Jos. A Bank Clothiers Management Discusses Q2 2013 Results - Earnings Call Transcript

Sep. 05, 2013 3:30 PM ETJos. A. Bank Clothiers, Inc. (JOSB)
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Jos. A Bank Clothiers (NASDAQ:JOSB) Q2 2013 Earnings Call September 5, 2013 11:00 AM ET

Executives

David E. Ullman - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

R. Neal Black - Chief Executive Officer, President and Director

Analysts

Bilun Boyner - JP Morgan Chase & Co, Research Division

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Mark K. Montagna - Avondale Partners, LLC, Research Division

Brian Gary Rafn - Morgan Dempsey Capital Management, LLC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Joseph A. Bank Clothiers Second Quarter 2013 Earnings Conference. [Operator Instructions] And as a reminder, today's call is being recorded. I'll turn the conference now over to the Chief Financial Officer, Mr. David Ullman. Please go ahead, sir.

David E. Ullman

Good morning, everybody. This is David Ullman, and I'm joined by Neal Black, our President and CEO.

Before we begin, let me start with the usual script, that our statements concerning future operations contained on this call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this presentation, the words estimate, project, plan, will, anticipate, expect, intend, outlook, may, believe, goal, attempt, assume, potential, should and other similar expressions are intended to identify forward-looking statements and information. Actual results may differ materially from those forecasted due to a variety of factors outside of our control that can affect our operating results, liquidity and financial condition.

Such factors include risks associated with economic, weather, public health and other factors affecting consumer spending, including negative changes to consumer confidence and other recessionary pressures; higher energy and security costs; the successful implementation of our growth strategy, including our ability to finance our expansion plans; the mix and pricing of goods sold; the effectiveness and profitability of new concepts; the market price of key raw materials, such as wool and cotton; seasonality; merchandise trends and changing consumer preferences; the effectiveness of our marketing programs, including compliance with relevant legal requirements; the availability of suitable lease sites for new stores; doing business on an international basis; the ability to source products from our global supplier base; legal and regulatory matters; and other competitive factors.

The identified risk factors and other factors and risks that may affect our business or future financial results are detailed in our filings with the Securities and Exchange Commission, including, but not limited to, our annual report on Form 10-K for the fiscal year 2012, and our quarterly reports on Form 10-Q filed to the date hereof. These risks should be carefully reviewed before making any investment decisions. These cautionary statements qualify all of the forward-looking statements we make on this call. We cannot assure you that the results or developments anticipated by us will be realized, or even if substantially realized, that those results or developments will result in the expected consequences for us or affect us, our business or our operations in the way we expect.

We caution you not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. We do not undertake an obligation to update or revise any forward-looking statements to reflect actual results or changes in our assumptions, estimates or projections.

The following presentation includes information regarding interim period sales in the current quarter. These interim period sales are not necessarily indicative of sales expected for the full quarter. Furthermore, sales are just one component of earnings, and no projection of earnings should be inferred from any discussion of interim period sales or other data in this presentation.

Now with that said, as usual, I will begin our prepared remarks this morning with an overview of our financial performance, much of which we pre-announced a few weeks ago. And then our CEO, Neal Black, will provide an update on some of the early encouraging signs we are seeing as we enter the second half of the year as well as an update on our business strategies. Following that, we will return to our previous practice of opening our call to a live question-and-answer session, in which we both will participate. When we finish our prepared remarks, the operator will give instructions about how you may ask a question if you wish to do so.

Let me note that we are aware that a transmission error led to a certification page as being omitted from this morning's 10-Q filing. We are working to correct that as quickly as possible, and we certainly expect those pages to be on file today. There are no changes to the financial statements that were filed this morning.

With that, let me begin with the financial performance overview. On August 15, we pre-announced our earnings. The results I will share with you today are very much in line with what we said at that time. In short, while total sales declined in the second quarter, we achieved stability in our gross profit margin rate which increased 40 basis points, including solid increases in June and July. This represents the first quarter in which the gross profit rate increased after declining in the last 8 quarters.

Having given that brief overview, here are the numbers. Net income for the quarter was $14.2 million compared with $32.2 million in the year-ago period, or a 38% decrease. Earnings per diluted share were $0.51, in line with the range we gave on August 15 of diluted earnings per share of $0.49 to $0.53.

