J. Crew Group, Inc. Q2 2007 Earnings Call Transcript

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 |  About: J CREW GROUP INC. (JCG)
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J. Crew Group, Inc. (JCG)

Q2 2007 Earnings Call

September 05, 2007, 4:30 PM ET

Executives

Allison Malkin - Investor Contact, ICR

Millard S. Drexler - CEO and Chairman

James S. Scully - EVP and CFO

Tracy Gardner - President, Retail & Direct Divisions

Analysts

Dana Cohen - Banc of America

Randal Konik - Bear Stearns

Kimberly Greenberger - Citigroup

Brian Tunick - JP Morgan

Paul Lejuez - Credit Suisse

John Morris - Wachovia Capital Markets

Roxanne Meyer - CIBC World Markets

Barbara Wyckoff - Buckingham Research

Richard Jaffe - Stifel Nicolaus & Company

Samantha Panella - Raymond James

Dana Telsey - Telsey Advisory Group

Marni Shapiro - Retail Tracker

Jennifer Black - Jennifer Black & Company

Presentation

Operator

Good afternoon. My name is Henry. I will be your conference operator today. At this time, I would like to welcome everyone to the J. Crew Second Quarter and First Six Months Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. Thank you.

It is now my pleasure to turn the floor over to your host Ms. Allison Malkin of ICR. You may begin your conference.

Allison Malkin - Investor Contact, ICR

Thank you and good afternoon. Before we get started, I would like to remind you of the Company's Safe Harbor language, which I am sure you are all familiar with.

The statements contained in this conference call, which are not historical facts, maybe these constitute forward-looking statements within the meanings 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.

With respect to each reference we make on this call to adjust the net income. A reconciliation of net income on a GAAP basis to adjusted net income has been provided, again, exhibit rates of today’s earnings release and exhibit rate of our earnings release issued November 21, 2007, which are available on our website.

And now, I would like to turn the call over to J. Crew's Chairman and CEO, Millard Drexler.

Millard S. Drexler - Chief Executive Officer and Chairman

Hi everyone and thank you for joining us to discuss our second quarter and six months results. I am joined today by Jim Scully and a group of our other senior partners at the Company. Following my opening remarks, I will turn the call over to Jim to review our financial highlights and update our outlook. We will then open up the call to questions.

We are pleased to continue our positive performance in the second quarter, concluding a successful spring season. As I have said before and say everyday all day to our team members, we are here only to satisfy our customers through our commitment to unparallel quality, style, and design. It looks sound and simple, but it’s actually not so simple. When the goods arrive, the customer response and we see the results and increased productivity and profitability.

Briefly highlighting the numbers for the second quarter. Revenues increased 13% to $305 million with a 6% increase in comp store sales on a realign basis and 19% direct sales increase. Gross margin expanded 160 basis points to 43.7% of the revenues and we leveraged expenses in the quarter with SG&A growing at 11% versus our 13% revenue increase. This drove a 38% increase in operating income to $37 million with our operating margin increasing over to 2 points to 12.2%. We are driving our business through our investments in the right goods, quality, style, and designs, and of course, taking care of every customer who comes to us in our stores, online and on the telephone.

I know I sound like a broken record than I am but we are here do the best we can. We continue to push our design and quality to the next level without spending collection business, we will be broadening our offering with a launch of a mini site online this fall and we are excited to announce that we will open up first J Crew collection store at Madison Avenue in the first half of 2008. Although, this is a small percentage of our business, we don’t foresee right distribution in many stores is it an opportunity, most importantly for us to continue to cater a more effectively to all of our customers who in addition to buying J Crew, many are also designer customers. We were able to offer a special make design fabrication to our partnerships as most of our customers now we use the best factories and mills in the world. Our ballet flats are from Italy, our lower B&O cash may goes without saying, and our Italian Super 120 Suiting for the all the woman on Wall Street and every other street who likes to wear high quality style suit.

We increased our store productivity during the quarter with sales per average square foot increasing 12% to $550 from $489. We continue to try to maximize every square foot in both our existing store base and our new stores. During the quarter, we opened seven new stores, five retail, and two madewell. We continue to tailor our new stores in both size and offering to each market. We remain on track to open 37 new stores this year, which is consistent with our long-term goal of 7% to 9% annual net square footage growth.

Direct sales exceeded our expectations for the quarter with the 19% sales increase. We are experiencing both better than expected sales and more returns than anticipated, which obviously results in significantly better profitability. We continue to be please with our crewcuts business. We are excited to launch our first crewcuts mini catalog for fall, which highlight our famous J Crew iconic style and items for ages two to ten and are seeing really positive results, because our customers who has been trying out for better quality and style for kids. They love our critters, argyles ballet flats in our core key accessory assortment.

As I mentioned during the second quarter, we opened two madewell locations Fashion Show mall in Las Vegas and Short Hills mall in New Jersey. We are on track to open two additional stores in the back half of the year. We opened made it more in Massachusetts this Friday, in the New York City location later this fall. Madewell remains R&D and the team continues to fine tune the business.

Now, I would like to turn the call over a Jim to review our second quarter financials and outlook in more detail.

James S. Scully - Executive Vice President and Chief Financial Officer

Thanks. As Mickey indicated our double digit top line growth coupled with our gross margin improvement and SG&A leverage led to a 38% increase in operating income and a 220 basis points improvement in our operating margin.

