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Executives

Allison Malkin - Integrated Corporate Relations

Millard S. 'Mickey" Drexler - Chief Executive Officer

James S. Scully - Chief Financial Officer

Tracy Gardner - President, Retail & Direct

Libby Wadle - Executive Vice President, Factory

Jenna Lyons - Creative Director

Analysts

Jeff Klinefelter - Piper Jaffray

Analyst for Paul Lejuez - Credit Suisse

Michelle Tan - Goldman Sachs

Kimberly Greenberger - Citigroup

John Morris - BMO Capital Markets

Janet Kloppenburg - JJK Research

Roxanne Meyer - UBS

Richard Jaffe - Stifel Nicolaus & Company, Inc.

Jeff Black - Barclays Capital

Analyst for Brian Tunick – J.P. Morgan

Christine Chen - Needham & Company, LLC

Sam Panella – Raymond James

Chris Kim - J.P. Morgan

Jennifer Black - Jennifer Black & Associates

J. Crew Group, Inc. (JCG) Q2 2009 Earnings Call August 27, 2009 4:30 PM ET

Operator

Welcome to the J. Crew second quarter fiscal 2009 results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Allison Malkin of ICR. Please go ahead.

Allison Malkin

Thank you and good afternoon. Before we get started I would like to remind you of the company's safe harbor language, which I am 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 might 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.

Now I'd like to turn the call over to J. Crew's Chairman and CEO, Millard Drexler.

Millard Drexler

Good afternoon and thanks for joining us. I am here with Jim Scully, our CFO, along with Tracy Gardner, Jenna Lyons, Libby Wadle and other senior partners of the company. I will begin with a brief overview of our second quarter results and then Jim will cover our financials in more detail and update our outlook. We will keep this brief to move quickly to your questions.

We are really pleased with our better than expected second quarter results. Revenues were up 6% and we managed our inventory and expenses driving gross margin and operating income slightly above last year with operating margin almost flat to last year at 9%. We ended the second quarter with a healthy balance sheet with approximately $200 million in cash on hand.

As you probably know by now we are and have been on a long term plan to be recognized for our quality, style, design and service. This mission puts taking care of our customer’s front and center in every part of our business; our products, our service, our store environment and our website. We are relentless day in and day out in pursuing what matters most to our customers.

We work with some of arguably the best factories and mills in the world. We have prints from [inaudible] and Liberty of London, beadwork from [Cheneza], shirting from Thomas Mason and outerwear from British Millerain to name just a few of many, many others. We want to be known for the best selection, assortment, product and merchandise and in order to do that there is no limit to where we will look in the world for iconic items with a J. Crew point of view.

As those that shop us know, we have curated and edited items we love from authentic brands such as Baracuta, Mackintosh, Timex, Barry, Red Wing, Barber, Ray Ban, Hunter and Bensimon sneakers. We continue to provide our customers with the best service we can whether they shop with us in our stores, on the web or over the phone. Each and every one of us is willing to go above and beyond for our customers. The word is spreading about our personal shopper services both in our stores and online. Erica runs our personal shopping service for direct and we have a dedicated team in each of our stores across the country.

In the midst of the sharpest retail downturn any of us have seen we have stayed the course on our long-term mission while taking some immediate steps to get our expenses and inventory in line with our revised business trends. There is nothing like a good old fashioned recession to make you run a better business. Our top line trend and inventory management in the second quarter exceeded our own expectations and we stabilized earlier than anticipated with both gross margin and earnings slightly above last year in the second quarter.

It is apparent to us that customers in this environment and almost any environment but this environment in particular are looking more and more for unique products they connect with emotionally while also offering a compelling value. We think because of this we are now finding ourselves be more and more relevant to both our existing and new customers. We have some of the season’s must-have items which is part of our DNA. For example, boyfriend blazer, the shoe boot, statement jewelry, the mini, our now famous skinny pant, the sexy pant, ruffled camis, art tees, matchstick and toothpick jeans.

We are well positioned from both a product and inventory management standpoint as we move into the fall season. We must continue to look for ways to emotionally connect with our customers in both our new and existing businesses. As you know we have recently opened some highly edited stores. Our women’s store on 79th and Madison, our stores in East Hampton, Malibu and our men’s stores at 484 and Broadway and our Liquor store just to name a few.

We have done these stores as the next layer on top of our business to attract a new audience and get the word out that we are competing with the designer business on a number of different levels. We are really excited to open our Crewcut store at 87th and Madison. The store is a curated collection of our children’s assortment located and it doesn’t get in any better kind of neighborhood. We also just put our second Crewcut catalog for back-to-school which is a huge marketing tool for us.

Madewell is gaining momentum and we continue to view this business as a long-term opportunity. We opened five new Madewell stores this quarter and currently operate 17 in total with plans to launch an e-commerce site in 2010. While we have seen signs of stabilization in our business the macro environment continues to be uncertain and I don’t think anyone knows what the back half of this year will bring as we anniversary the consumer reset.

