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rue21, Inc. (NASDAQ:RUE)

Q1 2011 Earnings Call

May 26, 2011 4:30 pm ET

Executives

Melissa Mackay - IR, ICR

Bob Fisch - President and CEO

Keith McDonough - CFO

Kim Reynolds - Chief Merchandise Officer

Bob Thomson - SVP, Real Estate

Analysts

Anna Andreeva - JPMorgan

Sean Naughton - Piper Jaffray

Michelle Tan - Goldman Sachs

Lorraine Hutchinson - Bank of America-Merrill Lynch

Paul Lejuez - Nomura

Adrienne Tennant - Janney Capital Markets

Stacy Pak - Barclays Capital

Jeff Black - Citi

Liz Dunn - FBR Capital Markets

Operator

Good day and welcome to the rue21 first quarter 2011 earnings results conference call. At this time, I would like to turn the conference over to Melissa Mackay of ICR.

Melissa Mackay

Good afternoon and thank you for joining us for rue21's first quarter 2011 conference call. Joining me today is Bob Fisch, President and Chief Executive Officer; Keith McDonough, Chief Financial Officer; Kim Reynolds, Chief Merchandise Officer; and Bob Thomson, Senior Vice President of Real Estate.

Before we begin, I would like to remind everyone that remarks made by management during this call will contain forward-looking statements about the company's future financial performance and plans. There are risks and uncertainties that could cause the actual results and implementation of the company's plans to vary materially from those in the forward-looking statements. These risks are referenced in today's press release as well as in the company's fiscal 2010 Form 10-K. Those documents can also be found in the Investor Relations section on the company's website at rue21.com.

All information discussed on the call is as of today, May 26, 2011. rue21 undertakes no duty to update its information to reflect future events or circumstances.

And now, I would like to turn the call over to Bob.

Bob Fisch

Good afternoon every one. On the call with me as usual is Keith McDonough, our CFO; Kim Reynolds, our Head Merchant. And joining us today for the first time is Bob Thomson, our Senior Vice President of Real Estate.

As anticipated during our last conference call in March, we started 2011 with a very good momentum. Our first quarter results were driven by highly productive new stores, followed mid-single-digit comp growth, merchandise margin improvement on top of record margins last year and good expense leveraging, providing nicely balanced drivers to our top and bottomline growth. This is the kind of quarter we strive to produce and that we are consistent in delivering.

Keith will go over detailed financials with you later on the call. But some highlights of our financial performance for the quarter were as follows.

Net sales increased 25.5% to $179 million. Comp sales increased 5.2% on top of the 7.7% increase in the first quarter of fiscal 2010. Gross margin increased 100 basis points on top of a record gross margin a year ago. Our SG&A leveraged by 90 basis points. And finally, operating income increased to 9.1% from 7.1% in the first quarter of fiscal 2010.

There were a couple of points that contributed to our success this past quarter and that I feel very confident about looking forward for the future.

First, the strength of our real estate strategy. I'm going to have Bob Thomson speak to you about this in a minute or so. The strong performance from our new stores isn't by accident. We have thought a lot since going public about a flexible real estate strategy. We have a very large group of store locations to choose from and we are selecting our new stores very carefully and ensuring that we are in the right communities that (starve) for the fashion and value that we deliver.

The point we want to make clear is that we are also in the best possible shopping centers in each community whether it is a strip center, an outlook center or a regional mall. We get competitive rents because of our flexible real estate strategy and the relationships with landlords that we've built over the years as a growing company. And we can lock in at these great locations at sharp occupancy costs for the next 10 years.

The second point I'm feeling confident about is our ability to drive our business with our everyday great value. One thing we've all heard a lot about this quarter from some of our retail peers was the need to promote because of the tough macroeconomic conditions like rising fuel and food prices. But at Rue, we continue to believe, that if you are offer a great fashion and value everyday, you do not need to overly promote to get the business.

As an example, we kept our best denim shorts at full price, $19.99, for the entire quarter. It is possible that we could have sold more units at a promotional price, but it would not have been the right thing to do for the business. And as a result of our value strategy, our selling average unit retail for the quarter was up approximately 8%.

We are focused on building our brand for the future and we want people to come to rue21 knowing they will get great deals and fashion at a great value at our regular prices and not to see what is being put on sale that day versus the day before.

And the third point that I'm confident about is the strength of our management team and our initiatives for future growth. My management team is experienced. We have been in this business a long time together. We take a prudent approach to the business. We are realistic about our opportunities and we have delivered what we say we are going to achieve.

As I mentioned to you on prior calls, planning and allocation has been a major initiative for us led by Mark Chrystal and his team. And because of his efforts along with Kim and her merchandizing team, we're able to run a regular value business and not promote more than we did during last year's very strong first quarter.

