Express Inc (EXPR) 2013 Q1 法說會逐字稿

Greetings and welcome to the Express Inc. first-quarter fiscal 2013 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Marisa Jacobs, Vice President of Investor Relations. Thank you, you may begin.

Thank you. Good morning everyone and welcome to our call. I'd like to open by reminding you of the Company's Safe Harbor provisions. Any statements contained in this conference call except those containing 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 suggested in those forward looking statements due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC, including today's press release. With me today are Michael Weiss, Chairman and CEO, David Kornberg, President, Matt Moellering, Executive Vice President and COO and Paul Dascoli, Senior Vice President and CFO.

I'm going to turn the call over to Michael now to speak with you about our recently completed first quarter and our priorities for the balance of 2013. When he completes his remarks, David will focus on some of our product initiatives and Paul will cover our first quarter financial performance as well as our second quarter and full year 2013 outlook.

We will then turn to Q&A before concluding the call.

Thank you Marisa and good morning to everyone joining us on this call.

I'm sure that most of you have already seen the press release we issued early this morning. It's nice to open the call by noting that our business performed well. We navigated through some tough external factors by delivering strong product, driving sales through the use of effective promotions and managing expenses well. This enabled us to come in at the high end of our guidance.

At the start of the quarter we knew we faced headwinds driven by higher payroll taxes and delayed tax refunds, which led to less disposable income for our customers, at the same time that unusually cold weather in several regions of the country led - in some places - to the Spring that "wasn't".

Those of you who were following us last year know that Q1 was our strongest quarter of the year and the one that represents the toughest comps to go up against.

The Q1 guidance we provided in March was developed on the basis of our actual performance in February and early March coupled with our expectations for the balance of March and all of April. Traffic had been weak leading up to the call and we weren't sure how consumers would respond to having less money in their wallets. In addition, the Easter shift meant we would lose the extra build week that occurs when the holiday falls several weeks after Spring break.

In any case, we capitalized on the natural traffic surge that did occur when Easter came, and used the same strategy employed during Thanksgiving. Once again, it proved very successful. A clear promotional message of 40% off drove significant business. And, because we again elected to take off all other promotions and disallow CRM coupons, in contrast to last year's Easter event when they were accepted, we did not unnecessarily forfeit margin dollars.

Once we got past Easter we naturally expected the weather to improve steadily so that the normal spring build would begin. When this did not play out as expected, we elected to get more promotional to drive traffic and to remain competitive within the mall. This tactic worked and enabled us to turn in results that are at the high end of our guidance. So, I'm pleased to report that even in the face of challenging traffic trends, net sales increased 3% and our comparable sales for the quarter were flat to last year. Our diluted EPS came in at $0.38, at the high end of our guidance. What we accomplished in the face of those challenges is a testament to the talent of the Express team.

When Paul speaks to you in a few moments, he will touch on other aspects of our Q1 financial performance. I will focus the balance of my remarks on how we operated during Q1, the progress we are making with our growth pillars and the initiatives we will be emphasizing during the balance of the year. As a reminder, our growth pillars include increasing sales productivity, expanding our store base, capitalizing on our e-commerce opportunity and increasing our international presence.

As I think about our sales productivity, I'm confident that we can drive improvements because of our product; to me it represents one of our strongest collections in years. David will do a deeper dive on this, but I believe that our spring offerings, both in the stores and online, really hit the mark and that we are successfully presenting the major trends driving our women's and men's businesses. And, as I look at our May and June receipts, I think we look great and am extremely confident about those items as well based on our current momentum. We're introducing differentiated product that combines great design with high quality production to reinforce the best of the Express brand.

As the stores continue to improve, productivity will in turn begin to build again. We're not yet back to our peak levels for some metrics, but it feels great to be moving in the right direction. So, as you've probably seen, our second quarter guidance calls for comps to be up mid-single digits and for our diluted EPS to come in at $0.17 to $0.21.

I also want to acknowledge the significant improvements we've been seeing in our Canadian stores, which are currently delivering strong double digit comps. We have been on the path to parity pricing there for some time now and we have finally completed those efforts so that every item in our Canadian stores is priced at par with its U.S. counterpart and with its on-line prices, something that becomes very obvious to customers looking at pricing on-line.

We've also begun to work with some new logistics partners whose pricing structures are enabling us to offer parity in shipping charges for E-Commerce orders. We know that our neighbors in Canada appreciate the opportunity to shop at our stores in their own neighborhoods instead of travelling across the border and the fact that their shipping charges are consistent with those being paid by our U.S. customers.

New store openings will continue during 2013, in both the US and Canada. Sixteen locations were identified at the beginning of the year and so far, three have been opened, one of which is in Canada. We've created a new table in our press release, Schedule Number 4, which lays out a variety of real estate details. We hope you find it easier than trying to take notes on all of this during our call.

