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Executives

Allison Malkin – IR, ICR Inc.

Millard Drexler – Chairman and CEO

Jim Scully – Chief Administrative Officer and CFO

Tracy Gardner – President, Retail & Direct

Jenna Lyons – Creative Director

Analysts

Kimberly Greenberger – Citigroup

Paul Lejuez – Credit Suisse Group

Michelle Tan – Goldman Sachs

Jeff Klinefelter – Piper Jaffray

John Morris – Bank of Montreal

Roxanne Meyer – UBS

Lorraine Hutchinson – Banc of America

Jeff Black – Barclays Capital

Richard Jaffe – Stifel Nicholas

Barbara Wyckoff – Jesup & Lamont Securities

Adrienne Tennant – FBR Capital Markets

Janet Kloppenburg – JJK Research

Christine Chen – Needham & Company

Dana Telsey – Telsey Advisory Group

Eric Beder – Brean Murray

Betty Chen – Wedbush

J. Crew Group, Inc. (JCG) Q4 2009 Earnings Call March 9, 2010 4:30 PM ET

Operator

Greetings and welcome to the J. Crew fourth quarter and fiscal 2009 results conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Allison Malkin of ICR. Thank you, Ms. Malkin, you may begin.

Allison 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'm sure you are all familiar with. The statements contained in this conference call which are not historical fact 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. And now I would like to turn the call over to J. Crew's Chairman and CEO, Millard Drexler.

Millard Drexler

Hi, everyone and thanks for joining us. I'm here with Jim Scully, our CFO, along with Tracy Gardner, Jenna Lyons, Libby Waddle and other senior partners at the company. I'll begin with a quick summary of our fourth quarter and full-year 2009 results and Jim will go through our financials in more detail and update our outlook for 2010.

We're extremely pleased with our fourth quarter results and how we ended the year. I'll let Jim take you through the fourth quarter details but let me take a step back and hit a couple of key highlights for the year. We achieved our highest ever operating margin for the full year of 13.4% and historically high earnings per share of $1.91.

Obviously, ending the year on a strong note in the fourth quarter was extremely important, given that we were up against 90 snow days. We more than recovered last year's sales volume which has been our own internal report card on how we're doing.

Sometimes it's hard for all of us to remember the environment when we started last year. We probably don't want to. But at that time, our focus was on, as always, micro management of all of our investments, from inventory to capital expenditures to every expense dollar we put into the business. But we will always continue to invest in creativity and innovation in our products, our people, our catalogs, our stores and online.

Our goal is to connect emotionally with each and every one of our customers and each and every one of our associates. We believe every time you listen to a customer or an associate, we're learning to run a better business. It is the best possible way to find out what you can do better.

We knew that given our control over our products and distribution that we had the opportunity to become stronger as a result of the overall economic disruption. Consumers have changed the way they shop and are more savvy than ever when it comes to quality and pricing. At the end of the day, it's about design, creativity and quality with value as the great equalizer and the role the Internet plays in our business today in accessibility to goods reinforces that.

We have always said that in the fashion business, you cannot compete on price alone and come out on top in the long run. While there is always a balance of offense and defense, we feel that we are well-positioned to capitalize in the significant creative investments we have made in quality, style and design and leverage our multi-channel platform.

We planned a year ago when things were different to be conservative on new store openings in 2010 and will open 15 new stores, growing square footage 3%. That said, we have been and are aggressively focused on the productivity of our base business and will be well-positioned to ramp up our unit growth in 2011.

We are personalizing and connecting each of our stores to its specific market. For example, Lincoln Road in Miami, Christiana Mall in Delaware, Women's Collection store at Malibu Lumber Yard, our Men's store at 484 Broadway to name just a few. Our plans for 2010 include opening our first wedding shop on 66th and Madison early this summer, which will essentially serve as a platform for the entire J. Crew wedding business.

We also see an opportunity in our factory business, which is highly productive for us. Our value assortment is even more relevant today. We're always working on new initiatives in our direct business, constantly innovating and creating and building a foundation for future returns. And finally, we are really excited about what is happening in our Madewell business.

Our Madewell results in 2009 were better than expected with a loss of $13 million, excluding one-time costs. We have signed deals with some really important new stores in 2010 and there's a lot of anticipation around the launch of our e-commerce site this summer and excitement around our collaboration with Alexa Chung.

We have effectively managed our business with a healthy balance of growth and margin expansion and it's our mission to continue to do so. With that, I'll turn the call over to Jim to review fourth quarter results and our first quarter in fiscal 2010 outlook in more detail. Thank you.

Jim Scully

Thanks, Mickey. I'll focus my comments on the fourth quarter and outlook and let you refer to our press release for fiscal 2009 financial results. Turning to the details for the fourth quarter, total revenues increased 19% in the fourth quarter to $461 million. Our store sales increased 23% to $311 million. This was driven by a 17% increase in comp store sales, coupled with a 5% increase in net square footage.

Our sales per square foot increased 500 – I'm sorry – increased to $577 on an LTM basis, which is above our 2007 performance of $569. In addition, direct sales increased 13% to $139 million. Gross profit for the fourth quarter was $202 million with our gross profit margin expanding over 16 points to 43.9%. The expansion in gross profit margin was driven by our merchandise margin increasing over 15 points, coupled with 50 basis points of buying and occupancy leverage. The merchandise margin performance was significantly better than anticipated, resulting from a substantial increase in full price sell-throughs. This drove a significant increase in AUR versus expectations.