We did very well at the regular price business in February and March and then even with the crazy weather across the country that affected so many of our peers in April, the cold, the rain and all those tornadoes, we did well ending the quarter with inventory down 2.9% per square foot, leaving us in great shape going into quarter two.

In terms of merchandise, our juniors business as well as our Etc! accessories and shoe businesses were the categories that drove our comp in the first quarter. The girls team did a great job with fashion tops with crochet knits, embellishments and appliques as well as our key items, fashion. Dresses also sold well this season and Denim at higher price points of 29.99 and 34.99 performed extremely well.

In guys, we had a slightly tougher quarter, but we have made corrections that will create opportunities for back-to-school. But we also had a big opportunity in the guys' accessory business with higher margins as our carbon elements and our watches and guys' jewelry also were selling well.

In the Etc! world, we were very proud to open up 500 stores this May. And we continue to see huge potential in our five prongs of the Etc! business, footwear, accessories, jewelry, fragrance rue-beauty and tarea, our intimated apparel and sleepwear business.

I also want to quickly speak about product course. Because of our flexible sourcing model and use of domestic-based importers, we were able to hold off on buying part of our back-to-school and fall goods, which means we are still buying back-to-school now that cotton prices have come down somewhat. We also have purchased only a minimal amount of holiday merchandise so far, which gives us a real competitive advantage and will allow us to hold key item prices consistent with last year.

We look to drive dramatic market share. If we do raise prices on some of our best fashion products, it will be consistent with how we have been operating. We have repeatedly said that there is no resistance to our higher price point in our fashion merchandise if we were delivering exceptional value to the customer.

Further, our higher-margin accessory category is not cotton dependant and is our fastest growing category of business. It now represents approximately 26% of our total sales and that doesn't even include guys' accessories, which is also a growing a category.

As I said earlier, today we are going to change it up and have our Senior Vice President of Real Estate, Bob Thomson, give you some insight into our real estate strategy. This is good timing for two reasons. First, I'm happy to say that because we opened eight stores today and now over 695 stores strong; and second, because Bob and I just returned from the real estate convention this week in Las Vegas where we met with all of our largest developers and we're more excited than ever about the opportunities that are out there for rue.

So now, I would like to turn this over to Bob.

Bob Thomson

As Bob mentioned, we just returned from the real estate convention where rue21 is being recognized as one of the industry's most exciting and fastest growing retailers in the countries.

Members recognized that we still have the ability to open a significant amount of stores over the next several years, but they also recognized that we have a disciplined approach to site selection and deal making. I'm pleased to report that we've secured 110 new locations for this year and we have already started securing 2012 deals.

As we reported today, we opened 39 stores in the first quarter, and these stores opened thus far this year are performing consistently with the new stores opened up in past few years. We opened our first store in Montana and South Dakota. And as of today, we have 695 stores in 46 states.

I want to talk to you a little bit about how we choose our sites. This really is a two-step process. First, choose the market for location. And second, choose the primary shopping center in the market.

For the first step, choosing a market, we leverage the knowledge of our real estate team we have built and that is based entirely on our headquarters here in Pittsburgh. We have gathered a lot of information about what makes a store successful from our years of experience operating in many varied types of markets. And we could line that insight with marketing research to find out the ideal location for rue21 store.

It isn't just based on the size of the market. We performed well in many different types of communities, small communities with lower average household incomes, where we are often the only game in town for fashion and quality; medium-sized communities, where are reasonable starting price point really makes us different from the rest of our competition; and even larger urban settings such as Houston, Salt Lake City where we serve a certain percentage of the population.

I also want to point out that we are able to perform consistently in areas of racial diversity. Our stores work whether they are located primarily in Caucasian or primarily Hispanic or primarily African-American, again a distinct competitive advantage. So in terms of location, there is a wealth of opportunity for rue.

Once we have chosen a market we want to enter, the second step is focused on choosing the primary shopping center in that community. As we have mentioned many times, our flexible real estate strategy allows us to be successful opening in strips, outlets or malls. So we have options that many of our peers do not have, which puts rue21 in a very favorable position with potential landlords. We typically own a variety of real estate. Plus, we are not locked in by one developer. If the rent isn't right in a closed mall and the community we want to be in, we can go across the street to a strip and do just as well.

To give you an example, we just opened at Tullahoma, Tennessee, which is a very small community, 18,000 people in town along with an army base, where there is no other fashion retailer. And our store in this strip center with five other stores down the street from Wal-Mart, the Tullahoma store was our top performing store for a couple of weeks after it opened.

That and a much different situation, we just opened in Sioux Falls, South Dakota, in a regional mall owned by Macerich. We secured a great location near (inaudible) retailers and got a great rent deal because of our relationship with the landlord and because the landlord realized that we fill an important value niche in the mall. This is the only good mall within several miles and has many other junior retailers, including AE, Aero, Buckle, Old Navy, Charlotte Russe, PacSun. And we are doing extremely well in this mall.

