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Executives

Joseph Teklits – Investor Relations of ICR, Inc.

Robert N. Fisch – Chairman, President and Chief Executive Officer

Keith A. McDonough – Senior Vice President and Chief Financial Officer

Kim A. Reynolds – Senior Vice President and General Merchandise Manager

Analysts

Stephanie S. Wissink – Piper Jaffray, Inc.

Paul Lejuez – Wells Fargo LLC

Rue21, Inc. (RUE) Q1 2013 Earnings Call June 5, 2013 4:30 PM ET

Operator

Good day and welcome to the rue21 Incorporated First Quarter Fiscal 2013 Earnings Results Conference Call. Today’s call is being recorded. And at this time, I would like to turn the conference over to Joseph Teklits. Please go ahead.

Joseph Teklits

Thank you. Good afternoon everyone. Welcome to rue21’s first quarter 2013 conference call. The speakers today are Bob Fisch and Keith McDonough, and CMO, Kim Reynolds is here for Q&A as well.

As a reminder, statements made during today’s call will contain forward-looking information about our financial performance and prospects. Our actual results could differ materially from those contained in our forward-looking statements made today. The risks that could cause our business and financial results to differ materially from those that we currently expect are included in fiscal 2012 Form 10-K and in subsequent filings we have made with the SEC as well as the earnings press release we issued today. All of these documents can be found on the investor relations website at www.rue21.com.

The information discussed in this call is as of today June 5, 2013 and the company undertakes no duty to update its information to reflect future events or circumstances. In connection with the proposed transaction with Apax, rue21 intends to file a proxy statement with the Securities and Exchange Commission and mail it to its stockholders. Information about the proposed transaction is set forth in the press release issued today and I would refer stockholders to the release for additional information. Neither this call nor the press release is a solicitation of proxy, and offer to purchase nor a solicitation of an offer to sell shares of rue21.

With that, I’ll turn the call over to Bob.

Robert N. Fisch

Thank you, Joe and good afternoon to everyone. Before we detail our first quarter results, let me quickly touch on the transaction we announced two weeks ago with Apax Partners, a global private equity firm. As many of you know, we signed a definitive agreement with Apax under which funds they advise will acquire all outstanding rue shares for $42 per share in cash or a total of $1.1 billion.

The transaction price represents a premium of approximate 23% to rue’s closing share price at May 22 and the day before the transaction announcement at approximately 42% premium to the 90 day volume weighted average price ending on May 23. As part of the agreement, the special committee which is comprised of three independent Directors is conducting a go-shop process with the assistance of advisors; they are actively soliciting, evaluating and potentially entering into negotiations with any parties willing to offer a superior acquisition proposal.

Pending the outcome of the special committee’s go shop process the transaction is expected to close before the end of calendar 2013 and is subject to approval by the majority of the stockholders unaffiliated with the SKM II funds, our largest stockholder as well as customary closing conditions.

We have filed the merger agreement and the related proxy statement which will have more background information about the transaction and will be filed within the next couple of weeks. As you can imagine, we are limited in what we can say while the go-shop process is still ongoing. For that reason, please keep any questions during our question-and-answer session today focused on our business results.

Now turning to the first quarter, as you know, we preannounced our sales and earnings per share results but we want to provide additional color and detail today. Despite a tough quarter for retail, we are proud to have achieved another 41 successful new store openings and net sales increase of 9%, gross margin expansion of a 120 basis points and gross profit increase of $10 million from the first quarter last year.

We also took important steps towards our launch of e-commerce and we are now on target to start operating our online business this November right in time for holiday gift giving.

Unfortunately, there were some challenges that affected us in the quarter, including increased payroll taxes and a late receipt of tax returns affecting consumer spending patterns. Then the weather did not cooperate. It was unseasonably cold this spring against the seasonally warm weather the last year. As a result it was tough to deliver the sales results we typically achieved in the first quarter with our new spring merchandise. So despite some black spots of our sales and earnings results did not meet our expectations for the quarter.

On a positive note, we continue to perform on the gross margin line. As you know we have been vigilant about protecting our gross margin and with 120 basis point increase in the first quarter, we have continued our record of margin increases. We continue to believe that even when traffic is down, reduced promotional activity year-over-year will support profitability for the long term much more than heavy discounting. We have done extensive promotional testing and when times are tough slashing prices did not always move the needle on sales to a large enough degree that will make up for the lost margin.

We succeed when we deliver trend right merchandise that the customer loves and then offer the product at every day great value. This has been the secret sauce of our success and as a result we did not over promote in the first quarter. To give you some details on merchandise, we are a business that balances both fashions with key basic items, not just only basic items.

While the seasoned category of girls and guy shorts and sandals and flip-flops, for examples, were off, we were able to somewhat offset the sales pressure with certain fashion categories not affected by weather such as woven shirts, fashion dresses, girls and guys jackets and girls and guys pants.

