Express Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: Express, Inc. (EXPR)

Express (NYSE:EXPR)

Q1 2013 Earnings Call

May 30, 2013 9:00 am ET

Executives

Marisa Jacobs

Michael A. Weiss - Chairman and Chief Executive Officer

David G. Kornberg - President

Dominic Paul Dascoli - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer

Matthew C. Moellering - Chief Operating Officer and Executive Vice President

Analysts

Paul Alexander - BofA Merrill Lynch, Research Division

Betty Y. Chen - Wedbush Securities Inc., Research Division

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

Jay Sole - Morgan Stanley, Research Division

Thomas A. Filandro - Susquehanna Financial Group, LLLP, Research Division

Janet Kloppenburg

Rebecca Duval

Roxanne Meyer - UBS Investment Bank, Research Division

Danielle McCoy - Brean Capital LLC, Research Division

Marni Shapiro - The Retail Tracker

Operator

Greetings, and welcome to the Express Inc. First Quarter Fiscal 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Marisa Jacobs, Vice President of Investor Relations. Thank you. You may now begin.

Marisa Jacobs

Thank you. Good morning, everyone, and welcome to our call. I'd like to open by reminding you of the company's safe harbor provision. Any statements contained in this conference call, except those containing 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 suggested in those forward-looking statements due to a number of risks and uncertainties, all of which are described in the company's filings with the SEC, including today's press release.

With me today are Michael Weiss, Chairman and CEO; David Kornberg, President; Matt Moellering, Executive Vice President and COO; and Paul Dascoli, Senior Vice President and CFO.

I'm going to turn the call over to Michael now to speak with you about our recently completed first quarter and our priorities to the balance of 2013. When he completes his remarks, David will focus on some of our products initiatives, and Paul will cover our first quarter financial performance, as well as our second quarter and full year 2013 outlook. We will then turn to Q&A before concluding the call.

Michael A. Weiss

Thank you, Marisa, and good morning to everyone joining us on this call. I'm sure that most of you have already seen the press release we issued early this morning. It's nice to open the call by noting that our business performed well. We navigated through some tough external factors by delivering strong product driving sales through the use of effective promotions and managing expenses well. It has enabled us to come in at the high end of our guidance.

Start of the quarter, we knew we faced headwinds driven by higher payroll taxes and delayed tax refunds, which led to less disposable income for our customers. At the same time, that usually unusually cold weather in several regions of the country led in some places to the spring that wasn't. Those of you who were following us last year know that Q1 was our strongest quarter of the year and the one that represented the toughest comps to go up against. The Q1 guidance we provided in March was developed on the basis of our actual performance in February and early March, coupled with our expectations for the balance of March and all of April. Traffic had been weak leading up to the call and we weren't sure how customers would respond to having less money in their wallets.

In addition, the Easter shift meant we would lose the extra build week that occurs when the holiday falls several weeks after spring break. In any case, we capitalized on the natural traffic surge that did occur when Easter came and used the same strategy employed during Thanksgiving. Once again, it proved very successful. Our clear promotional message of 40% off drove significant business. And because we, again, elected to take off all other promotions and disallows CRM coupons in contrast to last year's Eastern event, when they were accepted, we did not unnecessarily forfeit margin dollars. Once we got past Easter, we naturally expected the weather to improve steadily so the normal spring build would begin.

When this did not play out as expected, we elected to get more promotion to drive traffic and to remain competitive within the mall. This tactic worked and enabled us to turn in results that are at the high end of our guidance. So I'm pleased to report that even in the face of challenging traffic trends, net sales increased 3% and our comp sales for the quarter were flat to last year. Our diluted EPS came in at $0.38 at the high end of our guidance. What we accomplished in the face of these challenges is a testament to the talent of the Express team.

When Paul speaks to you in a few moments, he will touch on other aspects of our Q1 financial performance. I would focus the balance of my remarks on how we operated during Q1, the progress we are making with our growth pillars and the initiatives we will be emphasizing during the balance of the year. As a reminder, our growth pillars include increasing sales productivity, expanding our store base, capitalizing on our e-Commerce opportunity and increasing our international presence.

As I think about our sales productivity, I'm confident that we can drive improvements because of our product, to me represents one of our strongest collections in years. David will do a deeper dive on this, but I believe that our spring offering, both in the stores and online, really hit the mark and that we are successfully presenting the major trends driving our Women's and Men's businesses.

And as I look at our May and June receipts, I think we look great and I'm extremely confident about these items as well based on our current momentum. We're introducing differentiated products that combines great design with high-quality production to reinforce the best of the Express brand. As the stores continue to improve, productivity will in turn begin to build. We're not yet back to our peak levels for some metrics, but it feels great to be moving in the right direction. So as you've probably seen, our second quarter guidance calls for comps to be up mid-single digits and for our diluted EPS to come in at $0.17 to $0.21.

I also want of acknowledge the significant improvements we have been seeing in our Canadian stores, which are currently delivering strong double-digit comps. We have been on the path to parity pricing there for some time now and we have finally completed those efforts so that every item in our Canadian stores is priced at par with its U.S. counterpart and with online products, something that becomes very obvious to customers looking at pricing online.