Let me move on to the subject of our two flagship stores. It's exciting to be able to report that we finally took possession of the San Francisco site in mid-May. Now that we are in control of the property, I'm comfortable telling you that barring any unanticipated delays, the store should be open in time for the 2013 holidays. In terms of the Times Square store, the landlord is continuing the work he has to complete, joining together the two adjacent properties, before he can turn the site over to us. We continue to believe that a spring 2014 opening is realistic.

In March I spoke about another area of real estate focus that we consider to be important; what I referred to as "winning hub locations". My specific words were that we were "moving quickly to enhance our presence at these winning hub locations. It's an important way for us to build sales, promote the brand and introduce Express to new customers." Or said another way, we believe it is essential to maintain an important presence in top volume malls to remain competitive with the newer players who are opening compelling stores in these locations. As the retail landscape shifts, we must be able to do big business where big business is being done. And, we are doing that.

As noted previously, at the San Francisco Center we took additional space which just about doubled our square footage there. And a few weeks ago, we moved out of our original location at the Las Vegas Fashion Show Mall and into a new space that is more prominent, 50% larger and which boosts our presence within the mall. The store has only been open a few weeks, but it is far exceeding our expectations. In July, we're on track to do the same thing in Dadeland and we're expecting to see a nice boost there as well.

Another new initiative mentioned on our last call relates to domestic outlet stores. We've made progress on that front and remain excited about their potential. We recently hired a Vice President of Outlet Stores, who is expected to start shortly. His first priority will be to refine our strategy and develop a comprehensive business plan and operational roadmap for this important initiative. I do, however, want to remind you that our guidance for the full year excludes the impact of any expenses associated with the development of this business.

Our E-Commerce business grew by 48% in Q1 on a reported basis. We've invested in this area over the past year to improve the site performance and experience, and it's paying off in the form of higher conversion.

The move to free shipping on orders over $125 also accounts for a portion of the sales growth. The beauty of this business is that we can continue to offer a combination of product that is in the stores and supplement it with additional product, without space constraints. For example, men's and women's swimwear is only offered on-line. In categories such as men's suits and underwear and women's dresses, styles offered in the stores are supplemented by additional styles we only offer on-line.

On the international front, our guidance calls for our existing franchisees to open between 13 and 16 new stores this year. We remain on track to do so. In addition, we are continuing to evaluate opportunities to add franchisees in new markets.

One final international comment, although it's related to external events. The building collapse in Bangladesh was a horrific tragedy and something that we all hope will never be repeated. As many of you know, most of our product is made off-shore in a variety of different countries; however we are not manufacturing product in Bangladesh.

In conclusion, as I look at 2013 as a whole, I believe we have put the missteps of 2012 behind us. We learned valuable lessons, applied those learnings, and are moving forward. There is no doubt in my mind that the product in our stores now and what is coming in represents some of the best product we have created in quite some time. We are definitely moving in the right direction and along with the entire management team, I believe the business is on firm footing. With that, I'll turn the call over to David.

Thank you, Michael. Good morning everyone.

We just wrapped up another big weekend. For Memorial Day this year, we started our sale one day later and went to "40% off with no additional promotions or CRM". I'm happy to report that it worked very well. It was clean and simple to understand compared to the variety of different BOGO and percent off offerings that we used last year. We view the margin dollars generated over the holiday weekend as an important measure of success, and we saw a significant year over year uptick in that metric.

Turning now to Q1 and what worked and what didn't, the overall picture is one that I'm very pleased with, especially if we take into account the environment in which we were operating.

From an operational standpoint, we have made real progress and inroads executing our Go to Market strategy, especially on the women's side of the business. We are getting more and more thoughtful in terms of our approach to identifying key items that can be nurtured into something much bigger than originally estimated and conversely at moving quickly to clear out things that aren't working.

In terms of product, it's clear that we have fixed the women's sweater business, with sales and margins coming in at levels that beat last year. Sales of our woven tops grew as well.

And, of course you all know by now that one of the key drivers in that category is the Portofino shirt. This is a great example of the kind of key item that can be built into something of real significance. In addition to constantly flowing in new colors and prints, we've introduced a sleeveless Portofino and we'll keep maximizing the potential of this soft fabric.

We achieved this remarkable growth by chasing this item to get product into our stores quickly and by building out the variety and depth of our offering. This illustrates the importance of team work. For example, our production team capitalized on our long standing relationships with manufacturers willing to go the extra mile when opportunity presents itself. They partnered together to deliver huge quantities of an item that is in demand and successfully maintained the garment's high quality.

This is a good example of how we can build a strong future for the brand. Knit tops have turned around as well, especially our casual assortment.

As we shifted into more opening price points our overall AUR has come down a bit. At the same time, we've taken up prices on some items, including some of our knits and dresses, without dampening demand, demonstrating the power of the brand when the product is right.

