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Executives

Stuart Haselden -

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

Libby Wadle - Executive Vice President of Retail & Factory

Analysts

Karen Eltrich - Goldman Sachs Group Inc., Research Division

William M. Reuter - BofA Merrill Lynch, Research Division

Carla Casella - JP Morgan Chase & Co, Research Division

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Todd Harkrider - UBS Investment Bank, Research Division

Patrick DiMeglio

Emily E. Shanks - Barclays Capital, Research Division

J. Crew Group (JCG) Q4 2011 Earnings Call March 20, 2012 11:00 AM ET

Operator

Greetings, and welcome to the J. Crew Incorporated Fourth Quarter and Pro Forma 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 of J. Crew Incorporated. Thank you. Mr. Haselden, you may begin.

Stuart Haselden

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

Before we begin, I would like to remind you 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 a result of the acquisition on March 7, 2011, by TPG Capital and Leonard Green & Partners, the company prepared financial statements for the predecessor period from January 30, 2011, through March 7, 2011, and the successor period from March 8, 2011, through January 28, 2012. Additionally, in order to provide a comparison to fiscal 2010, we have prepared a pro forma statement of operations for fiscal 2011, giving effect to the acquisition as if it occurred on the first day of the fiscal year, which can be found in Exhibit 2 of our press release.

Please note that this pro forma presentation is only for the fiscal year 2011. Comparisons for the fourth quarter reflect actual results post-acquisition versus actual results pre-acquisition in the fourth quarter of 2010. We refer you to the supplemental MD&A and other disclosures in our Form 10-K for fiscal 2011.

During this call, we will refer to adjusted EBITDA, which adjusts for items such as noncash, share-based compensation, transaction-related litigation, as well as the impact of purchase accounting resulting from the acquisition. You can find a reconciliation of adjusted EBITDA in Exhibits 4 and 5 of our press release.

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

James S. Scully

Thanks, Stuart, and good morning. I will start today with a brief overview of our fourth quarter and fiscal year results, followed by an update on some of our key strategic initiatives. Stuart will then walk you through our financials in more detail, after which we will open the call to your questions.

For the fourth quarter, total revenues increased 13% with comparable company sales increasing 6%, comp store sales also increasing 6% and direct sales increasing 10%.

During the quarter, we continued to experience improving trends in our Women's business with our comp sales growth led by increases in Men's and Accessories. Our adjusted EBITDA totaled $59 million or 11.2% of revenues in the fourth quarter versus $52 million or 10.9% of revenues last year.

For the year, total revenues increased 8% with our comparable company sales increasing 3%, our comp store sales increasing 1% and direct sales increasing 11%. Our adjusted EBITDA totaled $282 million or 15.2% of revenues for the year versus $288 million or 16.7% of revenues last year.

We are pleased with the sequential improvement in our top line trend in 2011, particularly in our Women's business, and our customers have responded well to our spring product flows, which we are excited to see. At the end of the day, it is about the product and our mission is to offer the quality, style and design that our customers have come to expect from us.

I would like to spend a few minutes highlighting the progress we made on our key strategic initiatives in 2011 and to outline a few of our 2012 milestones, which we will update you on throughout the year. These key initiatives include: Store growth across both retail and factory; the continued growth of our J. Crew direct channel; expansion of our Madewell brand, both stores and online; our international expansion efforts in building the infrastructure and capabilities to support the execution of these initiatives.

On the retail store side, we opened 9 new stores in fiscal 2011, which included our first store outside of the United States at the Yorkdale Centre in Toronto in August. Our long-term goal continues to be to grow our North American square footage in the low- to mid-single-digit range annually over the next 3 to 5 years. In 2012, we plan to open 17 retail stores, which includes 3 locations in Canada. We will be opening in Vancouver late in the first quarter, Edmonton in the second quarter, and our second Toronto store at the Eaton Centre in the third quarter.

We are really pleased with our Men's only store performance and will continue to expand this concept this year. Earlier this month, we converted our store at 50 Hudson Street in Manhattan to a Ludlow shop, which is focusing on servicing our Men's suiting customer in respond to demand we saw at our liquor store downtown. We also opened a standalone -- we also plan on opening a standalone Men's store at The Grove in Los Angeles in the second quarter.