SG&A expenses for the fourth quarter increased 5% to $134 million, resulting in 380 basis points of leverage with the rate declining to 29%. Our operating income totaled $69 million, as compared to an operating loss of $20 million last year. Our gross margin expansion coupled with solid SG&A leverage drove operating margin to 14.9% of revenues.

Net interest expense for the fourth quarter totaled $2.2 million, compared to net interest expense of $1.6 million in the fourth quarter last year. Net income for the quarter was $40 million or $0.61 per diluted share, compared to a net loss of $14 million or $0.22 per diluted share in the fourth quarter of last year.

Turning to key balance sheet highlights. Cash and cash equivalents were $298 million at the end of the fourth quarter, compared to $146 million last year. Total debt was approximately $49 million at the end of the quarter as compared to $100 million last year. Inventories at the end of the fourth quarter were $190 million, representing a 2% increase versus last year and were down 3% on a per square foot basis.

Capital expenditures for the full year were $45 million. We are pleased with our positioning and expect to continue to build upon our momentum as we start the new fiscal year.

Turning to the outlook. We expect our earnings growth to be higher in the first half of the year, as we anniversary the margin deterioration associated with aligning our inventory with the difficult economic environment in the spring last year. In the second half of 2010, we expect that our earnings growth will moderate as we anniversary historically high gross profit margins and a significant strengthening in comp store sales.

Given this anticipated uneven growth between the first and second half, we are reintroducing annual guidance along with first quarter guidance. For fiscal year 2010, we expect diluted earnings per share in the range of $2.20 to $2.30, which compares to $1.91 for fiscal 2009.

Our annual earnings guidance reflects comp store sales growth in the mid single digits, direct sales growth in the high single to low double digits, operating margin expansion of approximately 100 basis points and we expect SG&A per square foot will increase in the mid single digits versus 2009. The full year also reflects an effective tax rate of approximately 40%, approximately 67 million diluted shares outstanding which compares to 65 million shares in fiscal 2009.

Capital expenditures of approximately $55 million, which includes plans the to open 15 new stores with annual net square footage growth of approximately 3% or 2% excluding Madewell and approximately $13 million in losses associated with Madewell which includes expenses for our e-commerce launch and is essentially flat to 2009 excluding one-time costs related to store closure and impairment charges.

For the first quarter, we expect diluted earnings per share in the range of $0.48 to $0.53, which compares to $0.32 in the first quarter of fiscal 2009. Our first quarter reflects comp store sales growth in the positive high single digits, direct sales growth in the high single digit to low double digits, gross margin expansion of approximately 400 basis points as compared to the first quarter of 2009 and approximately 66 million average diluted shares outstanding which compares to 63 million shares in the first quarter of 2009.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Kimberly Greenberger from Citigroup. Please proceed with your question.

Kimberly Greenberger – Citigroup

Great. Thank you. Congratulations on a record year. Mickey, I was wondering if you could talk to us about your longer-term growth plans. We understand obviously that here in 2010 you slowed down growth a little bit because landlords were not coming to the table with some great deals. It sounded to us in January when we talked like you're starting to see better real estate opportunities and you're opening up that pipeline. Longer term, what's the opportunity? Where do you expect the growth to get back to in 2011? Thanks.

Millard Drexler

Well, that's not long term, 2011 is next year. And so for me, I can answer as best as I can. We slowed down, thank God, a year ago, because I think it ended up being either lucky or smart whatever it was, it really worked out for us. We are seeing better deals now, the world is more normalized, the landscape continues to change daily, weekly and monthly and annually in the business so that for us actually creates more longer-term opportunity but that being said, we're looking at real estate much more seriously again for growth. We're looking at the direct business for more growth.

I can give a lot of answers. We're looking at crewcuts which is basically no pun intended a toddler for more growth, factory for growth. Now, most retailer merchants might say everything is going to grow but we don't know, we think everything is going to grow. We look at the penetration of J. Crew brand and Madewell as a potential. I didn't mention anything about Madewell because until we see it start to contribute earnings it's not going to be on the top of our – with so excited list. But in the meantime, the indication is good, but if you look at the size of J. Crew's brand in terms of the businesses we're in, relative certainly to number of our competitors at higher price points or lower price points, we think that – and we've always said this by the way, we're not in a race to get there first. We're in a race to get there best and the race by the way in our industry or in any business never really ends. Because I remember a few years ago we got the question, why only 9% a year square footage growth. Again, I thank God that we didn't do that.

But in any case, nothing has really changed, other than our ability to continue to be creative, innovative and connect to our customers emotionally. We still talk about 300 units for retail, that would exclude – well, I don't know if that would include or exclude Canada which is probably at some point 10 or 15 stores, a 100 factory stores and leveraging our direct platform which for us is a critically important long-term issue.

If you look at the direct business in America and worldwide, the impact that that will have on all of us and is having is really an extraordinary issue. It's not a matter of thinking bricks and mortar anymore. Some of the most successful retailers are actually retailers online only today, as you know. So we're investing in direct in that regard. But at the end of the day, we feel that the distribution we have is seamless. It's managed with a very focused point of view on our customers, on our product and the most important thing, if I was just walking down the hall and I asked our accessories merchant why is your business so good, she had a very simple answer. She goes the goods are great and you know, I don't think things change in that regard, so if we can continue to do our job, having terrific goods, being creative, knowing that the world's still chasing – look, everyone chases everyone else but at the end of the day we said this for the last six years, we invest in quality, so that quality does not wear off quickly.