We have planned our business conservatively as we don’t think anyone should be getting too optimistic in this environment and our financial focus remains on long-term, high quality earnings growth.

With that I will turn the call over to Jim to review our second quarter results and our outlook in more detail.

James Scully

Thanks Mickey. Turning to the details for the second quarter. Total revenues increased 6% in the second quarter to $358 million. Our store sales, which include our retail, factory, Crewcuts and Madewell stores, increased 7% to $259 million. This was driven by an 11% increase in net square footage partially offset by a 5% decrease in comp store sales. Our direct sales increased 6% to $88 million. As a reminder, our second quarter sales last year were impacted by the systems re-platform at the end of June.

Gross profit dollars for the second quarter were up 7% to last year to $147 million with gross profit margin expanding 20 basis points to 41.2%. The expansion in gross profit margin was driven by an essentially flat merchandise margin versus last year coupled with 10 basis points of buying and occupancy leverage.

The merchandise margin performance was significantly better than anticipated as a result of higher than expected top line performance during the quarter resulting in lower mark down and higher than anticipated AUR. SG&A expenses for the second quarter increased 8% to $115 million or 32.2% of revenues versus 31.6% of revenues last year. The second quarter SG&A expenses included charges of approximately $2.6 million related to underperforming stores and lease termination actions, an increase of approximately $7.5 million related to share base and incentive compensation expense in the second quarter versus last year. Also, as a reminder, last year included approximately $1.5 million in incremental expense related to the direct systems upgrade.

Operating income increased 2% from last year to $32 million with operating margin declining 40 basis points to 9%. Net interest expense for the second quarter totaled $1.1 million compared to net interest expense of $1.4 million in the second quarter of last year. Net income for the quarter was approximately $19 million or $0.29 per diluted share compared to net income of $18 million or $0.28 per diluted share in the second quarter last year.

Turning to key balance sheet highlights. Cash and cash equivalents were $204 million at the end of the second quarter compared to $113 million last year. Total debt remained approximately $100 million at the end of the quarter. Inventories at the end of the second quarter were $195 million representing a 100% decrease versus last year and were down 11% on a per square foot basis. Capital expenditures for the quarter were $12 million.

Turning to the outlook. For the third quarter we expect diluted earnings per share in the range of $0.30 to $0.33. Our third quarter outlook reflects comp store sales in the negative mid single digits, direct sales in the negative low to mid single digits, gross margin expansion of approximately 100 basis points, SG&A expense dollars increasing in the low to mid single digits versus the third quarter of 2008.

This year’s SG&A includes a $2 million increase in depreciation versus last year, a $4 million increase in share based and incentive compensation expense and also as a reminder last year’s third quarter SG&A included $5 million in incremental expenses related to the direct systems upgrade.

The outlook for the fourth quarter is challenging to gauge as we anniversary the events of last year. Given this uncertainty in the consumer behavior for the upcoming holiday season we have been conservative in planning inventory levels which could limit our upside potential. We expect average inventory per square foot at the end of the third quarter to be down to last year consistent with the decrease at the end of the second quarter.

With respect to the fourth quarter we expect comp store sales and direct sales growth in the positive low single digits, gross margin to be in line with our historical trend from the third quarter to the fourth quarter which averages down approximately 600 basis points sequentially, SG&A expense dollars increasing in the low single digits versus the fourth quarter of 2008. As a reminder, to the extent that sales exceed our expectations SG&A dollars will increase due to variable expense to support the business.

Annual net square footage will grow approximately 5% in total or 4% excluding Madewell. We have opened 23 new stores year-to-date with one opening remaining in the fourth quarter. Capital expenditures for the full year will be approximately $55 million with depreciation and amortization of approximately $52 million versus $44 million last year. We are also assuming an effective tax rate of approximately 40% and approximately 65 million diluted shares outstanding for the full year.

Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

My question is first of all on the comp guidance for Q3 it looks like you are not really looking for much of an improvement as you go against an easier comp. I wonder if you can share any color on what sort of a pattern you are looking for through the quarter or any other color on kind of spread of performance between factory and regular price stores that you have started to see materialize going into the fall season? Then just lastly an update on your direct biz circulation what you are looking for year-end. I know you have productivity measures there.

James Scully

First, with respect to comp guidance for Q3 our historical practice is we always go back and look at. The most recent trend we have is Q2 and obviously at a 5% negative comp it was actually consistent with Q1 and so for the first half we are running down five. That is always the basis for the trend. We think as we plan the back half we don’t really plan for unknown benefit we would expect. We just look at the current trend and then plan accordingly. We haven’t seen anything for the first couple of weeks that would lead us to change.