In the second quarter of fiscal year 2012, diluted earnings per share was $0.83 per share. For the second quarter of 2013, total sales were $232.5 million, which is a decline of 10.7% compared to sales of $260.3 million in the year-ago second quarter. Comparable store sales declined 15.9%, primarily as a result of reduced traffic, while dollars per transaction were up. Net income was 6.1% of total sales in the second quarter, so we continue to have strong results on this metric, just not to our high standards that we have achieved in the past.

As we have entered the third quarter, our sales increased in the month of August and we are working diligently towards that continuing which Neal will discuss in a few moments.

Sales in the direct business declined 1.9% in the period, but please remember that this compares to a 39.3% rise in direct sales in the year-ago second quarter. Combined comparable store and Internet sales in the second quarter of 2013 decreased 15.5%.

As I mentioned, the gross profit margin rate increased 40 basis points to 59.1% in the second quarter of 2013 as our average selling prices grew, and we believe we have passed the peak of the higher sourcing cost. The increase in the average selling cost occurred despite having an increase in sales of seasonal clearance products that remained as a result of weaker-than-expected sales. As we told you last quarter, we believe the increased merchandise cost we were seeking -- seeing peaked in the fourth quarter of 2012. Day-to-day gross margins on basic merchandise are stable.

Sales and marketing costs increased $400,000 in the second quarter of fiscal year 2013 to $96.6 million. The increase stems mostly from the occupancy, payroll and benefit costs related to the net addition of 43 stores since the year-ago second quarter, and higher Direct Marketing advertising costs. These increases were partially offset by significantly lower store advertising costs.

The G&A cost for the second quarter of 2013 were $2 million lower than in the second quarter of 2012 at $17.6 million, as we remain focused on maintaining our historic commitment to cost discipline in the quarter.

Tax expense decreased to $9.0 million in the second quarter of 2013, primarily due to lower profitability. The tax rate was 38.6% in the second quarter of 2013, which is 80 basis points higher than the tax rate in the year-ago second quarter, primarily as a result of higher state income tax rates.

Looking at our inventory balance, if you compare inventory at the end of the second quarter with inventory at the same time a year ago, it would be an increase of approximately 4% which relates primarily to the net addition of 43 new stores year-over-year.

We used approximately $12 million of cash on capital expenditures in the first half of 2013. This went towards the opening of 10 new stores, the relocation and renovation of a number of existing stores, payments for stores opened in fiscal year 2012 which were invoiced to us and paid in fiscal year 2013, and lastly, the implementation of certain systems and infrastructure projects, including the expansion of our distribution capacity and the project to upgrade our POS system.

We are on track to spend in the range of $34 million to $37 million in the full year of 2013. This will cover the opening of 30 to 35 new stores, the renovation or relocation of several stores, the infrastructure projects and carryover payments I just mentioned.

At this time, I will turn the call over to Neal Black, our President and CEO.

R. Neal Black

Thanks, Dave. Good morning, ladies and gentlemen. Let me begin with my view of our financial performance and the trends we have seen since the end of the quarter, and then I will get into some more operational detail.

As Dave discussed, our sales declined in the second quarter and this is deeply disappointing to us. We attribute this performance to a continuation of what I told you after the first quarter, an ongoing decline in response to our highly promotional marketing campaigns, somewhat offset by day-to-day sales in the non-promotional parts of our business. Of course, we have identified this trend and we have taken actions towards reversing it, including the ongoing modification of our promotional strategy. With that said, our sales results continue to reflect the impact of annualizing our year-ago spikes in promotional sales.

As we have entered the third quarter, and we have only 4 weeks in, through fiscal August, we are seeing that our total sales, our comparable store sales and direct sales have all increased. So the third quarter is off to good start, but it is still early in the quarter. The August 2013 sales increase is on top of a double-digit sales increase in August 2012. Therefore, with the gross profit margin rate turning up in the second quarter and the sales trend turning up in August, our declines may have bottomed out. I can tell you that each and every one of us at Joseph A. Bank is laser-focused on turning around these recent sales trends and delivering an improvement in the holiday season.

A key component of that has been an exhaustive analysis of our pricing and marketing. From a marketing spend perspective, as we have changed our promotional strategy, we have been more conservative overall and we are shifting a greater proportion of our spending to our image and value advertising campaign under our Making it WORK tagline. Sales from this campaign, which were roughly 1/4 of total sales, increased substantially in the first half of the year and at an improved gross margin rate. We'll be building on that success going forward.