Review the details, total revenues increased 13% in the second quarter to $305 million. Our store sales, which include our factory, retail, crewcuts, and madewell stores, margin improvement was driven by 240 basis points improvement in our merchandise margin partially offset by 80 basis points in buying occupancy de-leverage. Similar to the first quarter, the de-leverage and buying occupancy resulted primarily from a 50 basis points increase and buying cost associated with madewell and crewcuts which were classified as SG&A last year.

SG&A expenses for the second quarter were $96 million or 31.5% of total revenues versus $32.1 last year. The 60 basis points improvement was primarily due to the buying shift as just discussed. We achieved the remaining leverage while absorbing incremental cost associated new stores with new concepts, share based compensation, and pubic company cost. Our top line growth coupled with gross margin expansion and SG&A leverage led to our operating margin improvement.

Net interest expense for the second quarter totaled to $3 million and compares to net interest expense of $16 million in the second quarter of last year. The decline interest expense, reflects our post IPO capital structure, our ability to pay down debt based upon strong cash flow, and a lower interest rates on our debt. The resulting net income available to common stockholders was $21 million or $0.32 per diluted share. This compares to a net loss of $3 million or $0.08 per share in the second quarter of last year.

On an adjusted basis, assuming the IPO occurred at the beginning of the fiscal 2006 year and an effective tax rate of 38.6%. Net income in the second quarter of last year total $13 million or $0.21 per dilute share.

Turning to the six months. Net sales rose 18% to $602 million with comp store sales increasing 7% on a realign basis and direct sales increasing 25%. Gross profit margin increased 140 basis points and we experienced 130 basis points in SGNA leverage, driving a 48% increase in operating income and a 270 basis point improvement in operating margin to 13.5%.

Turning to key balance sheet highlights. We ended the second quarter with cash and cash equivalents totaling approximately 120 million. Based on our strong anticipated cash flow, we are evaluating potential usage of cash including a debt pay down in the third quarter. Inventory at the end of the third quarter was $159 million, up 18% from the end of the second quarter last year. As we have previously mentioned, there will be point in time inventory increases that sit above our sales trend as a result of the 53rd week in fiscal 2006. We continue to plan mid single digit comps and commensurate inventory in our comfortable with the level in composition of our inventory as we move into the back half of the year. Total debt at quarter-end was $175 million as compared to total debt of $250 million last year, reflecting the repayment of debt from cash flow. Capital expenditures for the second quarter were 21 million.

Turning to the outlook. On an annual basis, we continue to expect comp store sales growth in the mid single digits, direct sales growth in the high single digits. Net square footage expansion in the 7% to 9% range, and diluted EPS growth in success of 20%. Based on our second quarter results, we are increasing our full year earnings guidance range to $1.42 to $1.46 per diluted share as compared to our previous $1.37 to $1.41 range. As a released to the third quarter, we expect diluted earnings per share to be in the range of $0.35 to $0.37, which compares to $0.27 on an adjusted basis in the third quarter of fiscal 2006. As I know everyone is aware of the 53rd week in fiscal 2006 created a timing shift in the retail calendar in 2007, which has 52 weeks. Each quarter of fiscal 2007 starts and ends one week later than the same quarter in fiscal 2006.

The timing in the retail calendar this year has a favorable impact on the third quarter and an unfavorable impact on the fourth quarter when compared to last year. Realigning it last year’s third quarter for the calendar shift, resulting net impact of increasing last year’s third quarter sales volume by approximately $6 million. Assuming a normalized flow-through to earnings, this would imply an increase of approximately $0.02 to last year’s third quarter EPS. Realigning last year’s fourth quarter for the calendar shift resulted in net impact of decreasing last year’s fourth quarter sales volume by approximately $11 million. Assuming a normalized flow-through to earnings would imply a decrease of $0.03 to $0.04 to last year’s fourth quarter EPS. Our annual earning guidance reflects 37 new store openings and an effective tax rate of 39.8% and approximately 64 million shares outstanding for the full year.

And now I will turn the call back to Mickey.

Millard S. Drexler - Chief Executive Officer and Chairman

Thanks Jim. As we move into the back half for the year, we will continue to do the best we can do to meet our customer’s needs in terms of the assortment quality, style, design, and customer service. It's why we all come to work every day and now we are ready for questions operator.

Question and Answer

Operator

Thank you. [Operator Instructions].

Our first question is coming from the Dana Cohen of Banc of America. Please go ahead.

Dana Cohen - Banc of America

Hey guys, congratulations. I just want to actually just go over the gross margin issue, because even without the refiguring SG&A and gross margin, you would have de-leverage buying occupancy. And so, can you just talk a little bit more about that, what are your leverage points and why is there more de-leverage in that even excluding the refiguring?

James S. Scully - Executive Vice President and Chief Financial Officer

Sure, Dana. It’s Jim. I will talk… I will touch on the gross margins. Really in the B&O that you are talking about that we saw some de-leverage. We did mention that we did see 50 basis points in de-leverage associated with the madewell and crewcuts. We also in the second quarter had a little bit of pressure from non-comp occupancy as we ramped up our store expansion strategy. And we also have a little bit of pressure from the new concepts as we rolled them out, and we also had a little bit of incremental samples expense in Q2, which I would view as one-time issue and not an ongoing issue. I would say those issues drove the causes not having the leverage that you would seek in that not in the front.