Again, we not only have the flexibility in being able to get great sales results in malls, strips and outlet centers, we also have thrived in different types of communities.

So in closing, since I have been with rue, we have opened 500-plus stores. I have a highly experienced team that is able to build early on. And we have predictable real state model that deliver consistent results. We are very confident in our strategy and in the 2000 class of stores, and we are already in the process of working on 2012 deals.

I will now turn this call to our CFO, Keith McDonough.

Keith McDonough

Thank you, Bob. I'll review the first quarter financial details and then provide an update to our outlook for the second quarter and for the full year fiscal 2011.

Net sales for the quarter were $172.9 million, up 26% from $137.8 million in the first quarter of 2010. The increase was driven by comparable store sales increase of 5.2% on top of a 7.7% comp sales increase in the first quarter of 2010. Total sales growth was driven by an approximately 18% increase in transactions and an increase in AUR of approximately 7.5%.

We opened 39 stores and converted 12 compared to 31 stores, 13 conversions and 1 closure last year in the first quarter. We were operating 677 stores at the end of the quarter, up 20% from last year, consisting of 533 comp stores and 144 non-comp stores or about 21% of the total. Last year's total count at first quarter end was 565, consisting of 445 comparable and 120 non-comparable stores or about 21% of the total.

The closure last year was a store in Tennessee due to flooding. Although we have been impacted by all the recent news over the weather, we have not had to permanently close any store for weather or other reasons this year.

Gross profit for the quarter increased by 29% to $67.2 million and our gross margin expanded to 38.9% from 37.9% last year. This 100 basis point increase comes on top of a 280 basis point margin increase achieved in the first quarter of 2010.

The gross margin expansion this quarter was driven by a 30 basis point increase in merchandise margin and was additionally supported by 70 basis points of leverage of store occupancy, distribution and buying cost. Merchandise margin improvement was driven by lower markdown rate performance in the quarter.

As I will go into further through my balance sheet commentary, we also coupled the strong margin performance in the quarter with an excellent inventory management ending down 3% on a square footage basis.

Selling, general and administrative expenses increased by 22% to $45.4 million. The increase was 24%, excluding the $6.11 in non-tax deductible expenses associated with our secondary offering, which occurred last in the first quarter. Store expenses in the quarter did leverage by 20 basis points. And administrative expense, excluding the stock comp expense and last year's secondary offering cost, leveraged by 40 basis points in the first quarter.

As discussed last quarter, this overall SG&A expense performance was in line with our expectations, growing approximately at the rate of sales, but leveraging down if our incremental stock comp expenses excluded. That incremental difference in stock comp expense in the first quarter was a little less than $0.5 million.

Depreciation and amortization totaled $6.1 million, increasing 23% over a year-ago. The expense represented 3.5% of sales, leveraging down 10 basis points from last year. We are planning 2011 CapEx to be roughly $39 million net, which includes 110 new store openings, 35 conversions, store maintenance and fixture CapEx and our continuing IT support center and supply chain investments.

Operating income for the first quarter grew by over 58% to $15.8 million from $10 million a year ago. Our operating margin expanded by 190 basis points through the first quarter all time high of 9.1%, driven primarily by our sales growth and gross margin expansion. This performance comes on top of the first quarter results last year in which operating income grew by 95% and operating margin doubled.

The quarter's effective tax rate was 39.1% versus 41.4% for the same period a year ago. The higher effective tax rate last year was entirely a result of the non-deductibility of the secondary offering expenses. This year's rate is our normalized rate for the year excluding the free tax events. However, we do anticipate seeing a start of a general long-term improvement in this area due to various initiatives we have underway or are planned.

Finally, net income increased by 65% to $9.6 million for the quarter, up from $5.8 million a year ago. Fully diluted earnings per share were $0.38 versus $0.23 a year ago on approximately the same fully diluted outstanding share count of 25.1 million.

Turning to the balance sheet, cash and cash equivalents at the end of the first quarter were $55.6 million compared to $27.8 million at the end of the first quarter of 2010. During the quarter, we generated $5.5 million in cash compared to $1 million last year in the first quarter. This increase includes the impact of incremental CapEx in the quarter of $4.3 million. As I said earlier, inventory level at the end of the quarter were down 2.9% on a square foot basis.

Importantly, in the first quarter when we normally increased inventory from yearend levels, we actually increased inventory $4.4 million less than last year in the quarter with 112 more stores. We had no long-term debt on the balance sheet and our revolving facility of $85 million plus another $15 million accordion feature option. We did not borrow at all during the quarter and have no plans to borrow throughout 2011.

