JCPenney Q1 2007 Earnings Call Transcript

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JCPenney, Inc. (JCP)
Q1 2007 Earnings Conference Call
May 17, 2007 9:30 am ET

Executives

Bob Johnson - VP IR
Ken Hicks - President, CMO
Bob Cavanaugh - EVP, CFO
Mike Ullman - CEO, Chairman

Analysts

Deborah Weinswig - Citigroup
Charles Grom - JPMorgan
Christine Augustine - Bear Stearns
Jeff Klinefelter - Piper Jaffray
Michelle Clark - Morgan Stanley
Stacy Turnof - Merrill Lynch
Bernard Sosnick - Oppenheimer
Michelle Tan - UBS
David Glick - Buckingham Research

Presentation

Operator

At this time, I would like to welcome everyone to the JCPenney first quarter 2007 earnings release conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Bob Johnson. Sir, you may begin your conference.

Bob Johnson

Thank you, Nia and thank you for joining us on the call this morning to review JCPenney's first quarter earnings. We've scheduled this call to last about 45 minutes, which includes time for questions and answers.

Before we begin, let me remind everyone the discussion this morning includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect the company's current views of future events and financial performance. The words expect, plan, anticipate, believe and similar expressions identify forward-looking statements. Any such forward-looking statements are subject to risks and uncertainties and the company's future results of operations could differ materially from historical results or current expectations. For more details on these risks, please refer to the company's Form 10-K and other SEC filings. Also, please note that no portion of this call may be rebroadcast in any form without the prior written consent of JCPenney.

Replays of today's web cast will be available for 90 days. For those listening after May 17th, 2007, please note that this recording will not be updated and it is possible that the information discussed will no longer be current.

On this morning's call, we will have three speakers. First Ken Hicks, President and Chief Merchandising Officer, will review merchandise results for the quarter and what's ahead for second quarter 2007. Next, Bob Cavanaugh, Chief Financial Officer, will discuss operating results and review financial conditions. Mike Ullman, Chairman and Chief Executive Officer will conclude the formal remarks with his observations.

Ken will begin.

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Ken Hicks

Thank you, Bob. Good morning, everyone. This morning we reported first quarter earnings of $1.04 per share, which reflects continued improvement in the fundamentals of our business. We're very pleased with these results as the first quarter presented a number of challenges for retailers. We believe the style and quality of our merchandise that we offer at smart prices is resonating with our customers and positions us well for the second quarter and beyond.

With that in mind, let me start this morning by recapping our first quarter results. Looking at department stores, total department store sales increased 4.4% for the quarter and includes sales from 32 new and relocated stores open since the end of last year's first quarter. Comparable store sales increased 2.2%, in line with expectations. This increase was on top of a 1.3% increase last year and marks the 16th consecutive quarter that we've delivered a comparable store sales increase at JCPenney.

Sales were strongest during the March period and picked up at the end of April as Mother's Day shopping began. Sales increased across all areas of the country with the best performance in the Northwest and Southwest regions.

Looking at sales by merchandise category for the quarter, we had sales gains in both fashion and basic merchandise, and our private brands continued to outperform the store average, benefiting from the success of our newer brands such as a.n.a and east5th in women's apparel and Studio in home.

In addition, new launches this year, including our Ambrielle, our largest private brand launch, and two new brands from Liz Claiborne, Liz and Company and Concepts by Claiborne are all off to a strong start and performing above initial expectations. All of our apparel areas did well during the quarter led by women's apparel. Fine jewelry and women's accessories also had strong results.

We continue to be very pleased with the results we're seeing with Sephora inside JCPenney. By month's end, we will have 21 Sephora inside JCPenney shops and approximately 50 shops by the end of the year with an expanded rollout beginning in 2008. So overall, we're pleased with department store results in the first quarter.

Turning to direct, JCP.com continues to be our fastest-growing channel and we intend to maintain our leadership position in general merchandise Internet sites. Internet sales increased 18% in the first quarter with good results in apparel categories. This comes on top of a 22% increase in last year's first quarter. Overall, direct sales decreased 3.6% for the quarter, which was below initial expectations, primarily as a result of challenges in catalog, while we are seeing some positive trends in apparel areas, with growth in both lingerie and business apparel. In total, Catalog is being impacted by soft sales in our big books and continued weakness in the home category. We continue to manage the profitable transition of direct to an Internet channel supported by specialty catalogs.

Turning now to total company operating results, gross margin increased 70 basis points from last year's first quarter, ending at 41.5% of sales. This reflects continued improvement and overall inventory management, including better product flow to our stores. The expertise of our planning and allocation team and the utilization of our advanced systems and processes allow us to be more responsive to trends with more frequent merchandise deliveries and faster cycle times. This means our customers see fresh, exciting merchandise each time they visit us. We are also realizing the benefits of our strong sourcing capabilities and continued strong performance of our private brands.

SG&A expenses were 29.7% of sales, compared with 29.9% last year, and in line with expectations. SG&A expenses were leveraged by 20 basis points while making investments in growth drivers such as marketing for our Every Day Matters brand positioning, and the launch of our Ambrielle new brand as well as the addition of selling and general expenses associated with new stores.