We're not in the fast fashion business. We're in the high-integrity quality business and in so, our mission. We're not making our dough from discounting today. We have very healthy sell-throughs, not saying that these things last forever but if we do our jobs well, I think the platform for J. Crew that we are building and have built is really a dividend payer for the long term. And so that's my answer.

Kimberly Greenberger – Citigroup

Great. Thank you, Mickey.

Operator

Ladies and gentlemen, due to the high number of people in the Q&A screen, if everyone could limit themselves to one question and one follow-up question and then re-queue up for more. Our next question comes from the line of Paul Lejuez with Credit Suisse Group. Please proceed with your question.

Paul Lejuez – Credit Suisse Group

Thanks, guys. Jim, why so little leverage on the buying and occupancy side with that level of comps? And Mickey, just on Madewell, what metrics do you need to see to push Madewell growth ahead and what kind of sales productivity perhaps are you looking for and how far are you away from those metrics? Thanks.

Jim Scully

Hey, Paul, it's a good question on the buying and occupancy. You saw that in Q3, we had about 110 basis points of leverage, on about 14% in the top-line, 50 basis points in Q4 with 19%. It really is some kind of ins and outs between the years, between – on the buying side and also between the quarters.

So I would say it's more anomalies. If you look going forward in 2010, we would expect to leverage buying and occupancy with total revenue in the mid single digits. In terms of Madewell, you said what kind of metrics. Well, you know, we've had an interesting experience with Madewell and we've been kind of very cautious which, again, I'm glad to say we are seeing now every indication that people like it a lot, customers like it a lot. Day-by-day, we are going online this summer and we're pretty pleased about what that looks like.

Again, we have a conservative sale, sales plan, but we are – we're actually going to be looking at more stores for 2011. We're going to be a bit more ambitious about that than we've been. But, you know, we've seen a lot more consistency in our performance there over the last six months. I'm really happy to say. If you go into our stores today, I think you'll see an assortment that's much more reflective of – starting a new company is really complicated. It's not an exercise that I would recommend to most although some of us have been there successfully and not successfully. I think so we're actually committed.

We hired Alexa Chung who – Alexa's been pretty unknown but for us a muse of sorts for the Madewell brand. So I think we're really – I don't want to be too optimistic but we're spending a lot of times in the stores. We're looking at the customers. We're getting a lot of buzz and if you ask frankly a lot of women you know who shop in Madewell, you're going to see a lot more loyalty, higher traffic, better conversion and price points and we're becoming quite famous for our boots, our denim, our accessories, our scarves and it's actually nice to see. So I guess more to come in the next three months in terms of reporting.

Operator

Our next question comes from the line of Michelle Tan with Goldman Sachs. Please proceed with your question.

Michelle Tan – Goldman Sachs

Great. Thanks. Guys, the team has done such an incredible job over the past few seasons. I know, you've talked in the past about how some of the challenges in 2008 sharpened your focus. And I was wondering if you could speak to any more permanent changes that you've made on the process side, you know, over the last couple years that have also helped, whether it's planning and allocation or other kind of areas where you've really refined the model and where you could see continued momentum as a result of those changes? Thanks.

Millard Drexler

You know, Michelle, I'd say that if you look at what happened in 2008, it did make us I think a little bit sharper in terms of inventory management, expense discipline and CapEx. I think if you look about the process, I think what we saw is how important newness is in the stores and I think what we saw was – I don't think we necessarily changed the number of flows but we were heavier in our flows in the beginning of the period.

In addition, I think we talked a while back in terms of some systems issues that unrelated to the direct business about a distribution allocation tool and we started using that in the second half of last year in terms of getting size and color into the store at the store level and I think that's helped as well in terms of seeing sell-throughs for a longer period of time unwaving. So those are things that would carry forward into 2010.

Tracy Gardner

And one other thing to add. We've really, as a team, design team, merchandising team recognized how the business changes a bit in Q4 and we've really learned how to capitalize December better than we have before and that's something that we'll continue.

Operator

Our next question comes from the line of Jeff Klinefelter with Piper Jaffray. Please proceed with your question.

Jeff Klinefelter – Piper Jaffray

Yes. Thank you and congratulations to everyone on the team there for your execution this year. Two questions, one for Mickey. On the merchandising, you know, you talked about accessories being very strong for you. Can you give a little bit more of just a comprehensive overview of what really stood out category-wise, composition of your transaction; is that telling you anything about consumer, your core customer this year? And then Jim, just in terms of inventory, with respect to your guidance being stronger in the first half against easier compares and then moderating the second half. How is it that you're strategically positioning your inventory buys for the second half and how much flexibility are you going to have to chase what might materialize?

Millard Drexler

So, I'll go first, Jeff. So I think, when we look at inventory, I think as we mentioned in the prepared remarks, we ended Q4 on a per square foot basis down 3%. We would expect at the end of the first quarter to be up in the mid single digits with average inventory for the first quarter to be essentially flat year-over-year. I think for the remainder of the year, we'll be building inventory to the back half.

On a more normalized basis, I think you would see inventory per square foot to track closer to the comp guidance and also some of the direct guidance that we've given as we anniversary the back half of last year. In terms of – I use the accessory merchant as an example but we're pleased beyond that. You know what – I just want to explain what – beyond that, bracelets and jewelry and all that's selling well but it's not – yeah, they're trending well. But one of the things that we try to do is create demand and create businesses and you can talk about it. Look, our industry is negative growth or flat growth or whatever the economists say it is but we're just looking at it as how do we make J. Crew top of the mind, go to the stores every day, have trust and confidence in what we design and we do and we're at a point where we will take a position on something we feel is commercial, successful, trend-right and then try to build a franchise.

