J. Crew Group Management Discusses Q2 2012 Results - Earnings Call Transcript

| About: J CREW (JCG)

J. Crew Group (JCG) Q2 2012 Earnings Call August 30, 2012 11:00 AM ET

Executives

Allison C. Malkin - Senior Managing Director

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

Stuart C. Haselden - Chief Financial Officer

Libby Wadle - Executive Vice President of J. Crew

Analysts

Karen H. Eltrich - Goldman Sachs Group Inc., Research Division

Spenser Samms - BofA Merrill Lynch, Research Division

Carla Casella - JP Morgan Chase & Co, Research Division

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Patrick DiMeglio

Operator

Greetings, and welcome to the J. Crew Inc. Second Quarter Fiscal 2012 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It's now my pleasure to introduce your host, Allison Malkin of ICR. Thank you, Ms. Malkin, you may begin.

Allison C. Malkin

Thank you for joining us to review our second quarter 2012 results. With me today are Jim Scully, Chief Administrative Officer; Libby Wadle, Head of our J. Crew Brand; Stuart Haselden, Chief Financial Officer; and other members of our management team.

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

As a result of the acquisition on March 7, 2011, by TPG Capital and Leonard Green & Partners, the company prepared financial statements last year for the predecessor period from January 30, 2011 through March 7, 2011, and the successor period from March 8, 2011 through July 30, 2011.

Additionally, we have prepared a pro forma statement of operations for the first half of 2011, giving effect to the acquisition as if it occurred on the first day of the fiscal year and eliminating all transaction-related nonrecurring expense, which can be found in Exhibit 3 of our press release. The results of the second quarter of fiscal 2011 have not been prepared on a pro forma basis as the transaction was effective prior to the first day of the quarter. We refer you to supplemental MD&A and other disclosures in our Form 10-Q for the second quarter of fiscal 2012.

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

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

James S. Scully

Thanks, Allison, and good morning. I'd like to provide a brief overview of our company's progress as we reached the halfway point of 2012. Stuart will then walk you through our financials in more detail. After which, we will open the call up to your questions.

We are pleased with the momentum in our business and the strategic initiatives we have underway, and this is reflected in our financial results. The second quarter included a double-digit increase in comparable company sales and significant expansion in merchandise margin, which fueled a 38% increase in adjusted EBITDA as compared to last year.

Specifically, for the second quarter, total revenues increased 21% with comparable company sales increasing 14% and direct sales increasing 16%. Our gross margin increased 860 basis points to 45.1%. If we exclude amortization of inventory step-up as a result of purchase accounting from last year, gross margin increased 360 basis points driven by merchandise margin expansion and buying and occupancy leverage. Our adjusted EBITDA totaled $89 million or 16.9% of revenues in the second quarter of this year, which is a 38% increase versus the same period as last year.

Our second quarter results reflect a strong response to our spring and summer offerings. Our Women's business has benefited from our strategy to narrow our assortments and invest in big ideas, as I'm sure you all have seen firsthand in our stores and online. In addition, we remain focused on building our marketing capabilities, as well as the infrastructure required to deliver long-term high-quality earnings growth.

I would now like to turn the call over to Stuart to review our financial results in more detail and provide the outlook for CapEx for the year.

Stuart C. Haselden

Thanks, Jim. Turning to the details for the second quarter. Total revenues increased 21% to $526 million. Total comparable company sales, which include comp store sales, direct sales and shipping and handling revenues, increased 14%. Our store sales increased 24% to $384 million with net square footage growing 8% in the second quarter, driven by 33 net new store openings in the last 12 months.

We opened 6 new stores in the second quarter of this year. Direct sales increased 16%, which includes our J. Crew factory and Madewell direct businesses. Gross profit for the second quarter was $237 million. Gross profit margin increased 860 basis points to 45.1%. Last year included $22 million in amortization of inventory step-up as a result of purchase accounting.

Excluding this item, gross margin increased 360 basis points driven by 240 basis points of merchandise margin expansion, coupled with 120 basis points of buying and occupancy leverage. Our merchandise margin improvement resulted from higher full-price sell-throughs, driving lower markdowns versus last year.