With respect to circulation, circulation was actually down 36% in the second quarter. It was down 27% in Q1. So for the first half we are down 30%. We are planning to be down about 20% in the second half which will mean for the year we will average down about 25-27% which is consistent with where our guidance was at the end of Q1. As a reminder there, that is really about an efficiency gain there in terms of the productivity that you mentioned. We have eliminated some re-mails and we have done some testing. It is really not that we are touching fewer customers it is how we touch the customers.

Jeff Klinefelter - Piper Jaffray

One clarification there, I notice you doing more niche mailings specific to your female customers and specific to your male customers. Is that part of this testing and any initial feedback on that?

James Scully

It is part of the plan and also we are testing other things as far as the size of the book as well. I would say as we said all along, our [inaudible] was down 18 in Q4. I think I said as we continue to test we will continue to go further into the file with some of the benefits. I think just the number itself points to the fact we have been very happy with the testing and it has been very effective.

Millard Drexler

It is also not just testing. The niche mailings as you called them actually call attention to some focused parts of the assortment that might lose themselves if we didn’t call them out. We mentioned in the remarks that we will stop at nothing to give quality along with value and design for our customers. We are kind of like the little person on the block in this business a few years ago and now we are just trying to show our strength and communicating to the customer.

It is not just a test. It is gee if you want someone to know about what you do then you had better tell them and there is no better way today than a catalog or online so as you will notice the catalogs are very well thought out in terms of who knows that J. Crew in fact carries or Crewcuts carries the kinds of assortments we do.

This whole reset, I was on Madison Avenue this morning and we were looking for a bridal salon and I will tell you if I just walk Madison today I would think that Madison Avenue ain’t Madison Avenue. There were more empty stores than I have ever seen there and I think that speaks to a lot of what is going on in the better markets and the high rent markets that a lot of retailers don’t want to pay for anymore and can’t pencil out.

The niche mailings are part of a continuous strategy to continue to communicate as are our personal services we supply, as are each and every one of us communicating with customers, as are every factory in the world being part of our making of goods. It is really about being effective at communicating versus saving money. I don’t know any company that grow their business without investing.

Operator

The next question comes from the line of Paul Lejuez - Credit Suisse.

Analyst for Paul Lejuez - Credit Suisse

I was hoping you could tell us what portion your goods were sold at first mark down versus second mark down or third mark down compared to last year. Then secondly, if you could talk about the performance of the Crewcuts catalog and maybe did you get a bump in this quarter and that is why you are looking for the direct business to be down next quarter.

Millard Drexler

You know we don’t give out numbers of first, second mark downs. I think the best way to figure that out is visit our stores and I think you will see that we can’t be in the mark down business. Once you are in the mark down business and you try to get back to a regular price business and it takes decades. We are in the high integrity, high quality business and when and if, and we always make mistakes, our mistakes it is what our job is. When this recession hit we put our entire company on final warning for our jobs. We decided we like working here. We said we are not going to be buying goods the way we bought goods and all be employed in the company. So I think that merchant, planning and distribution and the design team made every effort to buy and invest right.

Just like in your business we are measured on our results and we have to pick the right stock or in this case the right styles but I think it is no secret, fourth quarter liquidation heavy, everyone was nervous and it wasn’t that long ago we thought is anyone going to come back to regular price. Well I will tell you they come back to regular price when they like the product and the merchandise.

As we look at our stores I can only say we feel very good about the integrity of our goods. You do not see in our windows today already at the beginning of fall take money off the product and the goods. That leads to one place and we don’t want to go there. We don’t give you numbers but it is one of our major objectives you must maintain that integrity or there will be no business left in 10 years because everyone can buy something cheaper except you can’t buy our products any place else except online, in our stores and in our catalog. That is a very important high objective and our job reviews are based on that.

James Scully

With respect to the Crewcuts catalog while we were pleased with that it did not have anything to do with in terms of the overall trend. I think what you need to recall is last year we had a disruption from the re-platform and what we have seen here is our direct business sequentially has been very consistent. It is just the comparison is difficult because of the disruption last year.

Millard Drexler

I just want to add one thing just so you know. This is not about a cutting cost quarter. It is about a building a product quarter and I find it interesting as you look at the business there is just so far you go in shaving costs. By the way the customers feel that in every which way but I just feel like we are not expensing ourselves to earnings here. We are investing in our business. The only area where we are quite conservative is in rents where until the landlords around America start to realize we will not sign leases without [inaudible] but otherwise we maintain very solid expense control and we review our expenses but we still continue to invest in our future.

Operator

The next question comes from the line of Michelle Tan - Goldman Sachs.

Michelle Tan - Goldman Sachs

I was wondering what you were seeing in terms of some of the drivers of sales, traffic improvement, better conversion, what you are seeing in terms of some of the new categories like jewelry. How do you feel about the trends for fall?