Dana Cohen - Banc of America

So, what should we think on go forward basis than, excluding this one-time the allocation, what is--?

James S. Scully - Executive Vice President and Chief Financial Officer

I think what we saw going forward, Dana, is that it is mid single digit comps. And on a national basis, we had 4% comp, and on a realigned basis, we had a 6% comp. So, I think that’s part of the… we have always said on a mid single digit comp we would see it. So, I think the numbers come to bear when we say that.

Dana Cohen - Banc of America

Thank you.

Operator

Thank you. Our next question is coming from Randy Konik of Bear Stearns. Please go ahead.

Randal Konik - Bear Stearns

Thanks. Mickey, can you just give us your just your general thoughts on what the consumers doing out there? And then, from a fashion perspective, but also from a economic perspective, we heard a lot about more traffics going a little bit here, your actual comp to the quarter was slightly lower than you long range plans, can you just gave your thought there? And Jim, can you just give us the… what was the inventory per square foot at the end of the quarter? And where you planning inventories at the end of the third quarter on a per square foot basis? Thank you.

Millard S. Drexler - Chief Executive Officer and Chairman

I am actually have no control nor any of the says whatsoever on the environment. And so, we are just running our business. I don’t want to sound narrow, but we can only deal with what we can control and the rest is up to the face that maybe. That being said, just to clarify Randy, we said mid single digit comps, which we have accomplished. We also look at comps over time as I look at the last, in fact, eight or 10 quarters, they vary. Our objective day-in and day-out is to, again, on the broken record investment in the right goods continue to build the quality and reputation of our business to everything we do. And in terms of the dealing with the environment which clearly is a little… it’s a little bumpy now, but the world’s always a little bumpy over the long-term. We just buy conservatively. We invest conservatively. We plan conservatively. And then it’s based on our ability as investors in merchandise to get the earnings, which again in this case got us pretty good earnings number for our sales. In terms of inventory, I will let Jim handle that.

James S. Scully - Executive Vice President and Chief Financial Officer

Yes, Randy. we have never really give the next quarter out in terms of the inventory if you look at where we were in the first half of the year, now if you look at the three data points apposed to two average inventory for the first half was up 17% versus revenue up 18%. We feel good about that. If you look at the back half, both the end of this quarter and the end of Q3, you will see point in time normally be given this shift in the calendar and will normalize at the end of the year. And just to add one thing beyond on consumer behavior which we can control to a degree based on our goods, what we do as we know in the word today, it’s either about perhaps lower prices or creative, better higher quality product. And if you look at our business and the results, I think you will see we continue to make every effort to differentiate our product, so that there is in fact a reason for customer to buy a J Crew and perhaps not at some other place. But I think that’s really in terms of the behavior, it’s over the last… from my perspective and our perspective, the drive here is continued to evolve and to invent and the short in the edge in our goods. So, I think that will stimulate the consumers. I have always said do not need one more apparel store in the malls or another online apparel or accessories side in the America. So, that’s our mission.

Randal Konik - Bear Stearns

I just need to ask you didn’t… you obviously don’t publish your retail comp stores are you factory comp, were they similar? Is it fair to say they are similar or were there a not similar trend?

James S. Scully - Executive Vice President and Chief Financial Officer

Randy, I think when we do we do not publish, but also don’t give color as well. It’s slippery slope.

Randal Konik - Bear Stearns

Yes, as the other quarters. I could say that aloud, right?

Operator

Thank you. Our next question is coming from Kimberly Greenberger of Citigroup. Please go ahead.

Kimberly Greenberger - Citigroup

Thank you. Mickey, it looks like we have got an emerging trend of men’s wear coming into women’s market. I am wondering if that would seem to be a great benefit to you if you also see other retailers that typically have products that are quite different from yours getting into styles that are similar to yours? And then just a follow-up for Jim. On the cash and the balance sheet, can you give us some idea of the level of cash you would like to maintain on a go forward such that we may be able to anticipate a debt pay down schedule ahead of time? Thanks.

James S. Scully - Executive Vice President and Chief Financial Officer

Sure Kimberly, I will go first. This is Jim. In terms of, I am going to give you the answer in inverse which is I think right now we are looking at potentially you got $40 million in a debt pay down. Typically, we do not do a debt pay down until the end of the year, we are currently evaluating a couple of issues in terms of working capital through the holiday season as well as a migration to open account, but I would say the number we are looking at is $40 million is given the fact that cash flow has been so strong through the first half of the year.

Millard S. Drexler - Chief Executive Officer and Chairman

Regarding trend, Kimberly, I mentioned you say there is a men’s wear trend, the men’s or men’s wear trend in women’s?

Kimberly Greenberger - Citigroup

Men’s wear trend in women’s.

Millard S. Drexler - Chief Executive Officer and Chairman

Okay, we don’t, we don’t see that I mean I don’t think you are talking about our suit business or some of the cute vests you see but we actually, if you are looking at our suiting business now, I don’t know if, I can tell you whatever you are looking at, we are looking at suiting as a major opportunity which is not necessary from our view point, men’s wear trend and it’s hard in the fashion world to really talk about trends, I know this is fashion week and I really can’t make sense of most designer presentations relative to what trends they are showing because a lot of what we see out in the runways are really Hollywood in the sense and a lot of it is not wearable and practical, it makes our industry very exciting.