In girls, we expect wovens will continue to perform well into the summer driven by fashion, shirting styles of tanks and lace. Girls pants and skirts and fashion dresses are also delivering increased sales with belted high, low, and lace trends driving these businesses.

In guys, we are seeing more success at our bottoms category, but we have strong category to positively effect the second quarter into the third quarter that we believe will deliver improvements to earlier sales trends. The etc! Division has turned the corner and is performing well in the accessory area as we thought it would and discussed in the quarter call before.

The jewelry business has improved with new and novel categories and strong statement necklace trends. Metals continue to dominate as the color trend and we feel good about the category going forward. And our tarea lingerie brand is also performing well with the addition of Bandos as the key trend this season.

Now moving to our number one growth driver for the first half of the year, real estate. As I mentioned, this past quarter we opened 41 new stores. As of today, we are now 934 store strong, with store number thousand expected to open in the fourth quarter.

While hitting store number 1000 is a significant milestone it does not make us a some mature constant by any means. I want to hammer this point home. We are not like most other specialty retailers. Most specialty apparels retailers are mall based concepts without the flexibility that we enjoy to open up very profitable stores in small town strip centers, outlet malls or regional malls. When we reached the point of having approximately 1700 stores, it’s likely that the majority of our stores will be in strip centers, and not in enclosed malls.

Actually a large number of our stores will be nowhere near a mall. This is a key differentiator for rue21. In the first quarter, we opened up stores in places like Guymon, Oklahoma; Roseburg, Oregon; Carlsbad, New Mexico. All great stores in smaller communities of underserved markets that opened up at almost 200% above plan and we are now on plan to open 125 new stores successfully again this year.

Our last call we spoke about new initiatives and new concepts that will be important for our future growth, very exciting, we would be opening one of our new concepts rue Guy in the South Shore Mall in Bay Shore New York on Long Island this August. It will still be a rue21 store but with a dedicated guy’s area, a separate guy’s entrance and more emphasis on merchandise for our guy customer. We already have a strong men’s business but in our underserved markets we know that significant productivity gains in the men’s business are there for us if we give our guy customers their own space in the store with a more masculine vibe. We plan to open approximately rue guys stores in 2013 – excuse me 20 stores at rue guys in 2013.

Another key real estate initiative is our etc! remodeled store initiative, we intend to elevate the customer experience through the use of a new store design in some of our high performance etc! stores as well as convert non-etc! stores to this new concept, we will change our layout and bring in colors, signage and fixtures that will make our etc! stores easier to shop and will express our fashion add value propositions, all with the goal of increasing traffic to the store, the duration of time spent in the store, and obviously sales gains.

We believe the successful conversion of stores into a new design will provide an incremental sales increase per store of approximately 15%. We just were at the real estate convention in Las Vegas talking to many of our developers and landlords a couple of weeks ago, who embraced the rue Guy and remodel concepts and will be participating with us in the course of these conversions. They saw the potential to increase traffic and sales just like we do.

Finally, I want to touch on our e-commerce business, which is an initiative that we have been heavily focused on and now projected to launch in November, we moved it up. We are very excited to get into the world of eCom and be able to provide fashion at everyday great value to customers that want to shop online or in our store.

We will also create an omni channel business and drive new traffic into the stores by engaging our current and new customers on the web. We already are doing this successfully through our social media presence and also our online marketing events.

So some of the remarks, I want to thank all of you who invested in rue21 and believed in us throughout the past few years. We believe that between our core growth strategies, strong management team and exciting new initiatives. We are well positioned to continue to drive profitability and achieve our long-term goals.

We are confident we will grow our comp store sales, total sales and profits into the future. Now, I would like to turn this call over to Keith for some financial highlights for the quarter.

Keith A. McDonough

Thanks Bob. I will review our financial first quarter and provide an update to our outlook for the second quarter and the remainder of the fiscal 2013 year. Our Q1 performance includes sales growth of 9.1%, gross margin expansion of 120 basis points, SG&A deleverage of 220 basis points creating an EBITDA margin decrease of 100 basis points.

Depreciation expense increased $1.5 million and anticipated over last year, deleveraging by 30 basis points resulting in an operating margin decrease of 130 basis points to 7.6% of sales or $17 million.

Our effective tax expense was once again favorable year-over-year, so our net income margin decrease narrowed to 80 basis points for the quarter to 4.8% of sales or $10.8 million. $35.4 million has been expended on our share repurchase program since the first quarter of last year, which helped to push our average diluted shares outstanding down for the quarter by $764,000 to $24.4 million since last year.