Additionally, on the retail side, we are constantly evaluating our store base and identifying markets where we see incremental opportunity. For example, we have a very exciting reposition in Manhasset New York scheduled for the second quarter, where we'd be relocating to the Americana Center with increased square footage.

On the factory store side, we opened 11 new stores in 2011, which included 2 standalone crewcuts locations. We expanded our factory crewcuts business significantly in 2011 and now operate 4 standalone locations and 59 shop in shops in our factory stores. Our long-term factory store strategy remains to grow our square footage by approximately 10% a year over the next 3 to 5 years, through a combination of new units and expansions in existing centers where we see potential upside.

Our 2012 plan is to open 10 new factory stores, including our first 2 factory stores in Canada. Our 2012 plans also include an exciting reposition at Woodbury Commons in the second quarter, where we are increasing our footprint to capture incremental opportunity.

Direct sales increased 11% in 2011 and our penetration to total company revenues increased to 29.4% from 28.5% in 2010. We made important progress in 2011 on our online international expansion, and currently ship to 29 countries including Canada, Japan, the U.K. and the entire Eurozone. This week, we are enabling global e-commerce to a total of 107 countries and 41 currencies through our partner FiftyOne.

We also launched a flat rate shipping program in the third quarter and made enhancements to our website during the year, which have been well received by our customers. Our long-range plan for the direct channel calls for outsize growth over the next 3 to 5 years through a continued international expansion, growth for madewell.com and factory.com in expansion of our core J. Crew business. We see the benefits of leveraging the infrastructure we have in place for our direct business.

On the Madewell store side, we opened 13 new stores in 2011 and now operate 32 Madewell locations. We are expanding our Madewell store footprint in 2012 with plans to open 15 new stores. We would be opening stores in Atlanta, Pasadena and Denver markets to name a few. Our marketing team continues to work to increase awareness of the brand, including expanding our digital marketing for Madewell and launching a social media outreach program this spring.

In addition to our international online and Canadian bricks-and-mortar expansion efforts, we are in the initial stages of exploring opportunities in the U.K. and Asia. We are focused on building our international team to support these expansion efforts and we are currently evaluating opportunities for store openings in 2013.

We also made important investments in our infrastructure in 2011 including the opening of our new call center in San Antonio, Texas in the third quarter, providing important added capacity and operational flexibility; the ongoing expansion of our Lynchburg, DC, which is scheduled for completion later this year; and we will continue to grow and build our capabilities across direct, marketing and international to support our growth initiatives. We are happy with the progress we have made to date on our strategic initiative to support our planned growth over the next several years and are pleased with the momentum in our business as we move into fiscal 2012.

With that, I will turn the call back to Stuart to review our financial results in more detail and provide the outlook for CapEx for the year.

Stuart Haselden

Thanks, Jim. Turning to the details for the fourth quarter. Total revenues increased 13% to $531 million. Total comparable company sales, which include comp store sales, direct sales and shipping and handling revenues, increased 6%. Our store sales increased 16% to $354 million. This was driven by a 6% increase in comp store sales, coupled with a 7% increase in net square footage. Direct sales increased 10%, which includes our J. Crew, factory and Madewell direct businesses.

Gross profit, excluding the impact of purchase accounting of approximately $3 million for the fourth quarter, was $203 million. Gross profit margin increased 90 basis points to 38.3%, driven by a 110 basis point increase in merch margin offset by 20 basis points of deleverage in buying and occupancy.

There are a couple of items influencing our gross margin results that I'd like to highlight. Our merchandise margin was negatively impacted by a $4 million reduction in shipping revenues versus last year. If you were to exclude shipping revenues from both of this year and last year, we would have experienced 160 basis points of merchandise margin expansion. Also, buying and occupancy includes a $1.4 million increase in occupancy year-over-year due to purchase accounting. Excluding the non-comparability, from both periods, results in 10 basis points of buying and occupancy leverage.

Turning to SG&A expenses. When you exclude the benefit of $2 million this year related to purchase accounting and litigation costs recoveries and $20 million in transaction costs that we incurred in the fourth quarter last year, SG&A increased 15% to $161 million, which represents a 50 basis point increase to last year of rate basis at 30.4% of revenues.

