J. Crew Group Management Discusses Q1 2011 Results - Earnings Call Transcript

| About: J CREW (JCG)

J. Crew Group (JCG) Q1 2011 Earnings Call June 9, 2011 11:00 AM ET

Executives

James Scully - Chief Administration Officer, Chief Financial Officer and Principal Accounting Officer

Stuart Haselden -

Libby Wadle - Executive Vice President of Retail & Factory

Analysts

Karru Martinson - Deutsche Bank AG

Christina Boni

Grant Jordan - Wells Fargo Securities, LLC

Spenser Samms - BofA Merrill Lynch

Andrea Cullen - Ares Management

Carson Dickson

Lisa Paisley

Colleen Burns - Oppenheimer

Karen Eltrich - Goldman Sachs Group Inc.

Unknown Analyst -

Carla Casella - JP Morgan Chase & Co

Operator

Greetings, and welcome to the J. Crew First Quarter Fiscal 2011 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Stuart Haselden, Treasurer at J. Crew. Thank you. Mr. Haselden, you may begin.

Stuart Haselden

Thank you for joining us to review our first quarter 2011 results. With me today are Jim Scully, Chief Administrative Officer and Chief Financial Officer; Libby Wadle, Head of Retail and Direct; and other members of our management team.

Before we begin, I would like to remind you of the company's Safe Harbor language, with which I am sure you are familiar. 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 in the press release issued in connection with today's call.

As you know, our acquisition by TPG Capital and Leonard Green & Partners closed on March 7. We wanted to start today's call by providing some context on the transaction and our post-merger financials. The transaction was financed by equity investments of $1.2 billion from sponsors, co-investors and management; senior secured debt financing of $1.2 billion; senior unsecured notes of $400 million; and cash on hand totaling approximately $300 million.

As a result of our new structure as a private company, we think it is helpful to highlight certain elements in our financial results to provide for comparability to prior periods. We will refer to adjusted EBITDA, which adjusts for items such as noncash share-based compensation, merger transaction costs, sponsor monitoring fees, as well as the impact of purchase accounting resulting from the acquisition. We will also refer to adjusted gross profit and adjusted SG&A.

In addition, the results we will be discussing on today's call reflect our performance for the combined period. A combination of results before and after the acquisition is not consistent with GAAP, and may yield results that are not comparable on a period-to-period basis due to the changes of accounting basis during these periods. You can find a reconciliation of adjusted EBITDA in Exhibit 3 of our press release, as well as additional information on gross profit and SG&A, highlighting our year-over-year variances in the MD&A section of our condensed consolidated financial statements for the first quarter of fiscal 2011 that we posted to our website this morning.

With that, I would now like to turn the call over to Jim Scully.

James Scully

Good morning, everyone, and thanks, Stuart. Welcome to the first earnings call following our acquisition by TPG Capital and Leonard Green & Partners. The format and timing of these calls will be a little different as I'm sure you would expect. The calls would generally follow the filing of our quarterly financials and focus on the prior quarter's results. We will not provide forward-looking sales and earnings guidance but will offer color around certain operating and liquidity metrics. We will also be joined from time to time by other members of management, including Mickey.

I will start today with an overview of our first quarter results and an update on our key strategic initiatives. Stuart will then walk you through our financials in more detail and we will open up the call for your questions.

Based on our multichannel approach to our customer, we have decided to begin including our direct business in our comp sales calculation. We will refer to this metric as company comparable sales. We plan to continue to break out our store comp and direct performance separately for an interim period.

For the first quarter, total revenues decreased 1% with our comparable company sales decreasing 3%. Broken out separately, our comp store sales were down 6% and direct sales increased 5%. Historical information on comparable company sales can be found in our press release.

Our adjusted EBITDA totaled $75 million or 18.3% of revenues in the first quarter versus $89 million or 21.5% last year. While we are disappointed with the year-over-year decline in first quarter earnings, it is worth noting that last year's first quarter was our historical peak by a significant margin. The weakness in the top line was due to the continued softness in our Women's business, while we saw relative strength from Men's, Crewcuts and Accessories. As previously mentioned, when we began to see deterioration in our Women's trend in the back half of 2010, we went back and made adjustments to our Women's assortment for 2011. Given where we were in our purchasing cycle, we were able to have a more substantial impact on our second quarter assortment, as well as the back half of this year.