Other operating expenses came in at expected levels. Depreciation and amortization was $100 million, reflecting additional costs associated with the 28 new stores opened in 2006, and seven stores so far in 2007. Preopening expenses totaled $6 million, in support of the new stores which opened in the first quarter and 15 new stores opening in the second quarter of this year. These growth-related expenses, depreciation and preopening, were higher than last year by $16 million or $0.04 per share. This demonstrates our focus on continuing to improve the operating fundamentals of our business while we accelerate growth.

Real estate and other contributed pre-tax income of $9 million for the quarter and includes income from normal ongoing real estate operations. Taking all this into consideration, first quarter operating income increased to $419 million, an improvement of $37 million. As a percent of sales, operating income improved 60 basis points to 9.6%.

Now I'd like to share with you a brief look at the second quarter from a stores, merchandising and marketing perspective. First, we will open 15 new stores in the second quarter. As we said at our recent analyst meeting, our plan is to open 50 new stores, both this year and annually for the next four years for a total of 250 new stores by 2011. We continue to build on our strength as America's gift-giving headquarters during Mother Day and have plans for great gifts for Father's Day.

We will also continue to improve execution within specific businesses. Dresses are a key fashion statement this year, and we have trend-right sun dresses planned for the upcoming months. We are very enthusiastic about the new product coming in women's apparel in Liz and Co., Dunner, Izod, Nicole and Bisou-Bisou, as well as fashion looks in our private brands from a.n.a, St. John's Bay, and Worthington. Intimate apparel will benefit from the continued development of our successful new Ambrielle brand and the upgraded intimate apparel environment of our stores.

In women's accessories, you'll see a new collection of better handbags by Sophia Caperelli, while we build on our already strong business with Genna de Rossi and Liz & Co. In shoes, we are adding a new line of Mamba sandals by the makers of Crocs this summer. In men's, we'll feature Concepts by Claiborne, our expanded line of golf apparel from PGA Tour and Izod and great polos and tees in St. John's Bay for Father's Day.

We believe we're well positioned for another successful back-to-school season, which begins for us in the July period. We have exciting merchandise and programs planned for the season. As an example, we've announced C7P, a Chip and Pepper production, which is an exciting new denim brand for Juniors and young men that will be available exclusively at JCPenney for back-to-school.

On the marketing side, I hope you have all seen our new Every Day Matters brand positioning. This positioning communicates to our customers that what matters to them matters to us every day. I want to emphasize that Every Day Matters serves as the foundation for accelerating growth across our company by enabling us to create a deeper, more enduring emotional connection with our customers. One of the most important elements of Every Day Matters is the role that our store teams play while they interact with our customers. To improve in this area, we are providing our associates with the training and tools they need to deliver superior customer service that will set us apart from our competition.

As we look ahead to the second quarter from a performance perspective, due to last year's 53rd week, second quarter sales will vary by month from last year's sales pattern, with a significant benefit expected to occur in the July period due to an additional week of back-to-school sales. Taking this calendar shift into account, total department store sales are expected to increase mid to high single-digits for the second quarter. Comparable department store sales are expected to increase low to mid single-digits in the second quarter.

We expect direct sales to be down low to mid single-digits in the second quarter. Internet sales are expected to continue to grow in the high teens. Catalog sales will continue to be challenged by softness in home categories. In addition, we have planned a later distribution of the fall winter big book and the postage increase that went into effect this month will impact circulation. We expect continued year-over-year improvement in our operating income as a percent of sales, principally from a higher gross margin.

Before I turn the call over to Bob Cavanaugh, I would like to note that we are of course mindful of the current economic environment and we believe it creates an opportunity for us. The significant improvements we've made to our value proposition are resonating with customers and are more meaningful than ever. We offer the styles found at other department stores with the quality our customers demand, all at smart prices.

In summary, we're pleased with our first quarter profit performance, which exceeded our initial expectations. In a challenging retail environment, we were able to accelerate our growth and achieve record earnings of $1.04 per share. We expect continued year-over-year improvement in our operating results in the second quarter and beyond. We are confident the strategies and initiatives we have in place will enable us to make an emotional connection with customers and expand our market share in support of our financial targets.

I'll now turn the call over to Bob Cavanaugh.

Bob Cavanaugh

Thanks, Ken, and good morning, everyone. We executed our plan in the first quarter and are obviously pleased with the progress we continue to make in strengthening the fundamentals of our business. As Ken noted, operating income for the quarter was $419 million, compared with $382 million last year, an increase of 60 basis points to 9.6% of sales, compared to 9% last year. That includes growth-related expenses, depreciation and preopening that were higher than last year by $15 million or $0.04 a share. This demonstrates our focus on continuing to improve the operating fundamentals of our business while we accelerate growth.

Interest expense for the quarter was $32 million. The income tax rate was 38.5%, and we had 228.8 million average diluted shares for the quarter. So together, income from continuing operations as well as net income were $1.04 per share for the quarter.