In terms of specific product, our peplum tops, for example, are amongst the strongest out there, our bra camis continue to grow and our pocket and crop T's are all exactly right for the moment. In dresses, we have a number of popular styles and our fit and flare dresses, in particular, are something that our girl clearly loves.

As we move into summer, I am seeing the fit and flare silhouette get even stronger and as fall approaches, we are adapting it accordingly. Many of these looks fall on the casual side, where there is no doubt in my mind that our offerings have improved dramatically since this time last year. Dressy knit tops are a category where we still have room for improvement, and with new tested receipts starting to flow in, I see real opportunity there in Q2 any beyond.

Pants and denim for women are continuing to do well, but our skirts are still lagging behind. As you would expect, we're keenly focused on this.

With respect to denim, indigo with different washes and destruction are doing well. We now have many different fits and lengths including crops, ankles and leggings. Part of our inventory build relates to ensuring that we have the right depth in this key category as we head into summer and the back to school period.

Once again the men's business outperformed the prior year's comparable quarter. Suits and jackets continue to be stand out categories delivering substantial growth, and carry some of our highest AUR's. I'm sure, based on Michael's comments, you won't be surprised to hear me say that sales of shorts were down year over year in the first quarter.

We've heard a lot of questions about our ability to comp the colored bottom trend that was so important last year and the short answer is that we managed to do it and deliver gains in both the men's and women's denim and casual bottoms categories. We anticipated the decline in interest in men's colored bottoms, but we didn't get the timing quite right and found ourselves somewhat over inventoried in that area on the men's side of the house. We've taken the necessary markdowns and have cleared through most of that inventory, but that is the primary reason why the units in our Q1 box sale were up over the comparable sale period last year. We expect to clear through the balance of this inventory in Q2 and we've incorporated this expectation into our guidance.

From a brand building perspective, the first quarter was exciting and the same can be said about the early part of Q2. Fashion Star, the NBC TV show we discussed with you in March, provided us with wonderful visibility. We've already had over a million hits to the Fashion Star page on our website, and more than half of those visitors were new to Express. Those hits in turn drove sales, not only of the Fashion Star product, but of Express product. The best part is that over half of those purchases were made by first time Express buyers, so it also led to an expansion in our customer base. We also received great publicity on NBC and lots of related media coverage.

Totally apart from Fashion Star, we held an exciting denim event in New York City. We created a denim lab to profile the breadth of our men's and women's denim collection. Over 100 editors, stylists and related fashion personnel attended and based on the great feedback we received, we hope to secure some very visible editorial coverage in the fall fashion press.

This kind of coverage is great on two fronts - it reinforces the relevance of our brand to existing customers and spurs other shoppers to check us out and, hopefully, become loyal customers themselves.

Let me conclude with a few forward looking observations. We are all energized by the results we're seeing from the new and re-ordered product in our stores. In terms of what's in the pipeline, what Michael said bears repeating. We entered the second quarter with reorders flowing in on some of our best items that we have seen in a while, including key items where we can drive real volume. We're also flowing in new items that tested very well and which represent relevant, exciting fashion.

Our focus on testing will continue, of course, and we believe we have identified the right styles to test in Q2 for holiday this year versus last year.

We are also planning to expand into a few new merchandise categories including the re-introduction of casual loungewear which, based on its past strong success, should do very well both in stores and on-line.

The quality of our product continues to be strong and when we combine great fashion with great quality, we offer our customer a truly compelling value proposition. We're taking an aggressive approach to driving the business forward and I look forward to updating you on our progress when we speak again in August.

With that, I'll turn the call over to Paul.

Thank you, David. Good morning everyone. Let me begin by reviewing our first quarter performance. Then, I'll turn to our second quarter and full year 2013 guidance.

As you have already heard from Michael and David, we approached the first quarter cautiously because the external unknowns that would ultimately affect our performance were more significant than normal. And, in the end, we were quite pleased with our performance and our ability to achieve the high end of our guidance. The macro environment is still challenging but we have made significant internal progress and put last year's problems behind us.

Our net sales for the first quarter totaled $509 million, a 3% increase over last year's first quarter. Once again, our growth in e-commerce was extremely strong. With a 48% increase year over year, it grew to $71 million, representing 14% of the business.

Our comparable sales were flat, following a 4% increase in last year's first quarter.

As you already know, our gross margin did decline. Specifically, gross margin was 33.6% of our net sales, down 450 basis points from the prior-year's 38.1%. This reflects pressure on both our merchandise margins and buying and occupancy expenses.

Our merchandise margin declined 240 basis points when compared to the same period last year. Our initial plans for the quarter called for certain promotional activity such as our Easter event, which Michael already spoke about. This promotion worked very well. Just as we reported when discussing our Thanksgiving promotions, we drove significant margin dollars that contributed to the achievement of our comp and EPS guidance.