If you look at our catalog and our online sale which is always and has stores which are always the best indication of what we feel look like. For us, it’s just a lot of style, it’s a lot of fabrication make detail but not necessarily a men’s wear trend. We are trying to, we know there’s a huge demand for suits out there that we continue to not fill but I think our third, our new catalog, the Paris catalog is very feminine, not so much men’s wear. You saw interesting, good looking clothes, wearable not intimidating and of the best quality possible so that’s really our mission all within the parameters of how we define the J Crew style.

In terms of people doing things that we do which I think you mentioned. The one thing that we know and I think this is true in every category of consumer products worldwide is there is no substitute for quality when a customer knows what quality is. And that is our mission, it’s what we do, we actually do it in our factory business as well. We really want to give the customer the relative quality that makes us stand out and differentiate from the competition. This that word differentiation is critical to us and we decided to play in the landscape we play in because we love to keep adding the quality along with value to our products along with most importantly, creativity.

Kimberly Greenberger - Citigroup

Great, thank you. That’s very helpful and good luck to you for the second half.

Operator

Thank you. Our next question is coming from Brian Tunick of JP Morgan. Please go ahead.

Brian Tunick - JP Morgan

Thanks, yes congrats guys. I guess two questions, one on the merchandise margins. Where do these amazing gains coming from? I guess we are assuming that most of that is from fewer markdowns. And then I guess the second question. You had a fantastic third quarter last year. Maybe just want to remind us were there any key categories or classifications that really stood out last year. We know we had a cool start to the quarter, I mean are you happy with your wear now, mix of products so that will be our questions.

Millard S. Drexler - Chief Executive Officer and Chairman

Margins and interest is two ways to look at margin. We can say we are sourcing better which we are as we get more important to our vendors and we get smarter at running our business. We are sourcing better in fabric and make. As importantly… probably more importantly, we are hopefully investing better and if you look at our business, the thing we want our customers to see is what we are famous for what we have the best assortment of without being over sported goes without saying and how well our investors or merchandises here. All of us who do that for a living invest in the goods to in fact hopefully have less marks downs, sell more and you also can’t discount the environment of our catalog and online which is a very, very important marketing tool for us. Because at the end of the day and I think if you look at the current catalog, it’s an environment that really speaks to the high quality and style of who we are. And then added to that the strength of the direct business, which really drove good full price selling, and of course, adds on to the margin increase.

Brian Tunick - JP Morgan

Thank you.

Operator

Our next question is coming from Paul Lejuez of Credit Suisse. Please go ahead.

Paul Lejuez - Credit Suisse

Hey guys, this is Paul Lejuez. Couple of questions on the direct business you guys said it did exceed your plan. I think it slowed a bit from the first quarter in terms of year-over-year increase. Just wondering if there was perhaps a pull forward of some sales into the first quarter. Or what happened on the circulation front in 2Q versus the first quarter. And also not sure if you can talk about this but I’d be curious to know trends in average order size that you are seeing on the direct set.

James S. Scully - Executive Vice President and Chief Financial Officer

Hey Paul its Jim. So first, I think as we may have talked after the last call or in between. We do plan the business by halves and we sort out the year and go to halves and if you look at the first half, the direct business was up 25%. We felt very good about that. In terms of circulation in Q2 it was flat. It was up 7% in Q1. It was flat on the first half; it was up 4% and for the year we continued to think that circulation will be flat.

Paul Lejuez - Credit Suisse

Anything on average order size trends there?

James S. Scully - Executive Vice President and Chief Financial Officer

No, we have never gotten into the metrics Paul in terms of the advert size or full rates of backlog.

Millard S. Drexler - Chief Executive Officer and Chairman

Just also to add to the direct business and exceeding our plan. We have been spending a lot of time knowing how important that business is long-term and the fact that return on investment for extra orders is actually zero, in that business you don’t have to build a store to get more volume. If you look at our site and you look at our catalog, hopefully, what customers are noticing much more their connection from categories of dominance through shopping environments whether it be the wedding dress business or the suiting shop which has been reformatted both online and in the catalog we have… we are getting much more connected also in trying to personalize our site with a behind the scene shoot in Paris and the following we get on that because lets face it the world’s about online every day all day. The benefit of us connecting to our customers like that is really driving we think a lot more traffic and driving a lot more business and then lots of exclusives about one-third of our… and we have said this before, one-third of our business is exclusive and our collection which is unique to our catalog.

And in a business like swim, where we are among the most dominant players in the market, if not the most. We really don’t do that in the stores. If you want one you must go online. And the world is migrating that way. No one knows the answers not an exact science. But for example, today when we needed something to day her in the office, no one had to run into a store to order something that was simply done by going to a stores online site and saying I need this I know what this is, I know what it looks like. And the other thing that’s driving it, which is really important which is the consistency of our fits, this all gets down to what a customer knows and recognizes every day. We have improved our fits, we have made them more consistent in men’s and women’s which of course drives more comfort and loyalty, it drives lesser return rate in our catalog and in our stores and its all those issues that go into making us a comfortable trusting place to buy online or in direct. And so, I think those factors in fact the fit factor in fact is critical. As we develop a much more consistent and dominant fit category business in out in our pant business both for men’s and women’s. The new men’s slim fit, the new women’s fit and so that’s I think is adding to the direct business along with I think a natural migration in the world is being very comfortable to buy things online.

Paul Lejuez - Credit Suisse

Thanks for that additional color, Mickey. Good luck.