Moving on to our financial condition. As of May 5th, the company had cash investments of approximately $3.1 billion. We ended the quarter with long-term debt, including current maturities, of $4.1 billion. As you are aware, on April 27 we closed on a very successful $1 billion senior unsecured debt offering. The offering was comprised of two tranches with $300 million of 5.75% senior notes due in 2018 and $700 million of 6.375% senior notes due 2036. This transaction was essentially the refinancing of higher coupon debt, including the early redemption on June 1st of the remaining $303 million of our 8 1/8% debentures due 2027, as well as approximately $625 million of long term debt that has or will mature in 2007 and 2008.

One last comment on long-term debt: in late April, both Standard & Poor's and Fitch Ratings revised their rating outlook for JCPenney from stable to positive. This again demonstrates the confidence they have in our ability to achieve our long-range financial targets.

Capital expenditures for the quarter were $244 million, in line with expectations and compared with $126 million last year. The increase in capital spending supports our long range plan for growth, specifically the opening of seven new stores in the first quarter and 15 new stores in the second quarter. Additionally, we continue to invest in our existing stores with plans to renew about 65 stores over the course of 2007. We continue to anticipate full year capital expenditures of $1.2 billion and we continue to expect that the contribution to cash flow represented by operating activities less the sum of capital expenditures and dividends will be approximately $200 million for the full year.

Turning now to earnings guidance for the second quarter. As Ken noted, we anticipate improvement in our operating income as a percent of sales, primarily from higher gross margin. In addition, our guidance for the quarter anticipates increases for both depreciation and amortization, and preopening expenses in support of new store growth and renewals. Depreciation and amortization is expected to be approximately $100 million and we anticipate about $14 million in preopening expenses. Together, these growth-related expenses are expected to be incrementally higher by about $15 million, or $0.04 a share higher than last year's second quarter.

Our guidance for net interest expense is $37 million for the quarter and includes the impact of the new debt offering. We will recognize a charge of $12 million or $0.03 per share related to the call premium and write-off of unamortized costs associated with the early redemption of our callable debentures noted previously.

Our tax rate is expected to be about 38.5% for the second quarter. You may recall that last year's second quarter included $26 million of tax credits, which represented $0.11 per share. We currently anticipate approximately 226 million average diluted shares, including about 3 million common stock equivalents in the second quarter.

For the second quarter, we expect earnings to be about $0.77 per share. Earnings for the second quarter are consistent with the initial guidance that we gave for the full year, which included the anticipated impacts of the new debt offering and bond premium expenses. So after rolling our first quarter results forward, we now expect earnings to be about $5.49 per share for the full year versus initial guidance of $5.44 per share.

In summary, we continue to maintain the financial flexibility to support the strategies of our long range plan. The growth initiatives we have in place are designed to accelerate both comparable store and total sales growth. Our team delivered a solid first quarter and we're pleased with the consistent strengthening in the fundamentals of our business, which will lead to sustainable operating performance improvement. Together, these drivers generated continued momentum of our customer value proposition and will enable us to achieve an annual EPS growth rate of 16% over the 2008 to 2011 period.

Now I'll turn the call over to Mike Ullman.

Mike Ullman

Thank you, Bob. Thanks to the progress we're making on many fronts, we were able to deliver strong -- and in fact higher than expected -- first quarter results and move up our EPS expectation for the year. We're continuing to improve our merchandise assortment and marketing plans to reinforce to our customers why we should be their preferred shopping choice. At the same time, we're continuing to make strides in expanding our gross margins to reach our goal of being the growth leader in our industry.

We're off to a good start in implementing our updated objectives and are well-positioned to deliver the financial results that we anticipate for the balance of 2007 as well as our new long range plan targets we laid out for you last month. We are mindful of the additional pressures that consumers are facing in the current economic climate. However, we don't believe there's been a material change in our consumers behavior. In fact, we believe that JCPenney's value propositions, which combines style and quality at smart prices becomes even more relevant, presenting an additional opportunity to introduce JCPenney to new customers while reinforcing our brand to our existing customer base.

Additionally, as emphasized at our analyst meeting last month, we believe there are ten key differentiators that will continue to set JCPenney apart from key competitors. First, our new brand positioning Every Day Matters. Creating a true emotional connection with our customers, where our associates are the key differentiators.

Second, the announcement of the upcoming launch of American Living, produced by the Global Brand Concepts Group within Polo Ralph Lauren. This launch, scheduled for next January, will be across our entire store: women's men's, children's, home, and accessories.

Third, Sephora inside JCPenney, currently the state of the art way to buy beauty products, is off to a very strong start and exceeding our expectations.

Fourth, our eight JCPenney power brands. Our power brands have large customer acceptance and loyalty and have a meaningful brand presence well beyond our ten shopping channels. Our eight power brands are Ambrielle, a.n.a, Arizona, Cooks, Chris Madden for the JCPenney Home Collection, St. John's Bay, Stafford in men's, and Worthington in Missy.

Fifth, our merchandise flow strategy. A state of the art flow process in terms of merchandising led by the strongest teams in the industry.

Sixth, our continued leadership in JCP.com. We continue to invest aggressively in the future of our dot com business in order to keep our leadership position as the largest general merchandise site on the web.

Seven, our commitment to new store growth. As you know, we're opening 250 stores over the next five years, most in our off-mall format, with 50 this year.

