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Operator
Good morning.
My name is Valery and I will be your conference facilitator today.
At this time, I would like to welcome everyone to the American Eagle Outfitters second quarter 2002 earnings conference call.
All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer period.
If you would like to ask a question during this time, simply press * and then the number 1 on your telephone keypad.
If you would like to withdraw your question, press the pound key.
Thank you Mr. O'Donnell, you may begin your conference.
Jim O'Donnell
Thanks, Valery.
Good morning.
This is Jim O'Donnell, chief operating officer. (inaudible) today include Roger Markfield, chief merchandising officer, and Laura Weil, chief financial officer.
Hopefully everyone has a copy of the press release of our second quarter results that I e-mailed out this morning.
It is available at www.ae.com.
If anyone needs a copy, call Cindy Jones at 724-779-5251.
Before we begin, I need to remind everyone that during this conference call, members of management will make certain forward-looking statements that contain current information which represent the company's current expectations or beliefs.
We caution investors the results may differ materially from the expectations or beliefs based on the risk factors described in our quarterly and annual reports filed with the SEC.
The second quarter was challenging and our financial performance did not meet our goals.
In response to a tough retail environment, we are planning our business conservatively for the back half of the year.
Importantly, we have implemented expense reduction in core control issues for the organization, which Laura will outline in a few minutes.
In the short term, we are reducing discretionary expenses that are not critical to the business, and we are looking for efficiencies in productivity improvement over the long term that will enable our company to operate at a higher level of profitability.
We had a challenging quarter.
We did achieve improvements in certain areas of operation during the second quarter.
Our payroll initiative continues to yield improvement.
In spite of the negative comps, we leveraged payroll by 20 basis points and sales were increased 4%.
Our distribution center productivity improved versus last year.
Payroll cost projected to climb 10% and total profits decreasing 17%.
Turning to real estate.
Year-to-date, we have opened 28 stores and remodeled 22 American Eagle stores in the U.S., growing our square footage by 17% over the same period last year.
Of these openings, 18 stores were in A malls, seven in B malls, and three in C malls.
Year- to-date by region, 15 stores were added in the west, 6 in the southeast, 4 in the northeast, 2 in the midwest and 1 in the mid-Atlantic region.
We entered the quarter with a total of 660 stores and we are on track to complete opening of 70 stores planned for this year.
The current plans calls for 29 store openings in third quarter, 13 in the fourth quarter.
We are also on target to achieve 38 remodels and expanded stores this year.
We are pleased with in-store performance. 2002 new stores are starting out stronger and are currently annualizing at over 85% of our mature store sales.
AE Canada, continues to strengthen during the second quarter.
We remain very pleased with acceptance of the brand in Canada.
However, there is still opportunity for full operating improvement, which we should approve as we grow the store base as the business matures.
We opened 5 AE Canada stores year-to-date and plan to complete 2002 openings in the third quarter with an additional 5 new stores.
That will take us to 76 stores at the end of this year.
Our initial plans for 2003 call for opening U.S. 80 stores and 60 store renovations in the U.S., and 10 new AE store necessary Canada, which will translate into 10% increase in total sales force.
Roger will discuss that in a few minutes.
Only real estate trends we are working on is new store design, which should be completed later this year.
Here is Roger.
Roger Markfield - Chief Merchandising Officer
Good morning, everyone.
As Jim indicated, second quarter performance was disappointing and certainly belong our financial goals.
Mall traffic and spending patterns have been inconsistent and the retail environment, especially in the teen space, has been competitive and promotional.
Our merchandising assortment this spring was not as strong as it should have been.
Our merchandising and design organization, we have made important changes, adding experience to key areas, including women's knits and sweaters, and significantly there has been a philosophical shift here in terms of our process.
We have always prided ourselves on speed to market.
With today's increasingly competitive market, we must be even more nimble, that includes reacting faster to shipping trends, making sure our assortment is differentiated and fashion right at all times.
Despite the challenges, there were a number of positives in the second quarter.
We continue to experience strength in key classifications, including women's denim, accessories, underwear, graphic t-shirts, skirts and capris.
Strength continued in men's denim graphic t-shirts and polos.
Comparable store sales were impacted by lower average retail price and lower transactions per store.
Units per store were down slightly.
Units per transaction were up and the average transaction value rose.
Customers are buying more units per transaction.
This is being driven in part by strong acceptance of new classifications, such as underwear, accessories and personal care.
Development to new categories in effect new businesses for us is an ongoing process and helps us not only strengthen the brand, but will add sales volume, as well.
Our merchandise margins declined in the second quarter.
Higher mark-downs offset improvement in IMU.
We continue to achieve lower product course, a trend we expect to continue this year.
Tight control of the inventory while enabling us to turn inventory at a faster rate.
Current inventories are clean and very lean.
Fall store inventory has been marked to out of store prices and we ended fall season with total forward inventories.
Our back-to-school merchandise presentations arrived in stores July 17th.
The women's assortment is stronger and more fashion-right than spring.
We are very pleased with the performance of certainly key categories.
Denim is strong.
The overall best performing category in both men's and women's.
Demand for women's denim, has been particularly strong and succeeded even our own expectations, resulting in lean inventories.
We are chasing this category and expect to be in a better position by early September.
