J. Crew Group, Inc. F1Q08 (Qtr End 05/03/2008) Earnings Call Transcript

May.29.08 | About: J CREW (JCG)

J. Crew Group, Inc. (JCG) F1Q08 Earnings Call May 29, 2008 4:30 PM ET

Executives

Millard S. Drexler - Chairman of the Board, Chief Executive Officer

James Scully - Chief Financial Officer, Executive Vice President

Allison Malkin - Integrated Corporate Relations

Analysts

Paul Lejuez - Credit Suisse

John Morris - Wachovia

Dana Cohen – Banc of America Securities

Kimberly Greenberger - Citigroup

Brian Tunick - J.P. Morgan

Roxanne Meyer - Oppenheimer

Jeff Black - Lehman Brothers

Richard Jaffe – Stifel, Nicolaus & Co.

Michelle Tan – Goldman Sachs

Barbara Wyckoff - Buckingham Research

Samantha Panella - Raymond James

Dana Telsey – Telsey Advisory Group

Marni Shapiro – Retail Tracker

Operator

Welcome to the J. Crew Group, Inc. first quarter fiscal 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Allison Malkin of ICR.

Allison Malkin

Before we get started, I would like to remind you of the company’s Safe Harbor language, which I’m sure you are all familiar with. The statements contained in this conference call which are not historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may 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 any reference we make on this call to adjusted earnings per share in fiscal 2007, the reconciliation of earnings per share on a GAAP basis to adjusted has been provided in exhibit 3 of our earnings release issued on March 11, 2008, which are available on our website.

Now I’d like to turn the call over to J. Crew's Chairman and CEO, Millard Drexler.

Millard Drexler

I will go through the comments quickly because I know you all have a lot of questions. Thanks for joining us on our first quarter 2008 results. Jim Scully, our CFO, is here along with our other senior partners in the company. I’ll turn the call over to Jim for financial highlights and updating our outlook. We’ll then open it up to questions.

For the quarter revenues increased 15% to $341 million with comp sales increasing 2% and direct sales increasing 17%. This strong revenue increase coupled with gross margin expansion and SG&A leverage drove a 20% in operating income to $53 million or 15.6% of revenues versus 14.9% last year. The 70 basis point improvement came on top of a 110 basis point improvement last year.

We continued our conservative planning and investing which led to strong first quarter results despite the difficult consumer environment. We drove high quality sales growth and increased margin. That said of course we would have liked to have higher comp sales but direct did over-achieve our goals.

We continue to drive the business through our investments in quality, style and design with a focus on our customers. As we always say those who continue to move forward and innovate are going to win over the long-term. We are not cost-cutting for the short-term but building and investing in our business for the future.

Our direct business which includes our catalog and online continues to exceed our expectations as said with a 70% increase in the quarter on top of a 31% increase in the first quarter last year. We continue to gain efficiency through the management of our stores and online as one seamless business proactively managing our inventory as one.

We see opportunities every day in new and existing businesses and categories. Our customers continue to love our wedding and bridesmaids dresses and we continue to differentiate ourselves in this business. We launched Yoga Online and our customers cannot get enough of it. We’re getting feedback and this is arguable that we have the best fitting and quality yoga clothes. We also have a terrific new costume jewelry assortment both in our stores and online and we will continue to expand on and elevate the offerings.

These opportunities of course go along with our franchise businesses such as Jackie cardigans, café Capri’s to name a few are our elements of design to differentiate ourselves. During the quarter we opened 7 new stores; 4 retail and 2 factory, along with our permanent Madewell store in Manhattan at Broadway and Broom. We remain on track to open a total of 43 new stores in 2008 and have been pleased with our recent openings.

We increased our store productivity with sales per square foot increasing 6% to $574 from $542 last year while our square footage has increased 10% over the last twelve months. We continue to be pleased with our Crewcuts business both in our stores, our catalog and online which offers our famous J. Crew iconic style for ages 2-10. We are very pleased with the performance of Madewell which continues to gain momentum and more and more customers every day.

As said, we opened our permanent store at Broadway and Broom and opened our eighth Madewell store in Annapolis on May 20th. We are very pleased with the reaction to the concept and to our product and merchandise. We plan to open two additional Madewell stores in 2008; Lennox Square in Atlanta and Tyson’s Corner and launch an eCommerce site some time during this summer.

We ended the quarter with a solid balance sheet and our inventories are well positioned for the summer. Our revised annual outlook, which we believe is appropriate, assume that our first quarter comparable store sales trend will continue for the balance of the year. For direct we have maintained our expectations of a high single-digit increase and as you know we have exceeded this target in the quarter.

We are comfortable with how we are positioned and proud of what the team is doing to differentiate J. Crew in a difficult economic environment.

With that I’ll turn the call over to Jim to review our first quarter results and outlook in more detail.