Eight, our store renewal program. As we announced at the analyst meeting, we're committed to renewing 300 stores over the five-year period, 65 this year alone.

Ninth, retaining and attracting the best talent in retail. We believe we have the best talent in retail and will continue to attract and invest in the careers of our associates.

Tenth and importantly, growth leadership. We are firmly committed to 16% EPS compounded annual growth rate in the period 2008 to 2011.

These ten key differentiators position JCPenney as a relevant, differentiated department store and accelerates our growth. We look forward to updating you on our progress and should continue to put our comprehensive long-range plan into action.

With that I will close my comments and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is coming from Deborah Weinswig - Citigroup.

Deborah Weinswig - Citigroup

Can you talk about the early reads on Every Day Matters? Is it resonating with customers as you had expected? Just maybe how you're thinking about marketing plans going forward in light of Federated's comments yesterday.

Mike Ullman

Well, certainly Every Day Matters has resonated with our associates, which is our first audience, our 150,000 plus associates are very excited about the opportunity to engage the customer in a more personal way. I think as you noted at the Academy Awards and our subsequent marketing programs, particularly the Mother's Day spot, it's a different type of messaging that they seem to appreciate that we understand them and we understand what really matters.

As we announced when we announced the program in early February, this is not a traditional retail advertising campaign, we will continue to balance this messaging and positioning from an emotional and a values perspective with our sales promotion and cadence of offering great smart pricing with a cadence that the customer understands. I would say that we're off to a good start. This is not a project, it's a process. This is not an advertising campaign. This is a brand positioning. I would say if you asked us six months ago if we're happy with this position, we'd be very happy with where we've come from where we set our target.

Deborah Weinswig - Citigroup

With regards to the launch of Ambrielle, can you talk about how it's performed versus your expectations? Based on what you've learned there, is there anything you'll be doing different when you rollout American Living in 2008?

Mike Ullman

Ambrielle has performed well above our expectations. If anything we're chasing goods, which is always a good challenge. Our store associates tell us the customers respond very, very well to the product; not only the style and quality, but also the way we've edited the assortment across the three sub brands. I think what we've learned is the customer really is willing to step up and pay for style and quality. So we see a somewhat higher price point in terms of out the door intimate apparel. Our intimate apparel business is one of the 10 fastest growing businesses in the store right now. So we believe that's being driven not only by Ambrielle, but also the strengthening of our national brand presence in intimate apparel.

We were a year ago concerned about how we transition from Delicates without losing volume as we moved out of Delicates into Ambrielle. We strengthened our national brand presence during that time. Fortunately, not only did that help with the transition, but that encouraged us to continue to focus the national brand business at where the customer was responding to it. I think we have the best of both worlds right now in intimate apparel, and it's encouraging us to move further with Ambrielle.

In terms of its impact on American Living. I think what it has taught us that by messaging at the point of sale very clearly in terms of what the proposition is and how the product is assorted, that will be a very focused presentation of American Living as it rolls out. We know that and we're very focused on that as we're planning for American Living.

Deborah Weinswig - Citigroup

With regards to traffic and the strength that you're seeing there, do you think that you're getting new customers? Or are you getting more sales or more transactions from existing customers?

Mike Ullman

It's both. I believe as most retailers will tell you, with high energy prices and the housing situation, which is not necessarily even across the country, obviously housing is a bigger issue in northern California and Florida and Las Vegas and Arizona; much more positive in the Northwest in the New York metro area, in Texas. So I think that new customers are being attracted because I think they can relate to our messaging and also the updating and trend right merchandising in the store. I think there's plenty of opportunity to attract new customers and I think our existing customers like what we're doing.

Operator

Thank you. Your next question is coming from Charles Grom – JP Morgan.

Charles Grom - JP Morgan

In your press release and at your analyst day last month you cited the early benefits of merchandise flow. Can you speak to what parts of the store this has and will continue to benefit the most? Any examples you can share with us?

Mike Ullman

As we mentioned at the analyst day, Charles, probably the kids' business is the business that has benefited the most in the last 12 months. But that just encourages us that the opportunity across all apparel categories is real. I think we're seeing that progress. We know that flow is a combination of the frequency of delivery, the relevancy of the merchandise that's being delivered in terms of velocity, as well as the shortened cycle time. We think we're uniquely qualified to capitalize on this because we have a very capable and highly expert planning and allocation team with state of the art systems and our ability to affect 45% of our business all the way back to the point of manufacture since 45% of our business is private label. We believe that this is a key to improving our gross profit by impacting flow.

Charles Grom - JP Morgan

That's helpful. The softness in the home category's been tough. Not real surprising given the discretionary nature of that purchase. As you look to the balance of '07, what levers do you have to more effectively navigate yourself through this?
Mike Ullman

Well, I think there's a difference between the big ticket home business and I would call the soft or home furnishings business. I think that furniture and window covering are biggest ticket businesses. Obviously as you slow down new home openings and there's more existing homes on the market, that is not probably that positive for window covering and furniture. We're almost annualized against those two big businesses and those are only two of probably ten businesses in the home area. The soft home business that we believe will respond faster. We think that Jeff Ellison and his team are well positioned to have American Living come into those assortments early next year.