So we're not in the – yes, so accessories are great but it's because of a lot of great items and in the assortment and setting up presentation both in direct online and the catalogs with full pages of impact on whether it's an item, whether it's one shoe or whether it's ballet flats and for us as we look at the long term, I think this is true of any business. You know, you've got to just out-product, your competitors. I think you've got to out-product them, out-buy them, be faster, know that every day you come to work there's going to be something else happening that will affect the trend of a business.

So we're just going down the road, looking at opportunities that we feel are next in line for us without giving up what we built. You know, when you construct a great pant like the mini or pixie plant or anything like that, it's not that we give it up but in other hand we construct, we fit, we try, we roll out and we're developing and building. So if one is seeing a lot of ruffles around today or whatever they're called, you know from everyone and anyone, you know two things, one, it's going to slow down, number one. And you're going to go on to the next and it doesn't go from 100 to zero, you also know that on when a customer trusts a brand and it's built with great quality and integrity and fit and design and with all the things we care about, you're going to build a loyalty and every color is not going to be exactly right, everything is not going to be perfect.

But over time, we're here to be in business and not open up more discount stores and more factory stores and buy the latest and greatest. So we look at it – it's beyond an apparel fashion business, it's a product business. People need to dress. They need to have respect for the brands. And they need to know it lasts and they need to have it easier to shop and that's why we'll be busy for the next many years continuing to figure out how to do that better.

Operator

Our next question comes from the line of John Morris with Bank of Montreal. Please proceed with your question.

John Morris – Bank of Montreal

Thanks. My congratulations as well on a really terrific quarter and year. Hey, Jim, on sourcing, we're asking a lot of our retailers, so the question I'm sure has come up quite a bit. As you look out on the horizon into the back half, cost pressures, if you're seeing any, I assume, correct me if I'm wrong, you're probably just beginning to place orders for holiday. Are you seeing any pressures on higher sourcing costs at this juncture and if so, how are you handling them? And then one quick follow-up.

Jim Scully

Sure. So John, when it comes to cost, what we've said is the back half of 2009, we were realizing about a 3% to 5% decrease and we expected that to carry into the first half of 2010. And I think we still feel comfortable with that. In addition, I think when we were out in California we said for the back half of 2010, while we saw some pressure, our goal was to keep it flat to 2009 and we're still comfortable with that. Our expectation is though that we will see some increases as we enter into 2011, into the spring season.

John Morris – Bank of Montreal

Okay. Good. And then for Mickey or Tracy or Jenna, what opportunities are you particularly excited about in spring as you look ahead here that you feel comfortable talking about from a merchandising standpoint?

Millard Drexler

I don't want to say more of the same was middle of March now. So you'll see new deliveries coming in again next week. It's just a matter of continuing the flow, newness, key, it's the oxygen in our business, new accessories, new merchandise, new prints and I think it would be hard to answer what is there. It's kind of a – it's a discipline. We have a newness flow and hopefully picking the right goods but I don't think there's a – of course, we always have a lot of strength in the spring/summer because of the excitement of our summer assortments.

We've always been known in the early days for spring, summer, go to the beach, J. Crew at the beach, et cetera. But I think you just see hopefully, we'll all see kind of more of the same transitioning out of more heavy into light weight and you'll also see a continued emphasis on our partnerships and collaboration which if you've seen GQ for example, this month, we are continuing to build the business where we feel we can appeal to a broader base of style, taste, customers, men, women, parents for kids and do all that in the factory stores at lesser, more value oriented prices. And the factories, of course, it's very reflective of last year's spring and summer which is formulaic for us to a large degree.

Operator

Our next question comes from the line of Roxanne Meyer with UBS. Please proceed with your question.

Roxanne Meyer – UBS

Great. Thank you and let me add my congratulations. Mickey, I was curious to get your thoughts regarding to what extent J. Crew's fashion positioning has evolved. It seems like you continue to push the envelope on fashion and I was just wondering how far you want to push it and if there's more room still to push it and then how is your customer base evolved in terms of what percent of your sales is coming from your core loyal customer versus new customers that continue to find the brand?

Millard Drexler

Look, you know, the best answer I have on this, seriously, is you've got to ask the people who shop at J. Crew. Every single day, we're assaulted or whatever by mostly good news, some bad. We will never be too fashioned. We will never do runway shows that have clothes that are number one ridiculously priced and number two, unwearable. Our design team in men's and women's has a lot of respect for fashion as a business and as a trend, not any different, by the way, than a lot of other great companies that I respect for the product. If you get too fashiony, you'll have a small business or a lot of markdowns.

So there's always a balance. I think on these questions, look, I'm in the stores every day as plus people are not shy about opinions, about what they think of J. Crew. But everything we do and of course, you make mistakes, we will – because without a mistake, there's no risks, no rewards, et cetera. But everything we do, actually we look at as commercial. And we're not interested in trend, we're interested in style. So if I watch the academy awards the other night, I'm not sure what I was looking at. The old world is not the new world and if you look at any industry today, old world loses, new world wins. There's been a revolution in America by companies like Google, Amazon, Apple continues to revolutionize but fashion for us is style. It's always a matter of good taste and good style and the thing today is what I like about our business is fashion that's wearable, that's style.

I don't know how many women – I don’t wear jewelry but how many women are asked now where did you get the necklace and I am so happy to see that it's from J. Crew when they tell me the story or we get the e-mails. What we put into jewelry is a huge amount of design, integrity, respect and pricing that is in fact much less than the triple markup or double markup competition. And I don't understand why these things – I do understand. It's happening now. It's all there. The fact of the matter is go online and that's what we do, try to buy goods online, go for the lowest price; it's a revolution happening in retail right now.