Our focus continues to be on those areas where we see opportunities to capitalize on the investments we have made in our business over the last several years to drive long-term, high-quality earnings growth. On the store side, our J. Crew store growth plans remain a priority for us. We continue tailor each of our new stores to each market in size and concept, with plans to grow square footage in the low to mid-single-digit range annually over a 3- to 5-year horizon. This includes our U.S. retail and Crewcut stores, as well as a handful of opportunities in the Canadian market.

We opened one new retail store in the first quarter and plan to open a total of 9 new retail stores in 2011, including one Crewcut store, as well as our first store in Canada at the Toronto Yorkdale Centre in the third quarter.

Our Men's business continues to be a highlight for us. We continue to be pleased with the performance of our Men's only stores, The Liquor Store, 484 Broadway, 1040 Madison, Copley Place in Boston and Garden State Plaza, and now looking forward to our Columbus Circle Men's store opening in the fourth quarter. Our repositioning of this business through a combination of product and curated items from our partner brands led to an increase in penetration to our total business in the first quarter. We continue to expand the reach of our Crewcuts business through a combination of shop-in-shop locations, standalone opportunities in key markets and through our direct channel.

On the direct side, we have some exciting things going on and that producing outsized growth in our most profitable channel. We continue to be pleased with madewell.com, which just had its one year anniversary in May. And as we expected, this launch has increased brand awareness and allowed more customers access to our Madewell product. On the international side, we're excited to be expanding our e-commerce reach in the third quarter of this year beginning with the U.K. We launched factory.com in September of last year, weekends only. And while we are still learning, we are pleased with the results so far.

Our Factory Store business is highly productive for us and we have plans to capitalize on the strength here, growing our factory square footage by approximately 10% a year over a 3- to 5-year horizon through a combination of new units and expansions in existing centers, where we see potential upside. We opened one new store in the first quarter and plan to open a total of 11 new stores in 2011, including 2 Factory Crewcut locations. We continue to view Factory Crewcut as a key opportunity and have opened 27 new shop-in-shops year-to-date. We now operate 2 standalone and 53 shop-in-shops in our Factory stores.

And finally, our Madewell store business. We opened 2 very exciting new locations in the first quarter, South Coast Plaza in Southern California and Fifth Avenue in Manhattan. We currently operate 22 stores and have plans to open 10 additional new stores by the end of this year. We are really pleased with what we're seeing in our Madewell business both in the stores and direct. We're excited about all the potential growth opportunities and feel we have made meaningful changes to our Women's assortment as we move into the second quarter and the back half of the year.

With that, I will turn the call back to Stuart to review our first quarter financials in more detail, and provide an update on CapEx for the year.

Stuart Haselden

Thanks, Jim. Turning to the details for the first quarter. Total revenues increased 1% to $409 million. Total company comparable sales, which include comp store sales, Direct Sales and shipping and handling revenues, decreased 3%. Our store sales decreased 3% to $281 million. This was driven by a 6% decrease in comp store sales, partially offset by a 3% increase in net square footage. Direct Sales increased 5%, which includes our, Factory and Madewell Direct businesses.

Gross profit adjusted for the impact of purchase accounting of approximately $4 million for the first quarter was $185 million, with our gross profit margin declining 380 basis points to 45.2%. The decline in gross profit margin reflected 250 basis points in merchandise margin decline coupled with 130 basis points of buying and occupancy deleverage. The merchandise margin deterioration resulted primarily from increased markdown activity as a result of a softer-than-anticipated sales trend, predominantly in our Women's business.

SG&A expenses, adjusted for the impact of purchase accounting and related costs of approximately $82 million for the first quarter decreased 3% to $124 million and were 50 basis points below last year on a rate basis at 30.2% of revenues. Adjusted EBITDA as outlined in Exhibit 3 of our press release for the quarter was $75 million as compared to $89 million last year. EBITDA rate declined to 18.3% of revenues versus 21.5% last year. Net interest expense for the first quarter totaled $17 million, which compares to $600,000 last year and is reflective of the debt incurred in connection with the acquisition.