Adjusted EBITDA, as outlined in Exhibit 4 of our press release, for the quarter was $59 million as compared to $52 million last year, with EBITDA rate increasing to 11.2% of revenues versus 10.9% last year. Net interest expense for the fourth quarter totaled $25 million, which compares to $0.5 million 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 $222 million at the end of the fourth quarter. Total debt was $1.6 billion at the end of the fourth quarter which compares to 0 debt at the end of the fourth quarter last year. Our inventory balance increased 13% versus last year at the end of the fourth quarter. This represented an increase of 6% on a per square foot basis. We are pleased with the composition of our inventory at the end of the fourth quarter and our levels relative to our sales trend. We expect inventory increases to remain in line with our sales trend through the first quarter of 2012.

Capital expenditures for the fourth quarter were $24 million and $96 million for the full year 2011. We expect capital expenditures to total approximately $120 million to $125 million for the full year of 2012, reflecting investments to support our growth initiatives with key expenditures for new stores, warehouse, some corporate office expansion, information technology enhancements and store renovations.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Karen Eltrich of Goldman Sachs.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Can you maybe expand on kind of some of the progress you made, what you're seeing with regards to your online international sales and how the Canada stores are maturing relative to the U.S.?

James S. Scully

Sure. This is Jim. So I think, as I mentioned in our comments, we launched the U.K. in August internationally and we added France, Italy and Germany in November, and in the entire Eurozone in January. So we are currently shipping to a total of 29 countries. So it's relatively new, but I think we're very excited by the trends that we're seeing and the response that we're seeing across the board. And additionally, I mentioned that we're adding an additional 78 countries later this week to bring the grand total up to 107 countries at the end of this week. So for us, it's a really kind of a low-capital investment way to see where the demand is globally. And I think that -- we feel that we're kind of uniquely positioned given our e-commerce platform to go international, to be able to test the market to see where that latent demand is, to kind of be a front runner to where we put bricks and mortar. In terms of Canada, the Yorkdale reception has been phenomenal. It exceeded our expectations. I would say that it compares in the top quartile, if not even higher in terms of performance stores here. Remember, it's only a Women's only location up there. But not only has it exceeded our sales expectations, I think the response to the higher-level merchandise in that store and full price selling has been a really good gauge for us and given us a lot of confidence about Canada. We weren't really that nervous about Canada, although it was our first step outside of the United States, but I think it is a good indicator for the size of the market up there. So you'll see us begin to kind of ramp-up expansion into Canada over the next 3 to 5 years. In addition, I think that a response from our retail full-priced side also positions us well to kind of capitalize on a relatively mature factory business up there as well. So for Canada, we see kind of the full suite going up there with retail stores, factory and online. And it could be a meaningful business for us over the next 3 years.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Great. And I guess in that same vein, how was expansion of Madewell going in terms of can you give us an update on how the economics of those stores are performing and how they compared to core J. Crew?

James S. Scully

Well, sure. So for us, Madewell is on slightly different curve, it’s on a maturation curve that we track relative to its sister stores, J. Crew stores. And I would say it's on track for our expectations, if not slightly exceeding. The store openings last year have performed extremely well. We're going to open 15 more this year. I think the composition of the stores opening this year are a little bit -- a slice of America. We're getting further into the Midwest and other parts of the country versus off the coast and down south. So I think it's going to be a good indication for us in terms of gauging the overall size of the opportunity, but we feel very good. And I think that beyond 2012, we would look to even ramp up even faster than the 15 stores we planned on opening in '12.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Great. And we definitely participated in, I guess, it was in December or November -- December, the friends and family promotion that you did at J. Crew. Was that something that was planned? And then based on what I saw in the store, it was hugely successful. Or is that in response to what proved to be a highly promotional environment?

Libby Wadle

Yes. It's Libby. Karen, we actually -- you did enjoy a promotion during the fourth quarter, probably the week or so prior to Christmas. It was not a friends and family, we do not do friends and family promotions. But yes, it was just -- the fourth quarter, as I think everyone knows, was very promotional. It has gotten -- that quarter has just gotten more promotional every year. And it's really sort of become the cost of doing business during the holiday season. And that's how we're really thinking about that quarter, go forward as we plan it.

Karen Eltrich - Goldman Sachs Group Inc., Research Division

Right. And final question, how are you planning inventories for the year? And I mean, how much benefit could we see in the second half with regards to cotton pricing coming down?