Our direct sales segment, as Dave discussed, decreased slightly in the quarter, but against a very tough comparison from the direct performance in the year-ago period. We continue to see direct as a very important component of our business and feel there is even more ground that can be won online, and we are constantly working to drive traffic and increase conversion rates once we have a customer on our site. Profitability online, however, is not where we want it to be, and we're working hard to improve our marketing strategies to enhance their productivity.

We're in the midst of an enhanced search engine optimization process that is producing encouraging early results. In addition, the profitability has been hurt by our company-wide declining gross profit margin rate in the last few quarters, so any improvements in this area would also help improve the direct segment profitability.

Moving on to our gross profit margin rate. It is encouraging as Dave told you. The gross profit margin rate was up in June and July, and we believe the gross profit margin rate declines may have bottomed out and have the potential to move up as we annualize significant declines in the second half of the year. We're working diligently to build on our progress by improving our marketing strategies in order to best and most productively support our stores and online businesses.

A positive note I should share in this regard is that our proprietary database of active customers, for both stores and online, grew 9% in the second quarter, which comes in addition to the 12% growth in the first quarter, and brings us to more than 4 million active customers. It is, of course, encouraging that we continue to attract new customers and we recognize the opportunity this offers. We're working aggressively to capture new customers with the goal of increasing frequency of repeat business, number of items purchased, and higher average unit retails.

Taken together, our objective is to return to a gross margin rate more consistent with our pre-2012 levels, and we feel we're on the right path, although it's too early to give more specific target timing. But overall, from both the sales and gross margin rate perspective, we have the potential to benefit in the second half of 2013, particularly in the fourth quarter, from easier comparisons than in the first half of the current fiscal year.

Let me now provide some insight into our merchandise trends. In the second quarter of 2013, all of our major product categories had unit sales decreases with the largest drop occurring in suits. This was primarily driven by declines in Traditional Fit suits during our larger promotional events and was partially offset by an increase in Slim Fit suits and increase in Traveler suits in the Making it WORK campaign. Sales of the more luxurious Signature and Signature Gold lines represented 13% of total merchandise unit sales for the quarter, which is down slightly versus the prior year due to a reduction in Signature suit sales.

In the past, our business casual product offering has typically filled the sales void when suits sales were down, but our offering this spring did not do so. As we told you last quarter, we believe our business casual assortment became too casual as we focused too much on weekend wear and not enough on clothes a man wears to the office. We're looking forward to a renewed emphasis on business casual and historic strength of Joseph A. Bank, with new merchandise this fall season. As we have said in the past, controlling merchandise cost without deterioration of quality, with the quality our customers expect from us is a top priority. As we mentioned after the first quarter, we expect our product cost to decline modestly through 2013. However, cost declines are not directly following the declines in the commodity prices of raw materials. Increases in other costs such as manufacturing, labor and currency valuations are offsetting some of the commodity declines. Our focus is, as always, continuing to seek the lowest cost in the world for the high qualities that we demand.

While maximizing the performance of our existing businesses is a foremost priority, we remain focused on our top internal growth initiatives. Let me give you an update on where we are on each of them. Number one, our website. Beyond what I just told you about our search engine optimization, we believe there is continued sales expansion potential through social marketing and our affiliate programs, and international expansion. While international is only a small portion of our direct sales, we have shipped to over 70 countries and we believe there is even greater potential in the future. As I said, we pursue this growth, and we're working hard to drive productivity of our marketing spend.

Number two, our tuxedo rental program continues to grow each quarter since we launched it in early 2010. And we're pleased with our spring prom season this year. That being said, our tuxedo business is still not big enough to report separately, and our core business still accounts for the vast majority of our sales.

Number three, our special sizes continue to be an important opportunity for us with a good portion of the business coming from our Direct Marketing segment. This reflects our ability to showcase our broad range of sizes and fits online, with Traditional, Tailored, Slim and Regal Fits, and Big and Tall size extensions, we make it so there can be no doubt We Can Fit Almost Everyone.

Number four, our Factory Stores. We're on track to open 8 new Factory Stores by the end of this year, bringing our total to 43. These new stores would represent an increase of over 20% in our Factory Store base, and we are well on our way to our target of 100 Factory Stores. The Factory Store business continues to help us attract new customers with a different profile, who are not shopping with us in our Full-line stores, and contributes positively to both sales and net income.