Millard Drexler

It is all about product, the right amount, the right pricing. Jewelry without a doubt in women’s I have a long list of stuff that we are selling. We also changed the flow strategically this year. It is about the goods and how they come in. If you look at our business you will see there is a lot less of corduroy, outerwear and cashmere in our stores because it is still 75-80 degrees out. We learned that last year for sure and the last 10 years. Our mini pants, boy blazer, our art tees and accessories; I don’t want to sound like a fashion director here but it is about going into the store, the product kinds of sing to our customers. If you hang out in the stores…that is what broadens market appeal. On CNBC they talk about Michelle Obama, etc., etc., we love all our customers but Michelle Obama and a lot of women who are now shopping with us at every age it is much less basic and much more emotion.

If you look at our assortments today you will see whether it is detail, color, stitch, embroidery, hair accessories, it is all an edge of design, etc. to that. I think that is to men’s, women’s and kids. In men’s our woven shirts we continue to dominate more and more in the men’s secret wash shirt, the Barry pants are a little slimmer and it is fashion that zooms across America in today’s world from the Internet and everything else. Ties and socks. We are very famous now. We just listened to customers about our t-shirts. What is kind of not hot right now is cold weather stuff. Corduroy, outer wear and cashmere are on plan towards slightly down to plan but it is still only the middle of August. We feel pretty good. For the fashion customer fall has started. We have our new flows in the store. I think the merchant team just flowed it much more effectively this year. The traffic also feels a bit better but then again we invest in a lot of catalogs and online and in marketing to get the traffic to feel better.

You will notice we are advertising a little more aggressively with the NY Times ads now which we really haven’t done much before. We are out there in this weak time to show the customer who is very open to not paying all the money she has been paying or he has been paying at the higher price designers which in a funny way for us as you look at the prices out there and we kind of wonder why.

We are also flowing goods more regularly and more often. The flow is the oxygen to our business. It is critical. The irony is you can do this for so long and every single season you are learning a lot more. I think the recession, the last fall really was a huge kick for all of us and we kind of said the rules are now not the same rules anymore in running our company. So we are operating under different rules now. Those at some point will have to change also in the future.

Operator

The next question comes from the line of Kimberly Greenberger – Citigroup.

Kimberly Greenberger - Citigroup

I was wondering if you could talk about how your inventory flow might change from third quarter to fourth quarter given the improvement potential in the comp in the fourth quarter. Is that being driven by a slightly less conservative inventory buy in the fourth quarter or is it just that there is so much average unit retail price recovery opportunity that you expect that to drive it?

Millard Drexler

Remember what we are up against. The nightmare of all nightmares. There was nothing worse than last fourth quarter. We lost a lot of money. I will tell you one thing we learned, to me it has always been a rule. It ain’t inventory that drives profit; it is the right inventory that drives profit. You can buy all day long today and if you aren’t buying the right stock, the right inventory, the right fashion it ain’t getting you the sales except at second and third mark downs and on promotions.

We have kind of to ourselves went into this season very conservatively and said look in my own experience if you look back over 50 quarters or whatever show me a company that didn’t have good earnings and high margins say they ran out of inventory. No one ever runs out. What it is merchants end up buying too much. They end up buying over sorted. They don’t believe in what they believe in.

So as we look at fourth quarter clearly there is a very low bar set in the world for fourth quarter. We put an expiration date on all the merchandise we buy and this fourth quarter I would like to think we are a lot more cognizant of December 23rd, right after that date it is all worth half of what it was the day before. It is worse than expired milk, bread and eggs in the super market. It is worth so much less. We also expect December again, late waiting for sales. People have good memories. By the way I think over the last ten years there has been a sale two weeks before December.

They don’t come out until then so we are treating holiday, it ain’t the greatest quarter to manage your business in the world. Everyone is Christmas, Christmas, Christmas. For a fashion company like ours the third quarter is arguably a better, more profitable quarter than fourth quarter because we are not going to empty our bins on the last two weeks of the year or else you end up with too much inventory in January as every retailer seems to do.

So we are trying to operate on a different model right now but knowing all of this points toward being conservative in inventory. Tracy and Libby today said gee what happens if we run out of certain things. It should only happen December 20th because the buying habits after December 20th is like I will take whatever I can get out of the store quickly. That is how it works. We are trying new things.

Kimberly Greenberger - Citigroup

I just wanted to follow-up on the question about the direct business you expect it to show a decline in the third quarter which is a deceleration from the really nice results in the second quarter. I am just not sure I understand exactly why the direct sales number should fall off a bit.

James Scully

If you look at the trend we were down two in Q4, down six in Q1. We were up six in Q2 but we were anniversarying last July where we didn’t really ship a lot of goods because of the new platform. So the plus six in the second quarter was more a factor of what happened last year than the trend improving between Q1 and Q2 of this year. The natural trend in our business right now for the first half of this year we are basically flat and we are giving guidance for Q3 which is low to mid single digits because it is consistent with that trend.

Operator

The next question comes from the line of John Morris - BMO Capital Markets.