Now turning to outlook, we continue to plan for 110 new stores in 2011 and are forecasting a split of 65 in the first half and 45 in the second. Conversion should reach 35 stores for the year. We also plan to close a handful of stores later in the year, all of which that have leases that are expiring. On an average, rue21 has closed two stores per year over the last five years.

For the second quarter of 2011, we expect diluted earnings per share in the range of $0.30 to $0.32. This guidance assumes a low single-digit same store sales increase, total sales growth of 19% and net income growth of at least 20% for the quarter.

For the full year of 2011, we expect to grow sales growth to be in the high-teens, approaching 20%, net income to grow by 20% or more. And EPS guidance for the year, we are increasing by $0.10 to be in the range of $1.50 to $1.54 on a fully diluted share count of 25.2 million shares.

As a reminder, our long-term forecast includes square footage growth total in the high teens, low single-digit comp growth and annual net income growth of at least 20%.

That completes my prepared remarks, and so I'll turn this call back over to Bob for some closing remarks.

Bob Fisch

At this point, we would like to open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question is from Brian Tunick with JPMorgan.

Anna Andreeva - JPMorgan

It's Anna Andreeva actually. Congrats on a terrific start to the year. Just looking at your topline, it's accelerated nicely and you guys are lapping easier comparisons for the rest of the year. Can you maybe talk about the competitive landscape in this space? Clearly, you are getting share right now and not during that at the expense of margin, which is great to see.

And my second question was about new stores. You said new stores were outperforming expectations. What are you seeing in some of the new markets? I know you've talked about Northwest as being a big opportunity to grow the store base. I am just curious how your mall stores performed versus non-mall.

Bob Fisch

The new markets are doing very well. We continued to do well in the great Northwest. We opened up two years ago and have expanded rapidly. We have now entered the areas of a small amount of stores. So I don't want to talk too much about that. But in the Idaho and South Dakota and Montana, areas. But we continue to do extremely well in the areas that we have built in the past like the Southwest like Texas and Oklahoma and New Mexico. We are in the South. We continue to do extremely well in Georgia, in Alabama, in Mississippi and Louisiana.

So we've seen the continued growth in existing markets and we see a continued growth in the new markets. We're proud of the factor that our new stores in 2011 continue do well and our new stores in 2010 do well over 2009, 2009 over 2008, 2008 over 2007 and continuing. That has been consistent through.

I'm not exactly sure of your competitive questioning. Could you explain that to me again when you're talking about our easier comparisons and competitors?

Anna Andreeva - JPMorgan

You guys are clearly gaining share in the teen space right now and not doing that at the expense of margin. You talked about the regular price selling. So maybe you could give us a little more color about that.

Bob Fisch

It's a couple of things. One, as we discussed on the real estate side, I think that the fact that we have gone after undeserved markets and continue to do that is a great competitive advantage. And I believe that we dominate the new centers.

And I think also the key, and we try to be consistent on this calls, is that we are firm believers in building a regular business. And there is incredible competition out there. Don't get me wrong. But I think it's really keep building the right fashion, the merchandise the customers love, that makes a difference. And I think that Kim and her team are doing excellent job of really working on that.

And I think that that gives us an opportunity for a competitive advantage and to drive market share. And I also believe that being able to maintain our prices unlike a couple of items of last year, in addition to keep going after that fashion so that you might raise prices, but not, let's say to last year, but in new products that are fashionable gives us a great opportunity also, because I think that there is going to be a lot of tough competition out there having a problem on that. And I think that we'll be at able to sustain that.

Kim Reynolds

I think the merchant team did a great job in identifying the trends for first quarter and the business is fairly consistent on top of the comp increase last year for the first quarter. The other piece of it we've been talking about is our good, better and best strategy. We've enjoyed increases in average selling retail in virtually every department of the company. We had a compelling assortment that saw the regular pricing level to reduce the markdown as a result of that.

Operator

Our next question is from Sean Naughton with Piper Jaffray.

Sean Naughton - Piper Jaffray

A quick question on the real estate. What type of opportunities are you seeing out there? Are you still seeing rent concessions year-over-year or rent reductions year-over-year in the markets that you're going into? And how are the build-out costs, whether your pre-opening expenses or raw material costs or construction costs, how are those playing out this year versus last year?

Bob Thomson

In terms of the rent or occupancy, it's very consistent with the prior three years, and I do not see that changing. In terms of opportunity, we will start the year of 2012 with 300 to 400 opportunities to total it down to that 110 stores or so the next year. So I feel very comfortable for the next three years in terms of what we're looking at.

Bob Fisch

We do not have a lot of store opening costs. Our stores can make money within the first month or two of operation, which is a great advantage to us. And you can see by what Keith mentioned as far as our expanse control, with opening 39 stores we were able to leverage expenses. And I think that's a powerful message for the future and that's important.

