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Executives

Hamish Sandhu - Chief Financial Officer and Principal Accounting Officer

Lori Nembirkow -

Marc Crossman - Chief Executive Officer, President, Executive Director and Head of Operations - Innovo Inc

Analysts

Steven Chang - MBF Capital Management

Ronald Bookbinder - Global Hunter Securities, LLC

David Griffith - Roth Capital Partners, LLC

Unknown Analyst -

Joe's Jeans (JOEZ) Q2 2011 Earnings Call July 11, 2011 4:30 PM ET

Operator

Good day, ladies and gentlemen. Welcome to Joe's Jeans Fiscal 2011 Second Quarter Earnings Call. My name is Melanie, and I'll be your conference coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Lori Nembirkow, General Counsel for the company. Please proceed.

Lori Nembirkow

Thanks, operator, and thanks to everyone for joining the call. Present on our call today to discuss our results are Marc Crossman, our President and CEO; and Hamish Sandhu, our CFO. Before we start, let me review the company's safe harbor language.

Today's call may contain forward-looking statements, which are statements of the company's or management's intentions, hopes, beliefs, expectations or predictions of the future. These statements are subject to risks and uncertainties that could cause our actual results to be materially different. You're cautioned not to place undue reliance on forward-looking statements, which speak only as of the date they are made.

I also refer you to our reports that are filed with the SEC, which includes our 2011 quarterly report on Form 10-Q filed today. This report contains the information that could also cause our results to be materially different than those contained in any projections, which may be made during this conference call. By making any forward-looking statements, the company undertakes no obligation to update them for revisions or changes after today.

Finally, a copy of our earnings release and a recording of this call will be available on our website, www.joesjeans.com, and a telephone replay will be available for one week from today.

Now I'll turn the call over to Marc.

Marc Crossman

Thanks, Lori, and thanks to everyone for joining us today. I'll speak about the second quarter results, and then I'll turn the call over to Hamish for a discussion of our financials. Finally, we will end with a Q&A session.

In the second quarter, our net sales were $24.7 million, and we generated operating income of $1.7 million, up 46% from a year ago. Our domestic women's wholesale business decreased on a year-over-year basis. As we stated on the last call, we made a number of midstream changes to the spring 2011 denim line. Accordingly, we saw areas of improvement in our business, allowing us to bring our stock-to-sales ratios in line and meet several of our department store plans.

However, our women's domestic specialty store business was a little challenging during the quarter. With that said, having made great progress with using our inventory levels in a short period of time, we're going to relax our cut-to-order policy in order to more effectively sell reorders on our popular styles and capitalize on additional sales.

Looking forward, we are very encouraged by the department and specialty stores' response to our fall and holiday 2011 line. Without a doubt, we are applying our styling, design and marketing to the most innovative fabrics and washes in the market. In addition, to support our fall and holiday lines, we are investing heavily in print and outdoor advertising. This campaign will start at the end of this month.

Our men's business grew double-digit this quarter on a year-over-year basis. Majority of the growth this quarter was generated from department store accounts. We are growing not only in the number of doors we are selling, but we are also taking market share from our competitors.

We are also very encouraged by the fact that we were seeing growth across our denim and collection. In fact, collection now represents 16% of men's sales, up from 11% a year ago. The steady growth of sales from our men's collection as a percentage total leads us to believe that our customer is embracing Joe's as a comprehensive lifestyle brand.

The weakness in the Japanese market was the biggest contributor to our double-digit international wholesale sales decrease. However, we are making steady progress in the addition of new international markets.

For instance, we recently announced that we opened the first of 7 planned licensed stores in the Middle East, and we just brought onboard new distributors in Russia and the U.K. We continue to believe that the international market represents a huge growth opportunity for Joe's for both new and existing markets.

Our wholesale gross margin was 43% during the quarter compared to 42% a year ago. The increase was driven by higher gross margins from our international business and collection items and was slightly offset by lower gross margins on our off-price business. We continue to hold margins steady on our core denim despite additional cost pressures.