James Scully

Turning to the details for the first quarter, total revenues increased 15% in the first quarter to $341 million. Our store sales which include our retail, factory, Crewcuts and Madewell stores increased 14% to $229 million. This increase was driven by a 2% comp store sales increase and a 10% increase in net square footage. Our direct business experienced a 17% increase to $101 million.

Internet sales represented 86% of our direct business versus 76% last year reflecting the ongoing shift of orders to the Internet from the phone.

Gross profit for first quarter increased 15% to $160 million with gross margin expanding approximately 30 basis points to 46.9% on top of 110 basis points of expansion last year. The 30 basis point expansion was driven by 110 basis points of merchandise margin expansion contributable to conservative planning and the efficient management of our inventory between our stores and online partially offset by 70 basis points by buying and occupancy de-leverage which was primarily related to non-comp occupancy pressure due to the accelerated timing of new store openings during the first quarter as compared to last year.

SG&A expenses for the first quarter were $107 million or 31.4% of revenues versus 31.7% last year. We achieved this leverage while investing in Madewell and Crewcuts and opening 34 net new stores in the last 12 months.

Top line growth coupled with gross margin expansion and SG&A leverage led to a 20% increase in operating income to $53 million or 70 basis points of operating margin expansion. We were able to achieve this operating margin expansion while absorbing approximately $3 million in operating losses related to Madewell as compared to $2 million last year.

Net interest expense for the first quarter totaled $2 million compared to net interest expense of $3 million in the first quarter of last year. The decline in interest expense primarily reflects our lower average out standing debt. Income before income tax increased 24% to $51 million compared to $41 million last year. Net income was $31 million or $0.48 per diluted share compared to net income of $25 million or $0.39 per diluted share in the first quarter last year.

Turning to key balance sheet highlights. We ended the first quarter with cash and cash equivalents totaling approximately $122 million with 100% of our invested cash in U.S. Government money market funds. Inventory at quarter end was $174 million representing an increase of 21% over the end of the quarter last year which compares to our 15% revenue increase in the first quarter.

The primary difference between the end of quarter inventory increase and our sales trend is due to an increase in year-over-year in-transit inventory. This is further evidenced by a significant increase in our accounts payable inventory leverage.

We reduced our debt by $25 million in April, ending the quarter at $100 million as compared to $175 million at the end of the first quarter last year. Capital expenditures for the first quarter were $15 million consistent with our full-year forecast of approximately $80 million.

Turning to our outlook. Our long-term goals remain comp store sales growth in the mid single-digit range, direct sales growth in the high single-digits, net square footage expansion in the 7-9% range and diluted EPS growth in excess of 20%. However, given the current macro environment and the comp trend of our business we are revising our outlook for the fiscal year 2008.

We now expected diluted earnings per share for the fiscal year 2008 in the range of $1.70 to $1.75 as compared to our previous guidance range of $1.85 to $1.87. This revised guidance represents a 10-14% increase in fiscal 2007 adjusted diluted earnings per share of $1.54.

Our revised fiscal 2008 earnings guidance reflects comp store sales growth in the flat to low single-digit range, direct sales growth in the high single-digits, net square footage expansion of approximately 11%, essentially flat operating margin versus last year with flat gross margin and SG&A as a percent of revenues, an effective tax rate of 39.8%, approximately 65 million diluted shares outstanding, capital expenditures of approximately $80 million and approximately $15 million in losses associated with Madewell which includes expenses related to the launch of the eCommerce site.

For the second quarter of fiscal 2008 we are increasing guidance for diluted earnings per share in the range of $0.31 to $0.33 which compares to $0.32 in the second quarter of fiscal 2007.

Consistent with our annual guidance our second quarter outlook reflects comp store sales growth in the flat to low single-digit range and direct sales growth in the high single-digits. We expect approximately 100 basis points of operating margin deterioration split evenly between SG&A and gross margin. We also expect merchandise margin to be flat to last year.

We continue to plan our inventory and expenses conservatively and have implemented initiatives to further tighten both which should favorably impact results in the second half of the year.

Now I’ll turn the call back to Mickey.

Millard Drexler

Thanks. As we move into the second quarter we continue to plan our business conservatively and focus on the long-term. We are here every day to provide out customers with the same quality, style and design they have come to know us for.

Now we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions)Your first question comes from Paul Lejuez - Credit Suisse.

Paul Lejuez - Credit Suisse

First I just wanted a clarification on your guidance revision. Is it more based on trends in the second quarter to date and maybe a weak May or have you really adjusted your thinking for the entire year? I know you lowered your comp guidance for the entire year but I’m just wondering if more of it came out of the second quarter. Secondly, I know you aren’t focused on cutting expenses necessarily in the near-term and I’m just wondering about how you feel about your ability to manage payroll hours for the remainder of the year?

James Scully

Let me first address the guidance question. The reason we wanted to adjust the comp guidance was based upon the recent trend in the business I would say that developed late in the first quarter and we saw that continuing. We thought it was better to be realistic as opposed to optimistic and we essentially just rolled through the trend for the remainder of the year. So that is the basis of adjusting the comp.