Given the difficult retail environment across the industry, we also layered in some additional unplanned promotions to drive traffic and remain competitive. We also offered deeper discounts on some distressed merchandise during our Q1 sale to optimally liquidate our remaining positions. These actions depressed our merchandise margins, but enabled us to end the quarter with a clean inventory position. It is important to note that our comp performance improved as the quarter progressed, and that elevated promotional levels have not been required as we entered the second quarter.

Buying and Occupancy expense increased by 210 basis points in line with our discussion in March. We incurred approximately $4 million in incremental pre-opening rent expense associated with our Times Square and San Francisco flagship locations. The balance of the increase related primarily to incremental costs associated with e-commerce fulfillment and the lack of leverage caused by flat comps.

Our overall SG&A expenses fell minimally to $113 million from $114 million in last year's first quarter. As a percent of sales, SG&A dropped to 22.1% versus 23% last year, a 90 basis point improvement.

Operating income was $59 million, or 11.5% of net sales. This compares to $75 million, or 15.0% of net sales in the first quarter of 2012.

Unfortunately, the impact of our promotional activity and B&O pressure outweighed the gains made on the net sales and SG&A lines. As you can see from our guidance however, we expect these pressures to ease as the year progresses.

Income tax expense was $21.2 million, representing an effective tax rate of 39.6% compared to $27.9 million at an effective tax rate of 39.9% in the prior year's comparable quarter.

Net income for the first quarter was $32 million, or $0.38 per diluted share on 85.5 million diluted weighted average shares outstanding. This compares to net income for the first quarter of 2012 of $42 million or $0.47 per diluted share on 89.3 million diluted weighted average shares outstanding.

Turning to our balance sheet, we remain in a very strong financial position. Cash and cash equivalents were $244 million at the end of the quarter and our Revolving Credit Facility remains untapped. Our long-term debt at the end of the quarter was $199 million, virtually unchanged from last year.

As I have said before, we regularly discuss with our Board the best deployment of our cash. Investment in the business remains our top priority since we believe that our four growth pillars represent excellent investment opportunities, along with our recently announced outlet strategy. With six months remaining, we also have $35 million of our $100 million repurchase authorization still outstanding.

Our capital expenditures during the quarter were approximately $17 million, flat with last year.

As expected and planned for, our total inventory increased compared to the end of last year's first quarter. We ended the quarter with $226 million of inventory, up 13% from the same time last year. The calendar shift due to last year's 53rd week accounted for approximately 4% of that increase. On a per square foot basis, inventory on hand was 6% higher than last year.

The primary reasons for the increase are the build to support our higher sales plan and our targeted inventory build in certain key categories.

As discussed on our last call, we are investing in higher denim inventory levels. We're doing this to ensure that we can keep our denim walls filled year round, to remedy current issues with size breaks, and to ensure that the customer views us as an authority in denim. We are also building inventory in certain key items like the Portofino shirt to support the sales growth we are experiencing. We're doing this without taking significant dollars away from other categories, since we don't want to give back the increases we are getting from strong performers elsewhere.

I'd now like to turn to our guidance for the second quarter and the balance of the year. You may have noticed that we have changed the format of our press release to include some additional guidance metrics and to present it in a table that I believe you will find quite easy to read.

Our expectations for the second quarter are for comparable sales to grow in the mid-single digit range. This compares to a positive one percent comp in last year's second quarter. We expect net income to be in the range of $15 to $18 million, or $0.17 to $0.21 per diluted share on 85.6 million diluted weighted average shares outstanding.

We expect a modest decline in our gross margin during the second quarter compared to last year. Merchandise margins are expected to be relatively flat compared to last year's second quarter, as the incremental promotional activity discussed earlier has abated.

Our buying and occupancy expenses will once again include an incremental $4 million associated with the flagship stores. This translates into approximately $0.03 per share. This will be the last quarter experiencing the full incremental load of the non-cash rent expense. In the third quarter, this amount begins to anniversary, so that the incremental expense falls to $1.2 million and in the fourth quarter, it will be flat compared to last year.

SG&A as a percentage of sales is expected to remain relatively flat compared to last year's first quarter.

In terms of full year 2013, we expect comparable sales to increase in the low single digit to mid-single digit range, an improvement over the flat comps delivered in 2012.

We have taken our full year net income guidance up to $127 million to $135 million, which translates into diluted EPS of $1.48 to $1.58, which includes the $9.2 million of incremental pre-opening flagship rent expense of approximately $0.065 per share. Just as a reminder, the guidance we provided in March was for net income in the range of $120 million to $132 million, or diluted EPS of $1.40 to $1.54. These changes reflect the fact that our first quarter came in at the high end of our guidance and that we now anticipate a stronger second quarter than contemplated when we first introduced our full year guidance. The EPS calculation is based on an estimate of 85.7 million diluted weighted average shares outstanding.