We've also begun to work with some new logistics partners, whose pricing structures are enabling us to offer parity and shipping charges from e-Commerce orders. We know that our neighbors in Canada appreciate the opportunity to shop at our stores in their own neighborhoods instead of traveling across the border and the fact that their shipping charges are consistent with those being paid by our U.S. customers. New store openings will continue during 2013 in both the U.S. and Canada, 16 locations were identified at the beginning of the year and so far 3 have been opened, one of which is in Canada. We've created a new table in our press release, schedule #4, which lays out a variety of real estate details. We hope you find it easier than trying to take notes on all of this during our call.

Let me move on to the subject of our 2 flagship stores. It's exciting to be able to report that we finally took possession of the San Francisco site in mid-May. Now that we are in control of the property, I'm comfortable telling you that barring any unanticipated delays the store should be open in time for 2013 holiday. In terms of The Times Square store, the landlord is continuing the work he has to complete joining together the 2 adjacent properties, before he can turn the site over to us. We continue to believe that a Spring 2014 opening is realistic.

In March, I spoke about another area of real estate focus that we consider to be important. What I refer to as winning hub locations. My specific words were that we were moving quickly to enhance our presence at these winning hub locations. It's an important way for us to build sales, promote the brand and introduce Express to new customers. Or said another way, we believe it is essential to maintain an important presence in top-volume malls to remain competitive with the newer players, who are opening compelling stores in these locations.

As the retail landscape shifts, we must be able to do big business where big business is being done. And we are doing that. As noted previously, at the San Francisco center, we took additional space, which has just about doubled our square footage there. And a few weeks ago, we moved out of our original location at the Las Vegas Fashion Show Mall and into a space that is more prominent, 50% larger, and which boosts our presence within that mall. The store has only been opened a few weeks, but it is far exceeding our expectations. In July, we're on track to do the same thing in Dadeland and we're expecting to see a nice boost there as well.

Another new initiative mentioned upon our last call related to domestic outlet stores. We've made progress on that front and remain excited about the potential. We recently hired a Vice President of outlet stores, who is expected to start shortly. His first priority will be to refine our strategy and develop a comprehensive business plan and operational roadmap for this important initiative.

I do, however, want to remind you that our guidance for the full year excludes the impact of any expenses associated with the development of this business. Our e-Commerce business grew by 48% in Q1 on a reported basis. We've invested in this area over the past year to improve its site performance and experience and it's paying off in the form of higher conversion. The move to free shipping on orders over $125 also accounts for a portion of the sales growth. The beauty of this business is that we can continue to offer combination of product that is in the stores and supplemented with additional product without space constraints.

For example, men's and women's swimwear is only offered online. In categories such as men's suits and underwear and women's dresses, styles offered in the stores are supplemented by additional styles we only offer online. On the international front, our guidance calls for our existing franchisees to open between 13 and 16 new stores this year. We remain on track to do so. In addition, we are continuing to evaluate opportunity to add franchisees in new markets.

One final international comment, although it's related to external events. The building collapse in Bangladesh was a horrific tragedy and something that we all hope will never be repeated. As many of you know, most of our product is made offshore in a variety of different countries. However, we are not manufacturing product in Bangladesh.

In conclusion, as I look at 2013 as a whole, I believe that we have put the missteps of 2012 behind us. We learned valuable lessons, applied those learnings and are moving forward. There is no doubt in my mind that the product in our stores now and what is coming in represents some of the best product we have created in quite some time. We are definitely moving in the direction -- in the right direction and along with the entire management team, I believe the business is on firm footing.

With that, I'll turn the call over to David.

David G. Kornberg

Thank you, Michael. Good morning, everyone. We just wrapped up another big weekend. For Memorial Day this year, we started our sale one day later and went to 40% off with no additional promotions or CRM. I'm happy to report that it worked very well. It was clean and simple to understand compared to the variety of different logo and percent of offerings that we used last year. We view the margin dollars generated over the holiday weekend as an important measure of success and we saw a significant year-over-year uptick in that metric.

Turning now to Q1 and what worked and what didn't. The overall picture is one that I'm very pleased with, especially if we take into account the environment in which we were operating. From an operational standpoint, we have made real progress and inroads to executing our good market strategy, especially on the women side of the business. We are getting more and more forethought in terms of our approach to identifying key items that can be nurtured into something much bigger than originally estimated. And conversely, are moving quickly to clear out the things that aren't working.

In terms of product, it's clear that we have fixed the women sweater business with sales and margin coming in at levels that beat last year. Sales of our woven tops grew as well. And of course, you all know by now that one of the key drivers in that category is the Portofino shirt. This is a great example of the kind of key items that can be built in something of real significance. In addition to constantly flowing in new colors and prints, we've introduced the sleeveless Portofino and we'll keep maximizing the potential of this soft fabric. We achieved this remarkable growth by chasing this item to get product into our stores quickly and by building out the variety and depths of our offering. This illustrate the importance of teamwork. For example, our production team capitalized on our long-standing relationships with manufacturers willing to go the extra mile when opportunity presents itself. They partner together to deliver huge quantities of an item that is in demand and successfully maintain the garments high-quality. This is a good example of how we can build a strong future for the brand.