In terms of expenses at the end of the day even with the reduced comp trend we still are guiding with high single-digits in direct and square footage growth so the top line will be growing in excess of 10% so what it means really is to be more disciplined with things such as head count and other areas where we are adding to the business because we still are growing at a significant rate. That does not mean we aren’t attacking other parts of the expense structure and micromanaging expenses but we do that on a day-in and day-out basis anyway.

Millard Drexler

To add to that, just to make sure we understand. We are not driving earnings through expense reduction. We are in this for the long-term. We are in an environment we thought it was prudent and wise to adjust our forecast. We are only 3.5 weeks now into the second quarter and we wouldn’t be doing our jobs well if we didn’t in fact revise and moderate the forecast. That being said the point on expenses is Jim and his team and all of us are looking at that but we know long-term one does not win on expense cutting. One wins on great product and forward movement in the business. We just thought it was real smart to do. We declared, if you remember, publicly in January that while everyone was arguing about a recession we said we are running a business that is acting as if it is in recession. We are very pleased with the results of the first quarter. We are pleased with our customer’s response to our merchandise.

On the other hand it is no secret, we all read the same papers, and none of us have a crystal ball so we’d rather be in front of the curve on this one rather than behind it.

Paul Lejuez - Credit Suisse

One quick follow-up in terms of your comp trends particularly in May. Has there been any difference in regional performance?

James Scully

We have not, and I won’t speak to current business but I would say even in Q1, we have not seen the regional weakness that we have heard about in the media.

Operator

The next question comes from John Morris – Wachovia.

John Morris - Wachovia

Mickey you and Jim talked about the timing of it. Can you go a little deeper in terms of where the weakness was coming from? Cutting a little bit deeper is it traffic? Are you seeing resistance? Is it certain price points? A little bit more color behind that. Then secondly, what is your thought process for inventory planning for the fall season? Is this affecting that? Should we assume you are curtailing your inventory plan to match the comp guidance?

Millard Drexler

Can I just put this in some perspective? We run the business long-term. We report quarter to quarter. To put it in perspective we are running the business conservatively. We run mid single-digit comps and I know of no business in the world that actually has a linear result on comps over the long-term. Number one.

Number two. We are very comfortable with our inventory position.

Number three. I will tell you that the summer businesses are very difficult. That is very important. They are difficult. We are a very important summer company as we are, I guess, a winter company. But if you look at the break down shorts and t-shirts frankly are tough. So that is an important issue. Clearly there are traffic challenges around America and clearly we are all sharing the same challenges and struggles. I think the whole retail industry is. But I think the expensing again is getting back to this is a business that we are not compromising. We are not taking wholesale changes in how we run a high quality, margin company and again this is one month out of three. We will see what happens.

But just as we manage our business day to day, we have got to forecast day to day too so that is why we have done that. We are always planning inventory and expenses to the comp trend.

I also want to say no one in this world with a company like our at the percent we do in direct should neglect the growth of our direct business. It is very important with gasoline at $4 a gallon with us having a very leading website and with our team very dedicated to that with a lot of new businesses like yoga, weddings, etc. New and older businesses on the web. Don’t underestimate the value of the web business in our case. I can’t speak for any other company.

Operator

The next question comes from Dana Cohen – Banc of America Securities.

Dana Cohen – Banc of America Securities

On the SG&A is there something going on that is ballooning? I’m just putting in the guidance and it looks like to get to the Q2 guidance SG&A dollars accelerate their growth in Q2 and then slow down in the back half. I’m just wondering if there is something going on here in Q2 that is sort of a timing issue?

James Scully

Not really Dana. What we said all along was to get leverage we needed mid single-digit comps so with the reduced leverage there is a little bit of pressure on SG&A. I will say that the business itself we have the lowest gross margin dollars in Q2 as any other quarter. It’s just that is our business model and it has always been our business model. In addition, the back half of the year obviously with more lead time we do have an opportunity to manage inventory expenses a little bit more aggressively in the back half of the year.

Dana Cohen – Banc of America Securities

Following up on your comment about seeing something late in the quarter and continuing into May would it be fair to say the comp trends were sort of front-end loaded and sort of above the 2 in the first half and then slowing in the back half? Is that a fair assessment?

James Scully

I think that would be fair.

Operator

The next question comes from Kimberly Greenberger – Citigroup.

Kimberly Greenberger - Citigroup

I just wanted to ask a couple questions on the gross margins. Could you talk a little bit more about what drove the merchandise margin improvement in the first quarter and why is it you think that will not continue? Secondarily the buying and occupancy de-leverage. It sounded like that was related to a shift in the timing of store openings. Is that in fact one time or should we expect some of that pressure to linger into the second or third quarter?

James Scully

I’ll do the easier one first which is the buying and occupancy de-leverage. It was a little bit more pronounced in Q1 because the new stores opened up earlier in the quarter so I would say a portion of it is one time. There is a portion which will continue in Q2, Q3 and Q4 but again that ties back to needing a mid single-digit comp to get leverage not only in SG&A but also on PNL. But there was an incremental piece in Q1 related to the timing of the stores on a year-over-year basis.