In terms of our real estate portfolio for 2013, please see our new Schedule 4 in the press release. We've laid out our domestic and Canadian plans for Q2 and the full year.

Our expectation for capital expenditures during 2013 remains unchanged from the guidance we gave in March, and is estimated to be between $110 million to $115 million. The increase over our 2012 spend is primarily driven by the incremental costs of preparing the flagship locations.

That concludes my comments so I'm going to turn the call back to Michael for his closing remarks.

Thank you Paul.

By now you certainly know that we are feeling very good about the business. We began the second quarter with product that has tested very well and that our customers are responding to in a very positive way.

Conversion is up and as I have said repeatedly, I view that as an important leading indicator.

The merchandise in the stores now is undoubtedly better than our inventory at this time last year and we are positioned to capitalize on this opportunity. We delivered and will continue to deliver the newness and quality that differentiates our business, that will drive the business forward and, over time, enable us to exceed our peak performance levels. Before wrapping up, I want to thank each of you for your continued support of, and interest in, Express.

Operator, at this time, please open the line so that we can turn to the question-and-answer portion of the call. Thank you.

Thank you. We will now be conducting a question-and-answer session.

(Operator Instructions)

Lorraine Hutchinson, Bank of America Merrill Lynch.

Hello, good morning, it's Paul Alexander for Lorraine. Can you guys talk a little bit about how you cut SG&A in the first quarter? What were the areas where you were able to pull back and will there be any pent-up or delayed spending that you're going to have to give back in future quarters? And then maybe related to that, could you expand on or clarify what you said about your expectations for the second quarter SG&A rate? Did you say you anticipate SG&A rate to be flat year-over-year in the second quarter? If so, that implies high-single-digit SG&A growth year-over-year so what accounts for the major difference between SG&A growth in second quarter versus the decline in the first quarter? Thank you.

I'll address your second question first Paul. We did say for the second quarter that we would expect SG&A on a percent of sales to remain relatively flat. If you look at some of those increases in spending, we have some increases in our IT budget as we've been working on the implementation of some new systems within our business. We also, as you know, had last year really held back in terms of adding any headcount into the organization. We're beginning to fill some positions that support our pillars of growth, specifically on the international side of the business, as well as on the e-commerce side of the business. We've been very, very disciplined in terms of our headcount in those areas. So those are a couple of the areas that will be driving some of the increase year-over-year. Marketing is remaining relatively flat.

We actually did not cut our SG&A that significantly in Q1. When you look at what we said in the script -- our SG&A on a dollar basis was relatively flat at about $113 million versus $114 million last year. We had increases in certain pockets and general decreases in others. We have been talking for the last 12 months about remaining very disciplined in terms of the control of our SG&A expenses. One thing that did decrease year-over-year, of course, was our incentive compensation expense, as you would expect, because our business hasn't performed to the level of the previous year. So, our incentive compensation accrual was certainly less this year in the spring season than last year so that fact impacted SG&A spending. But overall we did not do anything that we felt would hurt the business long-term and, on a full-year basis, we would expect SG&A to approximate last year on a rate basis. So we shouldn't see anything that's going to creep up unnaturally in the balance of the year.

Thank you.

Betty Chen, Wedbush.

Good morning, everyone. Congratulations on a great quarter in a tough environment.

Good morning, Betty, thank you.

I was wondering, perhaps this might be for either David or Michael, in terms of the product, it really sounds like there were several different key items that worked during the quarter. Is it fair to say that they continue to trend well in May because it sounds like you further invested behind them? And are there some new fashion trends that you could share with us without giving away your competitive secrets? And then if I could sneak in a second question regarding Fashion Star, that has been a terrific exposure for the brand. How long will that show last and how are you capitalizing on the additional names that you're adding to the file to retain that loyalty? Thanks.

Okay. Hello, Betty. Just to start off, we're very happy with the way in which May has started. It has really exceeded our expectations these first three weeks. In terms of looking at the trends as we're going forward, first of all, we have some great key items that drove the first quarter. The best of those key items we bought back into in much greater depth for the second quarter, and also as we look into the beginning of the third quarter, we see some of those trends continuing as well. We see lace continuing to be very important. We see leather trends as being very important. The whole athletic and sports influence in women's is getting stronger in terms of what we're seeing, and black-and-white has been very, very good for us throughout the first quarter and we see that continuing as well. In terms of Fashion Star, obviously we are thrilled in terms of the exposure and in terms of the visibility that we got from that. It was really, really great for the brand. In terms of capitalizing on that, obviously the names that we got get added to our list and we target our list very, very carefully in the approach that we take to e-mail and the way that we market the product. So it's a great advantage for us. Very, very big advantage.