And number five, our Full-line stores. We expect to open a total of 22 to 27 new Full-line stores in fiscal 2013 in convenient locations, in new and existing markets for us, and on lease terms that fit our stringent criteria. We opened 10 new stores in the first half of 2013, of which 7 were Full-line stores and 3 were Factory Stores. Combined with our new Factory Stores, this will bring our total number of stores to over 630 by the end of the year, making an increase of approximately 5% in our retail square footage. And I can confirm of what we told you last quarter that we plan to open stores at roughly the same pace in 2014, bringing us closer to our goal of operating approximately 800 stores nationwide, including approximately 700 Full-line stores and 100 Factory Stores.

So in these 5 areas, we see growth potential for our business. Importantly, they each enable us to leverage the 4 pillars that have been consistent in our business since our team arrived in 1999. Commitment to quality, achieved through aggressively managed worldwide sourcing, dedication to service, being in stock with a high-quality product mix, and delivered product innovation while maintaining our classic style position.

Now moving ahead. While current business trends have been challenged by a variety of factors, we've taken proactive steps to stabilize the core business, and we have a plan to return the company to a stronger earnings trajectory. As we do that, and as we have recently announced, we are pursuing an acquisition strategy that would enable us to leverage the core strengths of our operating team and the infrastructure we have built, ranging from our sourcing and distribution capabilities, track record of product innovation and real estate management, through our customer knowledge and the store experience we offer. These strengths have made our company a leader in the menswear business since our current team assumed leadership of the business in 1999, using virtually any key performance metric. These are also the strengths that have been instrumental to the record of performance we have achieved throughout that time. We are clearly focused on correcting the issues that affected us in the last several quarters and returning to the performance trajectory that we are proud to have been on by employing our core competencies.

We believe our best strategic path is to capitalize on our capabilities to take our company to the next level through a strategic acquisition, using the cash we have generated from running the business soundly and strategically over the past 14 years. Specifically, our goal in an acquisition is to create the potential for long-term earnings growth by integrating and growing an acquired company to drive shareholder value, which we believe could far exceed any short-term EPS impact that may be achieved by using cash in the form of a share buyback or a special dividend.

We have been surveying the marketplace for acquisitions for some time. And in doing so, we have reviewed a large number of candidates, in terms of their fit with our business strategy and core competencies, the accretion they would offer and the potential for substantial cost synergies that would enable us to drive profitable and sustainable growth in our combined businesses.

The Chairman of our Board, Bob Wildrick, has been at the center of this activity working aggressively to ensure that we are using our assets prudently, and whatever acquisitions we identify will contribute to a sustainable value creation for our shareholders. When the Board elected Mr. Wildrick to be Chairman of our company, he requested that we -- that he lead the review of strategic opportunities so that I could focus on the core business. He has analyzed many acquisition candidates, but the highly confidential nature of M&A activity has kept it out of public view. To ensure that we are getting the proper financial advice, the Board is also engaged both in AMCO and Goldman Sachs in this process. Of course, we cannot provide specific information about the candidates we have and are looking at, but we can tell you that they are mostly within the retail sector and have the potential for strong growth well into the future that we believe will be accelerated as a result of the skills and capabilities we would add to the equation.

While we are working to enter an acquisition in the near term, our ultimate decision will rest on 3 characteristics: the strategic fit with our business; the ability to leverage our core competencies; and the accretion and opportunities for synergies that would allow us to drive substantial value creation over the long term. But to be clear, even as we pursue this path, our Management Team remains keenly focused on improving the current business trends.

Before we take your questions, let me note that we are aware that we have not maintained the level of dialogue with the investment community that you would like. To that end, we have begun to institute some changes. We have reignited a systematic program of meeting with our major shareholders to benefit from their perspectives as well as to share our thoughts on where we are going as a company. The meetings we have held to date have been instructive and we are committed to keeping those going. And we're listening. We heard that you wanted a more timely conference call following the release of our quarterly results, so we have compressed that time window beginning with today's press release and conference call. We heard that you wanted a more professional investor relations effort, so we have retained a major IR firm to help us in that regard. And to ensure this is taken seriously within the company, we have designated our Lead Independent Director to actively oversee all of our communications activities. We heard that you would like interactive Q&A on these earnings calls, so we are reinstituting that beginning with today's call. We would only ask that you limit your questions to our operational and financial results, and the general performance of and our plans for the core business. Given the questions we have been receiving about issues such as acquisitions, we felt it was important to share our thinking in our prepared remarks. We feel strongly, however, that we have said everything here that we can say publicly at this time. Rather than speculate on a hypothetical acquisition, we think it appropriate to discuss the performance of the core business at this time. We appreciate your cooperation, so thanks in advance.