Our wholesale SG&A declined to $2.9 million from $3.8 million on a year-over-year basis. Our wholesale SG&A decline is attributable to reduced sample costs, the decrease in our facilities and distribution expenses and lower commissions. The reduced sales volume was virtually offset by increased gross margin and reduced SG&A expenses. Our wholesale operating income decreased slightly to $5.7 million from $5.8 million a year ago.

Our retail sales increased 52% from $3 million to $4.5 million during the quarter as a result of increasing our store base from 13 to 20 stores. This quarter, we had 6 stores in our same-store sales base for a full quarter. Same-store sales posted a 15% decrease.

This decrease is entirely due to a decrease in traffic. As a way to boost traffic in our stores in future quarters, we are investing in local advertising such as billboards tagged to our retail locations, print campaigns in local periodicals and utilizing social media for re-engaging our existing clients.

We are pleased to see that our conversion rate and average transaction value held steady from a year ago. We feel there is upside opportunity in our conversion rate and average transaction values in future quarters. Also, easing up on our cut-to-order policy for our own retail stores will give us the opportunity to react quickly and fill in on fast selling styles.

Our retail gross margins increased to 65% versus 64% a year ago. Our gross margins improved slightly in both our full price and outlet stores. On a consolidated basis, our retail operating income increased to $143,000 from $125,000.

I will now turn the call over to Hamish to discuss our financial results.

Hamish Sandhu

Thanks, Marc. For the quarter, on a consolidated basis, net sales decreased to $24.7 million from $25.9 million over the prior year period. Decreases in our wholesale sales channel were approximately mitigated by increases in sales from our retail channels.

Our overall gross margin improved by 3 percentage points to 47% from 44%. The increase in our overall gross margin was a combined result of a greater percentage of sales coming from the high gross margin retail channel and a year-over-year gross margin increase in both retail and wholesale channels.

Operating expenses was lower in the second quarter of fiscal 2011 compared to 2010 at $9.8 million compared to $10.4 million, respectively. Operating expenses decreased in our wholesale and corporate and other reporting segments. These decreases were achieved through lower payroll and better sampling of distribution controls. Operating expenses in our retail segment, however, increased, but only because we had 7 more stores this quarter as opposed to the comparative quarter a year ago.

As a result, our operating income for the quarter increased by 46% to $1.7 million from $1.2 million on the prior year. During the quarter, we continued to make progress reducing our inventory levels. Controlling expenses coupled with better inventory management generated $4.5 million of cash flow from operations during the quarter.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Jane Fillenleston [ph] with KeyBanc.

Unknown Analyst -

I had a couple of questions. I guess the first one was if you could tell us what the cash and inventory at second quarter end was?

Marc Crossman

Cash was about $8 million, and inventories were around $25 million.

Unknown Analyst -

$25 million, okay. And then also, how should we think about SG&A expense for the second half of the year?

Marc Crossman

I think it's going to be, as we kind of look at it sequentially, it shouldn't change too dramatically going out sequentially in the wholesale segment and corporate and other. And then retail, obviously, will trend up based on the additional stores.

Unknown Analyst -

Okay, and then who would you say are your direct competitors when you made a comment saying that you were taking market share from competitors?

Marc Crossman

I would say, on the men's side, we're talking about taking market share, in there would definitely be Seven. On some degree, I would say AG. Our primary competitor, Seven, has the vast majority of market share.

Unknown Analyst -

Okay, and would that be either similar to women's or...

Marc Crossman

Yes, women's, this group, expands in terms of who's sitting on the premium floor. But really, Seven and Citizens and to some degree, AG, also Hudson, a number of players.

Unknown Analyst -

Okay, how's your wholesale department store customers? I mean, have they increased their selling levels for the back half like in terms of, I guess, if you could just comment on the direction of backlog or just color on that?

Marc Crossman

Yes. For us, our backlog looks like it's going to be down pretty commensurate with where we came in this quarter on the wholesale side. So we don't see a dramatic change. We're in that phase where we're trying to regain market share by building our inventory levels back up. And you can't build your inventory levels back up until you start turning faster. And that's really what the turnaround on the women's wholesale side of the business has been about, is having a great fall and holiday line and being able to turn faster and then regain any lost market share.

Unknown Analyst -

Okay, so I guess what gives you confidence that women's product will work this fall, holiday?