Turning to SG&A expenses. SG&A increased 19% to $175 million or 33.2% of revenues versus 33.7% last year. Last year included $6.5 million in transaction-related litigation costs. Excluding this item, SG&A as a percent of revenues, was 100 basis points above last year. The second quarter also -- I'm sorry, the second quarter of 2012 also included a $10 million year-over-year increase in share-based and incentive compensation.

Adjusted EBITDA as outlined in Exhibit 5 of our press release for the quarter was $89 million as compared to $64 million last year, with EBITDA rate increasing to 16.9% of revenues versus 14.8% last year. Net interest expense for the second quarter totaled $25 million, which compared to $26 million last year.

Turning to key balance sheet highlights. Cash and cash equivalents were $213 million at the end of the second quarter, and total debt was $1.6 billion consistent with last year. Our inventory balance was $283 million at the end of the quarter compared to $260 million at the end of the second quarter last year. Inventory last year included a purchase accounting step-up adjustment, and in addition, we had some non-comparability in our in-transit inventories year-over-year. Inventory, adjusted for purchase accounting and normalized for in-transit, increased 24% or 15% on a per square foot basis. We are comfortable with our inventory level and composition as we enter the third quarter.

Capital expenditures for the second quarter were $38 million. We expect capital expenditures to total approximately $125 million to $135 million for the full year of 2012. This reflects our investment to support our growth initiatives with key expenditures, including 42 new stores, supply chain infrastructure investments, corporate office expansion, information technology enhancements and store renovations.

We are pleased with the performance of our business in the first half of the year. We remain focused on our product assortments while continuing to implement initiatives across our stores, direct and international channels that capitalize on the J. Crew and Madewell brands.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Karen Eltrich of Goldman Sachs.

Karen H. Eltrich - Goldman Sachs Group Inc., Research Division

As we look at the very impressive EBITDA improvement, how much of that would you attribute to just having the right product and the right inventory levels? And do we still have, in the second half of the year, still to come, the benefit of lower cotton pricing?

Stuart C. Haselden

Karen, it's Stuart. I'll try to speak to the second part of your question, and then maybe I'll invite Libby to address the first part. So, in terms of the impact on our margins from cotton pricing, we certainly are seeing a benefit in lower cotton price this year that's been slightly offset by higher costs in other categories, including wool. I will point out though, as we had mentioned on the first quarter call, our average unit costs in Q2, as well as our outlook for the second half, is that our AUCs will increase in the high single-digit range, which is being driven by the mix of our assortment. As we mix in the higher cost categories, our AUCs are increasing, but that is not pressuring our merchandise margins as those mix-related increases also take with them increases in IMU and AUR. So there's no pressure on our merch margin as a result. And the margins obviously do, as I mentioned, incorporate the benefit from the lower cotton pricing. So -- and also, in a year-over-year basis, we're benefiting from higher full-price sell-throughs versus last year, which again is reflected in the margin performance.

Libby Wadle

Yes, I mean, I can add -- this is Libby, I can add on, really Stuart just hit the nail on the head, really. It's about our full-price sell-through. It's always about the product, and we've been very, very pleased with selling our product at full price both in stores and direct, and at an improved margin rate. So it's really, again, mostly about the product.

Karen H. Eltrich - Goldman Sachs Group Inc., Research Division

Maybe then, following up on that, how are you feeling about your assortment for fall? And what do you think are going to be some of the key categories?

Libby Wadle

Well, we feel good about the assortment for fall. I mean, for fall, we really invested in wardrobing and complete outfitting. And then, as we see going into the fourth quarter and holiday, it's really going to be about gift giving, and that's how we're positioned. And I think that's how we're invested and how we're ready. And honestly, in terms of the environment in fourth quarter, I think we're invested and priced appropriately for how that quarter will pan out.

Karen H. Eltrich - Goldman Sachs Group Inc., Research Division

Great. And I got an email, very compelling email, that's advertising your personal shopper service which actually, again, I think is a great attribute and probably hasn't been advertised. Did you get a strong response to that?

Libby Wadle

Yes, I mean, it's our Very Personal Stylist program, and we've received a great, great response from that.

Karen H. Eltrich - Goldman Sachs Group Inc., Research Division

Great, and final question. Can you maybe give some commentary in terms of what you're seeing with regards to sales trends amongst your various channels, outlet, Internet, traditional Madewell and if any particular one is underperforming or outperforming?