Before I close the call -- this portion of the call, let me say that our Management and Board are dedicated to our roles as stewards of this company and as capital for the benefit of all of our shareholders. We are looking forward to a bright future.

With that, I'll turn the call back to David Ullman, who will host the Q&A, and operator, please open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we go to the line of Brian Tunick with JPMorgan.

Bilun Boyner - JP Morgan Chase & Co, Research Division

This is actually Bilun Boyner for Brian. We have a couple of questions. So first off, I'm still wondering how we should think about the gross margins going forward, given puts and takes on sourcing, supply chain initiatives and from a promotional cadence standpoint. And then the last few quarters, you've been talking to trying different marketing strategies. Can you provide more color on what seemed to work better there? And then finally, can you provide a little more color on tuxedo rentals? In the past, you talked about growing that business, so maybe if you look at acquisitions in that space?

R. Neal Black

I'll start by talking about the gross profit margin, specifically relating to August and how that trend continued based on the gross margin in the second quarter. While we believe our gross profit margin trend may have bottomed out, our gross profit margin was down slightly in August due to the timing of Labor Day. Since part of Labor Day weekend was in August this year, and was in September last year, we got some of the benefit of our Labor Day sale revenue in August, but that also impacted the margin. More specifically, sales and margin were both up after the first 3 weeks of August. Week 4 had an -- had the extra promotional days from the front end of Labor Day weekend, and after 4 weeks, sales were up even more then after the 3-week period, but margin was down slightly due to those extra promotional sales. So I think we're happy with the margin trend, but it's still too early for us to call that as a long-term trend against the upcoming fall numbers. Regarding the tuxedo, basically, on -- we had talked in the past about that. Right now, we're proceeding with the development of business using a supplier who owns the infrastructure and the inventory. And we're happy with the way that's working, but we don't anticipate making any changes in that, the structure at this time. I think the last...

David E. Ullman

Marketing.

R. Neal Black

The marketing.

David E. Ullman

You want to repeat your question on the marketing?

R. Neal Black

On the marketing?

Bilun Boyner - JP Morgan Chase & Co, Research Division

Yes, what seemed to be working, I guess you've been trying different strategies over the last few quarters.

R. Neal Black

Well, I think the most positive thing I could say is about our Making it WORK campaign. For the first half of the year, most of our Traveler collection products were included in that program. They accounted for about 1/4 of our sales and 1/4 of our inventory. The products were advertised to show their features and benefits, and were shown at simple value prices with no price comparisons. After 6 months, these products had sales and gross margin increases, and even while the promotional sales and other parts of the business declined. So we expect this to result in a better positioning for our brand. And that, more appropriately reflects the quality and value that we offer, so we'll be building on this success in the second half of the year, managing the balance between this style of marketing and our regular promotional activity.

Operator

And next, we'll go to Jill Nelson with Johnson Rice.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Can you talk about the performance of your new stores and then your thought process on continuing your 5%-plus square footage growth when your profitability at the core stores are still struggling?

David E. Ullman

The stores -- so, this is David. The stores that we have opened in the past several years have been very consistent performers, and have actually improved over the -- some of its predecessor groups of stores. However, we do find that our new stores tend to run somewhat in tandem with the direction of the overall business. So for example, in 2012, when we had a difficult fourth quarter, the new stores also were impacted by that. But generally speaking, we are pleased with the results of the stores and their progression. And we do see that they're continuing to develop and evolve at a faster rate than kind of the older stores.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Okay. And then just your thoughts on your core customers' appetite for Tailored clothing. Is there any risk that possibly you fill their closet, given some multi-unit sales that you've run in the past? And then, how can you attract a new customer at this point?

R. Neal Black

Well, I'll take that into 2 parts. First of all, the real issue for us right now, because the Tailored clothing business has cycles, is to reestablish our business casual side of the business. Over the past 14 years, we've got a really good track record of offsetting a slowdown in the suit business with an increase in the business casual business. And that hasn't been working for us in the first part of this year because we haven't had the right assortment on business casual, as I discussed, and we believe we have those corrections in place for fall. So the long-term trend then, as I've said many times in the past, the long-term trend in menswear is towards casualization in the workplace. And so, the suit business has cyclical elements to it that have a lot to do with the economy and the state of mind in the country at the time. And we've seen a couple of big surges in suit business, when things in the country aren't great. We had a big surge after 9/11, and we had another big surge after the financial crisis in '08. And we're still riding that particular peak right now. But it will decline and it's imperative that our business casual picks up the difference. And we believe that's a strength of ours, and that the -- our inability to do that in the first part of this year is assortment-driven.

