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J CREW GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This document should be read in conjunction with the Management's Discussion and Analysis section of our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 filed with the SEC. When used herein, the terms "J.Crew," "Group," "Company," "we," "us" and "our" refer to J.Crew Group, Inc., including its wholly-owned subsidiaries. Executive Overview J.Crew is an internationally recognized multi-brand apparel and accessories retailer that differentiates itself through high standards of quality, style, design and fabrics. We are a vertically-integrated, omni-channel specialty retailer that operates stores and websites both domestically and internationally. We design, market and sell complete assortments of women's, men's and children's apparel and accessories, including those under the J.Crew® and Madewell® brands. We believe our customer base consists primarily of affluent, college-educated, professional and fashion-conscious women and men. We conduct our business through two primary sales channels: (1) Stores, which consists of our retail, factory and Madewell stores, and (2) Direct, which consists of our J.Crew, factory and Madewell websites. As of August 2, 2014, we operated 269 J.Crew retail stores, 127 J.Crew factory stores, and 71 Madewell stores, in the United States, Canada, the United Kingdom and Hong Kong. A summary of revenues by channel for the second quarter is as follows: For the For the Thirteen Thirteen Weeks Ended Weeks Ended (Dollars in millions) August 2, 2014 August 3, 2013 Stores $ 443.5 $ 399.1 Direct 173.6 151.8 Net sales 617.1 550.9 Other(a) 10.1 8.2 Total revenues $ 627.2 $ 559.1 A summary of revenues by brand for the second quarter is as follows: For the For the Thirteen Thirteen Weeks Ended Weeks Ended (Dollars in millions) August 2, 2014 August 3, 2013 J.Crew $ 561.2 $ 511.7 Madewell 55.9 39.2 Other(a) 10.1 8.2 Total revenues $ 627.2 $ 559.1 (a)Consists primarily of shipping and handling fees and revenues from third-party resellers. A summary of highlights for the second quarter is as follows: - Revenues increased 12.2% to $627.2 million. - Comparable company sales increased 4.4%. - Direct net sales increased 14.4% to $173.6 million. - Income from operations decreased $19.8 million to $36.0 million. - We opened four J.Crew retail stores, five J.Crew factory stores, and one Madewell store. We closed one J.Crew retail store. 15 --------------------------------------------------------------------------------A summary of revenues by channel for the first half is as follows: For the For the Twenty-six Twenty-six Weeks Ended Weeks Ended (Dollars in millions) August 2, 2014 August 3, 2013 Stores $ 829.9 $ 779.3 Direct 370.6 328.0 Net sales 1,200.5 1,107.3 Other(a) 18.7 15.9 Total revenues $ 1,219.2 $ 1,123.2 A summary of revenues by brand for the first half is as follows: For the For the Twenty-six Twenty-six Weeks Ended Weeks Ended (Dollars in millions) August 2, 2014 August 3, 2013 J.Crew $ 1,098.0 $ 1,033.6 Madewell 102.5 73.7 Other(a) 18.7 15.9 Total revenues $ 1,219.2 $ 1,123.2 (a)Consists primarily of shipping and handling fees and revenues from third-party resellers. A summary of highlights for the first half is as follows: - Revenues increased 8.5% to $1,219.2 million. - Comparable company sales increased 1.4%. - Direct net sales increased 13.0% to $370.6 million. - Income from operations decreased $59.3 million to $70.0 million. - We opened five J.Crew retail stores, six J.Crew factory stores, and six Madewell stores. We closed one J.Crew retail store. - We refinanced our Term Loan Facility and redeemed our Senior Notes, which we expect to result in annual savings of $16 million in interest expense. We recorded a loss of $58.8 million in connection with the refinancing. How We Assess the Performance of Our Business In assessing the performance of our business, we consider a variety of performance and financial measures. A key measure used in our evaluation is comparable company sales, which includes (i) net sales from stores that have been open for at least twelve months, (ii) direct net sales, and (iii) shipping and handling fees. A complete description of the