Stuart C. Haselden

Karen, it's Stuart. So we're pretty happy to see a balanced outcome for the quarter across our brands and channels. I think from the press release, you can see that our direct business was up 16%, comparable company sales up 14%, which incorporates that. But you can see that there's a balanced picture between our stores and direct. I'll add to that, our Madewell business continues -- we continue to be very pleased with our Madewell business. We'll open 15 stores this year. We'll look to open 15 to 20 stores next year, which I think -- we point to that as an indication of how good we feel about that business and the ongoing success we're having with it. But again, very balanced result across all [indiscernible] channels.

Operator

Our next question comes from the line of William Reuter of Bank of America Merrill Lynch.

Spenser Samms - BofA Merrill Lynch, Research Division

This is actually Spenser in for Bill. I think last time, you had mentioned that there were a few categories that maybe you wish you had some more inventory in, were you able to restock in those categories? And how do you feel about them going into fall and holiday?

Libby Wadle

We're actually quite pleased with our inventory position in fall and holiday. I mean, as I think we've said in the past few quarters, we've really gone after our franchise items in those businesses. And based on the trends we saw in spring and summer, that made sense for fall. We brought back into those. And so yes, we feel very well positioned with our inventory in the right items. But to be honest, we always want more inventory in certain categories where we have a strong trend, and that's always good news.

Spenser Samms - BofA Merrill Lynch, Research Division

Okay. And then, with the increase in merchandise margin, was there a particular category, maybe men's, women's or children's that benefited the most, or was it broad based between all of those?

Libby Wadle

It was really across all categories.

Stuart C. Haselden

Yes, very balanced across all categories.

Spenser Samms - BofA Merrill Lynch, Research Division

Okay. And then, also it seems like the weather has been pretty favorable broadly. Do you think this has helped traffic for back-to-school?

Libby Wadle

No. I mean, honestly, and we've said this before, because I think weather has come up a lot this year, and we have not really -- we don't really measure the effect of weather on our business. And back-to-school as it exists for other companies, is not so specific for our customer.

Stuart C. Haselden

Yes, I think if you go back, Spenser, it was a warm winter, our goods, as we transitioned out of fall holiday last year into spring/summer this year did well. You could probably attribute -- there's some benefit from just the warmer weather earlier in the year. At this point, we're not seeing really anything point to...

Libby Wadle

No, I mean, I think people are buying wear now more than ever and for what's -- they want to -- whatever they're buying, they want to wear right now. And I think we are adjusting how we invest and assort our line accordingly. We feel good about that right now.

Operator

Our next question comes from the line of Carla Casella of JP Morgan.

Carla Casella - JP Morgan Chase & Co, Research Division

One question on same-store sales. Can you just talk about the monthly cadence and what you saw through the quarter?

Stuart C. Haselden

Carla, it's Stuart. So we actually don't break out comp store sales. We gave -- the statistic we quote now is company comparable sales which incorporates both store comps, as well as our direct online sales increases, and the rationale being that, our business strategy is so intertwined that, that's a better picture of the comparable increase year-over-year and our sales trend. And in addition to that, we're a quarterly reporter, and we don't break out the details by month.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. That actually leads into one of my other questions, you mentioned that the businesses are very intertwined. How much of your fulfillment do you do from stores, or can -- and do you expect that to change? We've been hearing more and more about that from some other retailers.

Libby Wadle

Right now, we do some fulfillment from stores, but it's small. And it's a big opportunity and very, very high on our priority list and agenda to really focus on the -- I mean, for lack of a better term, because everyone is using it, but the omni-channel experience and really the launch of our Very Personal Stylist program is really, sort of the beginning of sort of getting some momentum there to really sell cross-channel, and it's really about the product and not where you're purchasing it.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay, great. And then, we've heard some positive commentary from other retailers as they're moving into back-to-school about a pickup in women's. And given that your results are so strong as well and you have a good women's percentage, or women's weighting to your business, could you just talk about what you're seeing in the women's and what may be driving strength there?

Libby Wadle

I wouldn't say we've seen a pickup as much as a continued strong trend in our women's business. We've been pleased with our women's trend all year, and I think the mix of business is changing. What's trending is changing, more wovens are certainly trending right now in women's. But honestly, we're pretty balanced in our positive performance. We're very, very pleased with our men's business right now and our non-apparel, our shoe and accessory, and our handbag business has been strong.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay. And then, just one last question. Back-to-school, are you seeing the promotional environment any better or worse than last year?