John Morris - BMO Capital Markets

My question initially is with respect to sourcing cost benefits. Did you see any in that much better performance in gross margin and if so would you expect to see any into the fall and back half of this year? Also, I think you mentioned two points of lease termination expenses. Can you give us a little bit more color about that? What divisions, where were the stores and would we expect any more in the back half?

James Scully

If you talk about unit costs, first with respect to Q2 the Q2 gross margin increased year-over-year and it has been higher than our expectation and was driven by a little bit stronger top line and also just being more efficient at moving through the inventory. The actual cost benefit is the second half of the year which we talked about earlier this year when we saw the 3-5% benefit in average unit cost which we still are realizing and we still expect to realize in the second half of the year. That benefit comes in Q3 and Q4.

What was the other question?

John Morris - BMO Capital Markets

The second part was the lease termination.

James Scully

There are two pieces to that, there was an impairment charge for two stores and also an early termination of one store. I think you have heard us talk about from the very beginning of Madewell about two stores that we did not like in the portfolio. I think we were very open about that. One was in Vegas and we have closed that store and there was an early termination fee and then we also impaired two stores.

John Morris - BMO Capital Markets

Would you expect any more for the back half of the year or is that it for now?

James Scully

We actually test on a quarterly basis. We don’t forecast it because it is based upon a trailing 12 month cash flow and we will continue to test each quarter.

John Morris - BMO Capital Markets

Since we are talking about Madewell, what are you learning there so far? What kind of improvements have you seen from what you have been doing in denim and any other call out categories you want to touch on with respect to Madewell?

Millard Drexler

We are learning that nothing new here. Good real estate is critical. Our good real estate is performing well. Our slower real estate is beginning. I think we are learning we should not have started at $98 and it is a constant evaluation of where we take price points and now we are opening up at $59.50. What is working well is all our shirts, plaids, boyfriend shirts, tunics. We are pleased with the jean selling. Blazers, jewelry, corduroy is slow there. Basic t-shirts we had a really great run on them. Kind of that basic V’s and Crews are quite slow right now. We also know for sure that no one really knows about Madewell and the best we can do is get online there some time in 2010.

We are very pleased with the good stores’ volume and of course with the stores that aren’t so good, we have only closed one but their volumes have some way to go there.

Operator

The next question comes from the line of Janet Kloppenburg - JJK Research.

Janet Kloppenburg - JJK Research

I am fascinated with this building a brand portfolio, this portfolio brand you have been building that is a very hip brand and seems very complementary to J. Crew’s strategy. I understand that you want to improve the aesthetics of J. Crew but I’m wondering what is the ultimate goal of this strategy? What are you thinking about as you build this portfolio?

Millard Drexler

That is an interesting and good question. It is not about counting on that volume to be the biggest thing since sliced bread. I think what it does for us is as we look at the world going forward, and I think it is the only way to look at the fashion world and the world because rear-view mirroring today in our industry and every other industry ain’t working.

We look at that as it is almost a natural extension and a bit of a wakeup call over the last few years in terms of the way customers are shopping in our opinion is a lot different than the way they used to shop. I don’t see many people going into one store for all their needs. We started to look at other brands and kind of fell in love with them. I’m not even sure what the first or the second was but as we started to look at brands that complement J. Crew. Authentic, real, been around and I think J. Crew through thick and thin has always been positioned as kind of a business that had a lot of authenticity in its feeling even when the business went wrong on goods.

We start to look particularly in the men’s business. We started to realize guys love brands. Guys love what every other guy wears. Guys love what they have worn since they were 10 years old whether it is a 501 Levi, Converse or Jack Purcell, guys connect quickly to brands or if they have ten of their friends tell them it is cool and good. They don’t like to shop. They don’t spend a lot of time. Women to a degree also love brands but they don’t love them as much.

In any case, we look at it only as a natural extension to what our customers like. We also feel if we can’t provide it for them why have them go someplace else, particularly where it might be not as easy to find. There are certain items that are just plain perfect in our opinion or really the customer’s opinion. We don’t need to reinvent our own Red Wing boot when you can buy the original.

Bensimon sneakers at Madewell is the original. Jack Purcell is the original. Barber is the original. The [belt stack] jackets coming in are the original. The Jarling Raven knapsack is from Sweden. We have much respect for what is good in our own product and what is out there and by the way the customers feel the same way. We carry the Alden shoes in certain of our stores. I mean there is nothing better than the Alden shoe or the very famous Envy shoe from the Harrison Ford and the Indy boot from Indiana Jones.

So that is what we are looking at. Look, we carry Levis now. They are vintage collection only priced at $165 and above but for men, all men, they like what is there. They like what is expensive. Not what has been fooled around with. It is kind of like the grill on a Toyota T or the Mercedes Star, the Audi, the Willys Jeep which is around no longer. Things like that and we can’t replace it. I have to say it is really nice to have someone else hold the inventory for them to design it and we can’t improve upon that.