In terms of the 110 basis points we are very pleased with the merchandise margin performance in Q1. I can tell you that it came from really two things. We came into this season very conservative inventory and felt very good about it and I think it was a very strong and efficient management of inventory during the first quarter between the channels and transferring to our direct business, which we talked a lot about, and actually getting full price sell throughs at the direct business which drove overall higher full price sell through in Q1. But it was really the ability to transfer between the platforms.

Kimberly Greenberger - Citigroup

I’m just wondering why that trend does not continue to the second quarter or are you just including in your plan the possibility that promotional activity will need to be increased in the second quarter to move through your summer inventory?

James Scully

First of all we do plan on high single-digit direct. So we had a 17% increase in Q1 so there is the opportunity to feed the trend that we had in Q1 that based on our guidance does not set up that way. I did say that merchandise margin was flat in Q2 so we’re not expecting a change in promotional activity. The de-leverage is coming from the PNL side in Q2.

Kimberly Greenberger - Citigroup

So we should expect merchandise margins up in Q2, buying and occupancy de-leverage and that in effect will be a flat gross margin?

James Scully

Merchandise margin flat to low single-digit comp and a high single-digit direct business. That is the model.

Kimberly Greenberger - Citigroup

That’s driving 50 basis points in gross margin and pressure.

James Scully

Right.

Millard Drexler

I just want to say something. This is all a forecast. America in the last six months pretty much gets an F on forecasting in most sectors of America. Understand, this is not a science. Alright? It is not a science. We are here as responsible shareholders of the company to manage this business with the utmost of prudent and conservative ways. I don’t know anyone in the world, frankly, right now who will tell you what the margin will be other than best estimates for the next two months. This is a world that is going through rapid changes. No one forecasted the housing crisis except one or two successful people. No one forecasted the credit crunch. We forecasted a recession in January. Why? Because we felt it was never a downside to run a conservative business and not trying to be greedy at the top end and top line. We had a great first quarter relative to most of the competitors in this marketplace and we are sitting here in the middle of the fourth week of a twelve-week quarter so please understand we are trying to be prudent and we care more than anyone about how this forecast is and how it works. But at the end of the day when you are reading the papers every day in America and you are feeling the crunch it affects anyone and everyone.

I was in seven or eight cities in the last two weeks with my distribution centers, with the phone operators to Las Vegas, California, Annapolis where we opened a new store and I can tell you in America it’s not the way it was. People are seeing that and if you forget about that you just read the papers everyday because the papers are actually a great marketing tool to get the message out there. So we are doing the best we can do. By no means are we disappointed. More importantly, forget us….our customers by no means are disappointed in what they are seeing.

We are very excited in this environment. If I have to say shopping around the centers of America I haven’t seen a lot of great alternatives. At the end of the day we live and breathe for our product and our service and for the quality of that and we have not seen price resistance. That was a question I think John might have asked that I forgot to respond to.

We are running this business as best as we can for the long-term and we are all in a challenging environment. So understand this is a forecast.

Operator

The next question comes from Brian Tunick - J.P. Morgan.

Brian Tunick - J.P. Morgan

Can you talk about the retail and the factor business in light of the gas prices and consumers possibly looking for bargains in this environment? Are you seeing better trends in the factory business versus the full…

Millard Drexler

I think the performance has been consistent between both. We are fortunate in that we are not in a middle of the road business at all and we’ve said we wouldn’t want to play in that business. We play to an affluent marketplace. Traffic is down. You can ask anyone and everyone. It is down for sure. When traffic is down it affects, except our direct business, it affects retail. It is a very simple formula. I was in our factory store last week…where was I? In Riverhead. The difference is people will go to a register and instead of buying 5-6 items, now this is from the store teams, they might put one down and buy 4 or 5. The effect that has on any retailer over time all those putting one downs add up to a lot of things that don’t get purchased perhaps. I think we’re seeing an equal effect in a sense…I think all the shopping centers might…well they might not tell you, but the traffic is down pretty much throughout America on a reasonably consistent basis.

Brian Tunick - J.P. Morgan

If you could talk a little bit about if you are seeing weakness or strength in certain categories or price points that you can call out as a trend?

Millard Drexler

The weakness as I said is our summer business. Shorts and t-shirts. It is very simple. I never give weather reports and I’m not going to do that today. That’s the weakness. Pants in Men’s and Women’s, sweaters in Men’s and Women’s, jewelry has been very exciting, weddings I won’t say in Men’s. Wedding in Women’s…it’s a joke. Woven shirts in Men’s. The price point issue…we always buy prices with what I call scarce investments in the high end. We will not stop doing that but for example our $1,800 wedding dress is pretty much sold out because we didn’t buy a lot. Our suit business is showing really nice pluses right now. As we said we have a point of view of being a much more important suite seller.