If I could add just a little bit to that, Betty, because everything David said is really on the money but what I would include in this is that, of the best items that we have, the number one item as you know in the summer, spring/summer is the long-sleeved shirt, so an investment in that item, really does go forward, even though we bought it to promote heavily in Q2. What we're receiving now are forward fall colors and we feel that our best single item in the business will cost us almost no markdowns. Secondly, all the other items that we've reordered heavily because of tremendous good reaction in Q1 and are now receiving, such as the dresses, such as certain cut-and-sew tops, all were viewed as being great promotional items for the months of June and July so we're pretty confident in what we brought in additionally.

Great, well the stores do look terrific. Thank you and best of luck.

Neely Tamminga, Piper Jaffray.

Good morning, and I need to add my congratulations. It's just a phenomenal job on execution. So I have a question for you on the currency of the inventory, if I may. I get the whole investment levels of the denim side overall but just to allay any further concerns, can you talk a little bit about your spring carryover as you head into the summer months this year versus last year and then I just have one follow-up after that.

Hello, Neely, it's a David. We're very, very comfortable in terms of the way our spring carryover looks going into the Q2 sales. And in terms of the numbers and everything that we put in there, it is taken into account in terms of our guidance.

Yes, this is Matt. On top of that I'd add simply that, as we talked about in denim, we're basically building the seasonal lift denim product, which has very little risk associated with it. We believe it will provide some sales upside in the back half of the year because we have gotten feedback that we are broken in sizes and we do want to make sure that we're projected as the denim authority in the store. So we think that's a big positive and given the momentum of the business we're seeing in the last month, 1.5 months, we feel it's appropriate now to become a little more offensive and make sure we are in the position to capitalize on the great fashion that we have put in the store and that the customer is reacting to. I feel very good about our positioning.

Another important point -- Paul did mention it, but I would repeat it, Neely -- is that we have purchased so much of our biggest key items that unless we took a big part of that as additional inventory, we would have then had to obliterate other departments and our net gains would not have been any bigger. So we did take a shot on that, mostly because of what I just said but also because we felt a shot on that was safer considering it was a shirt that goes into fall.

That's really helpful and then just one quick follow-up here on the loyalty program? Just wondering if you guys can share, particularly as it relates to in-store conversion, which you guys have completely nailed and it's very, very, very encouraging -- how much did the loyalty program play into that specifically? And do you have any updates around the metrics of your program? Thank you.

It certainly played into it, Neely. We continue to see many repeat purchases by people who are in our loyalty program. What was really good, too, over the Memorial Day holiday is that in tracking that metric, we were also able to see a significant number of new customers coming into our stores. So, a higher percent of sales over the Memorial Day holiday were driven by our customers that are not necessarily connected to the program. So on an ongoing basis, it's been very, very good for us. We continue to use it for targeted marketing but at the same time, we see evidence that new customers are coming into our store and getting introduced to the brand as well and that's pretty exciting.

Congrats, you guys, good luck.

Jay Sole, Morgan Stanley.

I just had a question about the merchandise margins. You talked a little bit about it in the script, about why the merchandise margins were down. Can you provide more color on what the Easter promotion -- what percent of the merchandise margin was down because of the Easter promotion or what items were promoted? Was it warm weather items that didn't sell that were promoted? Or was it something else? And what is the opportunity to recover those margins in 1Q next year?

So, first and foremost, it was the general environment and us having to have promotions beyond what we had planned when we talked about our first-quarter guidance in our last conference call. We had planned the 40% off promotion for Easter and it did what we expected it would do. It capitalized on that natural traffic in the malls and it drove significant amounts of gross margin dollars for us. As we got further into the season, we needed to promote more to remain competitive in the mall. And there were some products that weren't working real well for us that we had to promote a little bit more, as Matt indicated, in our box sale. For instance, some of our men's colored denim was not performing as we had expected and we had a few casual knit tops that weren't performing as we expected so we promoted them at a deeper discount so, really there were products in both the warm weather, as well as other products that we had to promote a little bit deeper than originally expected. David, I don't know if you have anything else?

No, it's very clear. Just to repeat what Michael said, as we go forward into the second quarter, the items that we have reordered are of significant margin, they are proven in terms of their sales, and we believe that they can drive a significant amount of volume, so we're very encouraged in terms of the position that we are at as of today.

And we do expect that we will be able to recover some of that margin. Obviously, we said that merchandise margin was going to be relatively flat quarter over quarter compared to last year. In the first quarter we were down 240 basis points. So we do believe the strength of the line, as well as what we're seeing in the marketplace right now in terms of promotional activity, will allow us to start recovering some of that margin on a rare basis.

Okay, got it. That's really helpful. Thanks so much.

Thomas Filandro, Susquehanna.

Thank you. Let me add my congratulations, as well. A very well-executed quarter and thanks also for a comprehensive call. So, my question first is for David. David, can you be a little more specific on the AUR contraction comment that you made related to the opening price point strategy? And how should we think about that impacting the business going forward? And then the second part of that, or the third part of that, I would say is, can you help us understand what percentage of the mix and/or sales is moved into these opening price point categories? Thank you.