Operator

Our next question is from Mark Montagna with Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

So I've got a bunch of questions, but I'll just ask them individually. Last year, August comped up double digits, but finished the quarter up 4.8. I'm wondering, what caused that deceleration last year?

R. Neal Black

I would say that in the third quarter, that's when we began to see what we talked about is our -- the slowdown in our ability to annualize our promotional spikes and lack of -- or a decline in the response of just some of our promotional advertising. It wasn't aggressively apparent until we got into the fourth quarter. But in the third quarter, that would show you the volatility between the months is one of the reasons and it's one of the reasons we're positive about our turnaround in August this year. But it's a short time period, hence, too early to call to see if we've got that trend effectively annualized.

David E. Ullman

Yes, so we're happy, obviously, that we were able to anniversary a large increase in August and do very well against it. So we're just -- we're looking forward to being able to keep that trend going.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then next question. Finished goods inventory per store was down 3.5%, but sales were down 10%, kind of implies to me that you should -- that you probably have some spring carryover merchandise that needs to be marked down. I just wanted to verify that. Because countering that, it sounded like your gross margin was up through the first 3 weeks of August. So something -- I just need to make sense of those 2?

R. Neal Black

Well, I think the takeaway there is yes, we have obviously not achieved the sales that we wanted to achieve. So clearly, there's unsold inventory. A portion of that, as always, is a classic inventory that's not the markdown risk. But there is seasonal fashion out there. And as I said earlier in my remarks, in the second quarter, we had more -- a higher penetration of sales of clearance in the second quarter than we had a year ago, and still managed to improve the margin at the same time. And so, we're out ahead of -- we're out a little bit ahead of where we need to be in terms of the current season's inventory, but we will be clearing it into the fall season.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Did you think with that spring seasonal product that you're looking to reduce, does that put marginalized margin at risk of decline versus last year?

R. Neal Black

Well, it all depends upon the mix. We managed to mix out the second quarter pretty well in terms of clearance. As I said, an increased penetration of mix. But a nicely improved gross margin on the rest of the business, and it mixed all well. But the customer tells you, and we won't know until the sales come in. We've had quarters in the past where we've mixed out way too high on clearance because that's what they wanted. And we had it available and they bought more in relation to the regular goods than we had planned. That wasn't the case in the second quarter at the moment. I'm confident that we have the right pricing strategy in place for Q3, but we won't know until we get there.

David E. Ullman

And as a reminder to everybody, more than 2/3 of our sales come from core products that we sell each year. So the seasonal or a risk is typically associated with a smaller portion of our business.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then, next two questions and I'll just drop off and get back in. When -- which quarter can we expect to see you start to sell cotton-based products that have the cotton raw material cost that started at the bottom of the cotton cycle that started in June 2012? That's when -- it seems like June 2012 is when the cotton bottomed, and I'm trying to understand when does that product get to retail stores?

R. Neal Black

So it's a long and complicated sourcing cycle. We're sourcing product a year, give or take in advance. And we have a large inventory of core products, and a turn, particularly in core products, that's not superfast. And so the piece of it moved through. What we have said is we believe that the high-priced products peaked in their sell-through in our assortment in the fourth quarter of last year. And I think you can infer, from the gross margin in the second quarter, that we're seeing the new lower-priced products post the high-priced peak starting to move through our inventory now.

Mark K. Montagna - Avondale Partners, LLC, Research Division

But the stuff that's moving through right now, I assume, is that -- is some of that from when cotton bottomed or...

R. Neal Black

Well, I tried to outline in my prepared remarks that it's very hard to draw a conclusion from the commodity pricing cycle to what we actually see in finished goods. And in cotton, in particular, I can give you an example. The cotton commodity prices that are readily available and followed by most people are short staple cotton, which generally drives knit products worldwide that are driven by things like T-shirts. And a lot of the cotton that we buy is long staple cotton which is in much shorter supply, and has a different curve and is less readily visible on the commodity market from those numbers. So when -- just as an example, we had situations when the commodity prices were starting to come down in short staple cotton, very visibly to everybody that we were not seeing the same declines in long staple. And then you add to that, the other complexities of cost in the finished garment, meaning labor costs and currency and shipping and other factors, it's just hard to draw a line directly to the commodity pricing.

Operator

[Operator Instructions] And we'll go to Brian Rafn with Morgan Dempsey.

