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Executives

Allison C. Malkin - Senior Managing Director

James S. Scully - Chief Administration Officer and Executive Vice President

Stuart C. Haselden - Chief Financial Officer

Analysts

Spenser Samms - BofA Merrill Lynch, Research Division

Paul Simenauer

Karru Martinson - Deutsche Bank AG, Research Division

Jordan Hughes - Goldman Sachs Group Inc., Research Division

J. Crew Group (JCG) Q3 2012 Earnings Call November 29, 2012 11:00 AM ET

Operator

Greetings. Welcome to the J. Crew Inc. Third Quarter Fiscal 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you, Ms. Malkin, you may begin.

Allison C. Malkin

Thank you for joining us to review our third quarter 2012 results. With me today are Jim Scully, Chief Administrative Officer; Libby Wadle, Head of our J. Crew Brand; Stuart Haselden, Chief Financial Officer; and other members of our management team.

Before we begin, I would like to remind you of the company's Safe Harbor language, which I'm sure you're all familiar with. The statements contained in this conference call, which are not historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may differ materially from those projected in such statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC and in the press release issued in connection with today's call.

As a result of the acquisition on March 7, 2011, by TPG Capital and Leonard Green & Partners, the company prepared financial statements last year for the predecessor period from January 30, 2011, through March 7, 2011, and the successor period from March 8, 2011, through October 29, 2011.

Additionally, the company has prepared a pro forma statement of operations for the first 9 months of 2011, giving effect to the acquisition as if it occurred on the first day of the fiscal year and eliminating all transaction-related nonrecurring expense, which can be found in Exhibit 3 of the press release. We refer you to the MD&A and other disclosures in the Form 10-Q for the third quarter of fiscal 2012.

During this call, the company will refer to adjusted EBITDA, which adjusts for items such as noncash share-based compensation, as well as the impact of the purchase accounting resulting from the acquisition. You can find a reconciliation of adjusted EBITDA in Exhibit 5 and 6 of the press release.

With that, I would like to turn the call over to Jim Scully.

James S. Scully

Thanks, Allison, and good morning. For today's call, I will provide a brief overview of our company's progress for the third quarter 2012, and Stuart will walk you through our financials in more detail, after which we'll open up the call to your questions.

We are pleased with the results of our business during the third quarter, which reflect our efforts to deliver high-quality assortments for our customers and the progress we've made on our strategic growth initiatives. At the end of the day, our results are driven by the creativity and innovation of our products, our marketing and the way we service our customers.

Specifically, for the third quarter, total revenues increased 16%, with comparable company sales increasing 10% and direct sales increasing 13%. Our gross margin increased 520 basis points to 47.3%. If we exclude the impact of purchase accounting from last year, gross margin increased 410 basis points, driven primarily by merchandise margin expansion, as well as buying and occupancy leverage.

Our adjusted EBITDA totaled $99 million in the third quarter this year, which is an 18% increase versus the same period last year.

Our third quarter results reflect a strong response to our fall offerings and the impact of the ongoing strategic investments in our business. The third quarter included the launch of our standalone factory.com website, our first physical presence outside of North America through our collaboration with Lane Crawford in Hong Kong and the continued expansion of our Madewell concept.

We also announced yesterday the signing of the lease for our Regent Street store in London, which will open during the fourth quarter of 2013. This will be our first store outside of North America.

I would also like to take a moment to acknowledge the incredible effort made by our associates across the company to restore operations on Hurricane Sandy. While we were all inconvenienced to some extent, we are thankful that none of our associates were harmed during the storm. While we sustained some property damage and temporary closures to our affected stores, we believe the impact of the storm will not have a material -- will not be material to our fourth quarter results.

I would now like to turn the call over to Stuart to review our financial results in more detail and provide the outlook for CapEx for the year.

Stuart C. Haselden

Thanks, Jim. I want to provide a little more detail on the impact of Hurricane Sandy to our operations. We sustained personal property damage in 3 of our stores, one of which will remain closed indefinitely, and also experienced temporary closures in 131 additional store locations for time periods between 1 and 14 days. While this obviously affected our business in November, we believe the impact for Q4 will not be material, as Jim mentioned.

Turning to the details for the third quarter. Total revenues increased 16% to $556 million. Total comparable company sales, which include sales from stores opened at least 12 months, direct sales and shipping and handling revenues increased 10%. Our store sales increased 17% to $392 million, with net square footage growing 8% in the third quarter, driven by 32 net new store openings in the last 12 months. This includes 16 new stores in the third quarter of this year.

Direct sales increased 13%, which includes our J. Crew factory and Madewell direct businesses. Gross profit for the third quarter was $263 million. Gross profit margin increased 520 basis points to 47.3%. Last year included $6 million in inventory step-up amortization as a result of purchase accounting. Excluding this item, gross margin increased 410 basis points, driven by 300 basis points of merchandise margin expansion, coupled with 110 basis points of buying and occupancy leverage. Our merchandise margin improvement resulted from higher full-price sell-throughs, driving lower markdowns versus last year.

Turning to SG&A expenses. SG&A increased to $189 million or 33.9% of revenues versus 30% last year. Last year's SG&A included the benefit of $4 million in transaction-related net insurance recoveries. Excluding this item, SG&A as a percent of revenues increased 320 basis points from last year. This increase is related to an $8 million year-over-year increase in share-based and incentive compensation and strategic initiatives.