Okay. Hello, Tom. Thank you. I expect to see AUR remain flattish with promotional activity probably abating into the second quarter. In terms of its percentage to total of the mix and sales, you know what? Opening price points are very important in certain departments. But as we've said in the past, our best item this season is an item which is not an opening price point item. It is ticketed at $49.90, in terms of the Portofino shirt, and some of our successes in both men's and in women's are at the higher price points as opposed to the opening price point. The opening price points are very important as an entry point into the brand but I don't see them being a major part of the mix as we go forward. And as we've always said, we have no desire or interest to be the cheapest out there.

Excellent. And one quick follow-up if I can. You noted that the sales and margin performance of the women's business was up over last year. Can you give us a sense of how much room there is to expand the women's business, maybe in terms of productivity and/or margin? Maybe compared to the men's? Thank you.

There is opportunity, clearly, in terms of the women's business as we go forward for the balance of the year. As you know, the business, as we went into the back end of Q2, and also into Q3, was a lot worse for wear last year. And we've got opportunities in productivity in terms of merchandise margin to make improvements. So, yes, I see that Q2 and Q3 are definitely an opportunity for us.

The other thing to acknowledge in those terms is that two of our most important categories in women's, which are cut-and-sew knitwear and sweaters were the two categories that we had the most problems with last year. So clearly they present not just category opportunities but major volume opportunities. So we do feel a bit more secure in the ability for the women's business.

Thank you, best of luck.

Janet Kloppenburg, JJK Research.

Hello, everybody. Congratulations. I just wanted to ask a couple questions. First, Paul if you could just clarify on the SG&A ratio for the second quarter. Is it to be flat on a ratio basis to last year's second quarter? And, David or Michael, I'd love to hear what's going on in sweaters. It sounds like they are performing well right now, but I'm also interested in the tests because that will be very important for the third quarter. And in terms of your comp guidance for the second quarter, I have a two part question. Does that reflect the current trend and is there any benefit from the calendar shift at the end of July this year incorporated into your guidance that may be at the expense of the third quarter? Thank you.

So, Janet, to clarify SG&A, yes on a rate basis we expect it to be flattish, with potentially a slight improvement on a rate basis compared to last year. I'll address -- the comps also. They do, of course, include the current trends that we're seeing in the business as we've entered the month of May. It does not anticipate any significant calendar shifts that would impact how we would guide or what we would expect as we get into Q3.

Turning to sweaters, Janet, we had a very good first quarter. We obviously saw an increase going into the second quarter. We've seen them get even stronger. In terms of the items, we had a big success with our rolled sleeve sweater, In casual, we've had big successes with stripes; we've had big successes with studs; and also fine gauge is a much bigger part of the mix this year in Q2 than it was last year. We went into heavier gauges too soon at the back end of Q2 last year and we also had a lot of Lurex yarns in Q2 last year, which was just fundamentally wrong in terms of its timing. So we have a big opportunity in terms of the balance of the assortment, the mix of the assortment, and the price points that we've got going into Q2.

Okay, thank you and lots of luck.

Roxanne Meyer.

[Technical difficulties]

Rebecca Duval, BlueFin Research Partners.

Hello, guys, congratulations on a great quarter. The stores and product look really great. I was wondering, can you talk to me a little bit about your product extensions and what kind of strength and weaknesses you are seeing in those extensions. And, as you move on to create the whole lifestyle brand? Where are the positives and negatives coming from these and what kind of affect are they having on your UPTs?

I'm very excited about the categories that we've added over the last couple of years. We've gone into the personal care business; we've gone into the watch business; and in women's, we've gone into the shoe business in a very sizable way. All of these are really adding to the brand and they are obviously adding in terms of sales.. And as we go into fall, we're looking at adding in a casual loungewear assortment. As I said on the call, we've been there in the past and it was a sizable volume for us. We came out of it when the whole brand was repositioned in 2004 and 2005, and we see a very, very big opportunity in there going forward. So overall, I'm very, very happy in terms of what we're seeing with the addition of the categories that we've added to the brand.

And are you seeing any weaknesses in any particular extension?

No.

Is there anything not working?

No, we"re not seeing any weaknesses there.

Great. Well congratulations, again. The products look great.

(Operator Instructions) Roxanne Meyer, UBS.

Hello, can you hear me?

Yes, Roxanne. Good morning.

Excellent. Congratulations on the terrific quarter. And the strength of your outlook. Can you help us appreciate what's been most needle-moving for you as it relates to your e-commerce strategy that's driven your 40% plus growth these past two quarters? Obviously, very phenomenal, you're seeing a nice pickup here our top of already strong growth. And how should we think about the run rate going forward in this business? And then secondly, I'm just wondering if you could comment a little bit more on the online exclusive part of it? What percent of the mix is it now and what are you targeting longer term?