Stuart Haselden

Karen, its Stuart. So I think as we've said on the prior calls, we're seeing cost pressure in the high-single digits of Q1, that will begin to ease in Q2. We are seeing reductions in cotton in the low-single-digit range, which will have the most pronounced benefit in the second half. However, we are seeing increases in other categories, such as wool that we are actually mixing higher into in the second half. So that will offset some of that benefit. In terms of our inventory levels, we expect, as we had mentioned in the script, inventory levels in Q1 to be in line with our sales trend. We're seeing that average cost pressure in the high-single-digit range with units up in the low-single digits. And our goal is to have the inventory in line with our sales trend.

Operator

Our next question is coming from William Reuter of Bank of America Merrill Lynch.

William M. Reuter - BofA Merrill Lynch, Research Division

In terms of the fourth quarter, I'm curious whether the cotton increase in your raw material input costs negatively impacted of your margins. Meaning, did you guys not push through sufficient price increases and was that something that hurt the quarter's margins?

James S. Scully

Yes. It did hurt margins. We saw them, as Stuart said, up in high-single digits in the back half in Q4 last year. And when you say kind of sufficient price increases, we know we look at more less sufficient to cover the cost in appropriate price increases where we see value. So we did take and we concentrate prices up on the goods where we see an opportunity. We're not going out there and making sure it's necessary commensurate with the cost increase, so it's kind of -- it's somewhat bifurcated. So they definitely hurt us in Q4. But going forward, as Stuart mentioned, as we start mixing into higher wool and other categories, those are typically higher AUR products where we have greater pricing power.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. Do you have a sense for how much this might have negatively impacted the fourth quarter margins.

James S. Scully

We're not going to be breaking that up. But we'll say that typically cotton runs about 50% of our...

Stuart Haselden

That's right. Yes, that's right.

James S. Scully

So we know we're seeing increases. You can see where the spot market was during the year.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. And then in terms of the $4 million of lower shipping revenues that you called out in the quarter, I assume this is due to the flat shipping that you guys -- I think, you rolled it out in the third quarter. And I guess, number one, is that, right when you rolled that out -- and then I guess from that standpoint, we would still expect that this would negatively impact the next couple of quarters? Is that right?

Stuart Haselden

Well, I think, there's a combination of 2 things influencing the shipping revenues year-over-year. The first is the piece you called out, which is the introduction of the flat rate shipping structure. The second is just the promotional free shipping events that we ran opportunistically through the quarter. That remains an important lever for us to drive traffic to our website and that works hand-in-hand with how we measure our sell-throughs and our position as we -- versus our sales plans. So in terms of the forward looking, we haven't really commented specifically, but I would expect to see the same trends that you saw on a year-over-year basis in the second half continuing, as we lap those comparisons in 2012.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. And then just last one for me, a housekeeping. The $9.8 million transaction-related litigation that was, I guess, subtracted from your adjusted EBITDA, where did that hit the P&L?

Stuart Haselden

SG&A.

Operator

Our next question is coming from Carla Casella of JPMorgan Chase & Company.

Carla Casella - JP Morgan Chase & Co, Research Division

I have 2 quick questions. On the bonus accruals, I'm wondering if I understand this correctly. When you mentioned the MD&A that you didn't hit certain targets, so the bonuses weren't paid in the fourth quarter. Were those accrued in the first 3 quarters and then just reversed in the fourth quarter? And if so, how much was the reversal?

James S. Scully

There wasn't a reversal this year. So just a second, Carla. So just to be clear, this year -- last year, we had a take back in Q4. That was disclosed last year in Q4. And this year, we accrued a small amount, $1 million in Q4. But in addition, you have to look at the combination of bonus and stock-based comp together, this is not strictly the incentive bonus plan.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. I guess then on a follow-up would be, I'm trying to get a sense for -- is SG&A in last year 2011, in the early part of the year, is that a good run rate to use going forward or were there any other unusual accruals in the first part of the year that didn't recur this year?

James S. Scully

The front half of the year adjusted for the purchase price and transaction costs. Purchase price accounting and transaction costs is a good indicator of run rate.

Stuart Haselden

The only thing I'd add to that is we won't have bonus accrual...

James S. Scully

Next year.

Stuart Haselden

Yes, for 2012 based on performance.

James S. Scully

Right.