Operator

Thank you. Our next question is coming from John Morris of Wachovia. Please go ahead.

John Morris - Wachovia Capital Markets

Thanks. My congratulations to… on a great quarter. I guess starting with Jim, on the inventory can you tell us on an adjusted calendar basis what that would be on a per square foot or per store basis. It looks like touch high and I am wondering… I understand it’s a point in time and that there is a calendar shift, but maybe if you are going to give us a little bit more colors to how you feel comfortable about that the quality of the inventory.

And Mickey, on merchandising ahead in the fall and holiday season, where do you see the opportunity. I know you don’t want to go into too much detail on styles or trends. But where do you see the opportunity this year versus last year? Thanks.

James S. Scully - Executive Vice President and Chief Financial Officer

Hey John, it’s Jim. So, historically, we have not broken out where the shift was worth. But I would say that one thing I want to point your attention to is even with the shift and it being up 18% at the end of the second quarter, to use that as one of your points in the average we still set over the revenue trend for the first half. So, we are comfortable even using it as a bad data point. In terms of how we get comfortable going into the second half, it’s obviously by looking at the composition in the inventory and that we see the majority of the growth driving 18% to be fall and holiday and merchandise. So, we are very comfortable recognizing that’s related to the shift in the calendar. And now I say we are very comfortable with not the level but the composition as we enter the second half.

John Morris - Wachovia Capital Markets

That’s helpful Mickey.

Millard S. Drexler - Chief Executive Officer and Chairman

For third and fourth quarter and for holiday we look at holiday every year and holiday is obviously… I think we said this lots of reasons the last few weeks and always a push to kind to get people to us quickly. I have never seen a store that’s not too sorted in holiday including ours every year. So, what we have done this fourth quarter and into third… third quarter goods are here. We are in the third quarter business now. But we have taken an approach this year for really focusing in on… we kind of called quirky gift assortment, which really is another nickname for J. Crew gifts at really holiday pricing. The nature of the business and because we are in a better business and I think you know designer companies, better more expended companies kind of some time just set back a little during the holiday season. So, we are in the quirky gift business. Really good prices both in factory and retail in direct and online. We are using the argyle business because that’s iconic J. Crew. Now, out of where we have a dominant outwear business which again, a lot of business we are in differentiate because the fact the have the assortments and we out a lot of making to our goods.

But I think you are going to see hair, bangles, while these ballet flats, as you look at the development of our assortments that we will probably dominate a lot more than we ever have on less assortment, so that a customer goes into our stores will actually not see as much to choose from other than what we see but we also are at the higher end Kashmir socks, fun Kashmir socks, which certainly are not by any stress of the imagination that give away prices but certainly fun Kashmir, jewelry… custom jewelry business and very happy about what's going on there. But I think you will see a lot of color on… find out uniqueness. And as I said in the beginning, the key is differentiation across the customer will go to the lowest common denominator choice which usually ends up being price more than uniqueness. So, we are in the unique business, we are in the quirky business along with as special dress collection, et cetera. Kashmir gown, things like that. We have a lot of one of the kind things. So, it’s all the matter of the mix but we are excited and I think we can do better than we did last year we hope.

John Morris - Wachovia Capital Markets

Great. Good luck. Thank you.

Millard S. Drexler - Chief Executive Officer and Chairman

Thank you.

Operator

Thank you. Our next question is coming from Roxanne Meyer of CIBC. Please go ahead.

Roxanne Meyer - CIBC World Markets

A couple of questions. One, what is the biggest opportunity that you see for second quarter next year? Second, in terms of your category… I am sorry, your catalog strategy for the second half, you said particularly, summer is going to be flat but you can you elaborate a little bit on the actual strategy whether you are changing the mix of catalog, the number, or the size of the catalog? And the third on collection, how much of your sales are from a separate higher end customer versus your average J. Crew customer from what you are saying? Thanks.

Millard S. Drexler - Chief Executive Officer and Chairman

Okay, so let me… okay so next year second quarter we will see that tomorrow Crewcuts and J. Crew will see tomorrow and when we plan our quarters we pick up on the trends and strengths that we see and we start to de-invest, in fact, the things that we think will see too much, I really can't answer that right now because we are just out of it and I will have a better answer in a month once we see the collection in its final stages which of course has been planned out and actually designed already.

The other part of the question was collection. Well, it’s funny. I don’t think… first of all the first answer is we can't answer, actually we really don’t know who walks in the as a collection customer versus who is a J. Crew collection customer. I think it’s a matter in the world of style and taste. Because MINI Cooper S is a cheaper car, it doesn’t mean billionaires aren’t driving it. And I think you have seen that in the American consumer taste and feelings right now. Our job is to excide a customer who loves the style and taste and quality of our goods. And I would think as you walk around the streets of the world today we are as when I was younger… when we were younger, you knew we turn a Gucci customers were in fact, I suspect had a higher income. You don’t know that anymore today. So, our business is about scarcity and uniqueness more than the price of the goods. And I think it’s been fascinating changes over the last few years in that regard in American where we trade. We have customers who love our headbands off $15 or $18. Our socks at $2.40, our men’s t-shirts and buying especially new collection items.