So while we don't think the home business is going to be a great growth business for us in the near term, we believe we've managed through that with the strength of our apparel business and our accessories business.

Charles Grom - JP Morgan

On your cash position, which stood at about $13 per share, almost 18% of the stock price, I realize you have some debt payments coming and some pension funding to do, but it seems there's an opportunity there. Can you touch on where you could use it going forward? Not necessarily in '07, but maybe in '08, particularly with your net debt to EBITDA multiple of only 0.3 times, which is probably the lowest I've seen in a long time in retail.

Bob Cavanaugh

Well, I think, Charles, what we guided to with the analyst meeting in April is that we're on a glide path for $1.5 billion in 2011. So if there is any excess there in the pipeline going forward given the fundings you mentioned we needed to do related to pension and support our growth plan, then obviously that would give us more flexibility for growth to reinvest in our business as well as more financial flexibility for modifying and capital structure repositioning going forward. But again, our target hasn't changed. We're still glide pathing to that $1.5 billion in cash, which will cover our peak requirements for working capital as we look out over the long range plan.

Operator

Thank you, your next question is coming from Christine Augustine of Bear Stearns.

Christine Augustine - Bear Stearns

Could you please discuss direct sales a little bit more and what you might be able to do? Will you consider maybe changing your mix to more apparel and accessories? Would you consider maybe cutting circulation on big book? Do you think that it will take until you see a turn in the home business to really have improving trends in direct?

Mike Ullman

Let me just make an initial comment. I'll let Ken address some of the items. We have said for several years there's a natural transition from the print business into the dot com business and we've seen that we picked up almost $250 million last year in dot com. And not only in the home businesses on dot com, but also in the apparels and accessories business. We've seen that trend continuing and I think we've done a reasonably good job in managing that in a profitable way; the profitability in the print business and the profitability in the internet business. Ken may just want to speak to how we're continuing to target our print business and make changes to get through this transition.

Ken Hicks

Christine, we are taking a number of actions in order to make sure we have a very strong viable direct business. First and foremost is we are working very hard to continue to grow at a very aggressive rate our online business. We're doing that with the merchandise that we have and how we market it. We are growing other categories of goods. Our fastest growing categories of goods have been our women's apparel and women's accessories businesses. We're also working at other parts of the business such as children's and men's.

On the catalog side, we are reducing our dependence on the big books by using more specialty books. We are having reasonably good effect having more specialty books and those specialty books in many cases are targeted at these other classifications with ready to wear. We're having some great success in our ready to wear. We have 44 million names on file that we are able to target, these customers and make sure we get the right book to them for the right business. We're having some reasonable effects. We will make sure that we continue to manage the profitable growth of this business. I think that we are seeing the impact of some of these actions and are looking for more actions as we go forward.

Christine Augustine - Bear Stearns

Would you be willing to discuss the performance of new stores? Are they on plan, above plan? How are those looking?

Mike Ullman

Yes, I'd be very pleased to do that. I think there's some perception that because we're accelerating our growth of our 50 stores in our off-mall format that that's somehow going to be a disproportionate drag on our near-term operating results.

Quite the contrary. Our new stores have performed exceedingly well, accretive to our store productivity, and we believe by the time we get to the end of the fifth year, we'll have 80% of our stores will be new or recently renovated. And we think that's an important part of the proposition that we owe the customer a selling environment that she's very, very excited about.

So we're very happy with our return on invested capital, ramping up our capital investment this year by $0.5 billion is a big commitment on our part, we take it very seriously and we're very positive about its affect on profitability, sales productivity and ROIC.

Christine Augustine - Bear Stearns

My last question is with regard to the gross margin. Generally speaking, the split between the sales mix as a benefit and then the benefits from all of the processes, the planning and allocation inventory flow. Is it a pretty even split between those two to drive the gross margin in the first quarter and is that what we should see going forward? If you could just address that, thank you.

Mike Ullman

I'll just make one comment because Ken's fairly modest. I think our key performance in the first quarter given the sales environment is a real testimonial to our ability to understand how to manage inventory and how to flow inventory so that we didn't end up with clearance and actually our margin went up by 70 basis points in a time when many would have found it difficult to even be have plan levels.

So I'll let Ken answer the specific question regarding our mix and margin, but our team is very focused on the opportunity of the margin area and I think the first quarter's a good example of that diligence paying off.

Ken Hicks

Christine, there really three major factors that impacted the gross margin improvements. First and foremost is the product that we have. We've got product that we're able to sell at the planned selling prices more. We're not having to take the markdowns because it is strong product. That's a credit to our buying and product development organizations and making sure we have the right product there.

The second is our strong sourcing capability. We continue to gain improvements because of the sourcing capability that we have for our private brands and we are working to continue that leverage.

Third, which is the probably one of the most important factors is our ability to make sure that we manage that flow of merchandise that we talked about and all of the elements that go there as Mike spoke earlier that range from making sure we have the right product and the right store at the right time in the right size in the right quantities. And we continue to work to improve that. And that is something that I think we'll continue to see improvement over the course of our plan.