You don't need all these high margin, double markups because at the end of the day, I think the real question everyone should be asking is what percent of our goods and we won't tell you of course, sells at regular price because that is our mission. Our mission is reinvention of a business and yes we will make mistakes. We all remember last year fourth quarter when we're up against obviously a very easy quarter when you lose all that money.

But I think it's not going to be too fashiony and it's all about style and taste and not with the latest, greatest because the latest, greatest, anything on the academy awards which I know is a big fashion show worths really $5,000. They're custom made. They cost $10,000 and you know something, few people quietly wore J. Crew and we were delighted. No one said who you wearing, this was J. Crew but you know we hear more and more men and women asking for J. Crew and the interesting thing is our men's business has had a resurrection that we are so excited about that we see, we make it easy.

We have Jack knows best, there are rules guys asked about and we've give them the answers. And then we have some of the best makers in the world and wherein in two factories last week, our hand made shoes in both men's and women's, we just have a lot of respect for the true value of great make and great design. So you will never see us, I hope, be too fashiony, when we are too fashiony you'll see more markdowns and we'd like what you'd like to see.

Roxanne Meyer – UBS

Thanks for your insights as always.

Operator

Our next question comes from the line of Lorraine Hutchinson with Banc of America. Please proceed with your question.

Lorraine Hutchinson – Banc of America

Thank you. Good afternoon. Now, that gross margins are back up at the historical peak levels, can you just talk, maybe a little bit longer term where you think the best opportunities are to continue to grow your margins going forward?

Jim Scully

Sure, Lorraine. I mean, I think if you look back and what we've said is that we have – we always expected to be in the position to grow our EBIT margin 100 basis points a year and that was always the one-third through gross margin, two-thirds through SG&A and I think we're – eventually we'll be back there. We'll be back there on an annual basis this year and then going forward, I would expect that will be the model for the next two or three years. What we always said is out of that 30, one-third of 30, the basis points coming out of gross margins, about half of that in merchandise margin and some of the opportunity there will be related to Madewell as it matures and starts to hit new volumes and then in the B& O side, one of the things that we've done and I didn't mention this earlier in terms of structurally is I think everybody knows we went back and tried to renegotiate some rent relief and some occupancy.

So we do see some opportunity in the B&O side going forward. Not only from occupancy but also as we leverage the buying side. And I think we feel very comfortable in the outer years with that one-third, two-thirds and 100 basis points.

Lorraine Hutchinson – Banc of America

Thank you.

Operator

Our next question comes from the line of Jeff Black with Barclays Capital. Please proceed with your question.

Jeff Black – Barclays Capital

Hey, thanks. Can you maybe talk about your initiative on the direct side to sell into Europe and you mentioned Canada. I know we're not keen on stores over there but just what you're thinking overseas. Thanks.

Tracy Gardner

So – hi, it's Tracy. Direct – we're really not going to be discussing international right now but in direct, we see a great opportunity to expand the businesses that Mickey mentioned and also we're seeing, because of our prudent strategy and circulation last year, we have opportunity to grow circulation this year. We're seeing our customer file grow. We're getting customers. We're going to continue to mail them. Crewcuts has been really exciting. We'll be putting a direct mail piece in the mail almost every six weeks. And then we discussed some of the web opportunities we're seeing in Madewell as well but lots of opportunity in direct.

Millard Drexler

Just to add to that, as Tracy said, the Net-a-Porter deal is actually for us a great validation by we think one of the best online sellers in the world of better apparel who treats it as a serious business, great selection, Natalie Massenet runs that. We got together and we did that not for a great amount of profit motive, I mean, but we did it for a great amount of validation motive and hanging out with all those other people actually will show well for us. It gives us exposure to 170 countries and that alone is why we love Natalie.

Clearly, it's not going to be a huge markup business and I think we've said that. It's more about the fun of it and long-term we look at it as a really nice investment, just as we do with Ron Herman and Fred Segal, one of the – we think one of the great men's retailers in the world. We sell Ron. If you live in LA, you kind of know it and you shop it. And he reorders and we buy and we work together. We're not getting rich off the one store but it's no different than if Coco Chanel came and said she loved J. Crew, she is no longer around, of course. It's kind of a bit of a validation for us.

Canada, we're going to, slowly. We're looking at real estate now. International, we are looking at for sure and it's on the radar screen. We are, as I said, we're in a marathon and we look at this as not a ramp it up as quick as we can because we want to do whatever. This is a marathon to build a great business with hopefully a great team that designs great clothes and we deliver it in a great way. So – but we're going to be there some day. At what level, it's too premature to say.

Operator

Our next question comes from the line of Richard Jaffe with Stifel Nicholas. Please proceed with your question.

Richard Jaffe – Stifel Nicholas

Thanks very much. It's a follow on to the growth in the direct and the opportunity for further circulation. I'm trying to understand the SG&A leverage, given the increase in circulation and then the opportunities beyond circulation to drive the direct business.

Jim Scully

So Richard, when it comes to the SG&A leverage, I mean, remember that we saw a significant decrease this year in circulation in the high 20s for the year. At the same time, we were reinvesting some of those savings back into other forms of marketing and advertising. So it wasn't necessarily a 100% SG&A savings. So when Tracy talks about next year, I mean, the leverage issue is we see opportunity to grow the file from an ROI perspective, where before we were eliminating what we thought was low ROI distribution.