Marc Crossman

Well, we think it's a couple of reasons. One, we have a number of pretty innovative and new products that we're going to be launching for our fall holiday line. We have an update to the Ponte, which was really a very successful product for us in the past. We're going to advertise pretty heavily June through November and also books, and we haven't been in the books in quite some time. I mean, we feel like we have the right product. We revamped our core. So we've made a number of changes to the business, both from a core basic and a trend perspective. So we think that with all the changes we've made, that we should have traction at retail.

Unknown Analyst -

Oh, okay. So you said that you were bringing back your marketing book. When was the last time you had a book out?

Marc Crossman

Well, what I meant by book is marketing in the advertising. We're in the books like Elle and Vogue and...

Unknown Analyst -

Oh, okay, okay. So when was the last time you had that, like in terms of the breadth or depth of you're marketing that you're talking about doing for this fall versus, I guess, the last time you had that kind of...

Marc Crossman

That was back when we had launched the leggings, which was Q4 of 2010.

Unknown Analyst -

Q4 of '10, okay. Oh, and then just my last question was related to sourcing. Can you remind us how much of your cost of goods is material, labor and freight? And then what percent of cotton is material? I mean, what percent of your material component is cotton?

Marc Crossman

The cotton question is pretty easy. If you look at the latest metric or the latest quote for upland cotton is about $1.30 a pound, kind of trended. Well, it peaked in March at about $2.20 a pound I believe, and it's come down pretty dramatically. More normalized. It's been, I think, $0.90. I think it was $0.80 to what, $1.00 per pound. So we're probably a good $0.30, $0.40 above where we would normalize. It's about 1.5 pounds depending upon your yield of cotton in a jean after you subtract trends in any chemicals that you're putting in the jeans. And that's the cost of goods component, so that would be $0.40, about $0.60. It would be the delta in the cost of the cotton in your jeans relative to a more normalized level. So that $0.60 on a jean that we sell for about $75 is less than a point.

Unknown Analyst -

Oh, okay. And then like given the reduction, the recent reduction in cotton, when do you expect to see the raw material pressure lessen? Would it be -- is 2011 too -- would it be in late 2011 or 2012 or early '12?

Marc Crossman

I think what we saw is there's such a dramatic increase in the mills, ate most of the increase. And a lot of them had their cotton hedged out already. So I think that in terms of an easing, not seeing a dramatic increase in our pricing right now, I guess, is the best way to put it. And then on top of that, it's such a -- I don't want to say such a small component, but it is a very small component relative to the overall cost of goods. In average it costs much more, many more times than the rest.

Operator

Our next question comes from the line of David Griffith with Roth Capital.

David Griffith - Roth Capital Partners, LLC

Marc, could you touch maybe a little bit more on when you we're talking about relaxing your cut-to-order policy, kind of how relaxed you're getting there or kind of what direction you're going?

Marc Crossman

Yes, we had gone to a very strict cut-to-order, which brought our inventory levels -- I think we've peaked out August of last year. We brought our inventories down pretty dramatically. I think we peaked at 33 million, if I remember correctly. I'm down to where we are, about 26 million. It's like 25.8 million. At this point, what we're starting to do is open it up and maybe cut 10% over. It varies a little bit. The delivery where in the past, we were running at about 3% when we really tightened up. So we're not talking about a huge amount. But when you start focusing on which styles you were over cutting, we're not just going to do a 10% across the boards. We'll go in, and if we really believe in a style, we'll cut 30% over. So that's kind of what the general math is going to go from 3 to say 10.

David Griffith - Roth Capital Partners, LLC

And if I heard you correctly, you're also -- I mean, you're doing that for your retail stores, both outlet and in full price as well?

Marc Crossman

Yes, definitely for outlets and full price. Predominantly, full price right now, then it'll ultimately make its way down to the outlets. But for sure, we should be able to react a lot faster at our own full price stores and move merchandise in. We're definitely going to do that for our full price stores.

David Griffith - Roth Capital Partners, LLC

Okay, and then you actually started to touch on -- pardon, my next question is that inventory has -- you've really consistently brought it down each quarter sequentially. How do you feel about kind of where you are in terms of having a really curved merchandise versus stuff that you're still -- you're kind of working through the system basically?