Keith McDonough

From my perspective, I am seeing continued performance on the numerator side of that equation. We've talked about this a lot relative to measuring our new store performances. And we'd love what kind of (inaudible) is being generated against that investment in these new stores we've built into. And our investment is fairly static in 2011 so far relative to the 2010 stores. And the performance continues consistently with 2010 performances thus far.

So that's a great sign. As I have said, it's compelling to look at the returns continuing and being consistent and one of the reasons why we continue this path of 110 stores this year and beyond.

Sean Naughton - Piper Jaffray

Any differences in your traffic trends or between your outlet regional malls and strip centers? And then anything on how some of your stores performed in warmer market versus colder markets? Obviously, there has been a lot of shifting there this year, and whether or not Easter played out as you initially anticipated?

Bob Fisch

I would say in the outlets, strips and malls, a miniscule difference, less than a percent between all three of them, which I am very happy about. So there is a good consistency there. So wasn't that the outlook was so much stronger than the malls or stronger than the strips. They were very close. So that to me is very good.

Absolutely, there is some effects I think in April a little more in some of the Northern areas or Midwest areas and then in the some of those areas with all those tornadoes. And hopefully, the tornadoes will stop going on right now that's affecting people's lives all over the country.

I think there was a little effect right around Easter time to a little after, but not major. And so for the quarter, it was strong. But definitely, I look for the Northeast to get some warmer weather. As we are speaking on this call, there was a beautiful sunshine. And then just as we got on the call, the rain started pouring again. But that's Pittsburg.

Operator

Next we have Michelle Tan with Goldman Sachs.

Michelle Tan - Goldman Sachs

I was wondering if you guys could talk a little bit about the AUR trends, Keith, that you mentioned on the call? It seems like a pretty big acceleration. Is that a change because of something that's happening with the good, better, best strategy? Is that because of what happened with your decision on promotions? Was that a more definitive decision than you've had in the prior quarters? What's driving that acceleration in the AUR and how should we think about it going forward?

Keith McDonough

I think you touched on both of them. Both are drivers clearly. If I have to put more weight on one, I would say that it's the good, better best strategy. It's a true test of the merchants' performance this quarter that came through, delivered those higher AUR just by mix, and then of course managing our markdowns better than we did last year.

Bob Fisch

I think also some categories that really were highlighted were dresses, accessories and shoes, which we had very strong increases in AUR. We are very happy that all categories had increases in AUR, but those with the ones that had the strongest, and I think that in some cases, it shifted to higher retail price points which is due to fashion and a lot of fashion.

Michelle Tan - Goldman Sachs

I know you guys obviously had a fantastic year. In the second quarter when there is more clearance and there is somewhat less business to go after, sometimes you haven't seen as much strength just because there is less to buy into. You're guiding a little bit more conservatively on comps for second quarter. Should we read anything into that in terms of what you're seeing in the business? Help us think about how to think about your guidance for Q2 comp.

Bob Fisch

I would be upset if we didn't bring up that question. No, I would not read into that. We are three weeks into a quarter, and it's too early to get readings on things, but I'll tell you that I'm confident in our guidance and I'm confident in our merchandise strategy as I was in the first quarter. And I think that long-term, we always look at being conservative in single-digit comps, and I think it's prudent to do that right now. But do not read into something on that.

Keith McDonough

And I think we have given seven quarters of guidance as a public company, Michelle, and I think five of those have been low-single-digit comp guidance.

Michelle Tan - Goldman Sachs

And then anything in particular you guys have up your sleeve for back-to-school that's new that you're willing to share with us yet?

Bob Fisch

It's probably a little too early to share that. I can't think of anything that you could think of right now. I just want to get through the floods and the tornadoes now in May. May and early June is lower part of the business, and then July is starts to get stronger, getting ready for back-to-school. It's still too early. We think there are great opportunities because we are seeing we can still react from certain trends for July into August right now as we speak.

Kim Reynolds

When we walk away from a season like that, we always walk with collectibles, things we'd have done differently and may become an opportunity for this year. But certainly there is a strong list of four to five collectibles from last year that we're planning to capitalize on this year.

Bob Fisch

And we would be glad to discuss this, Michelle, with you when we talk about the next quarter.

Operator

Next from Bank of America-Merrill Lynch, we have Lorraine Hutchinson.

Lorraine Hutchinson - Bank of America-Merrill Lynch

You beat the quarter by $0.10, and I was just hoping to hear what was the biggest surprise during the quarter versus your guidance?

Keith McDonough

Well, I think the sales performance and the non-comp sales performance was exceptionally strong as well. We try to talk about that, but we don't get questioned about that very much. But I can tell you that that is an exceptional contributor to the topline performance. It usually is.

When we look out into the future and we talk about new stores and the performance, it's good to see the contribution coming on strong, continue to come on strong from the new stores. So aside from that, the discontinued markdown management throughout the quarter really excelled that merchandise margin, and that was probably the biggest contributor to the overall profitability.