measures we use to assess the performance of our business appears in the Management's Discussion and Analysis section of our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 filed with the SEC. Results of Operations - Second Quarter of Fiscal 2014 compared to Second Quarter of Fiscal 2013 For the Thirteen Weeks Ended For the Thirteen Weeks Ended Variance August 2, 2014 August 3, 2013 Increase /(Decrease) Percent of Percent of (Dollars in millions) Amount Revenues Amount Revenues Dollars Percentage Revenues $ 627.2 100.0 % $ 559.1 100.0 % $ 68.1 12.2 % Gross profit 236.7 37.7 230.0 41.1 6.7 2.9 Selling, general and administrative expenses 200.7 32.0 174.2 31.2 26.5 15.2 Income from operations 36.0 5.7 55.8 10.0 (19.8 ) (35.4 ) Interest expense, net 17.8 2.8 26.2 4.7 (8.4 ) (32.3 ) Provision for income taxes 7.5 1.2 12.1 2.2 (4.6 ) (38.1 ) Net income $ 10.8 1.7 % $ 17.5 3.1 % $ (6.7 ) (38.2 )% 16 --------------------------------------------------------------------------------Revenues Revenues increased $68.1 million, or 12.2%, to $627.2 million in the second quarter of fiscal 2014 from $559.1 million in the second quarter last year, driven primarily by an increase in sales of women's apparel, specifically knits, shirts, and sweaters. Comparable company sales increased 4.4% in the second quarter of fiscal 2014. Comparable company sales decreased 0.6% in the second quarter of fiscal 2013. Stores sales increased $44.4 million, or 11.1%, to $443.5 million in the second quarter of fiscal 2014 from $399.1 million in the second quarter last year. Stores sales increased 3.9% in the second quarter of fiscal 2013. Sales from stores that have been open for less than twelve months were $54.9 million in the second quarter of fiscal 2014. Direct sales increased $21.8 million, or 14.4%, to $173.6 million in the second quarter of fiscal 2014 from $151.8 million in the second quarter last year. Direct sales increased $17.8 million, or 13.4%, in the second quarter of fiscal 2013. The approximate percentage of our sales by product category, based on our internal merchandising system, is as follows: For the For the Thirteen Thirteen Weeks Ended Weeks Ended August 2, 2014 August 3, 2013 Apparel: Women's 56 % 56 % Men's 26 26 Children's 6 6 Accessories 12 12 100 % 100 % Other revenues increased $1.9 million to $10.1 million in the second quarter of fiscal 2014 from $8.2 million in the second quarter last year. Gross Profit Gross profit increased $6.7 million to $236.7 million in the second quarter of fiscal 2014 from $230.0 million in the second quarter last year. This increase resulted from the following factors: Increase/ (Dollars in millions) (decrease) Increase in revenues $ 36.7 Decrease in merchandise margin (22.4 ) Increase in buying and occupancy costs (7.6 ) Increase in gross profit $ 6.7 Gross margin decreased to 37.7% in the second quarter of fiscal 2014 from 41.1% in the second quarter last year. The decrease in gross margin was driven by: (i) a 360 basis point deterioration in merchandise margin primarily due to increased markdowns partially offset by (ii) a 20 basis point improvement in buying and occupancy costs as a percentage of revenues. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $26.5 million to $200.7 million in the second quarter of fiscal 2014 compared to $174.2 million in the second quarter last year. This increase primarily resulted from the following: Increase/ (Dollars in millions) (decrease) Increase in operating expenses, primarily Stores and payroll $ 16.5 Increase in depreciation 3.4 Insurance proceeds received in the prior year 3.0 Increase in share-based and incentive compensation 2.7 Other, net 0.9 Total increase in selling, general and administrative expenses $ 26.5 17 --------------------------------------------------------------------------------As a percentage of revenues, selling, general and administrative expenses increased to 32.0% in the second quarter of fiscal 2014 from 31.2% in the second quarter last year. Interest Expense, Net Interest expense, net of interest income, decreased $8.4 million to $17.8 million in the second quarter of fiscal 2014 from $26.2 million in the second quarter last year driven by the redemption of our Senior Notes. A summary of interest