Brian Gary Rafn - Morgan Dempsey Capital Management, LLC

Let me ask you, relative to and then maybe this audible you're doing on the business casual, we've been around in more than a dozen stores over the last 4 or 5 weeks. And it seems to me you're a little under-inventoried in fall items. Is that because you did this kind of audible planning, with trying to get more business casual in? We've owned a stock since '95, and just like when I've seen the stores, I see a lot of EIP, I'd see a lot of fuschia and aqua colors, I see a lot of summer. But I'm not seeing a lot of fall stuff yet.

R. Neal Black

A few years ago, Brian, we actually shifted the timing of our seasonal changes because of a demand by customers for a wear now. There used to be, a number of years ago, a transition period where most stores in the month of August would be completely converted to fall. And we are kind of on that cycle, but the weather is still very hot in most of the country. And we found that there was a big demand for running wear now product through the hot weather just like we run wear now products through the cold weather in the first quarter. And so we're on the conversion cycle that we planned. And I would say, it'll be the end of September before you see stores heavily converted. So that's not really about the -- either the sales trend or the changes in the assortment. The fall just -- the timing isn't on our cycle yet. It's just the transitional month, September, and we'll be pretty well fixed by the time we get to the end of the month.

Brian Gary Rafn - Morgan Dempsey Capital Management, LLC

Yes. Okay, okay. Given that you guys -- these buy 1 get 3 suits, 2 shirts, 2 ties and a cell phone, what you guys say, and I know you went into this and I think September of '08, you never thought this will be a 5-year battle plan. I get that. Would you assess that you kind of hit the peak of the capture of those type of, and I don’t want to call it shock advertising, but I mean, that's a pretty impressive sale relative to the amount of apparel that you get. Have you kind of run that to its limit?

R. Neal Black

I mean, you -- that's exactly the kind of the thing we're trying to describe when I say we're having trouble annualizing our promotional spikes. Those types of promotions, which were originally put in our cadence and meant to last 18 to 24 months, served us quite well, really all the way through 2011. But starting last year in the second half, they lost some of their impact, and we've been having trouble ever since, annualizing those types of big promotional spikes. And -- but here in August, we've got a mix that worked, and that's what we've been searching for, for 3 quarters.

Brian Gary Rafn - Morgan Dempsey Capital Management, LLC

Okay. How is it then, when you guys have these different focus sales and you put on something on promotion, how has your customer or your -- maybe your staff, how have they been able to accessorize the customer? Is a guy coming in, who sees the suit sale or sees the coats, is he coming in for that? And are you able to wrap some IPTs around him, or is he just strictly coming in for what's being promoted?

R. Neal Black

Well, as you know, we have a high quality, commission-incentivized sales force in all stores. And they make a living adding on to a transaction and building up the items. Now in some of those big promotional spikes that I talked about, there the promotion itself kind of built up the quantity of items in the transaction, and so it was easy. But we're certainly capable of building items per transaction through the skill and knowledge of our sales force. And that's where we've always been focused.

Brian Gary Rafn - Morgan Dempsey Capital Management, LLC

Okay. Let me ask you, Neal, as you guys look at -- you've been very good with Slim Fit and the Trim Fit, and the Tailored Fit and that type of thing, and I don't want to say it's kind of crowded out Big and Tall or some of the classic, but has that been designed to capture, in addition to the tuxedo rental, that younger customer, that 18- to 28-year-old guy? Or are you really finding that the Slim Fit and Trim Fit is really your core customer base?

David E. Ullman

Brian, this is Dave. Before Neal answers that, we do -- we'll have to ask you to go back into the queue because we do have limited time this morning, okay?

R. Neal Black

The beauty of the Tailored Fit is that that was our -- is our strategy for allowing every customer, including all of our regular customers, to convert their wardrobe to a more modern approach, a more trim-fitting approach. And it's designed to fit every guy, regardless of size. So now that was really meant to be a way for a guy to update his wardrobe. And for us, that's always nice when there's a cycle that tells a guy that he has to change out what he owns in his closet into something new for the look. And it's been really successful for us, and we were almost ahead of the curve, I would say, on that. Slim Fit, itself, cannot be worn by every guy. Slim Fit is for a thinner guy, many of whom happen to be younger. Like me, you don't -- you're not as slim as you were when you were young, and a Slim Fit is not necessarily for me. But I -- Tailored Fit is perfect for me. I would say the Slim Fit is meant to get us a newer, younger customer that might not have been looking at our classic styling. And it's working very well. It will never be as big for us as it is in some more trendier stores. But we try to fit everybody, and it's just an element that we wanted to add that allows us to do that. Tailored Fit is really where the business is for us.