Comparable store sales decreased 4.6% relative to a 1.7% increase in the prior year on a shifted calendar year basis. On a fiscal accounting period basis, comp sale decreased 5.1% which led to a greater spread in overall sales change relative to comp sales. Although our shifted comp measurement was unfavorable to overall sales in Q1, that relationship will flip in Q2 and become a favorable compare.

This quarter AUR was basically unchanged from last year moving up 0.5 percentage point and use per transaction increased 2.4% pushing average dollar sales up 2.6%.

We opened 41 new stores in the quarter compared to 40 last year. We are operating 918 stores at the end of the quarter, up 15.5% from last year, consisting of 752 comp stores and 166 non-comp stores or just over 18% of the total. Last year total count at Q1 end was 795 consisting of 635 comparable and 160 non-comparable or just about 20% of the total store count.

Gross profit for the quarter increased by 12.6% to $89.7 million up from $79.7 million last year. Merchandised margin increased by 120 basis points, led by both expanded IMU and decreased markdowns. We de-levered by 50 basis points in the fixed cost area of cost to sales primarily in store occupancy, but also by 10 basis points in buying the permit cost reflecting our expanded investment in the buying department talent and debt since last year as Bob has discussed in previous calls. All supply chain costs margins remained neutral for last year in the quarter.

Total SG&A express margin increased by 220 basis points, but of that increase stock comp contributed 40 basis points and our ecom platform construction investment cost another 30 basis points. Excluding those costs from overall administrative expense and that margin was equal to last year for the quarter.

Store expense margins increased by 160 basis points over last year due primarily to store related compensation which increased by 110 basis points. This de-leveraging even in a tougher top line environment we feel good than better. But we are optimistic looking forward as this is the area we have made some significant investments in retail. Projects simplification is entirely focused on improving human resource efficiencies and expanding sales conversion opportunities, so we plan that as an accretive opportunity in the future.

Early signs from the investments made in mobile scan technology and other process improvements have been positive. Depreciation and amortization totalled $9.0 million increasing 20% over a year ago. This expense represents 4.0% of sales within our expectations de-leveraging of 30 basis points from last year. We are planning 2013 CapEx to approximately $50 million which includes 125 new store openings, our investment in our ecom platform plus our continuing non ecom IT and supply chain investments.

Operating income for the first quarter decreased by 7.7% to $17 million from $18.4 million a year ago. Operating margins fell by 130 basis points to 7.6% in the quarter which is the same margin delta of our store compensation related expense. Again this has been a top area of investment and focus for this management team and a reason for optimism we will see this expense leveraging going forward and an improvement in operating margins.

The quarter’s effective tax rate was 36.3% versus 36.9 % for the same period a year ago. The lower effective tax rate was a bit better than a range of expectations for the quarter and going forward in 2013, we expect to rate not as exceptional as this, but relatively similar.

Finally, net income decreased by 6.9% or $0.8 million to $10.8 million for the quarter from $11.6 million a year ago. Fully diluted earnings per share were $0.44 versus $0.46 a year ago on approximately 24.4 million shares or 30% less than last year’s kind of 25.1%.

Now moving to our balance sheet, cash at quarter was $55.7 million compared to $81.8 million including investments at the end of the first quarter of 2012. Difference of $26.1 million but as said earlier completely offset by our investments in our share repurchase program since last year $35.4 million.

During the first quarter we generated $12.1 million in cash compared to $9.9 million last year in the first quarter. This increase includes the impact of incremental CapEx in the quarter of $0.8 million and $10.4 million in share repurchases.

Inventory levels at the end of the quarter were up 0.7% on a square foot basis, but this was primarily a timing issue that will normalize in Q2.

We have no longer debt on the balance sheet and our new revolver facility limit is $100 million, that’s another $30 million future option. We did not borrow at all during the quarter and we have no plans to borrow throughout the year of 2013, excluding any transaction proposed.

Now turning to our outlook, we continue to plan for 125 new stores in 2013 with 75 in the first half and 50 in the second. We also plan to close a handful of stores later in the year all of which have leases that are expiring. On average rue21 has closed less than two stores per year over the last five years.

The second quarter of 2013 we expect diluted earnings per share in the range of $0.51 to $0.53%, including $0.03 for our e-com platform (inaudible). This guidance assumes same stores sales increase to low single digit and total sales growth of over 20% and takes into account the calendar shift. Importantly any pick up in our [import] [ph] back to school week in Q2 will flip from Q3.

For the full year 2013 we are decreasing EPS guidance by $0.02 to adjust strictly for our first quarter result, as we remain just as optimistic for the remainder of the year as we did back in March when we last addressed the guidance.

Additionally, our estimated EPS impact from e-com remains at $0.10 for the year. This EPS guidance is based on a fully diluted share count of 24.2 million which again excludes any impact from proposed transaction recently announced.