Operator

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

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Really, just to follow-up. I appreciate some of your earlier comments about the competitive environment. Just trying to, I guess, get the right perspective on gross margins. So as I think about last year, seems like gross margin was hurt because of some of the fashion issues into the fourth quarter. So I was expecting a bigger improvement going into this year, but it sounds like some of the promotional events and free shipping weighed on that. As we look back 2 years ago, is it unlikely to think that low- to mid-40s gross margin rate is attainable again? Or is that -- you think more of a normalized fourth quarter is high-30s, low-40s.

James S. Scully

It's a good question. I think you have done a good job of summarizing Q4. I think, when we look back at Q4, I think that we did see momentum in the Women's business in the retail channel, and we felt good about that. We were up against the mall promotions that we've set. In our mall promotional channels, in factory and in direct, we did see a tougher environment out there where there was pressure on gross margins due to kind of, I think, the competitive environment out there. And we had to be careful over the last couple of years. We've kind of had -- each year has kind of had a big front half or big back half. So if the comparisons you have to look at, I think the low-40s is not a bad run rate if you look at a couple of years ago. If you've seen years before that were higher, a couple of years below that, so it's probably right in the middle. So it's probably not a bad target.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. That's helpful. And then can you just comment about how you dealt with the warm weather and any excess inventory you had?

James S. Scully

So we entered the year really well positioned. We take the marks when we need to take the marks. We pushed through the inventory that the composition at the end of the year we felt very good. So I think we didn't really have incoming -- any liability coming into the year. And it was nothing more than -- out of the ordinary in terms of impacted by the weather, which is our normal cadence of getting through the goods. We tend to do that. As Libby said, we took an opportunity to do some promotional activity in December when the traffic was there, so we didn't have that hung over until January.

Operator

Our next question is coming from Todd Harkrider of UBS.

Todd Harkrider - UBS Investment Bank, Research Division

I guess, to rephrase Karen's question regarding international direct sales. Obviously, that should be a big opportunity for you, but can you talk about if the U.S. direct sales increase in the fourth quarter went back out in free shipping or was the increases mainly from the international side?

James S. Scully

Sure. We wouldn't decomposite that much. But I would say that the impact of the international business was not significant enough to take the number from negative to positive. We did see growth in the core business.

Todd Harkrider - UBS Investment Bank, Research Division

Sounds good. And can you give us more color on the Women's side, if you back out Madewell, it seems like the aggregate Women's sales were down even with the new stores. I know you're reinvesting a lot in your core assortments on that side, and it appears like it's bearing fruits since trends have been improving. But can you give any color on magnitude there on the improvement?

Libby Wadle

Sure. As Jim mentioned, we've really seen good sequential improvements in the Women's business. As I've mentioned before, what we call our franchise businesses, it really continue to deliver strong results for us and our customer is really reacting to the fashion we're giving her and color. So between those 3, really, our core franchise businesses, our café capri, our schoolboy blazer, the items with the names, and then the new fashion and the color, it's been a great result so far.

Operator

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

Patrick DiMeglio

It's Pat DiMeglio stepping in for Karru. Just with the planned expansions in North America, what do you guys see as the long-term footprint potential there?

James S. Scully

Well, it's a good question. I think what we have said historically, just dating back to 2006 as it relates to J. Crew itself, the retail concept, we said that we saw upwards of 300 stores. And I think we'd see that higher to potentially 350-ish, maybe a little bit more just based upon the success we've had with some collection stores with Men's and with crewcuts. Then you layer in some opportunities in Canada, I think the metric that everybody uses for Canada is pretty much 10% of your store base or sales given that it's 10% of the population, so there is some autocorrelation there. So I think we would feel good about maybe -- and if you look at the base for retail, another 25-ish, 30 stores up there. And then at the factory, we've always said 100 to 125 factory stores. And I think the same kind of proxy would work for Canada as well.

Patrick DiMeglio

Okay. That's very helpful. One last thing, with CapEx higher -- going higher, you're expecting to go higher this year. Can we use that as kind of I run rate going forward or do you think there's a potential with further growth going along in the upcoming years that it could be higher than the 2012 level?

Stuart Haselden

This is Stuart. So the store growth that Jim described will continue to fuel our CapEx expenditures each year. We did have a couple of things that won't recur such as the expansion of our warehouse in Lynchburg. And looking forward to the 2012, we'll have office space costs here in New York which won't recur in subsequent years. But wouldn't expect the estimate that we have for 2012 -- wouldn't expect to go higher than that in future periods.