Operator

Your next question is coming from Jeff Klinefelter of Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

Yes, congratulations, as well on a strong start to the year to everyone on the team. Two questions, very briefly, One would be on traffic and then the second would be on lease rates. First on lease rates, as you pursue all of these renewals and move toward your 80% target at the end of five years, particularly in the enclosed malls environment, can you give some sense for as you renew leases, what's happening to the lease cost for the overall operating cost in those traditional mall locations? Particularly as it relates to your off mall locations.

In terms of traffic trends, there's been much concern and anxiety in the marketplace about overall national traffic trends being very negative, certainly through April but even through the beginning of May. Could you talk a little bit about how you see your own traffic as it relates or correlates historically with national trends?

Bob Cavanaugh

Sure, let me first speak to the traffic issue. As you know, we have a unique balance of on-mall and off mall real estate. Over 600 stores anchored in the best malls and over 400 stores in off-mall locations, 50 of which are in the new off-mall format. We measure traffic by day through our transaction accounts, and we believe that we're 4 or 5 points better in terms of traffic than the average mall traffic. I think it's fair to say that the overall traffic and shopping behavior in the last six months is probably less than it was a year ago overall. But for us it's up. So we're optimistic that it's not difficulty with having someone to talk to about our offer.

Off-mall locations, particularly the new off-mall locations, we're learning that it's more of a weekday opportunity for customers and they shop more frequently because of the proximity to their home. So we're seeing traffic actually even at a better rate in our off-mall locations and we're going to benefit more from that incrementally as we have more off-mall locations.

I would say everybody would like to have more traffic, but we're converting traffic well and the attractions in the store, the eight power brands, Sephora, soon to have American Living, these will be things that will be purposeful destination decisions on part of the customer, which will encourage new customers as well as encourage numbers of visits for existing customers.

As to lease rates, there's kind of an interesting phenomenon. I think it's fair to say that in the old days maybe the Sears and the Penney's of the world were the third and fourth thought process of a mall developer as they went for a new mall as they chased May or Federated or whatever. I think today we're being sought after. Obviously that allows a better negotiation on the real estate, either in a new mall situation, which there are a few per year, but particularly a renegotiation timeframe. We're having no difficulty working with developers to find off-mall locations. We've identified about 400 opportunities. We've said we're going to open 50 a year. Developers certainly understand that 50 a year means they have to compete. We're going to have a number of locations that we're going to wait until we negotiate the best possible real estate deal for the company.

So we're hitting our metrics on new stores or we wouldn't be hitting ROIC. We're very positive about the economics.

Jeff Klinefelter - Piper Jaffray

Just to clarify, you did say that your traffic tends to run 4 or 5 points above a national average?

Bob Cavanaugh

That has been our experience over the last six months or so.

Operator

Thank you, your next question is coming from Michelle Clark of Morgan Stanley.

Michelle Clark - Morgan Stanley

Hi, everyone and congratulations on a terrific quarter. The comments on traffic were very helpful. Can you give us a sense of where ticket trends were running during the quarter?

Bob Cavanaugh

Slightly up. It's also a mix issue. Without getting into the calculus of it, the fact that we had the 53rd week in furniture; some business went into the 53rd week and came out of the '07 numbers, obviously has an effect on overall ticket because of the ticket size. But we're pleased with our average unit retail.

Michelle Clark - Morgan Stanley

With respect to private brands on the sourcing front, can you give us a sense of what you're seeing from a costing standpoint? Have we started to see apparel cost inflation?

Bob Cavanaugh

I think pretty much in the industry that particularly China production, there are some pressures on costs. The new minimum wage in China, while it doesn't affect our factories because we don't actually pay minimum wage, we're above minimum wage in our large long-term relationship factories, and we're in seven to ten countries in the region. We recognize that these cost pressures will have some affect over time.

We feel sheltered from them this year; we planned properly this year to have the right mix of sourcing across the region. But I think it'd be foolish not to think that there aren't going to be cost pressures. There's been apparel deflation for something like eight to ten years. It's not unwise to contemplate the fact that won't it continue forever. One of the things we believe in is that we're earning the average retail in apparel by having better styling, more features, more trend-right at quality that frankly we will compete with anyone in quality. We're optimistic that that's going to work in our favor given our long-standing relationship there. We're not working through brokers and agents, we're dealing directly with the best in the business in terms of manufacturing.

Operator

Your next question is coming from Stacy Turnof - Merrill Lynch.

Stacy Turnof - Merrill Lynch

Could you give us some comments on how some of your stores are doing in the markets where Federated had closed? You are against those tougher comparisons last year. Did you see any slowdown in traffic there?

Mike Ullman

Just getting started.

Stacy Turnof - Merrill Lynch

So nothing yet at this point?

Mike Ullman

No, I'm saying we're just getting started. We think we have a lot to attract customers from many different competitors. First of all Federated hasn't closed. They closed some May company stores, Federated’s stores are open. We're willing to compete in those markets and we think we compete very well. As a matter of fact, we'd be pleased if our key competitors do well because frankly it brings traffic to the mall and we like traffic and we think we compete side by side with the best in the business. It's not us versus them, it's making an attraction, making shopping fun.

