By  on September 4, 2014

J. Crew Group Inc.’s second-quarter profits fell despite a double-digit gain in revenues as the retailer resorted to heavy promotions to reduce high inventories, with only limited success.

In the three months ended Aug. 2, net income dropped 38.2 percent to $10.8 million from $17.5 million in the year-ago quarter. Adjusted earnings before interest, taxes, depreciation and amortization declined less, falling 18.6 percent to $67.6 million from $83 million.

Revenues rose 12.2 percent to $627.2 million from $559.1 million, with store sales up 11.1 percent to $443.5 million and direct sales ahead 14.4 million to $173.6 million. Comparable sales were up 4 percent versus a 1 percent decline in the 2013 period.

But the company suffered through margin erosion, with gross margin down 340 basis points to 37.7 percent of sales from 41.1 percent a year ago. On a conference call late Thursday afternoon to discuss the results, Stuart Haselden, chief financial officer, said J. Crew’s merchandise margin was down 360 basis points “due to increased markdowns, and accounted for the majority of gross margin deterioration.”

Even with an aggressive markdown posture, J. Crew finished the quarter with inventories of $394.7 million, 22.9 percent higher than the year-ago level of $321.2 million, although up about half as much — about 12 percent — on a per-square-foot basis, the cfo said.

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While still committed to “the goal of reaching a position by the end of the year where our inventories are more in line with our sales trend,” Haselden pointed out that its current stocks were less dated than a year ago. “It’s important to point out that we have less spring and summer inventory on both a dollar basis and as a percent of total currently versus the same point last year….It’s just a matter of the amount we have versus the sales trend, which has produced the product margin pressure that we’ve talked about over the first half of the year.”

He expressed confidence that pressure would “begin to moderate” during the second half of the year, particularly if the anticipated easing of some product costs transpires.

Haselden declined to discuss results so far in the third quarter, but allowed that “the environment continues to be challenging, traffic continues to be a headwind. We’re not immune to that factor.” Promotions remain in a “heightened situation,” he said.

Haselden noted that the Madewell division, currently at 76 units, would expand by 20 stores this year, its largest annual increase. “We feel good about the way Madewell’s performing,” he said. “We see the same headwinds at Madewell but we’ve been able to manage through them effectively.”

The company put $35 million into capital expenditures during the second quarter and expects the year-end total to be between $140 million and $150 million, including about 55 store openings in total, information technology enhancements, store renovations and corporate office improvements.

In the first six months, J. Crew registered a net loss of $19.3 million versus net income of $46.8 million a year ago. The 2014 loss includes a $58.8 million pretax loss on refinancing. Revenues grew 8.5 percent to $1.22 billion from $1.12 billion in the first half of 2013. Gross margin declined to 38.2 percent of sales from 42.9 percent in the first half of last year.

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