Turning to key balance sheet highlights. Cash and cash equivalents were $280 million at the end of first quarter, which included $209 million related to the value of dissenting shares, which was paid out subsequently in May. Total debt was $1.6 billion at the end of the first quarter, which compares to $49 million at the end of the first quarter of last year. Excluding the purchase accounting inventory step-up, our inventory balance increased 22% versus last year at the end of the first quarter or 19% on a per-square-foot basis. This includes approximately 5% related to an early delivery.

Given the softness of our first quarter Women's business, as Jim mentioned, we are heavier in spring, summer inventory than we would like to have been at the end of the first quarter. We feel comfortable that our inventories will come in line with sales as we move through the second quarter and into the second half of the year.

Capital expenditures for the first quarter were $20 million, and we expect capital expenditures to total approximately $95 million to $100 million for the full year, reflecting our increased store opening plans, information technology enhancements, warehouse and call center expansions, store renovations and corporate facilities renovations.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from William Reuter of Bank of America Merrill Lynch.

Spenser Samms - BofA Merrill Lynch

This is actually Spenser in for Bill. I was wondering if you guys could comment at all on how much of the increase in inventory was due to higher units and how much was due to inflation.

James Scully

Spenser, it's Jim. Actually, we're not going to break out the components. I can tell you that if you break down the 19% increase on a per-square-foot basis, there was about 5 points of that increase which was related to an early delivery in our Factory business. So I think, probably that's the most detail we want to go into in terms of inventory composition at the end of Q1.

Spenser Samms - BofA Merrill Lynch

Okay. And then for the 6% decrease in comp store sales, are you guys going to comment at all on traffic versus ticket?

James Scully

No, we have not historically done that.

Spenser Samms - BofA Merrill Lynch

Okay. And then just one quick one. Can you remind us again what the cash taxes are going to be for fiscal '11?

James Scully

It will be approximately $5 million in 2011.

Operator

Our next question is coming from Karen Eltrich of Goldman Sachs.

Karen Eltrich - Goldman Sachs Group Inc.

Can you just maybe comment on how performance was in the traditional retail versus outlet, if you saw a large discrepancy there?

James Scully

Karen, I would say, we normally didn't really get into, even when we were a public company, too much of a distinction. What I would say is, we have seen probably as you would expect based upon recent reports that came out in comp store sales and just the general macro environment, I would say that you’d probably see more pressure on the value side than on the high-end and I would say that, that relationship probably holds true for us.

Libby Wadle

Yes, absolutely. This is Libby. And I would say, across really all channels, where we saw softness, it sort of was reflected in both of our Retail, Factory and our Direct businesses.

Karen Eltrich - Goldman Sachs Group Inc.

And as you mentioned for Women's, sales were a bit below expectation and I know we're not supposed to blame the weather. But do you think that the cold, unseasonable spring, do you think that did have an impact?

Libby Wadle

We don't like to blame the weather. I think everyone felt that, but I think, and we've spoken about our Women's problems really in the back half, about the back half of last year. And I think it was for us a little bit -- certainly, a little bit of weather it and environment and just the women shopper. But we have work to do in our Women's products and we did what we could for Q1 and we feel a lot better positioned for Q2 and go forward.

Karen Eltrich - Goldman Sachs Group Inc.

And with regards to getting the inventory back in balance, can we kind of expect the same rate of discounting activity in the second quarter? Or do you feel that you're a little better going into this one than you were in the first?

James Scully

I think we feel better going into Q2 than we did in Q1. And in terms of the promotional activity, I feel comfortable that it will not be any worse than Q1 and we're hoping that it’s better.

Operator

Our next question is coming from Grant Jordan of Wells Fargo.

Grant Jordan - Wells Fargo Securities, LLC

If you could give us a little more specifics in terms of how you're repositioning the Women's business, whether it's a lower price point, different trend, that would be great.