Mid tops have turnaround as well, especially our casual mid top assortment. As we shifted more in price points, our overall AUR have come down a bit. At the same time, we've taken our prices on some items, including some of our knits and dresses without dampening demand, demonstrating the power of the brand when the product is right. In terms of specific products, our peplum tops, for example, are amongst the strongest out there. Our bra camis continue to grow and our pocket and crop tees are all exactly right for the moment. In dresses, we have a number of popular styles and our fit and flow dresses in particular, are something that girls clearly love.

As we move into summer, I'm seeing the fit and flare silhouette getting even stronger. And as fall approaches, we are adopting it accordingly. Many of these looks fall on the casual side where there is no doubt in my mind that our offerings has improved dramatically since this time last year. Dressing and tops are category where we still have room for improvement. And with new tested receipts starting to flow in, I see real opportunity there in Q2 and beyond.

Pants and denim for women are continuing to do well, but our skirts are still lagging behind. As you would expect, we're keenly focused on this. With respect to denim, indigo with different washes and depth destruction are doing well. We now have many different fits and lengths, including crops, ankles and leggings. Part of our inventory build relate to ensuring that we have the right depth in this key category as we head into summer and the back-to-school period.

Once again, the Men's business outperformed the prior year's comparable quarter. Suits and jackets continue to be standout categories, delivering substantial growth and carries some of our highest AURs. I'm sure, based on Michael's comments, you won't be surprised to hear me say that sales of shorts were down year-over-year in the first quarter.

We've heard a lot of questions about our ability to comp the colored bottom trend that was so important last year and the short answer is that we managed to do it and deliver gains in both the men's and women's denim and casual bottom categories. We anticipated the decline in interest in men's colored bottom, but we didn't get the timing quite right and found ourselves somewhat over-inventoried in that area on the men's side of the house. We've taken the necessary markdowns and have cleared through most of that inventory. But that is a primary reason why the units in our Q1 box sale were up over the comparable sale period last year. We expect to clear through the balance of this inventory in Q2 and we have incorporated this expectation into our guidance.

From a brand building perspective, the first quarter was exciting and the same can be said about the early part of Q2. Fashion Star, the NBC TV show we discussed with you in March, provided us with wonderful visibility. We've already had over 1 million hits to the Fashion Star page on our website and more than half of those visitors were new to Express. Those hits in turn drove sales, not only of the Fashion Star product but of the Express product. The best part is that over half of those purchases were made by first-time Express buyers, so it also led to an expansion in our customer base. We also received great publicity on NBC and lots of related media coverage.

Certainly, apart from Fashion Star, we held an exciting denim event in New York City. We created a denim lab to profile the breadth of our men's and women's denim collection. Over 100 editors, stylists and related fashion personnel attended. And based on the great feedback we received, we have to secure some very visible editorial coverage in the fall fashion press. This kind of coverage is great on 2 fronts. It reinforces the relevance of our brand to existing customers and stirs other shoppers to check us out and, hopefully, become loyal customers themselves.

Let me conclude with a few forward-looking observations. We are all energized by the results we're seeing from the new and reordered product in our stores. In terms of what's in the pipeline, what Michael said bears repeating. We ended the second quarter with reorders flowing in on some of our best items that we have seen in a while, including key items where we can drive real volume. We're also flowing in new items that tested very well and which represents relevant, exciting fashion.

Our focus on testing will continue, of course, and we believe we have identified the right styles to test in Q2 for holiday this year versus last year. We are also planning to expand into 2 new merchandise categories, including the reintroduction of casual lounge wear, which based on its past strong successes should do very well both in stores and online.

The quality of our product continues to be strong. And when we combine great fashion with great quality, we offer our customer a truly compelling value proposition. We're taking an aggressive approach to driving the business forward and I look forward to updating you on our progress when we speak again in August.

With that, I'll turn the call over to Paul.

Dominic Paul Dascoli

Thank you, David. Good morning, everyone. Let me begin by reviewing our first quarter performance, then I'll turn to our second quarter and full year 2013 guidance. As you have already heard from both Michael and David, we approached the first quarter cautiously because the external unknowns that would ultimately affect our performance were more significant than normal. And in the end, we were quite pleased with our performance and our ability to achieve the high end of our guidance.

Macroeconomic environment is still challenging, but we have made significant internal progress and put last year's problems behind us. Our net sales for the first quarter totaled $509 million, a 3% increase over last year's first quarter. Once again, our growth in e-Commerce is extremely strong, with a 48% increase year-over-year it grew to $71 million representing 14% of the business.

Our comparable sales were flat, following a 4% increase in last year's first quarter. As you already know, our gross margin did decline. Specifically, gross margin was 33.6% of our net sales, down 450 basis points from the prior year's 38.1%. This reflects pressure on both our merchandise margins and buying on occupancy expenses.