Stacy Turnof - Merrill Lynch

My next question is, any color on the demographics of your customers shopping Sephora versus your JCPenney customer? How does that differ?

Mike Ullman

Yes, it's quite interesting because we now have enough stores open in new stores and also Sephora will be put in existing stores. First of all, in a new store, everybody's new in the store. That store is going to have a new profile customer because of the very nature of moving into a new community. In existing stores, the Sephora customer tends to be slightly younger and slightly more affluent than the average customer in the store and it's the second most frequently cross-shopped department, women's shoes being the first, which means there's a multiple purchase involved. It's not a come in, shop Sephora, and go home. It's shopping two or three or four departments while they're in the store. It's having the desired effect of increasing excitement, frequency and the relevance of JCPenney to that customer.

We think existing stores will take somewhat longer to get penetration just because that customer's been coming to the store for a number of years, that's their store and Sephora is new to their store. In a brand new store, everything's new to the customer. But we're encouraged. We're doing the volumes in excess of plan And that only encourages us that she's very happy with the price point, she's very happy with the assortment, very happy with the service and the 1,800 square foot footprint is the right size and positioning of the store is working very well.

Stacy Turnof - Merrill Lynch

My final question is on SG&A. Given the fact that the comps came in at 2.2%, I'm just curious, the break down between benefits from the store staffing model, getting leverage, where did you see that upside?

Mike Ullman

I think we leverage very well the store selling and support payroll. Given the tough environment, you think that might be an area where we'd be having difficulty. I think our store's management team did an excellent job. We keep reengineering in order to put more time in front of the customer. I think we did that well and we still improved SG&A as a rate in those two categories.

The areas where we had more pressure in SG&A were more on energy because obviously year-over-year energy costs are different. Although paid political advertisement, we did win the EPA energy award last year for managing our energy well through our technology and diligence at the store level. I think the SG&A given the difficult sales environment to pick up 20 basis points in SG&A as a rate is actually a good performance.

Operator

Thank you, your next question is coming from Bernard Sosnick -Oppenheimer.

Bernard Sosnick - Oppenheimer

This has been a very informative session and I want to thank you. My question relates to the direct division and the phrase profitable growth. Can we assume that the direct division had stable or improved profits in the first quarter despite weak sales and might that be due to the growing portion of internet sales?

Bob Cavanaugh

We were obviously under significant pressure in the direct business in terms of profitability. We would not want to lead you to believe that the profits were up in that business. But at the same time, we are profitable in the business we're doing and we're seeing where we are growing, such as the Internet where we are being more profitable.

Bernard Sosnick - Oppenheimer

Secondly, excluding the home business, you said you're doing well across the board. When the women's business does well, Penney usually performs very nicely. Can you amplify a little bit about your comments regarding dresses, how important that might be to the business, and touch on some of the other additions to the women's lines?

Mike Ullman

I'll let Ken comment on specifics but we're double-digit up on dresses on a comparable basis, so that should give you an idea that they're finding a lot of trend right merchandise. As you know, we don't use the weather as an excuse and we don't accept weather as an excuse, but despite the weather, we sold very well right through the whole pre-Easter selling season. We're quite confident about casual sportswear, about special sizes, about juniors, about dresses, about intimate. We just feel very good that all the design talent that we've attracted the trend talent that we have on board working with our merchants and planning and allocation people that we're making great strides in terms of getting the right merchandise in the right quantities at the right time and the right place.

Ken Hicks

You hear a lot of talking about the year of the dress. We are known as a great place to buy dresses. In the department stores, that's a particular strength of ours versus the competition. You look at the assortment of our dresses from fantastic sun dresses to prom dresses to the little black dress to business suits, we definitely feel we're well-positioned for the important trend as opposed to trying to play catch up and get into it, people know to come to us for that idea.

Bernard Sosnick - Oppenheimer

Could you just amplify a little bit on the new products in the women's business that have helped drive it? Not necessarily dresses, but you have the additional brands.

Ken Hicks

As I said in my comments, a.n.a. has been a terrific success for us in providing that modern woman's casual business in our private brands. We've had very good success with Liz & Co. Very pleased with that. Our Nicole business has been strong and our Bisou-Bisou business has been well. And we've also seen for our conservative customer, we've got a strong Dunner business. So we go the spectrum from very fashionable to trendy merchandise with things like Bisou-Bisou to Dunner and we've had strong performance throughout.

The other thing is a resurgence of our Junior business and seeing that business pick up with the strength of Arizona and our Buyer Works merchandise and that's with back-to-school coming. And you know the strength of our back-to-school performance. So that's a very good indicator what we see happening in the second and third quarter.

Bernard Sosnick - Oppenheimer

You've had several, maybe five, good back-to-school seasons in a row. What are you going to be doing particularly to drive this season?

Mike Ullman

Six, Bernie.

Bernard Sosnick - Oppenheimer

Sorry to short the count.

Mike Ullman

We honestly believe that last year was a pretty tough Juniors business. One of the things that Ken mentioned is that we're fact that we are on a great trend of juniors and young men's right now, bodes well. Kids' was really, really strong last back-to-school. We met with the kids people yesterday, and they feel very optimistic about the ability to grow our business there against the strong performance.