Libby Wadle

Sure. Not a lower price point, I can say that straight out. We spoke a lot about our Women's business and we had some product misses and we held on to some product categories and trends for too long last year, in the back half of last year. And we really cleaned that up for the first quarter and we pulled a lot of these businesses out. But we did not have the time in the product life cycle, really, to react quickly enough to redesign the line for Q1. So as I said before, we reacted as quickly as we could and we've adjusted and we still have our franchise businesses, those are the most important businesses for us that we will not walk away from. We are not making any major swings in prices. And as I said, we feel a lot better positioned in our product for Q2 and go forward, in the back half.

Grant Jordan - Wells Fargo Securities, LLC

Okay. And the bulk of the new product will be heading in Q3?

Libby Wadle

Yes. I mean, we have new product in Q3. Again, our franchise and classic businesses, we still have and believe in, and we have not walked away from. And we have new product in for Q2 that we have affected as well.

Grant Jordan - Wells Fargo Securities, LLC

Okay. And then in terms of product cost, how much of that are you planning to pass along to the consumer?

Libby Wadle

Well, I think we all know everyone's experiencing the pressures, the raw material pressures, the labor increases and all of that. And we are not making any broad stroke price increases. As we always do, we take into consideration where costs are going and we look at what our product is worth, and probably more at the higher end of the product, really you can look at cashmere as an example. We're taking a look at those prices. Cashmere prices have gone up significantly. It's no longer sort of an everyone yarn. It's gone back really to a luxury yarn, and that's really where we are positioned. We play in the luxury end of cashmere. We buy Italian cashmere yarns and we will price them accordingly. So that's an example. But we are not making broad stroke price increases in our product.

Grant Jordan - Wells Fargo Securities, LLC

Okay. And my last question on gross margin. You talked about losing 150 basis points due to cost deleveraging, 130. What kind of comp increase do you typically need to see to leverage your SG&A?

James Scully

We talked about total sales just given how big our Direct business is to us. So when we look at total sales, including Direct, I would say it's mid to slightly above mid-single digits.

Operator

Our next question is coming from Carla Casella of JPMorgan.

Carla Casella - JP Morgan Chase & Co

One question on the Women's business, actually 2 questions. Stuart, you said that some of the inventory that you're carrying today is still the Women's heavy inventory or is it more…

Stuart Haselden

No, no. I think what we're saying is that we're not concerned about the currency of the inventory. What we're saying is that the inventory that sits with us today had some of the same product issues that we saw in the back half of last year, and we're working through those just based upon how the life cycle works in our purchasing and design. So it's not a composition of the inventory. It's just working through it from a flow of new goods and where we can make adjustments. As Libby said, we had more of an opportunity to do that into Q2 than we did in Q1.

Carla Casella - JP Morgan Chase & Co

Okay. And by the end of Q2, then should it be in line?

Stuart Haselden

We expect by the end of Q2 that inventories will be positioned with our sales trend, yes.

Carla Casella - JP Morgan Chase & Co

Okay. And then can you just remind us of some of the details, the changes that you've made to the Women's for Q2 and for the back half?

Libby Wadle

Sure. I think we went after, as we all know, we were big into sort of the ruffle and the art tee business this time last year, honestly, when it was at its peak. And I think in hindsight, we probably wanted to walk away from that a little bit more quickly. And as we got into Q1, we pulled out that fashion and we did not have enough new fashion, really. As I said, we didn't have enough new fashion to replace that. And so we had, again, all of our great franchise businesses, which remained strong. And as we move into – our customer still loves novelty, loves print, loves color and all of that. As we get back into those businesses, we feel better positioned.

Carla Casella - JP Morgan Chase & Co

And you feel that you have that in there for Q2?

Libby Wadle

I think you can go to the store and probably see for yourself.

Carla Casella - JP Morgan Chase & Co

Right. And did you give a CapEx target for 2011 or a timing of the new store openings?

James Scully

So in the back of the press release, you'll see the new units by quarter and by concept. And then, I think, Stuart mentioned that the target for CapEx this year is $95 million to $100 million.

Operator

Our next question is coming from Christina Boni of RBC Capital Markets.