Bob Fisch

I think also Keith's control of expenses and leveraging of expenses, even though we're opening up a lot of stores, and we take that very serious to even though we have good expense control margins to keep working, to keep those expenses down. Cost containment is very important to us.

Lorraine Hutchinson - Bank of America-Merrill Lynch

And then as you think about inventory in the second quarter, I know you came into the quarter with inventory down. Have you been able to move the flow of receipts a little bit more quickly to support the comp?

Bob Fisch

Honestly, I think we're happy in the position that we're in. We think that we can turn a little faster. One of the things in addition to putting in our allocations systems, and that's going to enhance this more, whether we had allocation of planting system enhancements, we think that we could have better controls as mentioned on previous calls of inventory by store.

We've now learned we have 360 strip centers now. We have over 200 new malls over the last five years. So we are learning to maybe control the inventory better, which can give us a lower markdown rate. But actually when you do the sales, you're not going to have less receipts. So that's what I see as we move forward.

Keith McDonough

As we are working on implementing this new allocation system, the precursor to that has been business process change. And so all spring, we've been working on adopting new business processes and that's the first thing we need to change. And I think we may have seen a little bit of that impact in the first quarter and hopefully we can continue that going forward.

Operator

Our next question is from Paul Lejuez with Nomura.

Paul Lejuez - Nomura

The merch margin assumptions for the second quarter and full year, can you maybe just share those with us.

Keith McDonough

I can tell you that the overall gross margin we expect to grow in line with our sales. We're not being certainly aggressive from a guidance standpoint and expanding margins in the second quarter.

You might recall we turned in a record merch margin or close to it in the second quarter of last year. Bob said in his prepared remarks, there was a challenge in the first quarter matching that margin, but let me be clear we're not projecting a decrease in that area.

Paul Lejuez - Nomura

Is it that you're not seeing big cost increases or is it just that you feel confident in your ability to offset whatever increases you are seeing?

Bob Fisch

There are some categories where there might be minor increases, but not major, and we're offsetting them in other categories that we could be strong in. And as we said, we also have a very strong Etc! business that doesn't get affected.

This new reality of retailing, of working strongly with domestic importers and being able to leverage that and they can maneuver in other countries, some of them own their own factories, the factor that we have a lot of different domestic importers. So it's not like being just attached to one factory overseas. It has made a difference.

Kim has very prudently held back. She has got great experience and so does our merchandise managers and teams. Cotton prices were high. We could hold back, because we have such speed to market of buying, and so this is certainly not low now, but put in $1.55 range, it's just within $2.10. So therefore, we're able to leverage that a little, Paul. And I think that's part of the key.

Kim Reynolds

I think our business model and our sourcing model is unique in that we don't need to procure yarns or commit to garments or factories based on production until roughly 75 to 90 days before we actually need the goods. So we've worked very hard in controlling our cost and in cost averaging different vendors, but we were very aggressive in negotiating our pricing for the first half of the year and feel comfortable for the second half.

Paul Lejuez - Nomura

Keith, can you just maybe remind us, taking back to the second quarter of last year, did business trend better or worst as the second quarter progressed, the comparisons get easier or harder?

Keith McDonough

I think it was fairly stable throughout the quarter. I personally underestimated the Georgia tax-free impact that occurred the last two days of the second quarter last year. So that was a determining factor, but we have anniversaried that now. So I don't expect that to be a factor. But I would say it was fairly constant.

If you put our average sales on a graph, it would start at the low point in the first part of the quarter and move up to a crescendo at the last week of the quarter. So it does move up and then we're into August and back-to-school.

Operator

Our next question is from Adrienne Tennant with Janney Capital Markets.

Adrienne Tennant - Janney Capital Markets

Kim, my first question is about the good, better, best strategy. I know when we had seen you earlier in the year, maybe there was some talk of certain adding to the better and best so that you could, from a merchandise mix standpoint, mix up the AUR potentially. So I was just wondering what that distortion looks like.

And then, Bob, if you can talk about is there another level of stores at which you get to your next level of volume purchasing where you actually might get some price discounting and if that's going to happen in the near term to help offset any potential price increases.

Kim Reynolds

We introduced the good, better, best strategy in specific categories during first and second quarter of last year. At this point, virtually every category in the company has this strategy in place and we keep moving the envelope higher and higher and finding no price resistance is virtually every category, assuming the product is the right product.

In our business, we look to bring value to our customers. Value doesn't always mean an inexpensive price point. Value means getting a great price for something a customer wants. So we continue with the program and we continue to move the envelope and raise the bar in what the customer won't accept and it's what we're going to pay off on now.