Our merchandise margin declined 240 basis points when compared to the same period last year. Our initial plans for the quarter called for certain promotional activity, such as our Easter event, which Michael already spoke about. This promotion worked very well. Just as we reported, when discussing our Thanksgiving promotions, we drove significant margin dollars that contributed to the achievement of our comp and EPS guidance.

Given the difficult retail environment across the industry, we also have layered in some additional unplanned promotions to drive traffic and remain competitive. We also offer deeper discounts on some distressed merchandise during our Q1 sale to optimally liquidate our remaining positions. These actions depressed our merchandise margins, but enabled us to end the quarter with a cleaner inventory position. It's important to note that our comp performance improved as the quarter progressed, that the elevated promotional levels have not been required as we enter the second quarter.

Buying and occupancy expense increased by 210 basis points, in line with our discussion in March. We incurred approximately $4 million of incremental pre-opening rent expense associated with our Times Square and San Francisco flagship locations. The balance of the increase related primarily to incremental cost associated with e-Commerce fulfillment and the lack of leverage caused by flat comps.

Our overall SG&A expenses fell minimally to $113 million from $114 million in last year's first quarter. As a percent of sales, SG&A dropped to 22.1% versus 23% last year, a 90 basis points improvement. Operating income was $59 million or 11.5% net sales. This compares to $75 million or 15% of net sales in the first quarter of 2012. Unfortunately, the impact of our promotional activity and B&O pressure outweighed the gains made under net sales and SG&A lines. As you can see from our guidance, however, we expect these pressures to ease as the year progresses.

Income tax expense was $21.2 million, representing an effective tax rate of 39.6% compared to $27.9 million and an effective tax rate of 39.9% in the prior year's comparable quarter. Net income from the first quarter was $32 million or $0.38 per diluted share, an 85.5 million diluted weighted average shares outstanding. This compares to net income for the first quarter of 2012 of $42 million or $0.47 per diluted share on 89.3 million diluted weighted average shares outstanding.

Turning to our balance sheet. We remain in a very strong financial position. Cash and cash equivalents were $244 million at the end of the quarter and our revolving credit facility remains untapped. Our long-term debt at the end of the quarter was $199 million, virtually unchanged from last year. As I've said before, we regularly discuss with our board the best deployment of our cash. Investment in the business remained our top priority, since we believe that our 4 pillars of growth represent excellent investment opportunities along with our recently announced outlet strategy. With 6 months remaining, we also have $35 million of our $100 million repurchase authorization still outstanding.

Our capital expenditures during the quarter were approximately $17 million flat from last year. As expected and planned for, our total inventory increased compared to the end of last year's first quarter. We ended the quarter with $226 million of inventory, up 13% from the same time last year. The calendar shift due to last year's 53rd week accounted for approximately 4% of that increase. On a per-square-foot basis, inventory on hand was 6% higher than last year.

The primary reasons for the increase are the build to support our higher sales plan and our targeted inventory build in certain key categories, as discussed on our last call, we are investing in higher denim inventory levels. We're doing this to ensure that we can keep our denim walls filled year-round to remedy current issues of size breaks and to ensure that the customer views us as an authority in denim. We're also building inventory in certain key items, like the Portofino shirt, to support the sales growth we're experiencing. And we're doing this without taking significant dollars away from other categories, since we don't want to give back the increases were getting from strong performers elsewhere.

I'd now like to turn to our guidance for the second quarter and the balance of the year. You may have noticed that we've changed the format of our press release to include some additional guidance metrics and to present it in a table that, I believe, you will find quite easy to read. Our expectations for the second quarter are for comparable sales to grow in the mid-single digit range. This compares to a positive 1% comp in last year's second quarter. We expect net income to be in the range of $15 million to $18 million, or $0.17 to $0.21 per diluted share on 85.6 million diluted weighted average shares outstanding.

We expect a modest decline in our gross margin during the second quarter compared to last year. Merchandise margins are expected to be relatively flat compared to last year's second quarter, as the incremental promotional activity we discussed earlier has abated. Our buying and occupancy expenses will once again include an incremental $4 million associated with the flagship stores. This translates into approximately $0.03 per share. This will be the last quarter experiencing the full incremental load of the noncash rent expense. In the third quarter, this amount begins to anniversary, since the incremental expense falls to $1.2 million, then in the fourth quarter it will be flat compared to last year.

SG&A as a percentage of sales is expected to remain relatively flat compared to last year's first quarter. In terms of full year 2013, we expect comparable sales to increase in the low-single digit to mid-single digit range, an improvement over the flat comps delivered in 2012. We have taken our full year net income guidance up to $127 million to $135 million, which translates into diluted EPS of $1.48 to $1.58, which includes the $9.2 million of incremental pre-opening flagship rent expense, approximately $0.065 per share.

Just as a reminder, the guidance we provided in March was for net income in the range of $120 million to $132 million or diluted EPS of $1.40 to $1.54. These changes reflects the fact that our first quarter came in at the high end of our guidance and that we now anticipate a stronger second quarter than contemplated when we first introduce our full year guidance. The EPS calculation is based on an estimate of 85.7 million diluted weighted average shares outstanding.