Christina Boni

Just looking at the mix of your business, I mean, just relative to last year, the mix of Women's went down substantially. I presume that's just for all the reasons you discussed in terms of the weakness in Women's. Do you see going back to the same target levels as before? Or do you see that with the pickup in the Men's business, that you see in the Men's business becoming a bigger portion of your overall business? If you can give us a sense of that, that will be great.

Libby Wadle

Honestly, the Women's business is a very, very large piece of the business. And while the Men's business has had great strength and has absolutely picked up some penetration, as well as the Kids business continues to be strong. Can't forget that's a big piece of the pie -- a good piece of the pie. The Women's business will continue to remain the biggest piece of our business and we plan on making sure that it gets to where it needs to be.

James Scully

And then when you look at it historically, it's really just, really, 2 to 3 points difference over time.

Libby Wadle

Yes, it's pretty slight in terms of how the penetration changes.

Christina Boni

Okay, that's helpful. And just in terms of just the commentary that you had in the 10-Q, saying, you would expect business conditions to remain weak at least through the first half. Does that imply that you're saying that comps will remain negative in Q2? And if so, I guess, I'm just trying to reconcile as you work through the inventory, does that lead to further markdowns in order to clear that inventory to align with sales? I was just trying to get some clarification.

James Scully

Sure. I think if you look at the disclosure what it basically says is that we expect continued weakness in the top line through the first half of this year, which is what is consistent with what we've been saying since last year. That we knew we were in a situation where we had 4 tough quarters coming at us. And I think the good news is we're currently in the middle of the fourth quarter. The comparisons get easier in the back half, so we would expect to see year-over-year improvement in the back half. And as I said earlier, in terms of the gross margin impact in Q2 given the inventory positions, we think the year-over-year decline in Q2 will not be worse than it was in Q1.

Operator

Next question is coming from Colleen Burns of Oppenheimer.

Colleen Burns - Oppenheimer

On the cost inflation that you're seeing, is your expectation that you will offset that with price increases and SG&A savings for the back half of the year?

James Scully

Well, no. I think what we're seeing -- what we haven’t said is that in the first half of the year, we saw cost inflation in the low single digits. In the back half, we see it in the high single digits, low double digits. And it's kind of a double-edged sword. We are not up against tougher comparisons in the back half. Our focus in the back half is going to be on improving full price sales in the back half, and the pricing opportunities that Libby said earlier will be on the higher end of the merchandise. We're not going to give up our opening price points, and we're not going to look to pricing only to offset the cost pressures. We're working with our vendors overseas to help do that and looking at the supply chain and other areas. It's not our expectation that we're going to be able to offset that number totally in the back half. But again, the good news is we're up against easier comparisons in the back half.

Colleen Burns - Oppenheimer

Great, okay. And then just on the SG&A line, you guys did a good job this quarter. Are there SG&A savings that you're targeting for the rest of the year? Or how should we think about SG&A?

James Scully

SG&A was, and I think we disclosed this in the financial statements we put out this morning on the line. Q1 was benefited pretty significantly by the bonus swings this year-over-year and that helped. So that was primarily the driver in SG&A being relatively flat on a dollar basis, on an adjusted basis year-over-year. We constantly look at expense savings and expense opportunities. And obviously, we're doing that in the back half as well.

Colleen Burns - Oppenheimer

How much was that bonus benefit?

Stuart Haselden

It was $8.8 million. This is Stuart, Colleen. $8.8 million that included bonus and incentive comp. So as Jim mentioned earlier in our prepared remarks, Q1 of last year was a peak for us and as you would expect, we recorded peak bonus accrual in that period, which we did not this quarter.

Colleen Burns - Oppenheimer

Got you. And that number was just more of a first quarter comparison. You won't see that in the other quarters?

Stuart Haselden

Right, that's correct.

Colleen Burns - Oppenheimer

Okay. And then just lastly on the IT, I think you said, I think I saw in your Q, it’s like $25 million in CapEx for IT enhancement. What is that really related to?

Stuart Haselden

Well, that means is it's related to every asset of the business.

Colleen Burns - Oppenheimer

There’s no feature.