I find that in a time like this as long as we stay on target, stay on program, not give up any kind of quality aspect but be very shrewd in our investments and our goods, and buy newness…the one thing we know is if you give them last year’s best sellers this year and frankly you’re not going to sell as many as you’d like to sell. So it is always figuring out where the next move is. Skating to where the puck is, not to where it has been as Wayne Gretsky used to say. But we’re not by any means we are just sticking to the knitting and we’re just going in. There are lots of strengths in business and we’re doing the best we can do with some of the challenges we are all feeling.

No excuses here by the way. We’d like to have said comps were higher.

Operator

The next question comes from Roxanne Meyer – Oppenheimer.

Roxanne Meyer - Oppenheimer

Personally I think your apparel and accessories have never looked better and you called out shorts and tees. Overall is there a way to summarize how much of the issues out there are company specific versus macro and once we move beyond the summer season and head into fall are you feeling comfortable with your assortment? Is it more the macro headwinds that are the biggest problem? Do you think you are well positioned otherwise?

Millard Drexler

Roxanne, I know exactly what we’d like to do better and what we’d not like to do better. I have to say this is not an excuse. I think we are in a macro environment itself…you said something and I can go into any store in the world and find ten things wrong. That’s my job. My job is finding not what’s right but what is wrong. So there are issues, for example, that are wrong but by and large the assortment feedback we’re getting from our store teams, our catalog customers, from our online, I have to say I can always do better. We can all do better. 5-10% better. But the fact is we are getting great feedback. I don’t want to say it is macro. I go to all the stores. I am a chronic complainer.

So I came back from eight cities and the biggest complaint I had was in Madewell we’re out of size 25-28 jeans in every single store. We’re out of the Jackie Cardigan at many of our J. Crew stores. I’m pleased with that. I don’t want to say it is all macro. Any retailer in the fashion business can always do something better. But I don’t think at all…I’m trying to be objective. I don’t think we’re not where we should be at all.

I like the way Madewell looks. I like the way Crewcuts looks. We put a new floor set in today in the front of all our J. Crew stores with neutral tones. I think it looks good. So we’re trying.

Roxanne Meyer - Oppenheimer

It certainly sounds like with shorts and tees being the call out that perhaps it’s more of the basic items that maybe aren’t doing as well. Is that a category that perhaps you were over-exposed to? Or how do you feel about that?

Millard Drexler

Basic is an illegal term in this company. People get arrested when they use the word basic or chain store here. But I don’t want to say it is weather but we are one of the dominant men’s shorts…we’re probably one of the largest, better short sellers in America. I would have to guess that it has something to do with the….here is a silly statistic. I was in L.A. yesterday and on the news. You know you get a little desk and you listen to the weather reports. He said in L.A. they had 13 80 degree or better in L.A. I might be wrong on this, for the month of May last year…and he wasn’t talking to retail. It looked like a retail channel. Versus two over 80 this year. That makes a difference in the customer psyche.

More and more people are going to put off what they don’t need to buy. We know that closer to need. So I would say it’s not basics at all. The classics we have are constantly being updated. One of our best selling pants right now is a brand new item. It is a men’s officer Chino. I think it is $85, button fly, extra special wash chino. We just put it into a number of stores. It is rolling out in the fall. It came out third best pants quickly in the stores it is in. They want newness. They want fair value. They want to come in and be turned on and are not going to buy what is old or last year. And we are maintaining the integrity of our day-in day-out regular priced business as best as we can do.

Operator

The next question comes from Jeff Black - Lehman Brothers.

Jeff Black - Lehman Brothers

I guess the story has always been about the 4-6 comp and leverage on the 4-6 comp and if we are not going to get it obviously, Jim how are we putting initiatives into place that can really lever this down assuming we are in this environment in the first half of 2009 for example? Or do we have to live with the 4-6 leverage point to the extent we don’t get it we don’t get the earnings we thought we were going to get?

Millard Drexler

I just want to say, we ran…what were the comps for the first quarter? With a 20% earnings increase. Remember, we don’t sit still from quarter to quarter here. Every single day we’re managing the stores and expenses.

James Scully

And we had a 30 basis point leverage in SG&A with the 2% comp. I would say as the trend continues, obviously as I said before, we have the opportunity further out to manage to a lower comp level and we will do that and we have the opportunities to do that. I think when we said it is flat for the year I think that was just based upon the low to mid single-digits. We get better in the back half. It is harder to fix in the front half. So it is a combination of the two. If it were to go beyond that obviously we would be in a position to be managing to that lower level. It is more of a timing issue.

Operator

The next question comes from Richard Jaffe – Stifel, Nicolaus & Co.

Richard Jaffe – Stifel, Nicolaus & Co.

With the success of the Internet direct business are you cutting back circulation? What is the outlook for circulation for the balance of the year? Is that a source of savings as the customer converts over?