I think it is two things. One is it gives us nice volume. Two it makes us a more interesting place to shop. Three, they validate us as well as we validate them. We look for Jarling Raven, a Swedish company today, and they want a launch in America in a more important way. They came to us first in an important way. Tree Torn sneakers now, I think the world is about finding newness always and there are not a lot of stores taking those changes.

Of course when some of us do something the others try to do it but it is like a puzzle and a painting. Everything must fit into the vision of the store. So if you look at 484, the Liquor Store, it is more of a men’s thing than a woman’s thing. We are really happy in our kid’s thing. We had a lot of kid’s brands we are counting. It is major sneaker shoe thing in brands in men’s and women’s. That is why we do it. And people remember and the last thing is you don’t have to go search for it in a seven story store. You can buy the three right items because we do not buy lines. We buy styles that we think are kind of perfect.

Now again that is just a personal point of view on what we like for our assortment and for our curating of the assortment.

Operator

The next question comes from the line of Roxanne Meyer – UBS.

Roxanne Meyer - UBS

First, I am just wondering as it relates to the direct business how is you direct customer buying differently online versus in stores in terms of how much she is willing to spend and what category she is gravitating towards online if there is a difference?

James Scully

We really don’t see a difference between the two right now. They act in tandem. I think that is one of the things we see right now that the businesses are really performing pretty consistently at this point.

Roxanne Meyer - UBS

Second, I am wondering if you could in your own thoughts provide us some detail on the psyche of your female customer and how she wants to dress for work at this point. It seems like suits tend to be out of favor or a down trending category. I am just wondering if fundamentally she is really thinking about shopping for work in a different way.

Millard Drexler

One thing about the online and retail customers, we skew a lot of things to online so our customers kind of know it is online and it is retail. We have customers now who come in with a catalog. They mark it off. They say I’m not going to deal with figuring out what is in store and what is online. It is all part of the seamless shopping thing. They hand us the catalog in the store to their special person and say okay just get me everything or whatever.

The suit thing, the good old look like a man suit is kind of over. That tailored thing is not hip. It is mix and match. It is style. It is ruffles and camis. It is feminine. It is the boy blazer we have which we brought back when we unfortunately let it go two years ago. So I think as you are implying the suit business is not what it is. The matchy matchy suit and the classic woven shirt, those days are not for us now. They are not there. Now 40% of our assortment online is unique to that so I think there is a difference only in that they can’t always get it in the store. A lot of it is only available online so that is a difference in fact.

Roxanne Meyer - UBS

I am wondering if you can elaborate on some of your customer service initiatives. It sounds like you are saying the word is really getting out there about the personal service. I am just wondering what you are doing to take service to the next level and how it is differentiated?

Millard Drexler

First of all there are incentive plans. We have personal shoppers in all our stores. We live and breathe it every day. They know it is important to all of us. They know it is important to the team managing all the stores. I think it is a matter of having some pride in what you do. We reward, talk about, compensate and at the end of the day we also know that in better stores everywhere recognition, compensation and incentives are the key. Then again there is the respect or whatever you call it that everyone here there is the bureaucrats that 770 give to the field. We spend a lot of time there. We were in San Jose in our store last week. The question is how much of our business is in personal shopping and they gave us a pathetic answer. Then you say how many personal shoppers are there. They say there is one 20 hour part time personal shopper. No wonder the number is pathetic.

I think what the leadership in every company makes important is viral. It goes down through the line. It is how we measure, reward and recognize our people and by the way show me a great product that is not sold by personal shoppers. Every store has to have its fair share and we actually end up promoting people in the stores to personal shoppers because they are committed to learning how to do that. It is not easy to wardrobe yourself in a J. Crew store or anyplace else today. The designers invented this years and years ago.

Designer personal shoppers are all marketing people for those stores. They have huge portfolios of business or at least they did in the old days but you must know how to take care of that customer. It is part of our religion. We are expanding it. We have 29 or 30 online now. We probably don’t do as good a job as we can. We want to develop a personal relationship with every customer which starts from me and the team in this room to everyone else. It is just good business and we stand behind it. They know if they have a problem we are going to be here and we are going to answer their emails at all hours of the day. Griffey, [Sindor], John O’Dell and whoever in the company does that and myself or anyone else. It is not that complicated.

Roxanne Meyer - UBS

How many people on average are you adding per store? Is it really just a matter of re-shuffling responsibility in terms of in-store staff dedicated to that?

James Scully

It is really not about adding staff to the stores. It is more about shuffling some but making it a priority and utilizing the staff that we have.

Operator

The next question comes from the line of Richard Jaffe - Stifel Nicolaus & Company, Inc.

Richard Jaffe - Stifel Nicolaus & Company, Inc.