Marc Crossman

I think we have more room to go. You're not going to see us go from 33% to 25% to 18%, but you still have some room to bring your inventory levels down.

David Griffith - Roth Capital Partners, LLC

Okay, but you seem to be doing pretty well in terms of holding margins so you're not -- it doesn't appear like you're having to make any big sacrifices there.

Marc Crossman

No, it really -- it comes on the front end. In this case, you're absolutely correct. It's not they were running out, they're still over cutting and trying to bring our inventory levels down. We're running through that normal cycle that we have. Everybody sells in the off-price channel, running through that normal channel without having to really boost it up and just letting it not continually filling up that bucket, and we're just selling through what we have.

David Griffith - Roth Capital Partners, LLC

And then kind of following on to that, especially the department store and specialty store landscape, you've kind of gone through a couple of fashion cycles here in your fall products. What you've shown us, has really looked good. But I mean, do you feel like that's enough to drive kind of traffic to the department stores and to the specialty stores that you're getting some good reads on that?

Marc Crossman

Yes. I mean, it hasn't hit yet. As I've said, it's relative to where we were, missing trends and having our -- or missing a trend and having our core basics slow down. We've made so many changes through the system that it will move in some different direction. We happen to believe that it's going to move in the right direction. You're definitely not going to stagnate and continue to do what you were doing. So we believe in our product very much so, and I think that we're going to have the right products for fall and holiday. But it's definitely not more of the same from us.

David Griffith - Roth Capital Partners, LLC

Very good. So only 6 stores in the comp base. Could you maybe touch a little bit about how the other 14 stores performed relative to expectations?

Marc Crossman

Well, it was -- I mean, there are 2 ways to look at it. How we're doing relative to our sales levels and how we're doing relative to our profitability. And the non-comp stores were more profitable than the comp stores, looking at it from an EBITDA margin standpoint. In terms of the sales numbers as we see, we're going to have more stores coming to the comp base. They're not performing better on the top line. So I don't see that, as we add stores to the comp base, is that comp number is going to turn around and look a lot better just because we had some bad stores in the base. It's going to be a little bit more than that to turn those stores around. It's going to be product-based.

David Griffith - Roth Capital Partners, LLC

When you say non-comp stores have been more profitable, is that just a product of better leases and better expense management essentially?

Marc Crossman

Absolutely.

David Griffith - Roth Capital Partners, LLC

And then was there one store opened since the end of the quarter, is that correct?

Marc Crossman

Yes, one.

David Griffith - Roth Capital Partners, LLC

Okay, and then for the rest of the quarter, an expectation is a couple more?

Marc Crossman

I think for the rest of the year, we want to open at least 4 stores. We have kind of slowed down there for a little bit in terms of the pace of openings. But right now, I think 4. If we were to push it, maybe 6 stores.

Operator

[Operator Instructions] Our next question comes from the line of Ronald Bookbinder with The Benchmark Company.

Ronald Bookbinder - Global Hunter Securities, LLC

A couple of questions. Do you have any of the new styles in your own retail stores yet, and how is it performing there?

Marc Crossman

No, we don't. That product is really going to be hitting at the back half of this month. So they're a 7/30 delivery. It's not something that we can pull out off of a normal manufacturing cycle and get into our stores any faster.

Ronald Bookbinder - Global Hunter Securities, LLC

Okay, well then, what sort of reads are you getting from the department store? I think you said the backlog is down similar to the revenue. Are they, at least, a little bit more excited about this product coming in that they're hoping that you ramp it up?

Marc Crossman

Yes, for sure. When we talk about the backlog and the year-over-year, when you look at your inventory levels in a department store, that's a sequential basis. But your sales are being keyed against what you did the year ago. So when they drop, when you lose market share and they drop your inventory levels down, that then slides sequential. So they're not gauging that decrease a year ago. But then your sales, you really have to, as I said, form and turn faster than their department so that they bring your inventory levels back up. So we're in that phase right now where we really need to turn faster than we've turned in the past, get a little bit more confidence behind the product, and they'll start bring our inventory levels back up.

Ronald Bookbinder - Global Hunter Securities, LLC

Okay, and I think in your speech, you talked about an increase in off-price. Was that at the beginning of the quarter to clear goods? Or is it sort of steady throughout?