Stuart Haselden

The big buckets are obviously the Direct business is a big consumer of IT capital for us as we launch our International business. As we launch our retail store into Canada as well and consider other international opportunities, there's obviously IT spend that goes along with it. And then, a lot of that is just kind of the annual maintenance of our core systems.

Colleen Burns - Oppenheimer

Okay. So there's no major systems changes?

Stuart Haselden

No, not planned in that number.

Operator

Our next question is coming from Carson Dickson of T. Rowe Price.

Carson Dickson

Following up on Spenser’s question about cash taxes. I think you mentioned $5 million or so. What's driving that delta between GAAP taxes and cash taxes? What will happen kind of in years 2 and 3 from here?

Stuart Haselden

The biggest component is, as a result of the transaction, we accelerated the vesting of options and share-based comp, which was a large number, which is a tax benefit for us, and that was probably the biggest increase. Obviously, that’ll be offset going forward with additional interest expense as an offset to income. But the biggest item this year that's providing the shield is really the acceleration of the vesting of the options.

Carson Dickson

It sounds like going forward, cash taxes will be closer to GAAP taxes after 2011?

Stuart Haselden

Yes, after '11.

Carson Dickson

And then also, looking outside the guidance you gave us 3 or 4 months ago at the time of the transaction, doing the road shows. You highlighted very clearly at the time sort of the weaknesses you're going to have in Q1. How do you think things played out in Q1, kind of on a macro scale? Do you think the economy weakened a little bit or was all the weakness we saw in margins and sales, just what you expect at all from kind of your own company-specific issues? Or have you have seen any change in the macro?

James Scully

I think it's a really good question. I wish I really knew the answer to it. I would say that generally, I don't think we personally saw a big impact from changes in the macro environment. I do think that we did see competitors with more inventory and being much more promotional earlier than we would have thought. I think the delayed Easter made people nervous earlier in the business, and I think has been reported pretty widely publicly. Easter was not -- the shift was not as big as people thought. It could have been weather. It could have been a lot of things. But I would say, less about macro but more about competitive, we saw people being a lot more aggressive in markdowns.

Carson Dickson

Yes, I've been noticing there's few companies out there with some markdowns and inventory issues. So I was trying to feel for how much is company-specific and things like that. And also, kind of put the SG&A question as well. So if we adjust for that bonus, SG&A per square foot was up year-over-year in the 5% range not down as it first appeared at first glance. And is that kind of how to think about SG&A per square foot? Is it going to be up in that mid-single-digit range?

James Scully

That's probably a bad proxy.

Carson Dickson

And that’s kind of back to your, I think, deleveraging point as well or leveraging operating expenses. You need that kind of a comp as well, it sounded like?

James Scully

Exactly.

Carson Dickson

Okay. Well, and then finally, I noticed from the 10-Q you guys entered some swaps and some caps. What was the cost of all those?

James Scully

Well, the cap was approximately $700,000. And then obviously, we'll see with the swap, how it plays out.

Operator

Our next question is coming from Andrea Cullen of Ares Management.

Andrea Cullen - Ares Management

Not to beat a dead horse but on the inventory, I just want to make sure I'm understanding 100% correctly. The fourth quarter inventory has all been cleared, correct?

Libby Wadle

Yes, that's correct.

Andrea Cullen - Ares Management

Okay, great. So the first quarter decline in margins was really just there were still some fashion misses that had already been ordered in the stores and that’s what was getting cleared in the first quarter?

Libby Wadle

Exactly, yes.

Andrea Cullen - Ares Management

Okay. And then in the second quarter and going forward, you obviously feel better about the inventory that's going to be coming into the stores, and that, that should be less of an issue?

James Scully

Yes, and the level at which they were purchased.

Libby Wadle

Yes.

Andrea Cullen - Ares Management

And the level at which they were purchased. Okay, great. That's really helpful. And then, I know you watch and we watch too all of the retailers that have been reporting same-store sales. And the Saks and the Neimans, the luxury guys are obviously doing a lot better on the same-store sales score. On a going-forward basis, directionally, do you think now that the inventory is sort of out of the way that you should track along the lines of the luxury guys or more on the mid-tier?