Can you talk about the wedding business and the guy’s version of that which I guess would be tailored clothing, a long sleeved tailored for men being very much a secondary thought for men except for maybe at his wedding. Then the bridal business and the bridal party. How is that doing year-over-year and how do you see that as an opportunity for growth?

Millard Drexler

The wedding business, I don’t want to speak in platitudes but it is platitudinal. It is really good. We have an enormous following in bride’s maid dresses. Our wedding dress business is gaining. We have put it into 5-6 stores now and we are actively and now negotiating for a bridal salon which would give us visibility. By the way it is kind of the question about carrying brands. We put a bridal store on Madison Avenue and it has visibility throughout North America. We really are really pleased with the wedding, bride’s maid business. I think our service is commensurate. I have to say our quality and pricing not just bride’s maids but you wear the dress for the next year or so to any kind of special occasion or whatever you need to dress.

The men’s suit business we are going slow but sure. When we open the bridal salon we will carry men’s suiting. Fifth Avenue and the Liquor Store and 484 and online, we are pushing our men’s suit business. Keep it simple. Keep it easy. For $600, I don’t want to say $1,000 or $2,000 suit, but we are just trying to treat it conceptually. It is a special occasion. We want to have anything and everything there in one place to buy. Right now out of the 5-6 stores we are running it out of the back room without inventory. That is why we are going to take a little bit of a risk to open up a store with all the inventory; flower girl, ring bearer and a complete concept online which will only feed back into our catalog and direct business. It is kind of still a need out there and we fill the need.

Again it is not wading through tons of dresses to find a good assortment. We so focus in on editing, it is what we do all day.

Richard Jaffe - Stifel Nicolaus & Company, Inc.

Do you need a tailor either for the bridal party or for the guys? Is that sort of the next step when you build either a bridal shop on Madison or make it available online?

Millard Drexler

Next step meaning for a man?

Richard Jaffe - Stifel Nicolaus & Company, Inc.

For a man, a woman, if you have a bridal shop and you offer tailoring and it would need to be provided I would think for both men and women.

Millard Drexler

Tailoring is kind of a nightmare. The answer is we do minimal. Shorten the pants. Do whatever. We have to keep it simple. We have to buy your size and hopefully it is minimal. Our suits kind of fit that way for men. We don’t want to be all things to all people in men’s suits. There is Ludlow. There is Aldridge. Pick your shot. That’s it. Two suits. Two and three buttons. Keep it simple.

A lot of us have complicated a lot of business over time. People want it simple whether it is a shoe, jacket or kind of simple like a Levi jean.

Richard Jaffe - Stifel Nicolaus & Company, Inc.

If you lose some of the outliers, the customers who don’t fit those suits or can’t find the size and need an alteration, so be it?

Millard Drexler

If you try to get 100% of the customers you are going to have inventory for 150%. I have been there in my life as some of you know. If you want every single last customer then you had better be willing to slow down your inventory turns and lose some focus.

Richard Jaffe - Stifel Nicolaus & Company, Inc.

And some profitability.

Millard Drexler

Yes for sure.

Operator

The next question comes from the line of Jeff Black - Barclays Capital.

Jeff Black - Barclays Capital

You mentioned competing with the designer business and you talked about the edited lines and some better locations. Does that have any kind of implications for where you want to locate the full line stores going forward and looking out when do we see your return to your eightish or higher percent of square footage growth rate? Is that going to be something in 2010? Are you seeing the rents where you want to be or is that further out?

Millard Drexler

I think we are looking for stores opening we are on the hunt. There are not that many locations in America where there is a Malibu, an East Hampton, a South Hampton, Palm Beach. We are looking for those places for collection type stores. We are looking uptown for a men’s store in Manhattan now. We are looking for those places but this is all a mix. If you look at the designer world and this is just our opinion, a lot of it is image driven and licensing driven for income. It hasn’t been that much apparel driven but then again it is probably not the case because we are not in the designer business or experts. I think there is an air of covering your business with a certain image and a certain real opportunity to buy. 79th and Madison, East Hampton Stores, Malibu, those are very crowded stores. Our 87th and 5th store the effect that has is enormous. The important part of this is when will we start being more aggressive on signing up leases.

I don’t want to say it is up to the landlords but the days of in fact signing leases like today we had a decision to make. Do we have to work for the landlords for the next 30% of our volume or not. The really good stores we have and we have less than 20/20 resell stores. We know it can be bigger. It is just a matter of which way you think the world is going. Everyone is kind of optimistic now. I don’t understand. I see a lot of earnings reports even in houses got beat last year by a smidgeon. I am reading the headlines and then I’m looking at the earnings and I’m saying wow I just don’t understand if you lose money and you have no strategy to earn money and you can’t open stores where in fact you can’t make money with high rents.