In terms of our real estate portfolio for 2013, please see our new schedule for the press release. We've laid out our domestic and Canadian plans for Q2 and the full year. Our expectation for capital expenditures during 2013 remains unchanged from the guidance we gave in March and is estimated to be between $110 million to $115 million. The increase over 2012 spend is primarily driven by the incremental cost of preparing the flagship locations.

That concludes my comments. I'm going to turn the call back over to Michael for his closing remarks.

Michael A. Weiss

Thank you, Paul. By now you certainly know that we are feeling very good about the business. We began the second quarter with product that has tested very well and that our customers are responding to in a very positive way. Conversion is up and as I have said repeatedly, I view this as an important leading indicator.

The merchandise in the stores now is undoubtedly better than our inventory at this time last year and we are positioned to capitalize on that -- on this opportunity. We delivered and will continue to deliver the newness in quality that differentiates our business, that will drive the business forward and, over time, enable us to exceed our peak performance level.

Before wrapping up, I want to thank each of you for your continued support of and interest in Express.

Operator, at this time please open the line so that we can turn to the question-and-answer portion of the call. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Lorraine Hutchinson with Bank of America Merrill Lynch.

Paul Alexander - BofA Merrill Lynch, Research Division

It's Paul Alexander for Lorraine. Can you guys talk a little bit about how you cut SG&A in the first quarter? What were the areas where you able to pull back and will there be any pent-up or delayed spending that you're going to have to give back in future quarters? And then maybe related to that, could you expand on or clarify what you said about their expectations for the second quarter SG&A rate? Did you say you anticipate SG&A rate to be flat year-over-year in the second quarter? If so, I think that implies high-single digit SG&A growth year-over-year, so what accounts for the major difference between SG&A growth in the second quarter versus the decline in first quarter?

Dominic Paul Dascoli

So we did say that for the second quarter -- I'll address your second question first, Paul. We did say for the second quarter, that we would expect SG&A on a percent of sales to remain relatively flat. If you look at some of the increases in spending, we have some increases in our IT budget, as we've been working on the implementation of some new systems within our business. We also, as you know, had, last year, really held back in terms of adding any headcount into the organization. We're beginning to fill some positions that support our pillars of growth, specifically on the international side of the business, as well as on the e-Commerce side of the business. We've been very, very disciplined in terms of our headcount in those areas. So those are a couple of areas that will be driving some of the increase. Year-over-year, marketing is remaining relatively flat. We actually did not cut our SG&A that significantly in Q1. When you look at what we said in the script, we are -- SG&A on a dollar basis was relatively flat at about $113 million versus $114 million last year. We had increases in certain pockets and general decreases in others. We have been talking, for the last 12 months, about remaining very disciplined in terms of the control of our SG&A expenses. One thing that did decrease year-over-year, of course, was our incentive compensation expense, as you would expect, because our business hasn't performed to the level of the previous year. So our incentive compensation accrual was certainly less this year in the spring season than last year, so that impacted SG&A spending. But overall, we did not do anything that we felt would hurt the business long term. And on a full year basis, we would expect SG&A to approximate last year on a rate basis. So we -- here again, we shouldn't see anything that's going to creep up unnaturally in the balance of the year.

Operator

Our next question comes from the line of Betty Chen with Wedbush.

Betty Y. Chen - Wedbush Securities Inc., Research Division

I was wondering, perhaps this might be for either for David or Michael, in terms of the product, it really sounds like there were several different key items that worked during the quarter. Is it fair to say that they continue to trend well in May, since it sounds like you further invested behind that? And are there some new fashion trends that you could share with us without giving away your competitive secrets? And then I was -- if I could sneak in a second question regarding Fashion Star, that's a terrific exposure for the brand. How long will that show last? And how are you capitalizing on the additional names that you're adding to the file to kind of retain that loyalty?

David G. Kornberg

Okay. Betty, just to start off with. We're very happy with the way in which May has started, it has really exceeded our expectations the first 3 weeks. And in terms of looking at the trends as we are going forward, yes, we -- in terms of looking back, first of all, we have some great key items that drove the first quarter. The best of those key items we brought back into, as I've said, in much greater significant depth in the second quarter. And also, as we look into the beginning of the third quarter, we see some of those trends continuing as is. We see lace continuing to be very important. We see leather trends as being very important. I think the whole athletic and sport influence in women is getting stronger in terms of what we're seeing. And black and white has been very, very good for us throughout the first quarter and we see that continuing as well. In terms of Fashion Star, obviously, we are thrilled in terms of the exposure and in terms of the visibility that we got from that, I think it was really, really great for the brand. In terms of capitalizing on that, obviously, the names that we've brought get added to our list. And we target our list very, very carefully and the approach that we take to e-mails and the way that we market the product. So I think it’s a great advantage for us. Very, very good advantage.