There are a couple things, Roxanne, that have helped. One, we've done a lot of work on the front end of our platform and that's still in the early, early days. But it's certainly helped the overall customer experience and we'll see that more over the next year as well, which should add additional tailwinds for us on the e-commerce platform. A couple of other things that you mentioned, one is online exclusives. Originally, we did not really spend a lot of time and a lot of effort on the line extensions; we are now starting to work into a lot more line extensions. Those are proving very beneficial to the customer and to the volume that we're generating online. The second thing is that we also have introduced a much better platform for customers to order in-store and receive product via online. Those are two things -- and the third thing is that we have introduced free shipping with orders over the $125 threshold. One thing to note is that this has put a drag of about 30 basis points on our gross margin, and that will continue throughout the year. That's part of the drags that we've seen with our gross margin in Q1. But, we should see higher sales and higher profitability associated with that and certainly a better customer experience as well. So, we've been very pleased with our e-commerce performance and we expect to continue to see very strong double-digit growth for the remainder of the year.

Roxanne, the other thing I'd like to add in terms of e-comm exclusives. We are seeing it becoming a bigger part of the mix. As it stands today, it's probably about 5% to 8% of the sales on e-commerce, but going into the fall, what I'm excited to say is that we're going to be testing a performance active line online and we're also going to put it into a few stores, a very small number of stores, to see how that does. We see that obviously as a big, big opportunity. When you look at the growth of the market in women's apparel, a lot of it is coming out of activewear. So we think that that's going to be an opportunity for us, definitely online, but we're also going to be testing that in stores.

Great, thanks. I'm looking forward to seeing it and best of luck.

Danielle McCoy, Brean Murray.

I would like to add my congratulations on a great quarter. I was wondering if you could give us a little bit more color on how you view the outlet potential? What is the potential store mix and base line thinking? Are you looking to do any exclusive product? Things along that line?

So for outlets, we're still in the early stages of planning but we are looking at producing product exclusively for outlets, so made-for-outlet product that will be similar but different than our existing product in-store. We see this as a very large opportunity. This could be up to a $500 million opportunity over multiple years. So we are committed to executing this, as Michael mentioned. We have hired the leader for the the outlet business and we expect to move on this relatively quickly.

Okay, great and then, regarding entry-level price points, have you guys seen that really bringing in more of that little bit of a younger consumer? Or do you think it's more of an add-on to your target consumer's purchase?

The entry-level price points are important in terms of broadening our appeal. In terms of the younger consumer it's the fashion. And it's the approach that we're taking to fashion. So things like cropped tees, some of our ankle jeans, et cetera, are really appealing to -- and also graphic tees -- are appealing to a younger customer and we're seeing a lot of success in those areas. But really the entry price point is about broadening the appeal of the brand. As opposed to going after younger customers.

All right, great. Thank you, guys, good luck.

Marni Shapiro, The Retail Tracker.

Hello, guys. Congratulations on managing really well in this environment. Cold, freezing weather. So I have two quick questions. One, if you can just parse out at mall traffic versus conversion in the first quarter. I'm curious if she wasn't coming in the store, but when she was coming in, she was buying a lot? And then if you can put a little bit more detail around casual lounge -- I'm curious what you see this as, because I view this as a big white space in the market and I want to hear what your point of view is on what that space is? And what it will look like?

Sure, can you repeat that last bit? We couldn't hear very clearly, Marni, please?

On the casual lounge, if you can put a little bit of detail around it? I view that area as a white space in the market that no one seems to be attacking and I'm curious if your point of view on it is in line with where I'm thinking there is white space?

Well I don't know where you're thinking (laughter).

When she comes home from work and takes off her Editor Pants, she should put on something that's not her old college sweatpants, is what I'm thinking?

Exactly. I will let Paul answer the question on traffic and conversion.

So, we started off the quarter, as we indicated, it was pretty challenging from a traffic standpoint. It did get better throughout the quarter but not to the point where we're comping positively to last year, so it was a challenging metric for us. What was positive for us, though, was the conversion. We worked really, really hard in our stores to secure that sale and work the customer hard at the dressing room. And, all and all, we saw throughout the quarter, a positive impact in conversion, and also we saw a slight uptick in UPTs for the quarter, which also helped drive our topline.

And that's very positive. To your point, Marni, when people did come in the store, they were buying and, as Michael mentioned, we view conversion at the forward-looking indicator for the health of the business. When people do come in and buy, it's because they like the product, and that gives us confidence in the rest of the year.

Fantastic. The product looks fantastic in the stores right now so best of luck, guys, in the summer.

We have reached the end of the question-and-answer session. I would now like to turn the floor back over to Management for closing comments.

Thanks for joining us this morning. We look forward to speaking with you in August. Until then, enjoy your summer.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.