in the earlier part of 2008, we had not yet divested Disney. So we had other constraints around our business that caused us to want to slow some shipments last year. So we slowed some shipments of fall so that we received the inventory just in time to replenish in August. And then we slowed some shipments of holiday that were actually not received until September. This year, we didn't have a need to slow the inventory -- wanted to make sure that we had it in the United States in the right place at the right time. And so we actually had more holiday that was loaded. It's in transit. It was loaded on to vessels. Its title passes when it's loaded on to vessels. And so we just had more holiday on the water than what we had at this time last year.

That's very helpful.

Okay.

Now, was there any currency impact on the inventory?

It's really minimal. The currency impact on it -- because bear in mind, Canada is only about 10% of our total business.

Exactly.

You're talking about -- that's very minimal impact.

And then my other question regarding SG&A. You gave us the full-year guidance which was very helpful in terms of where you're planning SG&A. On Q2, you did deleverage excluding the one-time items a little bit -- maybe a little bit above your plan. Looking at Q3, could we expect -- is it possible to see some leverage in Q3?

Again, it all depends at this point in time on the top line. On a dollar basis, I expect SG&A to be lower year-on-year, notwithstanding the fact that we have more stores this year than what we had last year. But it really all depends on what happens on a top line basis.

Okay. So dollars for third quarter -- ?

Dollars for third quarter I expect to be down. Just by way of reference, last year we had 920 stores. This year, we expect to have 950 by the end of the third quarter. So we expect dollars to be down, but the leverage or deleverage will depend on what [happens].

Yes, of course. Great. Thank you. That's very helpful. Good luck for fall.

And we will take our next question from Dorothy Lakner from Caris & Company. Please go ahead.

Thanks. Good morning, everyone. I wanted to ask a question on gross margin. Just on the components, if you could comment on a little bit on the higher shrink. Is that something -- how far out of line is it? Is it something that you're very concerned about? And just what kind of component was that of gross -- of the gross margin deleverage in the quarter? And then just a housekeeping question, on the number of stores right now that do have the shoes? And lastly, I've seen that Borders, for example, Borders Rewards is offering discounts at certain stores and, I think, places. One of them. Is that something new that you're doing? Cooperating with other retailers to generate some traffic? And, is that something you're going to do going forward? Thanks.

Want me to start with shrink?

Yes, start with shrink.

Alright. So in descending order as you look at the gross margin decline of the -- in descending order of importance, deleverage was the single biggest reason for the margin decline.

Right.

Second down, it would be markdowns, which include markdown reserves. So basically just markdowns are Number 2. And then IMU is third. Shrink is fourth. And then, there are other costs -- .

Okay.

Minor, minor items. Shrink is concerning to us. We did see higher shrink in the fourth quarter of last year. And we did our full-year end inventory. And so, we are accruing to that higher level, by the time we get to the fourth quarter, we annual -- .

Annualize.

Anniversary. Exactly right. We annualize and anniversary the higher shrink rate. It's concerning to us. To some extent, it's part of doing business. We are doing everything we can to minimize it. But nonetheless at this point in time, we are accruing at that higher rate that we saw in the fourth quarter of last year.

In the third quarter again, you'll be accruing to a higher rate. Fourth quarter, that may -- it will hopefully start to flatten out.

It will -- I expect it to flatten out in the fourth quarter depending on how the inventory comes out because we had a catchup in the fourth quarter of last year.

Right. Okay.

I will add to that that shrink has been a huge focus of the management team here. It's something that I've become personally very involved in, and we have a lot of programs that we have put in place this year. But I do think part of that is the environment, obviously.

Right.

Economics. Turning to the shoe issue. [To be said] about our shoe business, we have always had shoes in all of our stores.

Right, right, right.

Of a reduced amount. We have an expanded shoe concept, and both of those businesses are improving greatly in terms of margin.

Both in-store, and then the side-by-sides?

Yes. And the side-by-side is a -- is one of the experimental formats for the new shoes. We also have some new formats there that we actually feel more strongly going forward in integrated format. But we do tend to think about core shoes which are in all stores and expanded shoes which are these larger stores to accommodate a much enhanced selection of shoes.

Right.

It's sort of the difference between 50 SKUs versus 180. So that's the difference between core and expanded.

Yes.

The expanded are in about 55 stores at this point.

That was the number I was thinking.

And then, in terms of the Borders thing, I have to plead ignorance on that one. We will have to figure that one out, and get back to you.

Okay. Alright. Thanks.

And our next question comes from Linda Tsai from MKM Partners. Your line is open.

Yes. Hi. Chuck, you made a comment about the new Fast Fashion program. Can you give us more detail on what it entails, and how it changes how you currently replenish inventories?

Yes. I think that our sourcing, which we consider to be a real core confidence is probably a little bit on the longer side because we are optimized more for costs than for speed. But nevertheless, there are certain parts of our business that we feel we benefit by having more speed. So what we have done is to take some important categories for ourselves, starting with really denim and graphic tees, and delay the decisions that we make on a significant portion of those lines until much closer into market. So we have just -- we have been working on this program for nine months or so. We have really implemented heavily this fall and are pleased are the results so far. But it's a bit early to see all the results. But it's something we feel very good about as an important component of our sourcing strategy.

Does this entail buying fabric and keeping it somewhere and then making it as trends come in?

It -- it more has to do with getting set up on fabric and capacity, but postponing some of the decisions that we make until we can read the trends more clearly.

Okay. And then some of the retailers have talked about a strong start to denim. Are you seeing this as well?

Denim, we are -- we had a longer second quarter season in denim. So actually denim for us was a little bit slower than we initially anticipated, but we are seeing that trend change now.

Great. Thanks very much.

Thank you.

(Operator Instructions) And we will take our next question from Marni Shapiro. Please go ahead.

Hello. Good morning, and good luck with the rest of fall if I forget to say. Could you just give a little bit more detail? You mentioned the store openings for the full year, but if you can just walk us through the third and the fourth quarter, if you wouldn't mind? And I wasn't sure if you had mentioned 2010? And then just one further clarification on the direct business? Could you talk a little bit about the e-mail and the marketing spend that's been shifted toward direct? And has it been successful, you're getting good click-through rates are you using your list more? Or are you using different avenues?

Okay. First in terms of the stores, as we said, we are thinking we are going to open about 30 stores for the year. We are going to close some stores. I think it's -- we are looking to open probably more stores in the third quarter and very few in the fourth quarter just because that's the timing that works out best. Now, in terms of the direct marketing side, we have done more investments in our direct mail, which is the mail that we send out. Or I should say we have maintained our -- we have reduced some of our spending overall, but we have protected the direct mail. We are definitely doing more spending in the direct channel than we have done before. And with the focus on gaining more traffic and getting more conversions, and those do seem to be positive. They do seem to be working for us. But in general, what's happening in the marketing is try to get a little bit more efficient in terms of how we spend the money. And again, focusing the spending from brand building to more sales building in this environment.

Great. That makes sense. And then do you ship internationally? And are there any areas -- I'm thinking particularly maybe South America -- where you're seeing some click-through on some sales?

No. We basically are a US website.

Great. Alright. Congratulations, and good luck going forward.

Thank you.

Thanks.

And we have no further questions at this time.

Well, I want to thank you all for joining us today. Thank you for your interest in the Company. Have a good day.

This concludes today's teleconference. You may disconnect at any time. Thank you and have a great day.