James Scully

In terms of circulation we are down 3% in Q1. We anticipate that it will be up slightly over 5% in Q2. We will be basically flat for the front half and we’ll be up double digits in the second half as we had mentioned, which gets us to about 5% for the year. The growth in it is because the categories of business that we’re reinforcing whether it be Crewcuts, Collection, and we are also going after the 12-month file. The direct is obviously a very important business for us so if we can maintain 5% with the growth we had in Q1 obviously we’re going to have a lot of leverage in that business. So we have managed the expense because of the increases in paper and postage, but we’re not looking at that as an expense savings because it is too valuable of a vehicle for the overall company.

Richard Jaffe – Stifel, Nicolaus & Co.

Related not so much to the size of the inventory but the quality or condition of the inventory, it appears to be heavily skewed to the warmer weather merchandise and so therefore not requiring markdowns as you enter what hope to be the warmer months. Is that a fair assessment?

James Scully

Yes. I’d say it too because one is the guidance that we gave for Q2 incorporates our current inventory position. So when I say we are comfortable with the inventory I say that in the context that we have revised Q2. The second thing is, one thing I look at in terms of the inventory is the accounts payable inventory leverage. So if you look at that you can see that the recency (sic) of the inventory is very healthy which is important to us. So we are comfortable.

Operator

The next question comes from Michelle Tan – Goldman Sachs.

Michelle Tan – Goldman Sachs

I was curious it seems like there has been a number of new special partnerships in the stores or online or the Globetrotter luggage or the Selima glasses. How significant is that business now and is that something you are looking to do more of going forward? Also, are there inventory risks there and how are your customers responding to it so far?

Millard Drexler

I think that is a good question. You will never see that as a big business in the company and they are all small little things that for us and it is part of our long-term strategy. We want to be great editors. We want to be great stylists and bring to customers things that are not out there in the marketplace that are easily attainable. Globetrotter we absolutely fell in love with it. It is a small, tiny company outside of England. It is hand-made, vulcanized luggage. It is addictive, the luggage. It is incredible. I will tell you we didn’t buy a lot and we don’t want to have a lot. I think America at the high levels now is ubiquitous in everything so called luxury. We don’t use the term and I think customers continue to look for scarcity and uniqueness. I go into all the stores all the time and if I see another one of those famous, luxury brands in every store, in every market, all over with the same things I don’t think it is so luxurious anymore. I think we see that and we could be wrong. Globetrotters does not have a logo on it. You would not know it other than by its exquisite style and colors. Selima’s sunglasses are non-logo’d and they are designed especially with Selima and for us. We don’t have an expertise in that. There is vulcanized special luggage. Sunglasses and glasses we would rather leave it to the experts.

We also think going forward it is not all about just what we can do. I think Jenna Lyons and her team recognizes that out there we scour the world for special, unique product. We have this incredible sneaker collection at Madewell that we’re selling out of. It is probably available only at our store in America pretty much. We’re looking a lot to that.

I think what it does for us is if you looked at the catalog and you look at the Globetrotter page what that says for J. Crew is a lot more than it does in dollar volume. Although I will tell you our Italian luggage, Lungarno Luggage, at $1,800 to whatever the prices are…$2,200, we couldn’t be more thrilled with the selling. I think it just enhances the feeling of us not being a store that is formulaic, has the same things and it also creatively allows our customers, our catalog team and all of us to have much more fun. We called someone today who has his own personal sandals made far away in the world and we asked if we could do a little collection with him on his sandal. It is a very cool item.

So, long answer to the question but it is all part of somewhat of the mystique and interest that we think we need to provide to continue to draw more and more customers. What the good news here is, is that the responses have been absolutely and really strong. Selima sunglasses, Globetrotter is like 4 days old. Redwing Vintage boots. Do we need that? It is our number one shoe. It is special to us. I think customers really appreciate that.

I think at the end of the day they know we’re thinking as much as anyone is about the creative spirit of our company. The new store in Tribeca. Men’s, the Collection store and Women’s, they all will carry special and unique, along with our own J. Crew, special and unique. The key for us is obviously not over-buying special, unique and that is always a challenge.

The answer is we don’t see it as big but we see it as very special and much more important in terms of the perception of our company than the reality of the dollars.

Michelle Tan – Goldman Sachs

I think the luggage looks great. I agree. It does cool things for the brand. Another quick question on the inventory. How does it look in units relative to dollars? Also, I know you mentioned the increase is a lot of in-transit products. What is the reason for the higher in-transit inventory?

James Scully

The in-transit is just a point in time. There is nothing to it. There is not a strategy. It is simply a point in time. You’re always subject to.

Michelle Tan – Goldman Sachs

So it’s not anything with bringing in things earlier this year?

James Scully

No. It’s just a purely point in time issue. We typically don’t give composition in terms of units and cost in terms of inventory. We’re not [inaudible] we’re just comfortable with it as we enter Q2.

Operator

The next question comes from Barbara Wyckoff - Buckingham Research.