Michael A. Weiss

If I could add just a little bit to that, Betty, because everything David said is really on the money. But what I would include in this is that of the best items that we have, #1 item, as you know, in the summer, spring/summer, is a long sleeve shirt. So an investment in that item really does go forward, even though we bought it to promote heavily in Q2. What we're receiving now are forward fall colors. And we feel that our best single item in the business will cost us almost no more of those. Secondly, all the other items that we've reordered heavily because of tremendous good reaction in Q1 and are now receiving, such as the dresses, such as certain cut and sew tops, all were viewed as being great promotional items for the month of June and July. So we're pretty confident in what we brought in additionally.

Operator

Our next question comes from the line of Neely Tamminga with Piper Jaffray.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

So a question for you on the currency of the inventory, if I may. I get the whole investment, levels of the denim side overall, but just allay any specific concerns. Can you talk a little bit about your spring carryover as you head into the summer months this year versus last year? And then I just have one follow-up after that.

David G. Kornberg

Neely, it's David. Very, very comfortable in terms of the way our spring carryover looks going into the Q2 sales and in terms of the numbers. And I think that everything that we put in there is taking into accounts in terms of our guidance.

Matthew C. Moellering

Yes. This is Matt. On top of that, I'd add simply that, as we've talked about the denim, we're basically building the seasonal denim product which has very little risk associated with it. We believe it'll provide some sales upside in the back half of the year because we have gotten feedback that we are broken in sizes and we do want to make sure that we're projected as the denim authority in the store. So we think that's a big positive. And given the momentum of the business we're seeing in the last month, 1.5 months, we feel it's appropriate now to go become a little offensive and make sure we are in the position to capitalize on the great fashion that we have put in the stores and that the customers are reacting to. So I feel very good about our positioning.

Michael A. Weiss

I think and another important point, Paul did mention it, but I would repeat it, Neely, is that we have purchased so much of our biggest key items, that unless we took a big part of that at additional inventory, we would have to obliterate other departments and our net gain would not have been anything. So we did take a shot on that, mostly because of what I just said, but also because we felt a shot on was safer considering it was a shirt that goes into fall.

Neely J.N. Tamminga - Piper Jaffray Companies, Research Division

So that's really helpful. And then just one quick follow-up here on the loyalty program. Just wondering if you guys can share with us, particularly as it relates to in-store conversion that you guys have completely nailed and very, very encouraging, how much of the loyalty program play into that specifically and do you have any updates around the metrics of your program?

Dominic Paul Dascoli

It certainly played into it, Neely. We continue to see many repeat purchases from people who are in our loyalty program. I think what was really good too, over the Memorial Day holiday, is tracking that metric, we were also able to see a significant number of new customers coming into our stores also, as a higher percent of sales over the Memorial Day holiday were driven by our customers that are not necessarily connected to the program. So on an ongoing basis, it's very, very good for us. We continue to use it for targeted marketing. But at the same time, we see evidence that new customers are coming into our store and getting introduced to the brand, as well, and that's pretty exciting.

Operator

Our next question comes from the line of Jay Sole from Morgan Stanley.

Jay Sole - Morgan Stanley, Research Division

I just had a question about the merchandise margins. Can you -- you talked a lot about in the script about why the merchandise margins were down. Can you maybe provide more color on what the Easter promotion, what percentage of merchandise margin was down because of Easter promotion or what items were promoted? Was it warm weather items that didn't sell that weren't promoted or was it something else? And what's the opportunity to recover those margins in 1Q next year?

Dominic Paul Dascoli

So it's really -- first and foremost, it was the general environment and us having to add promotions beyond what we had planned when we talked about our first quarter guidance in our last conference call. We had planned the 40% off promotion for Easter and it did what we expected it would do. It capitalized on that natural traffic in the stores -- in the malls, excuse me, and it drove significant amounts of gross margin dollars for us. As we get further into the season, we needed to promote more to remain competitive in the mall. And really, there were some products that weren't working real well for us that we had to promote a little bit more, as Matt indicated, in our box sale. For instance, some of our men's colored denim was not performing as we had expected and we had a few casual knit tops that weren't performing as we expected. So we promoted them at a deeper discount. So really, it's -- there were products in both the warm weather, as well as other products that we had to promote a little bit deeper than originally expected. David, I don't know if you have anything else.

David G. Kornberg

I think it's very clear. I think that, just to repeat what Michael said, as we go forward into the second quarter, the items that we have reordered are of significant margin, they are proven in terms of their sale. And we believe that they can drive a significant amount of volume. So we're very encouraged in terms of the position that we're at as of today.

Dominic Paul Dascoli

And we do expect that we'll be able to recover some of that margin. Obviously, we said that merchandise margin was going to be relatively flat quarter over -- this quarter compared to last year, in the first quarter we were down 240 basis points. So we do believe the strength of the line, as well as the -- what we're seeing in the marketplace right now in terms of promotional activity will allow us to start recovering some of that margin on a rate basis.

Operator

Our next question comes from the line of Thomas Filandro with Susquehanna.

Thomas A. Filandro - Susquehanna Financial Group, LLLP, Research Division

So my question, first, is for David. David, can you be a little more specific on the AUR contraction comment that you made related to the opening price point strategy? And how should we think about that impacting the business go forward? And then the second part of that or third part of that, I would say is, can you help us understand what percentage of the mix and/or sales is moved into these opening price point categories?