Tracy Gardner

And again, we don't circulate to what we will not make the commensurate money on. So we definitely not – the team is kind of great at doing that and in fact in growing the business, there's a whole new world. Mickey talked about its transforming. We are taking all the money that we're not spending on productive circulation. And again, we don't invest in on productive circulation. We're throwing it at the Internet and we're seeing incredible returns on our search. Our search, our affiliate marketing and we're really seeing a whole new frontier to explore and go after to grow this business.

Jim Scully

And so when we talk about the increase in circulation, we're talking for 2010 to be in the mid single digits growth after a couple years of significant reductions.

Richard Jaffe – Stifel Nicholas

That's helpful. The new frontier is the wireless frontier; is that correct?

Tracy Gardner

Really just being out there on the Internet and being where our customers are and really getting our mind share and the word out about J. Crew.

Richard Jaffe – Stifel Nicholas

Great. Thanks a lot.

Operator

Our next question comes from the line of Barbara Wyckoff with Jesup & Lamont Securities. Please proceed with your question.

Barbara Wyckoff – Jesup & Lamont Securities

Hi, everyone. How are you balancing the need for wear now product with moving the season forward? And I guess this would be sort of going – talking about spring into fall or summer into fall.

Tracy Gardner

The best way I can say it is we are starting to view our self as seasonless. We really do. I mean, the only time you'll see us get really specific to a season will be in the fourth quarter when we deliver our coats. But even then we had great success this season in Q1, extending the life of our wool coat business into February. But we're really – we're sort of agnostic to season. We buy what we love and what you can wear now.

Barbara Wyckoff – Jesup & Lamont Securities

Okay. Thank you.

Operator

Our next question comes from the line of Adrienne Tennant with FBR capital markets. Please proceed with your question.

Adrienne Tennant – FBR Capital Markets

Good afternoon and let me add my congratulations. Jim, I think this is a question for you. Can you talk about the comp cadence over the past – over the fourth quarter, the three months and then is there any commentary on current trends quarter to date and Mickey, can you talk about the direct business, as you run a much cleaner markdown business and the direct has been a channel for clearing markdown. Does it change the way that you think about promos and kind of marketing online?

Millard Drexler

I'll answer that first. Not at all. The less markdowns, the higher the margins, the cleaner the inventory, the more cash to invest in new flow and in fact, online is the great price mechanism in all the world today. So anything we or anyone puts online, it's a very value-driven world which is why we kind of like the fact that we control our brand and our name or else we would be quite afraid every day to go into a marketplace where almost every brand you could imagine was on sale one place or another. That being said, our value play is factory.

Our other value play is J. Crew goods, which if you look at the range of our pricing today, it's at 10 bucks to $1,000 or $1,500 and the really exciting thing for us which we didn't mention is the range of demand in direct and in retail is over that entire price range. And I want to say, we invested a lot of years into becoming being able to market at prices that even in our own opinion – you know, this business has always, kind of, been defined you're high, you're low, but it's all old news in a way. We're low, we're high, we're medium and then we have factory which I think is even much greater value which gives us an opportunity for our own core brand extension so on and so forth.

And then the other interesting thing is the factor store broke the ramp, I think it gives more prestige to J. Crew brand because when you open up a factory store within the Metropolitan areas and all the brands at a regular price shop, sell within 20 blocks, I think it just enhances the true value. New York magazine had an article two weeks ago, what is the real retail of a product. And if you ask most customers in the world, they know the real retail of products. They find it, they look for it and the savvy customer I referred to in opening comments, it's just not hard to Google any brand in the world. We do it, find out the best price of – you name the brand, it will be there, particularly in certain categories of business.

So to answer your question, the value play for us is factory, online sale goods is always of course at a lower margin than regular priced goods. But our key is to keep turning and flowing new and getting rid of and moving forward and it's a dynamic that's really religious to us.

Jim Scully

The first set of questions, being in a quarterly issuer of comp, we do not typically talk about the monthly trends. I would say that relatively consistent and given the fact that we mentioned that it was AUR driven, I think you could imply what happened last year in terms of the markdown cadence and understand what happened throughout the quarter. In terms of current trends, we never talk about current trends. But I would say, that we use current trends in order to provide guidance which we did this quarter and everyone knows we're later in the quarter this year because it's the year end and obviously the trend that from the fourth quarter is reflected in our guidance for the first quarter.

Operator

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

Janet Kloppenburg – JJK Research

Hi, everybody and congratulations. Mickey, I was excited about the collaboration with Alexa Chung and just actually saw her on the cover of British Vogue and I was wondering if you could elaborate a little bit on her role, how much design leeway she'll have, how much the designers will be working with her? Will the line be exclusively designed by her, I mean, the entire line or will she be doing certain categories and if we could look for these types of collaborations, perhaps for the J. Crew brand as well. Thanks.

Millard Drexler

Yeah. It's an interesting question. We started looking probably about six or eight months ago. We said we couldn't, in jeans in particular, you kind of need some iconic or muse-like or hip or whatever to start wearing your jeans and when you start a little business, it takes time to get known unless you have this kind of tipping point of some major person, whoever that might be, wearing the jean or you're actually paying off a lot of celebrities to wear jeans.

But Alexa, we kind of looked and we did our own internal – go on the phone, you do the loud speaker, you say who's cool and who's unknown. Alexa might not like to hear that because she's getting more known. This was six or eight months ago. And Alexa came into like one of the high levels of cool, unknown and very Madewell and so we met her, we chose, we chatted. We also knew she liked our clothes. She's English who now lives in Brooklyn with a very cool rock star which is usually the case, young muses or whatever and cool people, if we only were rock stars in our early days.