I think J. Crew as a matter of style point of view in chase we can differentiate it. We are really in the business on understanding the modern habits of the fashion customer today and she nor he, they are at H&M autos as much as they are at after designer stores. So, we kind of like the idea of appealing to the broad spectrum who by the way they are chasing their style and after that it very hard to figure out who has what and they are driving fancy cars or cheap cars with someone and so forth. So, I don’t know if that’s a good answer but we share at the highest end product with things that for us say value too.

Roxanne Meyer - CIBC World Markets

Well, great. That’s very helpful. The one just on the catalog of fall.

James S. Scully - Executive Vice President and Chief Financial Officer

Catalog, our pages are flat in the second half. It’s been a reallocation of pages and consistent with Mickey said of our Q4, we have added a gift book in Q4. So, there is an addition for Q4. But in a pages basis the second half it is flat.

Millard S. Drexler - Chief Executive Officer and Chairman

We just… it’s all the matter of productivity. We could open up is we wanted to, twice as many stores. We don’t want to… we want to force ourselves to be really smart through the investors and our existing square footage, we want to be conservative about new store and it is all about return on investment in most stores. And that’s where we are very pleased when the productivity grows more than the square footage grows. That to me is a very happy sign in our Company.

Roxanne Meyer - CIBC World Markets

Sure is. Best of luck.

Operator

Thank you. Our next question is coming from Barbara Wyckoff of Buckingham Research. Please go ahead.

Barbara Wyckoff - Buckingham Research

Hi. Question on second quarter. If you could do it over again, what could you… would you do differently in terms of merchandising flow et cetera?

Millard S. Drexler - Chief Executive Officer and Chairman

Man you are tough. I would…

Barbara Wyckoff - Buckingham Research

More of freshen your mind.

Millard S. Drexler - Chief Executive Officer and Chairman

I think we would have had a lot more jackets than we had and a lot more jackets because we sold out early, we sold out quickly. We would have had a less assortment of dresses for sure. We… it was a nice quarter. I am asking my partners for a little help. More dominance… I am repeating what Tracy is saying, or Libby. What you got, tell me.

Tracy Gardner - President, Retail & Direct Divisions

We would have had more dominance in pants a little earlier. I mean, frankly, the appetite for the finer things.

Millard S. Drexler - Chief Executive Officer and Chairman

We keep selling our better and better we actually like and we are not going to risk anything on more expensive, better, unique, but the novelty sweater sort of the pattern car gains, wild. But again, the more you buy, probably the less wild. So, we are just trying to balance the portfolio on investments. All in all, I think the pant thing and the jacket thing was probably a pretty big opportunity for us.

Barbara Wyckoff - Buckingham Research

Okay. Thank you.

Operator

Thank you. Our next question is from Richard Jaffe of Stifel Nicolaus. Please go ahead.

Richard Jaffe - Stifel Nicolaus & Company

Thanks very much guys, and congratulation as well. A question on the collection opportunity. Looking down the road, is there an opportunity for a mini collection book, a very focused collection business that could be developed well beyond, where it is today?

Millard S. Drexler - Chief Executive Officer and Chairman

Well, Richard’s, it’s totally evolving right now. I think if you asked me about it three years ago, I would have said we are not sure. Ask about today, we are doing a separate section. In which book is this now guys?

Tracy Gardner - President, Retail & Direct Divisions

[Inaudible].

Millard S. Drexler - Chief Executive Officer and Chairman

No, when’s it coming out. There is an accessory insert, but what’s happening. We look at November book today it’s interesting. Look at November book today we have a set up meeting, allocation of pages. It’s been styled. It’s been shot so on and so forth. And there is actually hard to differentiate as you are moving forward in what is collection, what isn’t collection. If you look at our sweaters in our stores, we are beginning very famous for people. I love hearing customers tell us that when people say, did you get a better product? Did you get that whatever? Where did you buy it? No, it’s J Crew. The fact of the matter is the premium we put on is design and design does not cost extra because if it is really good. We have a very important design department. And so, a lot of it is running into collection feeling, but when you look at September. That’s not the book.

Tracy Gardner - President, Retail & Direct Divisions

The Paris book.

Millard S. Drexler - Chief Executive Officer and Chairman

Right. The Paris book right now has an accessory collection section in it. I don’t… as we said in our prepared remarks early on do not see it as a big business. We see it as an umbrella business frankly. And the first store on Madison Avenue is where people shop for those kinds of things we have seen in our East Hampton stores, we see it in our Resort stores, we see a big demand on that. Our job is to play the return on investment being right with not betting anything too large on expensive goods, because if you buy too much of the high risk goods, you get your butt kicked on markdown. We have a scare strategy not because we hide things in the back and have a waiting list, we have it because it’s smart profit and smart investments for us.

I also think if you look at crewcuts. It’s along the same lines. It’s special, unique, and again, in America I think you have to look at this out of the box in a sense where people are moving to. The fast, cheaper, players are really strong. And we don’t want… we can’t be that, it’s not in our DNA. We don’t want to be a middle player either in our factory business where we create value when the style, design, quality business and we think there is a pretty good landscape of opportunity related to everything we are looking at in the shopping centers on the streets of America. So, that’s the answer on collection. We don’t want it to be too big, because frankly businesses like that cannot be that big unless perhaps you go worldwide and you start licensing and things like that. It’s not what we do well.

Richard Jaffe - Stifel Nicolaus & Company

Got it. Thanks very much.

Operator

Thank you. Our next question is coming from Samantha Panella of Raymond James. Please go ahead.