Barbara Wyckoff - Buckingham Research

I would echo Roxanne. I think Morocco looks great. Did the comp results from the outlet store mirror the regular priced stores? Could you talk about what you’re planning for new store openings in 2009 and then I have a question about Madewell.

James Scully

The plan for, we’ve always said 7-9% square footage growth in the long-term. We haven’t given specific guidance for 2009. I’d say at this point it would be within that range. So we’re not necessarily changing our plans. This year it is 11%. It is a little bit higher based on the fact we were able to capitalize on a couple of opportunities.

Barbara Wyckoff - Buckingham Research

Did the comp results from the outlet stores mirror the results from the regular stores?

James Scully

We’ve never broken out the difference between the two but I think Mickey said earlier the trend has been relatively consistent between both.

Barbara Wyckoff - Buckingham Research

Then Madewell. Could you just talk a little bit about the customer? Is this the same customer that is coming in now that was your target customer initially? Is it too early to talk about how many stores you need to break even?

Millard Drexler

On the break even, Jim I’ll leave that up to you. I’ll talk about the other part.

James Scully

Sure. We have not given a specific number of units. What we have said is we’re going to make a decision in the second half of this year in terms of the roll out strategy. We needed to get a couple of more stores under our belts. At that point we can talk about the long-term roll out strategy and the PNL impact.

Millard Drexler

Madewell, it is interesting. We have now eight stores. It has been very helpful to have the Manhattan store here. We like what we see there. We’re very pleased. We’re comping now. I’m not giving out the comps but we’re comping three of the stores that have anniversaried themselves. Century City, Austin Texas and Short Hills. Anyway, the customers are…any new business is kind of a work in progress. The company this August will be two years old. We’re moving forward. We have a really nice customer. We’re targeting…I don’t want to use an age. It is kind of a hip, younger woman. Not teenage. We have good teenage customers.

It depends on where you are. I was in Las Vegas yesterday evening and I asked…it is our smallest volume store and unfortunately it is not in the best location, the shopping center, but more importantly no one knows what it is. So 20% of the customers according to the team know and have heard of Madewell. 80% haven’t. The high end of hearing that is about 50%. Then having of course the tourists…the big tourist Mecca these days and domestic. I like who I’m seeing there. I like the response to our jeans. We are in the $100 jeans business and our garment dyed jeans we are just really pleased. We are out of size 25-28. They are starting with size 24. We’re getting fame for 4-5 items. The nice vibe and feel to the store, I think if you have been in the stores, they kind of feel good. They look good. So I can only say we are very pleased with what we’re seeing right now.

I think it is on track. I think it is going to where it needs to go. I will qualify all that by saying it is still R&D. We’re being very conservative. We did not need it for the growth of this company. In fact if you look at it, it is again in the spirit of us being long-term investors, all of us myself included, into R&D and it is losing a fair amount of money every year but we really like where it’s going right now. We think the team is well set and we’re very pleased.

Operator

The next question comes from Samantha Panella - Raymond James.

Samantha Panella - Raymond James

I’m just curious, earlier when you stated that your expectation for the direct business to be up high single-digits but then you reminded us it was up 17% for the first quarter are you trying to infer that perhaps it could be better or were you trying to give us a feel for lower than that high single-digit growth as we look through the remainder of the quarters?

James Scully

I think we have been consistent since the IPO that it is high single-digits and we have been fortunate that we have exceeded that. I think what we have always said is that plan the inventory and expense to the high single-digits to the extent that the demand is higher that provides an opportunity for higher flow through to the bottom line.

Millard Drexler

The other thing is, the reality of the world right now is no one really can quantify it. The migration from catalog to online is huge. Number two, from retail to online is pretty strong and it is never measurable. So when you take a comp forecast and a direct forecast we kind of treat it as one business and we encourage the migration. We make a lot more money per transaction online than we do in a store for obvious reasons. We have huge leverage. So I think you are dealing with a long-term issue here with the online business and it being for us a really important part of the growth.

But I think when you look at high single-digit we hope we really kick butt on that. We also hope we beat the comps. I think it is really averaging out to 2. Gas is a real issue advertised in our face every day. Whether you fly or drive, it is driving a huge amount of inflationary cost into the average lifestyle of everyone. So that is really what we see there. So I hope to beat it but you never know.

Operator

The next question comes from Dana Telsey – Telsey Advisory Group.

Dana Telsey – Telsey Advisory Group

Mickey when you think about planning the balance of the year, holiday season coming up in this current environment, how do you look at planning for holiday whether it is product assortment, price, how are you thinking about it? Lastly, Jim if you think about planning for next year are you getting better deals from the real estate developers given what is going on in the environment? Is there opportunity for that?