Anyway, so we met with her and we made a deal and we – there's 10 items, I believe, 10 items or so, 10 to 20 items Libby tells me. We've seen them. She designed them with Kinley [ph], our designer. She's very – you want to be like Alexa kind of person. She's not like dressed to the nines. She has her own incredible style. She's totally cool. She's totally you want to look like her and be like her and we totally just like the way she is. A lot of girl crushes on Alexa here and a few boy crushes, but a lot of girl crushes on Alexa that's the girl crush part. Anyway, she designed the collection. We had a preview by editors during the fall fashion week and she showed the clothes along with Ken [ph] and the team and we kind of – she's quietly involved but I have to say, some of the clothes which we're launching this fall are things that we're really excited about and it's not higher or well-known designer, sell the goods cheap and get out of it, it's hopefully going to be a longer term collaboration and we'll see how it works out.

I think we frankly felt that to jump start Madewell a little, you needed a few things, more great goods, which I think we've done, a great muse or someone who can be out there, speaking about us in the right way. Having the woman who was our target identifying with someone like her and we didn't want someone who was obviously in it for the high advertising fee. Because you know, we look at celebrities and say oh, high advertising fee, do they really drive a Buick? I don't think so. So that's why we did it and I hope you like what she does and you'll see her more around.

Operator

Our next question comes from the line of Christine Chen with Needham & Company. Please proceed with your question.

Christine Chen – Needham & Company

Thank you and congratulations on another great quarter and the year. I was wondering, Mickey, if you could just talk about – I mean, the fourth quarter was so strong for you guys but there have been some missed opportunities so how are you thinking about that as you guys are planning holiday? Thank you.

Millard Drexler

Next holiday.

Christine Chen – Needham & Company

2010, yes.

Millard Drexler

Well, you know, we haven't seen it yet of course but Jenna and Frank and the teams are working on it along with Jenny Cooper. You know, it's hard to answer that because…

Jenna Lyons

We definitely saw some operational things in our stores we need to fix. From a customer perspective, we feel like between direct and retail, we can be a little more seamless. Some of our big stores we couldn't stand looking at the lines and a little bit of the frustration so definitely some operational issues and frankly, we even have opportunity for more flow and we definitely see in the non-apparel world opportunity to sort that even more.

Operator

Our next question comes from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Dana Telsey – Telsey Advisory Group

Good afternoon everyone and congratulations. Mickey, you talk about the product trends changing and the new environment and Tracy, I like that word, seasonless. As you think of your different channels or different distribution, do you see given this new direction any changes the in the potential, whether it's better margins or sales or online, catalog, stores, both full price and outlet and Madewell? Thank you.

Tracy Gardner

There's a couple – I mean, Trish and team are looking at things like 24/7 shops in terms of resort wear and we definitely see some opportunity to try to have things live a longer life but at the same time we're balancing the customer's insatiable desire for newness and basically our style that Jenna spoke of. We just see flow. We just see this trend of people wanting to wear what they buy from us today, the second they buy it. So we will continue to optimize that. But on the web, there's definitely an opportunity. There's no wall. We can really capture the demand of a coat in March or a bikini in December.

Operator

Our next question comes from the line of Eric Beder with Brean Murray. Please proceed with your question.

Eric Beder – Brean Murray

Good afternoon. Congratulations. Want to talk about the niche stores, the Men's store and I guess the roll-out of the wedding store. How do those fit in going forward and what kind of – where do you see the wedding business going forward?

Jim Scully

The strategically, the Men's store – well, we did the first liquor store, the Men's store, Garden State store, we're now opening on 79th and Madison, the Men's store on the North West Corner opposite to Women's store. I'll tell you one thing I feel good about is that not a day goes by that we're not figuring out how to move forward and creatively think about our future.

So what happens is you come to work in the morning, things happen, you feel – you figure it out and we decided that this is maybe 50 years too late. That it would be nice to have a Men's store. Why? Because guys don't love walking into the back of a women's store. Now, you could ask why we didn't figure that out or any of us 20, 30 years ago and we were just not smart about it. So we decided that it was time to give a guy his own environment, his own point of view and in the old days, when there were men stores around that, truly Men's stores, it was kind of a different vibe. The world has changed a lot. But long story short is we felt we could not do justice to a guy who has taste and style and wants to be a Men's store by walking into a crowded Women's store and oh, by the way in the back is 2,000 feet of men's stuff, not terribly styled, designed or bought right. That plus we kind of felt coming down the road was an opportunity to be buyers of goods outside of our own design, because men are creatures of habit. They want rules. They want regulations. They want to buy the same jean they wore 30 years ago and it sometimes takes a mountain to move a guy into a new direction.

Because we all dress the same as we have since we're 10 years old, that being guys. So we opened up the liquor store, it was a – I'd say it was a large, cheap rent, a bar. It was fun. We did have it, although it – there's very little downside because the rent was so – I don't want to say it in front of the landlord who I assume is not on the call. We had a great rent. And we said if nothing else, this will raise awareness and get us a chance that they could spot. People don't go to a restaurant with great food and if it's an ugly environment with bad service and have to walk through McDonald's, they're not going.