David G. Kornberg

Okay. Tom, thank you. I expect to see AUR remain flattish. And really, with promotional activity probably are baking in to the second quarter. I, in terms of its percentage total of the mix and sales, I think, you know what, opening price points are very important in certain departments. But as we've said, in the past, our best item this season is an item which is not an opening price point item, it's ticketed at $49.90 in terms of the Portofino shirt. And some of our successes, in both men's and in women's, are the higher price points as opposed to the opening price points. I think the opening price points are very important as an entry point into the brand, but I don't see them being a major part of the mix as we go forward. And as we've always said, we have no desire or interest to be the cheapest out there.

Thomas A. Filandro - Susquehanna Financial Group, LLLP, Research Division

Excellent. And one quick follow-up, if I can. I think you noted that sales and margin performance of the Women's business was up over last year. Can you kind of the give us a sense of how much room there is to expand the Women's business maybe on terms of productivity and/or margin, maybe compare it to the Men's possibly?

David G. Kornberg

I think there is opportunity, clearly, in terms of the Women's business as we go forward for the balance of the year. As you know, the business, as it went into Q2, back end of Q2 and also into Q3, was a lot worse for wear last year. And I think that we've got opportunities in both productivity in terms of merchandise margin to make improvements. So yes, I see that Q2 and Q3 are definitely an opportunity for us from that standpoint.

Michael A. Weiss

I think the other thing to acknowledge in those terms is that 2 of our most important categories in Women's, which are cotton-sewn knitwear and sweaters, were the 2 categories that we've had the most problems with last year. So clearly, they present, not just category opportunities, but major volume opportunities. So we do feel a bit more secure in the ability for the Women's business to grow.

Operator

Our next question comes from the line of Janet Kloppenburg with JJK Research.

Janet Kloppenburg

I just wanted to ask a couple of questions. First, Paul, if could clarify on the SG&A ratio for the second quarter, is it to be flat on a ratio basis to last year's quarter? And David or Michael, I'd love to hear what's going on in sweaters. It sounds like it's performing well right now, but I'm also interested in the test because I think that will be very important for the third quarter. And in terms of your comp guidance for the second quarter, a 2-part question. Does that reflect the current trend and is there any benefit to the calendar shift at the end of July this year incorporated into your guidance that may be at the expense of the third quarter?

Dominic Paul Dascoli

So Janet, to clarify SG&A, yes, on a rate basis, we expect it to be flattish, potentially slight improvement on a rate basis. But as we said, flattish on a rate basis compared to last year. I'll address the -- the comps, of course, do include the current trends that we're seeing in the business that we've experienced as we've entered the month of May. It does not anticipate any significant calendar shifts that would impact how we would guide or what we would expect as we get into Q3.

David G. Kornberg

Going to sweaters, Janet, we had a very good first quarter. We obviously saw an increase going into the second quarter. We've seen it get even stronger. In terms of the items, we have big success with our long sleeve sweater in casual. We've had big successes with stripes. We'd have big successes with studs. And also, fine gauge is a much bigger part of the mix this year in Q2 than it was last year. I think we went into heavier gauges too soon at the back end of Q2 last year. And we also had a lot of Lurex yarns in Q2 last year, which was just fundamentally wrong in terms of its timing. So I think we have big opportunity in terms of the balance of the assortment, the mix of the assortment and the price points that we've got going into Q2.

Operator

[Operator Instructions] We do have a question from the line of Rebecca Duval with BlueFin Research Partners.

Rebecca Duval

I was wondering, can you talk to me a little bit about your product extensions and what kind of strengths and weaknesses are seeing those extensions? And as you move on to create the whole lifestyle brand, where the positives and negatives are coming from these? And what kind of effect are they having on your UPTs?

David G. Kornberg

I think I'm very excited about the categories that we've added and developed over the couple of years. We've gone into the personal care business. We've gone into the watch business. And in women's, we've gone into the shoe business in a very sizable way. All of these, I think, are really adding to the brand. And they are obviously adding in terms of the sales that we're seeing. And as we go into fall, we're looking at adding in a casual lounge wear assortment which, as I said in the call, we've been there in the past and it did sizable, sizable volume for us. And that we came out of it when the whole brand was repositioned in 2004 and 2005. And we see a very, very big opportunity in that going forward. So overall, very, very happy in terms of what we're seeing with the addition of the categories that we've added to the brand.

Rebecca Duval

And are you seeing any weaknesses in any particular extension? Anything that's not working?

David G. Kornberg

No, no. No, nothing that will lead to that.

Operator

[Operator Instructions] Our next question comes from the line of Roxanne Meyer with UBS.

Roxanne Meyer - UBS Investment Bank, Research Division

Can you help us appreciate what's been most needle moving for you as it relates to your e-Commerce strategy that's driven your 40% plus growth this past 2 quarters? I mean, obviously, very phenomenal, you're seeing a nice pickup here on top of already strong growth. How should we think about the run rate going forward in this business? And then secondly, just wondering if you could comment a little bit more on the online exclusive part of it? What percent of the mix is it now and what are you targeting longer term?