Adjusted EBITDA, as outlined in Exhibit 5 of our press release, for the quarter was $99 million as compared to $84 million last year, with EBITDA rate increasing to 17.8% of revenues versus 17.5% last year. Net interest expense for the third quarter totaled $24 million, which compared to $25 million last year.

Turning to key balance sheet highlights. Cash and cash equivalents were $196 million at the end of the third quarter, and total debt was consistent with last year at $1.6 billion. Our inventory balance was $349 million at the end of the third quarter compared to $292 million at the end of the third quarter last year.

Inventory increased 19% or 11% on a per square foot basis. We are comfortable with our inventory level and composition as we enter the fourth quarter.

Capital expenditures for the third quarter were $34 million. We expect capital expenditures to total approximately $135 million for the full year of 2012. This reflects key expenditures to support our growth initiatives, including 45 new stores, information technology enhancements, warehouse and corporate office expansion and store renovations.

We are pleased with the performance of our business in the first 9 months of the year, and we believe we are well-positioned as we enter the holiday selling period. We remain focused on delivering the best product and service we can for our customers and are excited to continue making progress on our strategic initiatives across all channels of the business.

Operator, we would now like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of William Reuter, Bank of America.

Spenser Samms - BofA Merrill Lynch, Research Division

This is Spenser, actually, in for Bill. I appreciate you taking my questions. I was wondering if you could talk about -- talk broadly about the promotional environment and whether or not this is kind of in line with your expectations and if it's maybe more promotional or less promotional than last year?

Allison C. Malkin

Well, for the third quarter, it was really sort of a nonissue, that promotional environment in Q3. Is that what you're speaking about?

Spenser Samms - BofA Merrill Lynch, Research Division

I mean, I guess, in third quarter and then I guess with the Thanksgiving Day weekend behind us, if you could, I mean, I guess, any commentary you'd be willing to provide?

Allison C. Malkin

Well, with the Thanksgiving weekend, we've been happy so far with the reaction to our product in Q4, including our Black Friday and Cyber Monday results. As far as our promotional posture for Q4, honestly, we're relatively the same position to last year. So we don't really expect it to get any better or less promotional than last year, and really, the only difference would be our efforts to create a more seamless experience for our customer online and in-stores with regard to the promotional time periods and events. And as far as the external environment, I mean, I think it's pretty promotional out there. I think you can sort of see for yourself. I don't think that's getting any better. I think that will continue to probably get more challenging as the course goes on.

Operator

Our next question is from the end of Carla Casella from JPMorgan.

Paul Simenauer

This is Paul Simenauer on the line for Carla Casella. Could you first -- could we talk about mall traffic trends, specifically the trends between outlet malls and regional malls?

Stuart C. Haselden

So we don't disclose the KPI specifically. But I can tell you that the traffic that we've seen has been probably flattish year-over-year. And we're not that dissimilar to, I think, what the broader market has seen. Certainly, the shock of Sandy in the Northeast had an impact on traffic in this part of the country. But I guess, what I'm getting at is traffic is not driving our business, not driving these results.

Operator

[Operator Instructions] Our next question is from the line of Karru Martinson of Deutsche Bank.

Karru Martinson - Deutsche Bank AG, Research Division

You guys recently amended your credit agreement. I was wondering if you could walk us through the rationale for the amendment and the outlook for the capital structure?

Stuart C. Haselden

Sure. The amendment to the ABL was really to take advantage of where debt markets are right now. It was aimed at improving our cost, the cost of our capital structure. And so the ABL was able to help us reduce our pricing for loans under the ABL, as well as the fees related to the unused commitments. So those -- that was really the primary purpose for the amendment to the ABL, just taking advantage of where the market is. And in terms of our broader capital structure, it's -- other than that amendment, we're comfortable with where the capital structure is.

Operator

Our next question is coming from the line of Jordan Hughes of Goldman Sachs.

Jordan Hughes - Goldman Sachs Group Inc., Research Division

Just one question on SG&A. It's up about 320 basis points. I know some of that was stock-based comp. But can you talk more about the strategic initiative spend you made during the quarter and if that's something we'll see going forward?

Stuart C. Haselden

Yes, Jordan, it's Stuart. So as we've said on some of the earlier calls, we do see some pressure in SG&A as a result of some of these strategic initiatives. Some of the ones that I mentioned, to call out, would be the investments we're making in our direct business, both from an infrastructure standpoint and as well as the technology itself. And the factory.com launch earlier in October is a good example of that. Other things that are noteworthy from an investment standpoint, international expansion, certainly, as we are exploring and expanding our capabilities to pursue these international opportunities, there are investments that come along with that. So that's only the part of the picture. And then lastly, marketing. We've made significant investments in our marketing programs, not only in just advertising -- it's very visible externally -- but also in customer analytic capabilities. So we think that's an important driver of our business across all our channels. So I think those are really some of the key things I point to, to help get some color number strategic initiatives.

Operator

At this time, there are no further questions. I'd like for back to management for further comments.

Stuart C. Haselden

Well, Jim, thank you for joining us today. And we look forward to speaking with you when we report our fourth quarter results and for the full year in March. Thanks.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation.

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