For the year, we continued to expect comp sales growth in the low single digit and overall sales growth to be in the low teens.

That completes my prepared remarks and so I’ll turn this call back over to Bob.

Robert N. Fisch

Thank you, Keith and at this point, we will be happy to open this call up to any questions?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Steph Wissink from Piper Jaffray.

Stephanie S. Wissink – Piper Jaffray, Inc.

Hi, good afternoon, everyone. Just a couple of questions for us, guys. One would be, Keith, you talked about the $0.10 drag from e-Commerce being consistent with your prior guidance Even though that launch is going to happen sooner, are you not anticipating any offset in revenue from that business in the 2013 period?

Keith A. McDonough

We are anticipating revenue in the fourth quarter, but we are still maintaining the same EPS impact. So what I’m telling you is that we don’t anticipate that revenue to be accretive from an EPS standpoint. As we ramp up that platform, expenses will ramp above our expectations. Our earlier expectations were to offset that at gross margin accretion.

Stephanie S. Wissink – Piper Jaffray, Inc.

Okay. That’s helpful. And then, Bob, maybe a question for you on the gross margin. It’s been remarkable that you’ve been able to kind of stretch that margin further, despite some volatility in the sales (inaudible). How do you think about that margin line over the course of time? How much more room is there? And where are the initiatives focused in terms of driving that margin higher?

Robert N. Fisch

Well, I think that I see us being as consistent as we have been in the past and that, well, I don’t know we see us having huge jumps of 80 basis points or 100 basis points. I see us continuing to grow in that and I think there is more room. I think that the factor that we are not tapped out and still have dry powder to build our business without being up against heavy promotions allows us to run our business properly. I think the factor that between the key categories of as we continue to develop in our accessory areas, where it’s tarea lingerie or the jewelry or other areas or shoes continues to grow I think will help us in the margin gains.

Kim A. Reynolds

Also Stephanie, it’s Kim, how are you? We wanted to point out that helping with that gross margin expansion is the good, better, best programs we have been talking to you guys about in the past, which also helps us in the gross margin IMUs.

Stephanie S. Wissink – Piper Jaffray, Inc.

Okay, thank you guys, best of luck.

Robert N. Fisch

Okay thanks Stephanie.

Operator

(Operator Instructions) We will now move to Paul Lejuez with Wells Fargo.

Paul Lejuez – Wells Fargo LLC

Hey, guys how are you?

Robert N. Fisch

Hey Paul, at least they are really consistent on your name?

Paul Lejuez – Wells Fargo LLC

Yeah, consistently inconsistent.

Robert N. Fisch

Okay.

Paul Lejuez – Wells Fargo LLC

So inventory, just wanted to talk a little bit about units where you said versus the dollars that you reported, sorry if I missed that if you mentioned it. Also curious about plans for the rest of the year, how you see inventory trending as we move into the second half? And then also just wanted to ask you about mall performance versus off-mall.

Keith A. McDonough

Units aren't going to be too dissimilar from that metric I gave on the prepared remarks, Paul, 27% probably 25% to 28% up, we do see that normalizing, a lot of that was timing at the end of the quarter, a lot of that inventory is in the distribution center to be shipped out, and we do expect it will normalize nicely in the second quarter and we are counting on a good finish to that second quarter as we all know the calendar shift now pulls a whole week of back to school business into the second quarter.

Robert N. Fisch

Which I think is significant that we wanted to make sure also that we are prepared that last week of July, which this year, as you know, and our business is one of the strongest back to school weeks usually is the first week of August, which is now the last week of July. So we want to be definitely prepared for back to school there.

And to the other point on mall performance, mall performance has been as good if not a little better than stripping out the performance. And so that’s what gives me encouragement that it isn’t just promoting deeper and deeper that while the mall players as you know who they are promoting very deeply, we are still competitive in that and just by promoting deeper doesn’t make more business. So I think that we’re able to hold our own there and keep building in these underserved markets. So I am encouraged by that sector too.

Paul Lejuez – Wells Fargo LLC

Yeah. Got you. And just one more, Keith. Could you just remind me, what is your average transaction size in the store? And what are you hoping to see from the eCommerce business?

Keith A. McDonough

So the average transaction size, it is around $28. Importantly our average credit card transaction is closer to $42 and we are [pro-forma] [ph] our transaction size from the eCom standpoint around that same dollar figure right now.

Paul Lejuez – Wells Fargo LLC

Got you. Well, best of luck, guys. And congrats.

Robert N. Fisch

Thank you very much, Paul.

Operator

And at this time there are no additional questions in our queue.

Robert N. Fisch

Okay, well, thank you very much again for all of you being on the call and I wish everybody a great summer and a great start to back to school and everybody peace. Take care.

Operator

That does conclude today’s program. Thank you all for joining.

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