I think the A landlords it is a game we are playing with them. We will not work for landlords. I have seen too many companies work for the landlords and by the way when the company has some short term or longer term problems the first thing they do is close 100 stores with lousy leases and bad locations. So we cannot be strapped with a landlord thing. I wish I had a better answer for that. We have an online business that is out there and we feel long-term good about it. We feel very good about getting more productivity out of the stores.

The world has a way of changing on that. I think hopefully we are going to start looking at some better opportunities now. Look, some Manhattan rents have come down a little bit. They are not where they should be but it is certainly a question we have. As I said we are not in a hurry. The last thing you want to do is paying that landlord. You hate it when you open a store and you are planning a space. In one case I heard a $30 million plan doing $15 million. You are miserable. If it is a $5 million plan and you are doing $3.5 million you hate the location even though it is a good location. I wish I had a better answer.

Operator

In the interest of time we ask you to please ask only one question. The next question comes from the line of Analyst for Brian Tunick – J.P. Morgan.

Analyst for Brian Tunick – J.P. Morgan

You talked about the Madewell business. It seems like that is taking a little more time to turnaround than the core J. Crew brands. Any update in terms of the operating expectation for the year? I think the last number you gave us was about $15-16 million for the year?

James Scully

First, in terms of an update for the loss, it was $15-16 for the year. We said that before and that forecast remains today. The impact of Madewell in Q2 was approximately $5 million. With respect to it taking longer I wouldn’t say that was the case. I would say that Madewell wasn’t immune to the consumer reset last year and I would say it is performing more consistently with J. Crew than not.

Operator

The next question comes from the line of Christine Chen - Needham & Company, LLC.

Christine Chen - Needham & Company, LLC

I am wondering, definitely you have a lot sharper price points on a lot of items in the stores and I am wondering since you have started implementing that has it helped with conversion? Has it helped with full price sell through? Are the sourcing costs enough to offset the lower price points?

Millard Drexler

Our price points actually are the same. The mix and the perception is changed but it is actually when you add it all up it is the same. You go up a little. You get a little more value in some things. The average price point, I don’t know if that is the right word, the average unit retail is pretty much the same as it has been. What we have decided to do is not over buy expensive goods essentially and have a different balance and message in the catalog and online.

Now, again the goods determine conversion. The selling determines conversion. Like I say, we have been kind of happy with the trend of the business in that regard.

Operator

The next question comes from the line of Sam Panella – Raymond James.

Sam Panella – Raymond James

With your focus on your accessories and handbags and jewelry in the women’s area, do you see this portion of your business becoming a larger portion of the whole? I believe it is around 12% as of last quarter?

Millard Drexler

Yes. Especially in this environment it is much easier to pick up an accessory that is simple. It is well priced. It is fun. It gives you a chance to change your wardrobe. I also think competitively speaking it is kind of a compelling assortment. Our pricing is all really value. A lot of it is driven on value. I think sometimes that doesn’t get mentioned. The fact that for the last six years we have worked really hard at putting together good design, good fabrics, and good value has made a large difference.

I can’t tell you how many people buy our merchandise and say wow why go across the street to Madison Ave or wherever. There is a compelling value story in this. I think the world with the reset is now a compelling value buyer for any product whether it is a $3 peach that is the best in the world or a $2,000 whatever or a great car that is a lot of money. People want value and they don’t want to pay inflated prices for goods that aren’t worth it because they know there is a double or triple markup versus a single markup. They know who wins on these things. I think that is the interesting battle going on out there. I never want to forget, and our customers know this and it is really important, we never forget what they are paying for a garment.

I looked at a pant today for $98, an all wool cuff pant, the Harlow pant. I couldn’t believe the price. I go into the store as a customer and I see $98 but the min is $79.50. Then you realize and go around a 10 block radius of wherever that store was and try to find that quality and I think that is so unstated in our business in all this. The reality is if you can buy a casual, we did it with casual, we are doing it with jewelry. We go to the better stores. The expensive designer stores. We compare everything we do and then we say to a degree what can we do that is differentiating that? There is so much that goes into that. The fit alone with Mario. The fit campaign. The mini fit. We had a letter from a customer that said look you eliminated, it was funny she talked about the GAP pants in 1988 that we eliminated in 19 whatever. She said never eliminate the mini. Never take it off the line. Never. You never say never in women’s business. Guys may think that way but it is about also giving really good value.

I think every business in the world has a perceived value. From peaches to a good nectarine to a great ice cream cone to whatever. People will pay. Then they know what they are getting. I think we play that value game in a very important way and we are turning out a discount. The value measures itself and everything has one price, more than every today as you know.

Operator

Unfortunately we have no more time for questions. I would like to turn the floor back over to management for any closing comments.

Millard Drexler

Thanks for joining us. I hope everyone enjoys their last two weeks of the summer. We will talk to you again in November on the third quarter call. Thanks again for joining us.

Operator

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: J. Crew Group, Inc. Q2 2009 (Qtr End 08/01/09) Earnings Call Transcript
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