By  on June 5, 2014

J. Crew Group Inc., while working to get inventories down in line with sales trends, has seen improvement in traffic in the second quarter though it’s not back to where it once was.

“We have seen a sequential improvement in traffic since Q1 but it still remains a headwind, meaning that traffic remains down versus last year,” James Scully, J. Crew’s chief operating officer, said during a conference call Thursday, a day after the retailer reported first-quarter results that fell short of expectations.

J. Crew’s net loss of $30.1 million reflected the tough selling environment and a refinancing package expected to produce annual interest expense savings of $16 million. Revenues increased 5 percent to $592 million, with comparable company sales decreasing 2 percent.

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There were some bright spots in the quarter, including progress with international expansion, and a big increase in sales at the Madewell division, which did better battling the “traffic headwinds” than the core J. Crew operation and retailers generally. Madewell posted a 35 percent increase in sales to $46.7 million during the first quarter, compared to $34.6 million in the year-ago quarter. Last month, Madewell opened on New York’s Madison Avenue, flaunting a new store design that plays up the brand’s category strengths including denim, accessories and swim. Madewell aims to open 20 stores this year. Stuart Haselden, chief financial officer, said that Madewell’s expansion this year “is an indication of how we’re pleased how Madewell is performing and we’re looking to continue to invest and grow that business.”

Also last month, J. Crew men’s and women’s units opened in Hong Kong’s Central district, marking its first two stand-alone stores in the Asia-Pacific region.

J. Crew’s inventories entering the second quarter were too high, though Haselden noted, “We do expect inventory levels to moderate over the course of the year such that by the fourth quarter, we expect our inventory position to be better aligned with our sales trend. In terms of aging, we’re very comfortable with the composition of the inventory. It’s very current. It’s not a situation where we have a backlog of prior period goods. We just have a lot of the current flows. And that said, given that elevated inventory position entering Q2 specifically, combined with just the macro environment and the traffic trends, we will likely to continue to see pressure on our product margins in the current quarter.”

Haselden described the quarter as disappointing across all product categories, with the traffic headwinds from the fourth quarter spilling into the first. “We took steps to stay on top of the inventory,” he said. “The environment in Q1 was really a mess. The weather compounded the promotional environment.…The inventory picture remains a focus for us. We are happy to not be over-stored. Our store base is very productive.”

The operating results of the first quarter and J. Crew’s outlook led to a “substantial deterioration in the excess of fair value over the carrying value of the stores reporting unit,” the company said. “To the extent that the operating results continue to decline, the company may record a noncash goodwill or intangible asset impairment charge. The goodwill allocated to the stores reporting unit is $942 million. The intangible asset for the J. Crew brand is $885 million.”

The company said an impairment charge, if any, would not affect operations, liquidity or financial covenants, and would not change management’s long-term business outlook or strategy.

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