Samantha Panella - Raymond James

Good afternoon. Jim, going back to the calendar set, I am just curious. How much that impacted your direct business first quarter relative to second quarter and then again third quarter to fourth quarter? Is it similar to the comp store sales impact?

James S. Scully - Executive Vice President and Chief Financial Officer

As for the first half, it was not a… for the direct business, it was not that big. In the third and fourth, you do have a shift. We have not given that out Sam on a separate call maybe we will do that. But at this point we have not broken out, what the disclosed what the shift is for the direct in the second half only for the store sales.

Samantha Panella - Raymond James

Okay. And then one more question. Just regarding your accessories business it seems like that’s becoming more prominent in the stores particularly with the lot of discards that I saw on the jewelry. Just curious, what percentage of that business that is now the accessories in the second quarter this year versus last year? Thank you.

Millard S. Drexler - Chief Executive Officer and Chairman

We don’t break that out but you are right about seeing it and feeling it. It’s all part of productivity and what’s pickup versus serious time to take the bite. What do you try and what don’t you try on? We have had a mission to dominate in certain categories, hair stuff, style, fashion hair stuff, bangles, which if you noticed the worldwide has begun. We are very excited about that opportunity. Again, none of this is going to add up to huge business, but it’s adding up pretty nicely right now. Scarves, and filling every, almost every square feet, forget it filling every square foot with an appropriate style or assortment that has not in fact been duplicated throughout the store. We are getting into a strong soft position, because we think it is a fun pickup category. And a lot of shopping is emotional, I mean most of it is probably not planned, and we are not the place where they go and have a shopping list. The more we can offer that is exciting and better, belts is important, but you are actually right where you are seeing it. It’s important and you will continue to see small vignettes of accessory items on every blank wall in the stores as we move forward.

Samantha Panella - Raymond James

Thank you and good luck.

Operator

Thank you. Our next question is coming from Dana Telsey of Telsey Advisory Group. Please go ahead.

Dana Telsey - Telsey Advisory Group

Good afternoon everyone. Mickey can you please give us an update on madewell and how you see that progressing? And Jim, can you just talk a little bit about IMU opportunity do you see more there in any particular categories. What you are doing in sourcing and is CapEx still on track for this year. Or is there any adjustments? Thank you.

James S. Scully - Executive Vice President and Chief Financial Officer

Hi Dana. This is Jim. First in terms of CapEx, we are still comfortable with our range of $60 million to $ 70 million for the year. And we spent about $32 million here to date so far. In terms of IMU, what we have said in the past is when we see IMU opportunity going forward its more from the scale of the business as we grow and become more important with our vendors. And we saw that in the first half of the year and we expect to see that in the second half as well.

Millard S. Drexler - Chief Executive Officer and Chairman

Madewell. I am actually pleased we have a few stores that probably should have been in the second tier of opening. We have some other stores that we are delighted we are opening. The most important thing is first of all we have a new team, we have new leadership in merchandizing Laura Lewinski joined us as a Chief Merchant. Laura was at Jimboree and Janee and Jack and she started about three weeks ago she moved to New York from California. So, she is partnering with the store w we are really pleased with. New business are interesting because they take a lot of time, a lot of work a lot of noodling and re-noodling and I think the best answer particular for you Dana is go to short hills and you tell me what you think of it because I go there and I don’t know how many of you have been to the short hill store or the other stores.

New goods are in the roll out comes in three weeks from now we are really pleased with, we’re pleased with the direction its taking. As we have said in our prepared comments it is R&D the colors like the feel of the store, we are opening in Manhattan, we are opening Natick at this Friday which is really a high end shopping center, fashion center and we are opening in downtown Manhattan some time I hope by the end of November, which is really a very important store for us but if you look at our goods I think it fits a nice niche in the market. I think that again, our mission in the world is to create styled goods, designed goods and goods you can't see every other place and the differentiation is there so we are kind of without seeing more this is too new, we are actually pleased with what customers are telling us I kind of tells you where I think, again, just as an investor or an observer of our business I think short hills or century city or north park kind of tells you where the business is heading. And you will see pretty big changes which you should by the way from last years first quarter.

The business is one year old last week. Seems to me its 20 years old, because the amount of stuff that goes into it. But Jeff Pfeifle is working closely with that design team and we are on it were looking at it and we are working it. And by the way this is a business that when people have asked about it and how long do you give it. We are very passionate about this business and the opportunity long-term. But we are not emotional about this if it’s not going to make money in the company. That’s really important and we said we are going to give it time till we feel its working or until we feel its right not working. But I think the customers always speak most importantly and we are just working it and we are moving forward.

Dana Telsey - Telsey Advisory Group

Thank you.

Operator

Thank you. Our next question is coming from Marni Shapiro of Retail Tracker. Please go ahead.

Marni Shapiro - Retail Tracker

Hey guys, congratulations on great quarter. Good luck with fall. Mickey, you have talked a bit about and touched a bit on the hair and the jewelry, if you could just talk about, which of those segments and include if you wouldn’t mind beyond just the totes and some of the other fun stuff in store, which have you seen the best traction in?

And then if you could also talk a little bit about crewcuts, if there is an opportunity to do accessories and that type of stuff, because to me, I do think it is special and unique, but crewcuts have that sort of acceptable snob appeal is the best way I could describe it. So, even there opportunity to add some accessories there as well in hair et cetera?