Patrick DiMeglio

Okay. And then your primary focus for free cash flow going forward? Is it just to reinvest in the business or pay down debt?

Stuart Haselden

It's certainly, first and foremost, it's to fund the investment requirements of the business. And then secondly, to build financial flexibility.

Operator

Our next question is coming from Emily Shanks of Barclays Capital.

Emily E. Shanks - Barclays Capital, Research Division

I was curious if you could speak to any potential other supply chain cost inflationary pressures you are anticipating and specifically around labor?

James S. Scully

Sure. So you see what is going on and you've heard a lot out of the press. So labor represents about 35%, about 35% of the overall cost and we source heavily in China. You see a migration of a lot of labor from southern China to northern China, which kind of leads to higher labor cost. So we do see a little bit of pressure there. But we are, right now, managing that through looking at other countries in Asia. Right now, we're experimenting with factories for our factory business in order to make sure that the quality and delivery expectations are met before we start moving the retail business, J. Crew retail business there. So it's one way to help offset some of the increases we're seeing on labor. We don't see extremely -- we don't see significant increases, we are seeing the pressure, but we do have the flexibility to move outside of China to help manage some of those.

Emily E. Shanks - Barclays Capital, Research Division

Okay. That's helpful. And then just drilling down on 4Q results. Did you see any notable trends by geography domestically?

Libby Wadle

No, we didn't.

Emily E. Shanks - Barclays Capital, Research Division

Okay. Great. And my final question is just around within the Women's category, specifically work apparel, if you could you just comment on how the sell-through trends are tracking?

Libby Wadle

Sorry, for work apparel?

James S. Scully

Yes.

Emily E. Shanks - Barclays Capital, Research Division

Yes.

Libby Wadle

Well, honestly, we don't have a specific category for work. We feel like a lot of our apparel categories really worked for work, I should say. But it's really, as Jim mentioned, really, the higher priced goods are really what's checking. And a lot of that is probably what she is buying to wear to the office. So again, our cashmere, our schoolboy blazer, our -- we do have some suiting pieces that are working quite well, our wool café capri in the fourth quarter. All of these types of things, our pencil skirts, those things are all certainly work-related and are part of really where we're seeing a traction in our business versus the more casual areas like knit t-shirts, which I think everyone seen a down trend.

Operator

Our next question is coming from Carla Casella of JPMorgan Chase & Company.

Carla Casella - JP Morgan Chase & Co, Research Division

One follow-up on the shipping costs. You had mentioned in the fourth quarter, it was pressured because of the free shipping. Will that continue or in the first 3 quarters of the year, you see more shipping promotions so it will be until the fourth quarter of the year until we annualized that or is it really just a fourth quarter phenomenon?

Stuart Haselden

Well, as we had described, we launched the flat rate shipping program in August of this year. So until we lap that, we're going to see pressure on the shipping revenue. And then we'll have some level of promotional free shipping activity that will be more driven by the market circumstances.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. Great. And then one other follow-up. On the sales per square foot, $618 per square-foot, that's a nice improvement. And I'm wondering if it varies dramatically by concept?

James S. Scully

Actually, it doesn't -- I mean it varies by retail factory in Madewell. It's not as substantial as you might think in terms of the variations. And it's driven largely by the size of the box. I think know that Madewell had smaller boxes on average. And then if you look at factory in J. Crew, there's a difference in the size of the box. When people look at the productivity, and they look at the $618, I always caution people they need to look at what's happened to the overall size of the box over the last 4 or 5 years, because we've shrunk the size of the box by about 20% over the last 4 to 5 years. And that's driving a lot of the improvement in productivity as we tailor the size of the stores we open in each market and reallocate other stores that are bigger. So it's not only is it the re-merchandising efforts in the stores, but it's also the physical size of the box is coming down.

Carla Casella - JP Morgan Chase & Co, Research Division

So do you see that still increasing from just that size change?

James S. Scully

I think we've got the size right at this point. And I think -- so I don't see the same decline in the size of the box going forward. I think that productivity going forward will be driven by the merchandising and some of the marketing initiatives that we have underway.

Operator

There are no further questions at this time. I'd like to hand the floor back over to management for any closing remarks.

James S. Scully

So it's Jim. So I appreciate everybody joining us today. And we look forward to speaking with you when we report the first quarter results at the end of May. Thanks.

Operator

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

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