expense is as follows: For the For the Thirteen Thirteen Weeks Ended Weeks Ended (Dollars in millions) August 2, 2014 August 3, 2013 Term Loan Facility $ 15.8 $ 11.9 Senior Notes - 8.1 Amortization of deferred financing costs 1.3 2.5 Hedging losses 0.2 3.5 Other, net of interest income 0.5 0.2 Interest expense, net $ 17.8 $ 26.2 Provision for Income Taxes The effective tax rate for the second quarter of fiscal 2014 was 41%. The difference between the US federal statutory rate of 35% and the effective rate of 41% was driven primarily by (i) state and local income taxes, (ii) the recognition of certain foreign valuation allowances, partially offset by (iii) benefits of lower rates in certain foreign jurisdictions. Our expected annual effective tax rate for fiscal 2014 is 38%. The effective tax rate for the second quarter of fiscal 2013 was 41%. The difference between the US federal statutory rate of 35% and the effective rate of 41% was driven primarily by state and local income taxes. Our annual effective tax rate in fiscal 2013 was 39%. Net Income Net income decreased $6.7 million to $10.8 million in the second quarter of fiscal 2014 from net income of $17.5 million in the second quarter last year. This decrease was due to: (i) an increase in selling, general and administrative expenses of $26.5 million, offset by (ii) a decrease in interest expense of $8.4 million, (iii) an increase in gross profit of $6.7 million and (iv) a decrease in the provision for income taxes of $4.6 million. Results of Operations - First Half of Fiscal 2014 compared to First Half of Fiscal 2013 For the Twenty-six For the Twenty-six Weeks Ended Weeks Ended Variance August 2, 2014 August 3, 2013 Increase /(Decrease) Percent of Percent of (Dollars in millions) Amount Revenues Amount Revenues Dollars Percentage Revenues $ 1,219.2 100.0 % $ 1,123.2 100.0 % $ 96.0 8.5 % Gross profit 465.9 38.2 482.0 42.9 (16.1 ) (3.3 ) Selling, general and administrative expenses 395.8 32.5 352.6 31.4 43.2 12.3 Income from operations 70.0 5.7 129.4 11.5 (59.4 ) (45.9 ) Interest expense, net 39.4 3.2 51.9 4.6 (12.5 ) (24.1 ) Loss on refinancing 58.8 4.8 - - 58.8 NM Provision (benefit) for income taxes (8.8 ) (0.7 ) 30.7 2.7 (39.5 ) NM Net income (loss) $ (19.3 ) (1.6 )% $ 46.8 4.2 % $ (66.1 ) NM Revenues Revenues increased $96.0 million, or 8.5%, to $1,219.2 million in the first half of fiscal 2014 from $1,123.2 million in the first half last year, driven primarily by an increase in sales of women's apparel, specifically knits, sweaters, and shirts. Comparable 18 --------------------------------------------------------------------------------company sales increased 1.4% in the first half of fiscal 2014. Comparable company sales increased 2.4% in the first quarter of fiscal 2013. Stores sales increased $50.6 million, or 6.5%, to $829.9 million in the first half of fiscal 2014 from $779.3 million in the first half last year. Stores sales increased 5.6% in the first half of fiscal 2013. Sales from stores that have been open for less than twelve months were $104.1 million in the first half of fiscal 2014. Direct sales increased $42.6 million, or 13.0%, to $370.6 million in the first half of fiscal 2014 from $328.0 million in the first half last year. Direct sales increased $50.6 million, or 18.2%, in the first half of fiscal 2013. The approximate percentage of our sales by product category, based on our internal merchandising system, is as follows: For the For the Twenty-six Twenty-six Weeks Ended Weeks Ended August 2, 2014 August 3, 2013 Apparel: Women's 56 % 57 % Men's 25 24 Children's 7 6 Accessories 12 13 100 % 100 % Other revenues increased $2.8 million to $18.7 million in the first half of fiscal 2014 from $15.9 million in the first half last year. Gross Profit Gross profit decreased $16.1 million to $465.9 million in the first half of fiscal 2014 from $482.0 million in the first half last year. This decrease resulted from the following factors: Increase/ (Dollars in millions) (decrease) Increase in revenues $ 53.1 Decrease in merchandise margin (51.6 ) Increase in buying and occupancy costs (17.6 ) Decrease in gross profit $ (16.1 ) Gross margin decreased to 38.2% in the first half of fiscal 2014 from 42.9% in the first half last year. The decrease in gross margin was driven by: (i) a 420 basis point deterioration in merchandise margin primarily due to increased markdowns and (ii) a 50 basis point increase in buying and occupancy costs as a percentage of revenues. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $43.2 million to $395.8 million in the first half of fiscal 2014 compared to $352.6 million in the first half last year. This increase primarily resulted from the following: Increase/ (Dollars in millions) (decrease) Increase in operating expenses, primarily Stores and payroll $ 25.8 Increase in depreciation 6.1 Increase in share-based and incentive compensation 3.9 Insurance proceeds received in the prior year 3.2 Increase in advertising and catalog costs 2.0 Other, net 2.2 Total increase in selling, general and administrative expenses $ 43.2 As a percentage of revenues, selling, general and administrative expenses increased to 32.5% in the first half of fiscal 2014 from 31.4% in the first half last year. 19 --------------------------------------------------------------------------------Interest Expense, Net Interest expense, net of interest income, decreased $12.5 million to $39.4 million in the first half of fiscal 2014 from $51.9 million in the first half last year driven by the redemption of our Senior Notes. A summary of interest expense is as follows: For the For the Twenty-six Twenty-six Weeks Ended Weeks Ended (Dollars in millions) August 2, 2014 August 3, 2013 Term Loan Facility $ 30.3 $ 25.1 Senior Notes 5.3 16.3 Amortization of deferred financing costs 3.0 5.0 Hedging losses 0.5 5.1 Other, net of interest income 0.3 0.4 Interest expense, net $ 39.4 $ 51.9 Loss on Refinancing In the first quarter of fiscal 2014, we refinanced our Term Loan Facility and redeemed our Senior Notes. In connection with the refinancing, we recorded a loss of $58.8 million, the components of which are as follows: For the Twenty-six Weeks Ended (Dollars in millions) August 2, 2014 Prior unrealized losses on cash flow hedge $ 22.4 Call premium on Senior Notes 16.3 Write-off of deferred financing costs 15.6 Other financing costs 4.5 Loss on refinancing $ 58.8 Provision for Income Taxes The effective tax rate for the first half of fiscal 2014 was 31%. The difference between the US federal statutory rate of 35% and the effective rate of 31% was driven primarily by (i) state and local income taxes, (ii) the recognition of certain foreign valuation allowances, partially offset by (iii) benefits of lower rates in certain foreign jurisdictions. Our expected annual effective tax rate for fiscal 2014 is 38%. The effective tax rate for the second quarter of fiscal 2013 was 40%. The difference between the US federal statutory rate of 35% and the effective rate of 40% was driven primarily by state and local income taxes. Our annual effective tax rate in fiscal 2013 was 39%. Net Income (Loss) Net income (loss) decreased $66.1 million to a net loss of $19.3 million in the first half of fiscal 2014 from net income of $46.8 million in the first half of last year. This decrease was due to: (i) a loss on refinancing of $58.8 million, (ii) an increase in selling, general and administrative expenses of $43.2 million, and (iii) a decrease in gross profit of $16.1 million, partially offset by (iv) a decrease in the provision for income taxes of $39.5 million and (v) a decrease in interest expense of $12.5 million. Liquidity and Capital Resources Our primary sources of liquidity are our current balances of cash and cash equivalents, cash flows from operations and borrowings available under the ABL Facility. Our primary cash needs are (i) capital expenditures in connection with opening new stores and remodeling our existing stores, investments in our distribution network and making information technology system enhancements, (ii) meeting debt service requirements (including paying dividends to an indirect parent company for the purposes of servicing debt) and (iii) funding working capital requirements. The most significant components of our working capital are cash and cash equivalents, merchandise inventories and accounts payable and other current liabilities. See "-Outlook" below. 20-------------------------------------------------------------------------------- |