Libby Wadle

Not really, nothing specific for us, better or worse.

Operator

[Operator Instructions] Our next question comes from the line of Grant Jordan of Wells Fargo.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

You talked a little bit about how higher full-price selling or more full-price selling helped the gross margin. Would you say on average that your retail prices are higher or similar to where they were last year?

Libby Wadle

I would say similar to where we've been, to be honest. We're just having stronger sell-throughs, the reaction to the product has been positive.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. And any thoughts on how that might trend over the next several years?

Libby Wadle

I would [ph] think several years? You should have my job. We feel -- I think for this quarter and half, we feel good about our merchandise mix and how we're positioned. And we're keeping that in mind as we buy for next year.

Grant Jordan - Wells Fargo Securities, LLC, Research Division

Okay. Second question, I appreciate that color on CapEx, $125 million to $135 million this year. Any initial thoughts on, just directionally, where that will be going into 2013?

Stuart C. Haselden

Well, I would say it's probably more like that number than not. We're probably looking at, as I mentioned, 15 to 20 new stores in Madewell, for the retail brand, mid single-digit increase in square footage. We'll have ongoing investments in technology, supply chain and store renovations. So it's probably not a bad assumption to have a number that's pretty similar to this year.

Operator

Our next question comes from the line of Karru Martinson of Deutsche Bank.

Patrick DiMeglio

It's Pat DiMeglio, stepping in for Karru. I was wondering if you could give us an update on the men's only stores, how they're going? And if you've had any luck with new locations?

Libby Wadle

Yes, and we -- we're pleased with our men's only store. We just opened one, most recently -- last week, in South Coast Plaza, and we have 2 more planned openings this year.

Stuart C. Haselden

Copley and The Grove.

Libby Wadle

Yes, our Copley store and our Grove store. So we've been very pleased, and we've been -- we're really opportunistic looking at our opportunities -- thank you, Stuart. There will be 9 men's only stores by the year end.

Unknown Analyst

Okay. And can we expect similar growth in the next couple of years? Or maybe ramped up a little bit?

Stuart C. Haselden

It's probably too soon to say. We're very enthusiastic about the concept. I would say, all those stores are doing very well. It's exciting. We're still evaluating just how big it can be. It's probably a more affluent customer, probably higher in demographics that we target. So it's certainly a market-by-market decision and discussion. So it's probably just too soon to sell, but we're very optimistic.

Unknown Analyst

Okay, great. Just lastly for me, any update on international expansion specifically, London, Hong Kong?

James S. Scully

So sure, it's Jim. So for us, international is more about building a global brand and being disciplined about the way we do it. We've been very excited about what we've seen online internationally. And also what's happened in Canada. So our focus outside of North America will be in the U.K. and hope to be open in the back half of '13, and then Hong Kong in the front half of '14. And I think importantly, in October, we launch our partnership with Lane Crawford in Hong Kong, which has received a lot of press overseas and we're extremely excited about it, just given that they're really the premier high-end player in the space. And being aligned with them is really generating some good buzz for us over there.

Operator

We do have a follow-up question from the line of Carla Casella of JP Morgan.

Carla Casella - JP Morgan Chase & Co, Research Division

You mentioned that your inventory on a per-store basis is up about -- well, per square foot, I think 15%, and your average cost up in the high single-digits. So does that imply that the 2/3 of that increase is really just the cost?

Stuart C. Haselden

Well, yes. I would say if you're looking at per square foot, up 15% and you're up high-single digit, I'd say more -- it's more balanced, more 50-50 cost, 50-50 units.

Carla Casella - JP Morgan Chase & Co, Research Division

Okay, great. And then, what -- given that you've opened the men's stores, what percentage of your business is now men's versus women's?

Stuart C. Haselden

Well, it's -- I think the penetrations that we show in the Q, break out for you, I think it's around 24% in men's at this point. So that number has ticked up over the last few years. So I think that reflects the strength and the investments we've made in the men's business.

Operator

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

Stuart C. Haselden

Well, thanks for joining us today, and we look forward to speaking with you when we report our third quarter results at the end of November.

Operator

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

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