Bob Fisch

And to your other question, I think that what we are doing now, and I'm accepting that was very bright of Kim and her strategy, is that we're going to end this year with close to 740 stores or so, whatever in that range, or close to 750 stores, and a lot of the domestic importers we were doing business with we're now looking to do business with them also in the guys area.

So that means that instead of 750 stores of clout, you now have 1,500 stores of clout. And that probably helps make a difference also in leveraging any cost increases. So you see that as far as continuing stores, yes, I think as you get bigger and bigger you have a little more opportunity, but that alone makes a big difference. To me, that was bright to do to then coordinate the factories to have girls and guys merchandise.

Operator

Our next question is from Stacy Pak with Barclays Capital.

Stacy Pak - Barclays Capital

Fundamentally, just on the store thing, I don't understand why simply buying domestically means you don't have a cost increase, because as I understand it, the domestic suppliers are still producing and buying? So they're forced to face a cost increase. So why are you not seeing any cost increase? And are you saying your AUC is flat Q1, Q2, Q3, and Q4, or exactly what are you saying on that?

Kim Reynolds

First of all, a small percentage of our merchandise offering is produced domestically. And that fabrication that we do domestically isn't necessarily cotton-based. But I think Bob's reference and our business model altogether includes domestic importers. That's using our domestic marketplace for production. Overseas and the difference to that and possibly some other retailers in how they source and produce goods is that we don't take a fabric or a yarn or a factory position until the time that we're ready to place an order. And our domestic importer does that on our behalf.

Stacy Pak - Barclays Capital

But the question still stands, Kim, which is your domestic importer is faced with higher costs, so why aren't you?

Kim Reynolds

I would say that one of the great things about what we do is if we have a T-shirt or we have an item, we'll source them with several different makers, and when you have the sizeable orders the way we do, one of those makers will hit the price or come much more closely to it. We have our vendors compete for our business.

Stacy Pak - Barclays Capital

Theirs are going up double digits. So I guess I just don't understand why. But are you expecting AUC flat each quarter this year?

Keith McDonough

We don't give guidance quarterly. We have talked a little bit about the second quarter. We talked about the year. It really is something we can't commit to relative to each quarter every year.

What I would add to Kim's comments, however, is that we are a franchise that is growing into 20% to 25% topline. That means a lot to the vendor community that Kim is interfacing with. And I would also say scaling and providing those numbers from a quantity standpoint means something and is bringing vendors to the table.

I would also say that statistically we have become less dependent on the top five, top 10, top 20 and top 50 vendors than we were last year. Kim is doing one heck of a job in leveraging the competitiveness out there and bringing on new vendors that could mean something or are meaning something to our bottomline.

Bob Fisch

I think also that there is a power of strong negotiations, and you have more leveraging when you're working with domestic importers than you just try to do something overseas, importing-wise. There aren't that many companies that do what we do now. Most people are totally tied into inflexibility and can't change their systems. We can.

It's hard to sit and say we might be one of the few that aren't going to have big increases. And to Keith's point, we are not going to give guidance on that, but we do see minimal increases in the second half of the year. That is what we see.

Stacy Pak - Barclays Capital

Are you seeing your sourcing costs come down with the decline in the raw cotton cost?

Bob Fisch

No, I see that it's stabilized, that it's not as big a push to get what we want, but that this helps us. In some cases, the domestic importers take a little less. In some cases, they take a little less. They are able to do that, but that's what it is. What I would do? I think that Keith and I will be glad to talk to you about that separately, and I'll be glad to have a conversation with you that makes you feel comfortable.

Stacy Pak - Barclays Capital

And then let me ask you, Kim, on the denim trends, are you excited about the denim trends you are seeing for your customer for fall? Is your customer embracing the newness that's happening in denim? Is that relevant for you?

And then, Bob, can you talk about also just your customer for a minute? What's the household income of your customer and why does the increase in food and gas and high unemployment not matter besides that?

Bob Fisch

We are just a great fashion value. If they got to buy some thing, they're buying from us. We are gaining market share. Now we've performed well in good economic times, and we've performed well in poor economic times. When there was that great recession in 2008-2009, we performed well. So we are performing well now too. So I think I don't want you or anybody else to think that there isn't something out there. It's just that I think they're coming to rue, because we can given them that fashion and value.

Stacy Pak - Barclays Capital

Kim, how about the denim? What do you think?

Kim Reynolds

I think there is lot of newness happening in the girls' bottoms category, both denim and non-denim categories. We actually are starting to ship a lot of that to our stores right now. So we're fairly bullish on the newness.

Operator

Our next question comes from Jeff Black with Citi.

Jeff Black - Citi

What you're saying is that you guys saw cotton prices come down and then made the decision, "Hey, we have the flexibility to let them go down further and we'll keep some open to buy," because it very easily could have gone the other way? And then second, on the Etc! stores, do you break out the AUR difference between a normal store and one within Etc! platform in it?