Not that I'm comparing our women's department to McDonald's but anyway, we opened a liquor store and wow, amazing education. Then we said okay we're ready to step up. We opened our first store in Garden State. We separated it. We put it out there and wow, we were really happy. Now, things don't happen as quickly outside of Manhattan as they do in Manhattan. We took that into account which is why the second store was in fact in Garden State. Then we opened up Broadway. We got more aggressive on the suiting business and we said well, guys spend $3,000 on suits or might they spend $800 on a suit. Italian made, strong, good needle, made in the Far East but that's okay because a lot of designers are going the same way or maybe Romania, Bulgaria wherever else they are making. So we said this seems to be where the future's going and then we really invested in outside brands. I can only tell you that that Men's store to us has not only been inspiring and done really wonderful business. Again, it's Manhattan, you've got to do a lot of business in Manhattan or else you're not doing so well.

But it's been a great inspiration for the rest of the Men's, so if you go around and look at our Men's stores now around America, we're expanding our brands Timex, Sperry, Aigle [ph], Persol, Plus [ph], Barbour, Belstaff to about 20 plus stores and so that's given us a credibility and it's given us the ability and the strength to move forward and guys are looking for the same thing that everyone's looking for, high integrity, value and not spending 200 bucks for a sports shirt and a designer by the way, our wash shirts we make them in a lot of the same places, so on and so forth.

Tracy Gardner

It's also been a great source of growth in direct as well.

Millard Drexler

I don't want to stay everything Hunky Dory in those shops, got to do a lot of volume, Garden State started very kind of slowish for the first six months but now it's moved in. We're investing in the future, going slow, not quick on men's. We have our fourth store opposite to Women's – and wedding speaks for itself. Jenna and Tracy, I'm a guy, I didn't know – I don't know what a woman goes through on a wedding. But the team – and remember I'm surrounded by a lot of women who like addiction to weddings by – not expects by women is extraordinary. We started a few years ago and the vision was and it's the same thing as men's unless you articulate a point of view, kind of like when Apple decided to build stores 11 years ago.

The feeling was you cannot articulate your business without a beautiful shop that speaks to it. Online is sometimes not good enough. You have to touch and feel, by the way, it's one of the reasons we have our catalog but touch it and feel it. So the wedding store on 66th and Madison in our mind will do that. Now, we have doubled the amount of fitting rooms we have there than we have in any of our other stores. We've tested wedding shops in how many stores is it now?

Tracy Gardner

It's ten.

Millard Drexler

Ten stores, Chicago, I believe.

Tracy Gardner

Boston, Atlanta.

Millard Drexler

And I have to say, I mean, our appointments are filled up all the time. Wedding, for most women is about the experience from A to Z and we felt we needed a shop on Madison Avenue to have a woman feel that experience with those that she shops for wedding. Sometimes like when you're in the store and you see wedding parties come in, a crowded store on a Saturday, you kind of want their own store, so we're opening up – I don't when the store opening? This summer, we hope, end of May, summer and that's why we did it. Then we'll have a better answer as to where it goes and the one thing we warn ourselves always is you can't take on too many things beyond what you're doing so wedding's really an extension of what we're doing. We're not taking a group of designers because we've had a group of designers. We're actually trying to leverage in wedding and Crewcuts and jewelry and et cetera, a business that we have designed team for it and a technical team and a resourcing team, now we're saying what's the next generation of distribution for those products.

Operator

Our last question comes from the line of Betty Chen with Wedbush. Please proceed with your question.

Betty Chen – Wedbush

Hi and good afternoon. I was wondering if you can speak to any sort of regional differences that you're seeing across the chain and then also, I was curious on your pricing strategy, in store versus online, Mickey. We've been noticing that perhaps some of your higher priced, more detailed oriented merchandise may be shifted around some of your retail locations. Is there some kind of shift in your strategy on how much of the higher priced items you want to place in store versus showcasing them online? Thank you.

Millard Drexler

Okay. Well, first of all, regional, you know, other than some climatic issues of hot weather in September, October in warm weather stores, we carry; it's not a big issue. Best sellers are best sellers in most places. The real important difference is demographic more than regional per se. But there are weather differences in our planning and distribution team adjusts for that. For example, certain stores will have shorts or a few shorts all year, et cetera. If I understand your second question correctly, the prices are always the same online and in the stores or they should be. But I think you're saying the determination of the investment, whether it's online or in stores, I'm not sure I understood that.

Betty Chen – Wedbush

Were you talking about the more expensive?

Millard Drexler

She can't speak anymore. Anyway, so the allocation is we're going slow but we're moving it up a little more quickly. Online is one inventory so we like to have online and demand is – and you'll see more and more collection emphasis, better emphasis as our customers demand more. We're getting more but there will always be somewhat scarce and this store is very selective.

Tracy Gardner

Very selective stores and we can always see the demand that we would have had on our collection items that we're definitely seeing a nice opportunity there. But in the stores, we're very, very judicious.

Jim Scully

Yeah. But the one thing we see is, you know, we talk about price and quality. For us, the world is moving in a way of buying quality and buying price. We've always said we get a much higher ROI on online. But you'll see, as I said, we're expanding Men's to 20 stores. We're seeing really nice response to people who are migrating to us from the better competition because the customer's seeing what they carry and some of the traditional higher end department stores versus what we have and that's the fact that we keep every day pushing for that marketplace, along with continuing to expand our reach to all customers who want quality, style and design. Is that it? So thank you. All right.

Millard Drexler

Operator?

Operator

Ladies and gentlemen, there are no other questions in the queue at this time. I'd like to hand the call back over to management for closing comments.

Millard Drexler

Well, thanks again for joining us. Look forward to speaking to you when we report our first quarter results in May. Thanks a lot. Bye.

Operator

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

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Source: J. Crew Group, Inc. Q4 2009 Earnings Call Transcript
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