The one thing we have in our release that I'll point out is that we have a week extra back-to-school in the July period, so our business is going to look very strange in terms of pagination between July and August this year. But we're going to have a very strong start in July, we feel very good about back-to-school. Every Day Matters overall brand positioning, we'll be able to execute our version of back-to-school within the context of Every Day Matters. And as you know, back-to-school is bigger than Christmas for these young categories. So we focus a lot of attention on back-to-school.

Bernard Sosnick - Oppenheimer

What are your thoughts with regard to the denim business upcoming?

Mike Ullman

Well, we are the largest Levi customer in the United States, or retailer in the United States, we feel we own that business for the customer and Arizona's on a great trend. We can call that the best of national brands and the best of private brands. C7P offers basically luxury styling and quality. The way they put it together for our customers at a very, very smart price, we think that'll be lots of fun. Be easy to talk about and be easy to present in the store. We tend to be optimistic and execute against optimistic. I think we have every reason to believe that back-to-school will be a great time for us.

Bernard Sosnick - Oppenheimer

Again, I want to thank you for making this a very helpful session.

Mike Ullman

Thank you.

Operator

Your next question is coming from Michelle Tan of UBS.

Michelle Tan - UBS

Following up on what Chuck was asking about before on share repurchase. It seems like with the second quarter guidance, you're implying that there is several hundred million of buyback that will happen this quarter. Is there any change to the expectation that you're just going to be buying back primarily with the cash flow from last year?

Bob Cavanaugh

No change in our expectation, Michelle. We still have the authority from the board to repurchase $400 million. That's in the plan and reflected in the second quarter. I think if you look at the guidance for the second quarter being 226 million shares, we're focused on the repurchase program in the second quarter as well as the guidance for the full year you may recall was 228 million shares. It really has to do with the pacing of anticipated option exercises through the year versus the pace of the buy back in the second quarter, which leads to that 226 million for the quarter and 228 million for the year. No change from what we reviewed at the analyst meeting.

Michelle Tan - UBS

Great. Just thinking about the calendar impact, it seems like there's obviously a benefit to sales in the second quarter versus the third quarter. Is there any similar margin change because of the calendar? In terms of the profitability of those weeks that shift?

Mike Ullman

I would say nothing profound. We plan everything at very granular levels so there's always changes because of the mix. I would say our sales promotion calendar is the reason for the shift, not necessarily the mix of business per se.

Michelle Tan - UBS

Just one last question on Sephora. Just looking at the opportunities to enhance the marketing for Sephora given it's only in a select number of stores, is there any progress in terms of possibly clustering stores by market and doing some more regional advertising?

Mike Ullman

Actually, the market in Portland is a market that we're going to open a number of stores in the same timeframe so we can test our marketing ability across a population. Support can be concentrated primarily in new stores for a while because we're obviously investing at the time of the store being built with the proper sized pad, the proper positioning in the store and so forth. We know we can accelerate the number of store openings at some point to hundreds of stores. Right now we're balancing obviously our capital investment and renovations, our capital investment in new stores, our capital investment in American Living and we feel very good about the portfolio of things we have going on and how we're going to go forward with Sephora.

Michelle Tan - UBS

But even without that marketing, I think you said earlier, Sephora was ahead of your plan?

Mike Ullman

Yes.

Operator

Your final question comes from David Glick - Buckingham Research.

David Glick - Buckingham Research

Good morning and another congratulations on the quarter. My two questions related to the two key selling periods coming up, Father's Day and back-to-school. You've given us a fair amount of color of back-to-school.

In terms of Father's Day, obviously the men's penetration is very high in June. How has men's been trending relative to the store? Ken, if you could comment on your relative preparedness and what the key drivers are going to be for Father's Day. On back-to-school, just curious about if your transitional strategy changed relative to last year. August was a bumpier month for you. Have you changed your approach to wear now merchandise in that particular time period?

Ken Hicks

With regard to Father's Day, we feel very good about what we have for Father's Day and how we're positioned for Father's Day. We continue to learn and develop our gift business and the Every Day Matters campaign for Father's Day will be a very strong campaign. We see that as a good business for us. The men's business has been good, but not as good as the women's. But I think the timing here will help that.

We've seen some good success with Izod, with Concepts by Claiborne. Our big and tall business has been very strong and we're seeing a very good resurgence in the young men's business. That's what gives us the confidence in the men's business.

With regard to August, obviously we have a strong marketing campaign set for the back-to-school period. We will be very well positioned for back-to-school. As Mike said, it'll be a little truncated between July and August as we lay it out, but we still see the performance of wear now. And you will see more of that. We will continue to be very clean and very appropriate for the time of year.

One last comment on the men's business. As we go forward, we feel American Living, obviously, because of the Polo Ralph Lauren Global Brand Concepts strengthen the men business, that that will be a particular strength of our American Living Program. I met yesterday with a group of people to discuss some of the things that we were looking at going forward and we see it as a benefit to keep our strong position in this men's market.

Operator

Thank you, I would now like to turn the call back over to Bob Johnson for any closing remarks.

Bob Johnson

That concludes today's call. Thank you all for joining us.

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