Dominic Paul Dascoli

Yes. So there's a couple of things, Roxanne, that have helped. One, we have done a lot of work on our front end of our platform and that's still early, early days there. But that has certainly helped the overall customer experience and we'll see that more over the next year as well, which should add additional tailwinds for us on the e-Commerce platform. But a couple of other things that you mentioned, one is online exclusives. Originally, we did not really spend a lot of time and a lot of effort on the line extensions. We are now starting to work into a lot more line extension. Those are proving very beneficial to the customer and to the volume that we're generating online. The second thing is that we also have introduced a much better platform for customers to order in store and receive product online. Those are 2 things. And I'm sorry, the third thing is that we have introduced free shipping with a $125 threshold. One thing to note, that has put a drag of about 30 basis points onto our gross margin and that will continue throughout the year. That's part of the drag that we've seen with our gross margin in Q1. But we should see higher sales and higher profitability associated with that. And certainly, a better customer experience as well. So we've been very pleased with our e-Commerce performance. And we expect to continue to see very strong double-digit growth for the remainder of the year.

David G. Kornberg

I think, Roxanne, the other thing I'd like to add in terms of e-Com exclusives. We are seeing it becoming a bigger part of the mix. As it stands today, it's probably about 5% to 8% of the sales on e-Commerce. But going into the fall, what I'm excited to say is that we're going to be testing a performance active line online and we're also going to put it into a few stores, very small amount of stores, to see how that does. But we see that obviously as a big opportunity. When you look at the size of the growth of the market in women's apparel, a lot of it is coming out of active wear. So we think that that's going to be an opportunity for us. Definitely online, but we're also going to be testing that in stores.

Operator

Our next question comes from the line of Danielle McCoy with Brean Murray.

Danielle McCoy - Brean Capital LLC, Research Division

I was wondering if you could just give us a little bit more color on how you view the outlet potential? What the potential store base might be and if you're looking to do any exclusive product, things along that line?

Dominic Paul Dascoli

So for outlets, what we're doing, we're looking at, for outlets, we're still in the early stages of planning, but we are looking at producing product exclusively for outlets. So made for outlet products. So that will be simpler, but different than our existing product in store. And we see this as a very large opportunity. This could be up to $500 million opportunity over multiple years. So we are committed to executing this, as Michael mentioned. We have higher -- the leader for the online business -- I'm sorry, the outlet business. And we expect to move on this relatively quickly.

Danielle McCoy - Brean Capital LLC, Research Division

Okay. Great. And then regarding that entry-level price points, have you guys seen that really bringing in more of that little bit of a younger consumer or do you think it's more of like an add-on to your target consumer purchase?

David G. Kornberg

I think that entry-level price points in terms of broadening our appeal, I think in terms of the younger consumer, it's the fashion. And it's the approach that we're taking to fashion. So things like crop tees, some of our ankle jeans, et cetera, are really appealing to -- and also graphic tees are appealing to the younger customer. And we're seeing a lot of success in those areas. But really, the entry price points is about broadening the appeal in the brand, as supposed to going after the younger customers.

Operator

Our next question comes from line of Marni Shapiro with The Retail Tracker.

Marni Shapiro - The Retail Tracker

So I have 2 quick questions. One is if you can just parse out at all traffic versus conversion in the first quarter. I'm curious if she wasn't coming in the store, but when she was coming in, she was buying a lot. And then if you can put a little bit more detail around casual lounge. I'm curious what you see this as, because I view this as a big white space in the market and I want to hear what your point of view is on what that space is, what it will look like?

David G. Kornberg

Sorry, can you repeat that last bit, we couldn't hear it clearly, Marni, please?

Marni Shapiro - The Retail Tracker

On the casual lounge, if you can put a little bit of detail around it. I view that area as a white space in the market that no one seems to be attacking. And I'm curious if your point of view on it, is serve a line with where I'm thinking as white space.

David G. Kornberg

Why, I don't know what you're thinking.

Marni Shapiro - The Retail Tracker

When she comes home from work and takes off her editor pants, she should put on something that's not her old college sweat pants, is what I'm thinking.

David G. Kornberg

Exactly. I will let Paul answer the question on traffic and conversion.

Dominic Paul Dascoli

So we started off the quarter, as we indicated, pretty -- it was pretty challenging from a traffic standpoint. It did get better throughout the quarter, but not to the point where we were comping positively to last year. So it was a challenging metric for us. What was positive for us, though, was the conversion. So we worked really, really hard in our stores to secure that sale and work the customer hard at the dressing room and all. And we saw throughout the quarter positive impact in conversion. And also, we saw slight uptick in UPTs for the quarter, which also helped drive our top line.

Matthew C. Moellering

Yes. And that's very positive. To your point, Marni, when people did come in the store they weren't buying. And as Michael mentioned, we view conversion as a forward-looking indicator for the health of the business. When people do come in and buy, they like the products and that gives them confidence in the rest of the year.

Operator

We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comment.

Michael A. Weiss

Thanks for joining us this morning. We look forward to speaking with you in August. Until then, enjoy your summer.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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