James Scully

I think we always feel like we track more towards the high-end than the mid or low-end.

Andrea Cullen - Ares Management

Okay. And then also on your growth plans, particularly as it relates to overseas and also Japan, can you give us any update on how you're thinking about that over the course of this year?

James Scully

Sure. So I think there's really 2 phases. First is, I mean, as of today, we really don't have any international exposure outside of the limited shipping that we do to Canada and Japan. We're extremely excited about opening our first international store. It is in Canada at Yorkdale but it's a big step for us as a company. And then in Q3, also beginning to provide shipping from our Direct business to the U.K. We're also looking at potentially broadening that to a couple more countries in the fourth quarter. So those are the initial plans for this year. We'll continue to focus on growing both of those new businesses. In addition, we are taking some time to look more globally at Asia and other parts of the world as it relates to bricks-and-mortar and the Direct business, but it's very early in our thinking and we'll just keep people posted as we made progress on that topic.

Operator

Our next question is coming from Karru Martinson of Deutsche Bank.

Karru Martinson - Deutsche Bank AG

In terms of the COGS, I was wondering if you could break that down in terms of broad buckets, labor versus material versus shipping and everything else?

James Scully

In terms of the increases?

Karru Martinson - Deutsche Bank AG

Well, in terms of the increases, but also I guess as an overall, how should we be looking at the COGS going forward?

James Scully

So let me just make sure I understand the question. You're asking what component of our COGS is the raw material…

Karru Martinson - Deutsche Bank AG

Labor versus…

James Scully

Labor and raw material costs? Okay. It's a really different -- it's a really tough question because each category of business is much different, whether it be knits, whether it be wovens, whether it be accessories.

Libby Wadle

Yes.

James Scully

So I would have a tough time answering that, and I'd be very careful to answer it. I'd say, obviously, the majority of it is the actual raw material costs and then the labor and transportation will be the remainder.

Libby Wadle

Yes, the majority is the raw material and the construction.

Stuart Haselden

Right. And of the raw material, cotton's probably the biggest category followed by wool. As you'd see in our disclosures, in our 10-K, we do a large proportion of our production in China, so we're exposed to the labor cost trends in China.

Karru Martinson - Deutsche Bank AG

Now a number of other retailers have talked, and it’s mostly been just talk about looking for additional new production facilities moving to lower-cost countries. Where do you guys stand on that? Is that something that you're actively considering?

James Scully

Well, I think the most important thing, when we talk about sourcing costs, I think, the most important thing for us to keep people focused on is that we are a quality-focused company when it comes to looking at our product, so that is the most important. And in addition to price, which is obviously important, there's flexibility and there's on-time delivery. So we're constantly looking at other countries in terms of a way to shift production in order to save money. But we're so dependent on the quality product and also in terms of reliability, in terms of delivery. You don't want to be caught in a situation where you're saving a couple of pennies on a garment and it's a late delivery because the damage is far greater than what you would save in shifting to another country. So for us, for a lot of the more detailed work that we do, China still has the best quality. So for a big portion of our business, we will be there until that develops on an equal basis in other countries. But we're constantly looking at the rest of the world to find lower-cost alternatives that have the same level of quality.

Karru Martinson - Deutsche Bank AG

Okay. Just in terms of the lead times for inventory. I mean, is this kind of a 6 months from when you place the order? Or is that the right way to look at it?

James Scully

It's more like 4.5 to 5 months of the financial commitment when we place the order. It's a 9-month creative cycle. But it's about 4.5 to 5 months and that's on a weighted-average basis. It's obviously different again for each different category. So when you roll up the entire assortment, it's about 4.5 to 5 months.

Karru Martinson - Deutsche Bank AG

Okay. And if we were just to look forward into 2012, your cotton has come off rather dramatically from the peaks. Are there any early indications that you're seeing there from your vendors?

James Scully

We're very, very early in conversations because right now, we're really focused on Q4. But the initial indications based from some of our recent trips, it seems to be leveling off in early '12. But again, we're very early in those discussions.