Operator

And we do have a follow-up from Mark Montagna with Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Neal, you mentioned that the 2014 stores would be at a similar pace to 2013. I'm wondering what percent of those stores next year are going to be Factory? And then how many leases have you signed already for 2014?

R. Neal Black

Well, we've never given a lot of color on the breakout of the future store openings because it's basically opportunistic for us. We're in the market all the time looking for sites. One of the things that we did do without getting into the specific numbers is, we have a concentrated effort now for 2014 of getting the openings earlier in the year, and really trying to prevent store openings happening into the holiday season. In the last few years, we've had some drift in our opening schedules that's allowed, in my view, too many in November, for example. And I'd love to get more in February and less in November as a strategy. The Factory Stores themselves, it's a very difficult call. We always like to open more. But we keep the number fairly low based on the fact that almost all the quality centers are 99% to 100% full. And so we're just waiting in line for the right spaces at the right prices. And it's hard to predict. We think we can get a number similar to this year. By the time we get there, maybe a few more. But it's a by-the-quarter kind of update. And so I'm happy with what we have in the queue right now for the first quarter of '14, a little bit more than the first quarter of '13. And I'll add color to that every quarter based on how we've succeeded.

David E. Ullman

Yes, so Mark, we have a list of targets that we have, both on the Full-line stores and the Factory Stores. And it's just a matter of when the opportunistic deal comes along in the right space.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then you're in a bit of a transitionary period or year right now. So have you given any thoughts of upgrading your systems for the merchandise inventory allocations. Because according to your 10-K, it has not been updated since it was fully installed in 1999. It just seems like that would be a great way to improve your efficiency, boost the profits because some of that foreign labor is never going to go back down to where it used to be, and some costs, you're just never going to get back.

R. Neal Black

Well, we have an effort underway right now on our POS. It's kind of taking our systems initiatives. The money that we're spending there is headed into the stores where we think it's most important. We feel we have strong systems in place to make projections for production and to manage our inventory, stocking and replenishment. And I think right now, we're focused on the stores. Anything you want to add to that, Dave?

David E. Ullman

Yes, and I agree. I mean, that's so -- we are focusing on our POS upgrade that we've mentioned publicly. So the focus there is really customer-centric. We expect the new POS system to be much faster and more efficient; to be able to process customers and to enable them to utilize tuxedo rental and enhance our tuxedo rental process; to be able to use our omni-channel process which we have had in place for about 5 years, it enhances that; and to be able to handle our sophisticated promotions we do. So we think the customer focus is where we should start. And anything as far as product, as Neal mentioned, again, I'll go back to 2/3 of our products are core products, and we're able to manage that at a different level and a different pace than we manage the seasonal businesses and we do have 2 different approaches for them.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And catalog mailings, how much do you expect those to be down versus last year?

David E. Ullman

Okay, Mark. Mark, just so everyone knows, this is the last -- this will have to be the last question. So we do -- we will certainly address your question, but this will be the last question then. Thank you, everybody.

R. Neal Black

Our total direct mail, including catalog, is up. But the catalog itself continues to decline in its mailing quantity. The response to the catalog now is almost all on the Internet. There's very little of the old call center catalog business remaining. And we manage that, a mailing at a time based on the productivity. I've been happy with the productivity in the catalog and it affects, again, the omni channel, as Dave mentioned. But we're looking at it now basically as the driver, primarily a driver for the Internet, and adjust that accordingly. The real issue for us is not our own customer database, but catalog mailing also includes a large amount of prospect mailing, where we buy names basically from other Direct Marketing people. We don't do that in the regular mailings for the stores, but for the catalog, we always have and have a methodology there. And the names, the available -- the amount of available quality names in our segment has really deteriorated over the last 5 years. And so there's not as much available for us. And so we're focused heavily on our own customers, and we prospect on the Internet in other ways and it's one of the reasons we're focused a lot on television because we look at that as our prospect and vehicle for the store channel.

David E. Ullman

We view the catalog, just like we do any other marketing pieces we have, whether it's direct mail, radio, TV. It's just another element of our entire marketing package. And we analyze their productivity to see which are driving the most volume at the best results. So as I mentioned, this -- that will conclude the call. We do appreciate everybody joining us today.

Operator

Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.

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