Millard S. Drexler - Chief Executive Officer and Chairman

Okay. Huge time on crewcuts, and if you look at it we are preaching to acquire on that and remember crewcuts is now one year and five months old. And really on these businesses, we go into school every single day. So you are actually right about crewcuts. We are very pleased with the way it’s taking form and shape, and we just delighted with that.

In terms of the accessory assortments, what you see is kind of what you get with us. If there has been anything challenging, it’s been the better and we don’t have the much inventory, so it’s okay. We are trying to figure out if in fact there is a better, more expensive handbag business other than the few styles we sell. But there is a big opportunity in things you are looking at, whether its hair, accessories, we have a wonderful shoe business, ballet. We had a mission a year and half ago to be a very important ballet seller, ballet flats, it’s happening in crewcuts now, also kids… hair is happening, kids so. Again every single day we are looking for the opportunities and most importantly differentiation in those assortments.

Marni Shapiro - Retail Tracker

Great. That helps. And if you could just follow-up on follow up on the density levels in the store. When you look back at your spring assortment and how dense, I mean, just specific to the J. Crew stores, how dense the stores were? And then look forward to fall and holiday, were you pleased with where the stores were for spring, or do you think there's still opportunity there?

Millard S. Drexler - Chief Executive Officer and Chairman

Well I think, this is… well first of all what’s interesting in the spring, lower retails, more units per store. The average retail everywhere in the spring and summer are less in terms of density, but we are staging the growth here. Remember lot of questions come, what’s the environment like, is it up? Sure, yes, it is up there. When we go out reports and glowing and flowing and all that, but we are looking at this is planned growth, a conservative mid single digits, mid single digit inventory and I think I have said this before, I have never seen a company or business that needs a lot… too much inventory to grow its earnings or its profits. So, we are stepping it up, by the way we stage the growth in stores A, B, C, D and E. We visit marketplaces, we are out there, I know tracing our team, we recently at visiting stores and when we get to marketplace, you say gee, the competition looks this way, we know as more business, that’s why we are taking very selective incremental investments, but again that inventory control is religion here.

Marni Shapiro - Retail Tracker

Okay, Good luck guys.

Millard S. Drexler - Chief Executive Officer and Chairman

Thanks.

Operator

Thank you. Our final question is coming from Jennifer Black of Jennifer Black & Company. Please go ahead.

Jennifer Black - Jennifer Black & Company

Hey congratulation. Hey Mickey I have a few questions. One I wondered if you could talk about, have you thought about doing anything in activewear?

Millard S. Drexler - Chief Executive Officer and Chairman

Yes.

Jennifer Black - Jennifer Black & Company

Is that an opportunity?

Millard S. Drexler - Chief Executive Officer and Chairman

Yes.

Jennifer Black - Jennifer Black & Company

Okay, okay. And then…

Millard S. Drexler - Chief Executive Officer and Chairman

What you want me to say, yes.

Jennifer Black - Jennifer Black & Company

I like to…

Millard S. Drexler - Chief Executive Officer and Chairman

You seems at some points.

Jennifer Black - Jennifer Black & Company

And then secondly your fit, I mean I notice that right away. Are you seeing a much higher conversion rate and when did the newer fits specs start flowing in? And then I have one more question.

Millard S. Drexler - Chief Executive Officer and Chairman

We are seeing definitely on fit, a higher conversion and more importantly a lower return rate. On the pant fits and the short fixed. It’s funny because those are the details that going to making, you fit a woman’s pant well. And you got a loyal customer and we recognized that, but if… even here looking at the pant business on the sheet here and the returns and the conversion, yes, the answer is it really does help a lot.

Jennifer Black - Jennifer Black & Company

And when did you start flowing in the near… more--?

Millard S. Drexler - Chief Executive Officer and Chairman

Spring… at the beginning of spring, again, one of the missions was pant fits in woman… and in men we have a new slim fit pant, which is actually been a really important pant. And Mario was fit expert, has worked on that, along with the design team and the merchants. So, we started doing it in spring and we have our Madison fit, our Capri fit and you are seeing those big rollout. And we are very pleased with the reaction, but the most important thing, not just pants shoes and everything else, consistency of fit and the right technical investment. I want to say we really; we worked a lot on that. All those things kind of in the back of the house, you don't see these see as easily unless you try on the clothes, which every woman does and knows.

Jennifer Black - Jennifer Black & Company

Okay. And then lastly… and the fit is spectacular. Am I wrong to believe that wide legs or the trouser fit will be a much bigger than skinny legs?

Millard S. Drexler - Chief Executive Officer and Chairman

Tracy just said to me, they both really important.

Jennifer Black - Jennifer Black & Company

Okay. It is seems like woman, it’s easier to wear the trouser and wide legs. Are you met both the trouser and wide legs?

Millard S. Drexler - Chief Executive Officer and Chairman

No. Tracy was saying the both…

Tracy Gardner - President, Retail & Direct Divisions

They are both important. I think the skinny is becoming more straight and then the trouser is absolutely important in both denim and wool fabrications.

Jennifer Black - Jennifer Black & Company

Okay. Great. Thanks very much.

Operator

Thank you. I will turn the call over to management for any closing remarks.

Millard S. Drexler - Chief Executive Officer and Chairman

Well, I just want to thank you everyone and we look forward to speaking with you during our third quarter conference call in November. Take care, everyone. Thank you.

Operator

Thank you. This concludes today’s conference. You may now disconnect.

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