Bob Fisch

The second question is no, we do not break out AURs or gross margin metrics across any of the three categories of business.

Kim Reynolds

We didn't hold off on buying what we needed to buy. We are saying that our sourcing model is slightly different in that we didn't need to commit to the second half of the year's cotton production to pay high prices. And many of our makers' cost average was we buy it with other retailers that maybe paid slightly higher.

Operator

Our next question is from Liz Dunn with FBR Capital Markets.

Liz Dunn - FBR Capital Markets

I guess I'm still a little confused as to why the comp is expected to decelerate as we move through the year. You guys did a great job sort of forecasting your business for the first quarter even on more difficult comparisons, making the call that comps would be up low-to-mid-single digits. So I am feeling confident in your guidance for the balance of the year. But why is it decelerating on an easier comparison?

Could you just dive into a little bit of the challenges you may have had in the guys' business and what you're doing there to improve those trends going forward?

Keith McDonough

Well, I think the first question is simply visibility for one. We were giving that Q1 guidance much later in the quarter than we are giving this Q2 guidance. And it's not unlike us to go out with single-digit guidance. That's the guidance we've traditionally given. Unless we see some sort of other variable that creates or that we react to, to change that guidance, but that's generally the guidance which you'll hear from us.

Bob Fisch

I think also that long-term or short-term, Keith is right on what we do in guidance. I think in the first quarter, it was a little later in the season. And we saw that maybe it could be a little better. The merchandise is acceptable or not, I am not saying the merchandise will be accepted well in this quarter, but it's too early. And to me, it's just more prudent to plan that way. That's just the way we are.

To me, I wouldn't if our business was up 15% or 5%, I wouldn't get crazy after a couple of weeks, because if my business is up 15%, I wouldn't sit down and say let's just project higher. We are a little different because of our speed to market. We do have an opportunity that most of people don't have. And because of that, I would like to react. If business gets a little bit stronger, we think we have a stronger comp. We still can react to that, even move up goods or purchase goods. And that to me is a competitive advantage.

So I think that we're trying to do a good job on this to be prudent about it and be conservative about it. And I think in the long run, that's good. The only question is if comps are extremely important, 85% to 90% of our growth is also non-comp.

So both of those are very important to us. And I think as Keith said earlier, we want to work on that. We never talk about that. But most companies don't open up the 110-plus stores. And so that is part of our future. And I take both of them very serious, and this company takes both of them very serious.

Kim Reynolds

In reference to your question about our guys business, you are correct. I just wanted to remind that guys was by far the number one comp increase last year for first quarter. We don't expect to increase on top of strong increase performance that we have as a company. But guys definitely led the company last year.

I think there were some collectibles in guys. There is definitely a fashion shift and definitely shift out of wovens and into our knit categories that we are addressing immediately. And we expect to see that change as we get into the second quarter. And in addition to that, as I mentioned collectibles earlier, that will be our opportunity for first quarter next year.

Bob Fisch

We're getting back into having the right (inaudible) fashion for guys. And I am too confident with Kim and her merchant team. They are very good at what they do, and they're going to deliver for us for to back-to-school and going forward.

Liz Dunn - FBR Capital Markets

And then just one more follow-up on the sourcing, if I may. Are you saying you're sourced through what period at this point? And then you have made this comment a couple of times about you are buying from men's business and the women's business. Is that a change from what you were previously doing?

Kim Reynolds

I think with regards to placements, we are placing goods that ship next Friday, and we are also placing goods that probably ship towards the beginning of August. And in some cases, depending on the category, we will be shipping, fourth quarter. So we have money open from now all the way through and at this point of our flexible business model.

Bob's reference was that because we use our vendors very much as production arms, by grouping the girls buys and the guys buys together, this store count totals around 1,500 stores. It's actually a lever that rue21 has, and we can take advantage of it because of our huge growth.

Operator

And that does conclude our question-and-answer session. I would like to turn the call back over to Bob Fisch for any closing commentd.

Bob Fisch

I would like to summarize probably not on sourcing right now, but we will talk about that later. I was confident going into the first quarter and we are confident again going into the second quarter that we continue to feel good about our business. We are able to produce a solid quarter on same-store sales result and strong margin on top of strong results a year ago despite the weather, the raw material increases and high fuel prices. We were also able to raise our outlook for the year.

For the past seven quarters as a public company, we've achieved a solid net income growth that replicates what we delivered doing our prior eight years as a private company. But we do not rest on our laurels, and we are constantly building our business, our brand and our infrastructure so that we can continue to grow earnings for our shareholders, including the 65% earnings per share growth in the first quarter.

I look forward to speaking to all of you in the next quarter and give you the insights and delivering our results. Thank you very much and everybody have a great afternoon. Good bye.

Operator

That does conclude today's conference call. We appreciate your participation.

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