Millard Drexler

Let’s start with the last one. The deals are not better yet. Although we feel it. I have never seen, I don’t know if this is an indication, as many empty stores on Madison Avenue as I do now. Empty for long periods of time. I think the days of working for the landlord…well we don’t want to work for any landlord. They are our best friends and partners, but we don’t want to be in business for a landlord. In fact, even in the high end markets now streets, empty stores. We haven’t really felt too much in the shopping centers yet. But practically speaking when you have private conversations with a developer of course they are more flexible. We’re in a unique position because we have 50 million catalogs that drive traffic to our stores and developers know that. A lot of times we come in lifestyle centers as a bit of a destination. Even in East Hampton we opened on Newtown Lane and all of a sudden it’s not just us. Newtown kind of overtakes Main Street to a degree.

We get a little more help now on that but not rent. Maybe more contribution. But you know our industry is in an interesting time now and there is not a lot of compelling alternatives out there and a lot of companies, we all know, have a lot of stores. We are fortunate that we are still talking about not having too many stores and searching for new outlets of growth.

In terms of holiday that is a really good question because holiday is always a season that begins and ends about two days in front of Christmas. Everything you own December 22 pretty much expires unless it is go-forward goods. So we have a rule in the company that December 22, it is kind of…the answer is what don’t you want too much of on December 22. The question is what are Christmas goods? Things you don’t want to own a lot of. December has become the biggest promotional month in the world and no one can forget that. It just drives a lot of traffic and it is a different kind of traffic.

So we are planning very conservatively. We are looking as we speak right now we are investing in Holiday. Our December ownership toward the end of the month we want to be much more forward as we have a large, I call it Crew spring customers. You look at the better businesses in the world December is not an important part of designer companies. Once spring hits their apparel is so expensive. We have a very dominant spring/summer Crew apparel business so we’re doing that. We’re looking at sensitivity…by the way I would have said this a year ago and a year from now, much more sensitivity and simplicity on buying. That being said it is our responsibility and I’ve never seen it be as good as it has to be, please let’s not own a mark down inventory December 22. I guarantee this year, it is a guess or a personal opinion that the customer is going to continue to wait.

I was in the shopping centers the last two weeks. There are so many sale signs everywhere. People are smart. They know it. They are going to wait. They always do wait. It is a last two-week rush. That is what we’re doing, Dana. We’re leveraging direct very importantly. Easy to buy gifts. Easy to purchase stuff in the store. Not crazy prices. Much less of the high-end wardrobing business that we’ve had before. Try to be as clean as we can be at the end of December.

Operator

The final question comes from Marni Shapiro – Retail Tracker.

Marni Shapiro – Retail Tracker

If you think about circulation and you think about your expense structure, without cutting into the bone of circulation because I do think that catalogs comp top of mind impact about the brand when it arrives, is there an opportunity there to maybe cut the number of pages or play around there at all for the J. Crew brand? Then could you also just talk a little bit about some of the markets like New York or Vegas where you have a bigger international business? Are you seeing those markets at least perform a little better at the Crew brand at all?

Millard Drexler

In terms of the productivity of the books, we are playing around constantly with that. We’re always trying to optimize it. If you look at our pages lately, for example in Men’s you will see the beginning of an always list in the Men’s books. We are taking the men’s business and guys are very narrow in how they shop. They only buy validated, always goods. So if you look at our pages now and I think it is pretty dramatic over the last six months, the environment, the pages, the editorial pieces, the kid’s expansion in the book, we are constantly noodling the book and we’re always never perfect but striving for improvements in productivity.

So I think what you’re looking at in the catalog, and by the way all that business goes online. It is amazing. It goes to stores and it goes online.

Marni Shapiro – Retail Tracker

I worry about when people start to cut the actual circulation, not the pages, because of the top of mind reference when you get the book.

Millard Drexler

It is by far, for us, the most profitable business we have. The leverage is extraordinary and it is the only 50 million unit directed fashion catalog. If you think about it at our quality and style around. This is not a business moderate priced goods or promotional goods. That is our biblical way of communicating with customers. I have to say I’m kind of new to the catalog business but it is a very wonderful tool. Our twelve month new customer file is growing in a very healthy way. As I said before we brought in a really terrific team to do that. So, the answer is no there. Again, we are always noodling and looking.

Marni Shapiro – Retail Tracker

The international. I was just curious in the markets where you have a big international customer base.

Millard Drexler

I was in Las Vegas yesterday and didn’t see too many people around. I think Las Vegas, the tourism business, from what I was told is down a few points in Las Vegas. New York…Hawaii by the way because of the airline situation. We just opened in Hawaii and there you are seeing all the retails are suffering but it is only one store and we’re very pleased and its not a make or break. I think Manhattan retailers are really lucky. If you have Manhattan, big stores like a lot of department stores do, boy oh by is that driving foreign business. I was just in our Madewell store today. I would say 2/3 of the customers were either tourists or foreigners and you are seeing it regularly.

It is amazing what is going on because remember our products are really cheap here for them. I don’t think it has an appreciable degree in terms of our business unless we were running big flagship department stores there because I think that’s where they’ll be picking up huge benefits from tourism.

Operator

I would now like to turn the conference back over to management for any closing comments.

Millard Drexler

Thanks for joining us. We will speak to you when we report second quarter results in August. Thanks for joining us. Take care.

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