Marc Crossman

Steady throughout. I mean, it varies from time period to time period. But it's just -- we have a program that we run in one month. It may ship faster than the next month. But it's not a major increase in the business.

Ronald Bookbinder - Global Hunter Securities, LLC

And then in the press release, I think, you talked about that your company-owned stores were less promotional. Were you not clearing so much through there and just clearing it through the off-price? Or why was there a difference that you were clearing more to the off-price and increasing gross margin in your company-owned stores?

Marc Crossman

Okay, so just really quickly, to back up on the gross margin. When we were talking about the lower gross margins on off-price, we weren't saying that it was more gross margin. We were just trying to say, listen, if we did 43 this year, 42 a year ago, just a general movers and directional pieces that make up that. So it's not -- we didn't have a change per se in what our plan was for the off-price business. In terms of promotional in our own stores, again, we're talking about a point here. So it's not a -- you have to have some reason for why it changed a point. But it wasn't we were a lot less promotional or a lot more promotional. Certainly, we had, a year ago, towards the tail end, we have talked about having a little bit of excess collection going through the channel. But again, we're talking about a point. This is not a major move in one -- or a major shift in one direction or the other.

Ronald Bookbinder - Global Hunter Securities, LLC

Okay. And traffic, why do you think the traffic was down so much? Do you think it was product? Or do you think it's the overall environment? What do you think was driving that?

Marc Crossman

I think it's product, whether it's a wholesale account or a retail account. I firmly believe that we have the right product now to drive sales. And I think we had, as we have talked about, had missed a couple of trends and didn't have the product. And when you don't have the product, the traffic's down.

Ronald Bookbinder - Global Hunter Securities, LLC

And on conversion, what is your conversion and how are you planning on improving them?

Marc Crossman

Yes, I think our conversion same-store sales is running at -- one second, let me see here. Outlet was 40% and full price was 51%. Not sure I can do a lot more to improve those metrics.

Ronald Bookbinder - Global Hunter Securities, LLC

That's pretty good.

Marc Crossman

Yes, and quite frankly, as you start picking up the traffic and the volume, you would expect that, that conversion rate would actually come down.

Operator

Our next question comes from the line of Steven Chang with Rudgear Capital.

Steven Chang - MBF Capital Management

It sounds like, from what you said earlier, that you felt like you missed a little bit of business by not having enough inventory, and that was more with specialty stores and with department stores. Am I understanding you correctly?

Marc Crossman

Yes, yes. As I said, we had made some changes to our product. You can't have massive, wide-reaching changes to a product when you identify that you need to layer in some styles. But we had enough that -- yes, we didn't capitalize it. We had to throw, and I will say throw -- we had to put consistent players in the assortment and we did so quickly. If we weren't cutting enough or didn't have enough fabric and it fell through, yes, you missed sales. And that happens more so at the specialty store level than it does the department store level.

Steven Chang - MBF Capital Management

And a different question. When you look at your retail business, where do you think the operating margin eventually goes? Or could you break out how much of the SG&A is overhead versus store level?

Marc Crossman

I think ultimately -- I don't know if we had said what our EBITDA margin is right now. EBITDA margin is running just under 20%. And I think some of our competitors out there comp at 40%. So I think even though we don't have the price point that they have in our business and the margin, they have obviously a higher price point and a higher margin. I think we certainly can target towards 30%. Our SG&A that we have right now, our corporate SG&A has not changed materially in quite a few quarters.

Steven Chang - MBF Capital Management

So that 20% EBITDA margin, that's on a store level?

Marc Crossman

Store level.

Steven Chang - MBF Capital Management

And home office expenses for retail, that would be in the corporate SG&A or in the retail SG&A?

Marc Crossman

Which expense, the corporate expense for retail?

Steven Chang - MBF Capital Management

Yes.

Marc Crossman

That would fall in the actual retail of the P&L.

Operator

Ladies and gentlemen, I show no further questions at this time. I'd like to turn the call back over to Marc for closing remarks. Please proceed.

Marc Crossman

Great. I appreciate everybody being on the call with us. If you have any questions, you can either call me or Hamish. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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