Operator

Our next question is coming from Ruth Chou [ph] of E Advantage.[ph]

Unknown Analyst -

I was wondering if you could give more information on Direct Sales, was the increase based on adding the Madewell site and factory online or if you could just break it out?

James Scully

One second. So just to restate your question, you're asking for more detail on the Direct Sales to break out the subcomponents in terms of versus Factory and Madewell?

Unknown Analyst -

Yes.

James Scully

Actually, okay, I understand the question. We actually don't break out the components just like we wouldn't break out the components on the store side as well for the different subcomponents. But I would tell you that Madewell and Factory, obviously, just being recently launched are a relatively small piece of the overall business.

Unknown Analyst -

Okay. So the organic growth for Direct Sales is still a lot more?

James Scully

Say that again?

Unknown Analyst -

The organic sales were still up for the Direct segment?

James Scully

Well, let me just make sure we understand a couple of the components. Factory is new this year. So that business is new. So there's no comparable to it last year, so that's all plus on the top. Madewell until May was a plus, and that was a new business. So there are components of it, which helped because there was no prior year driving it. So even though it was small, it was a plus.

Operator

You have a question coming from Carla Casella of JPMorgan.

Carla Casella - JP Morgan Chase & Co

Two follow-ups. One, you talked about the stock comp, the bonus accrual in first quarter last year of $8.8 million. Was there a reversal of any of that in second quarter or in the back half of last year that would make the comparison for SG&A more difficult as we go forward?

James Scully

Yes, and we disclosed those in our Qs last year.

Carla Casella - JP Morgan Chase & Co

The reversals?

James Scully

Yes, in the back half of last year.

Carla Casella - JP Morgan Chase & Co

Okay. And then, when we're looking at comparisons in the back half, last year in the fourth quarter, gross profit was down about 650 basis points. Can you say how much of that was clearance and markdown versus just cost increases, so we can get a sense of what a normalized margin would have been?

James Scully

Yes, it's hard to break it out. The vast majority of it, I mean, the vast majority of it was related to markdown and not costs.

Carla Casella - JP Morgan Chase & Co

Okay. And then inventory dollars, should those be up in the back half just on costs or similar to where they are now? Or on a dollar basis, how much should they be up as we get into the back half?

James Scully

So it's a difficult question to answer when we're not going to give forward-looking guidance. But I think what we've said that the inventory increase in the back half would be aligned with where we see the sales trend.

Operator

Our next question is coming from Lisa Paisley of Aberdeen.

Lisa Paisley

I was just wondering if you can confirm for us what the operating cash flow was in the quarter?

James Scully

Sure, one second. We're just going to flip it. It was disclosed in the Q. Yes, we posted it to our website this morning.

Stuart Haselden

Yes, this is Stuart. I think on Page 21 of the Q that was posted, the combined net cash provided from operating activities was negative $92.5 million, which obviously was impacted by all the transaction-related items, the share-based comp and all the purchase price accounting adjustments, to name a couple.

Operator

Our last question is coming from Colleen Burns of Oppenheimer.

Colleen Burns - Oppenheimer

Just one follow-up on the Women's assortment changes in the back half of the year. You talked about feeling better about the Women's trend. Have you tested some of the fashion that you're rolling out in the back half of the year? Or why do you feel better about it?

Libby Wadle

We feel better positioned based on just having -- listen, we know just based on what we know now what our customer love. Even though we’ve had a tough Q1, certainly things worked and we've been able to take what we've learned. And even honestly in Q3 and Q4, there were things that were good and we've been able to really expand upon those. And of course, we've been able to make bigger ideas of things that maybe we did not buy enough of that were really good, we ran out of, what have you. And we've maximized, again, these businesses as we go into Q3 and Q4. And our customer, as I said before, she continues to respond to great novelty, print, color. And so we feel good about our assortment offering built on that.

Colleen Burns - Oppenheimer

So it is a little bit of an expansion of what's worked so far?

Libby Wadle

Absolutely, absolutely.

Operator

Thank you. At this time, I'd like to hand the floor back over to management for any closing comments.

James Scully

So it's Jim. So thanks, everybody, for joining today, and we look forward to speaking with you when we report our second quarter results in September. Thanks.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.

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