Women's knits continue to be soft.
Through the first three weeks of back-to-school season, women's comps have improved.
Our men's business on (inaudible) is off to a slower start.
Keep in mind our men's business was very strong last year.
Men's denim and knits have been good perform resulted results have been better in regions where school starts earlier.
Despite a number of positives in the new assortment, the retail environment remains very choppy and sales trends are inconsistent.
In light of this, we will maintain tight inventories and are planning the full season conservatively.
Based on initial back-to-school performance, we have adjusted our plans and reallocated buys in the strong categories.
Our fall update arrives in early September, new items are mostly in the women's area.
I am happy to say early reads are very encouraging.
E-commerce business gets better and better.
Evidence of both increasing brand strength and our dedication to growing the business.
Second quarter sales at www.ae.com rose 35.over last year's tremendous growth, sales increased 135%.
The use of sessions increased 36%.
As ae.com becomes a valuable piece of our overall business, we continue to explore new ways to maximize this venue.
Now, a word about Bluenotes.
On July 24th, we introduced the repositioning of Bluenotes brand to target a new customer.
The hippy urban-inspired 17-year-old high school student.
It is very early.
We are disappointed with early performance.
We remain excited about the brand's positioning.
It is distinct and unique.
We believe transitioning Bluenotes from a price-driven jeans store to a lifestyle brand was the right strategy to take.
Over the long term, it should lead to higher profit margins and stronger growth potential.
However, we positioning a brand does not happen overnight.
We have lost some of the old customers and it will make time for new customers to discover the brand.
We will monitor customer response and tweak the brand until it is right.
As Jim mentioned, we are pleased and the company is extremely strong and enduring.
We will stress denim into holiday, right through to spring underscoring year round denim in our stores.
Store productivity is not the highest in the industry.
We believe we remain the brand of choice for our target customer and we will do everything we must to remain their first choice.
We need to be better, faster and more nimble than we have already become.
We are focused on doing just that.
Here is Laura.
Laura Weil - CFO
Thank you, Roger.
Good morning, everybody.
Total consolidated sales for first quarter ended August 3, 2002, rose 9.2%, reaching record $319.2 million, compared to $292.4 million last year.
Our second quarter sales included 18.8 million from the Bluenotes chain, compared to $21.2 million last year.
Second quarter comparable store sales for AE brand declined 4.8%, compared to comp increase of 4.6% in second quarter last year.
Same-store sales, including both American Eagle and Bluenote stores, declined 5.5%.
Comps for Bluenote stores decreased 13.9%, compared to comp store sales increase of 2.5% in the second quarter of last year.
Turning now to margins.
Our consolidated gross margin deleveraged 250 basis points from 36.9%, to 34.4% in the second quarter, due to lower U.S. merchandise margins and the deleveraging of buying occupancy and warehousing cost in the U.S. business.
As Roger noted, our U.S. merchandise margins reflected improvement in the IMU, which was offset by higher mark downs in the quarter.
We experienced deleveraging of rent in occupancy, buying and warehousing costs.
The overall impact from Canadian operations on the gross margin was not material.
A higher gross margin at AE Canada was essentially offset by lower gross margin at Bluenotes.
On consolidated basis, second quarter SG and A as a percent of sales declined 30 basis points to 25.4%, from 25.7% last year, despite the negative comp in the quarter.
SG and A per square foot decreased 8% from the second quarter last year and SG and A per average store decreased 3.7%.
The leveraging of SG and A was driven primarily by increased efforts to control expense, resulting in leverage in communication, store salaries, professional services, IT, supplies and travel.
As Jim noted earlier, further expense reduction are major initiative across the entire organization.
We expect current efforts to translate into continued SG and A leverage during the back half of the year.
Through renegotiations of significant contracts, we have reduced expense in areas such as communications, equipment leasing, and maintenance and credit card processing.
Discretionary expenses in areas such as travel, advertising and professional services are also being reduced.
We are allowing only critical strategic positions to be filled within the company and we are evaluating all areas of the operation to improve productivity and efficiency.
Depreciation and amortization expense as percent of sales decreased 50 basis points to 3.9%, from 3.4% last year.
The increase was due primarily to new and remodeled stores in the U.S..
Other income in second quarter was 196,000 compared to last year.
The reduction was due primarily to higher interest expense.
Net income for the quarter was 10.1 million, compared to $15.3 million last year, and diluted earnings per share were 14 cents, compared to 21 cents per diluted share last year.
Now, let's turn to the balance sheet.
Our balance sheet continues to be very strong.
Cash and short-term investments increased by 101.5 million to $177 million, from $75.5 million at the end of second quarter in 2001.
During the second quarter, we continued to control our inventory.
Total consolidated merchandise inventory increased 2.5% to 148.8 million from $145.1 million at the end of the second quarter last year, while gross square footage increased 17%.
U.S. inventory per gross square footage decline happened 11.5% at end of second quarter, compared to last year.
In view of the current operating environment, we will continue to conservatively manage inventory.
It is our expectation that at the end of the third quarter, total inventory at cost will be lower on per square footage basis compared to last year.
Capital expenditures totaled $14 million and year to date, totaled $32 million, related to new and remodeled U.S. stores.
Current capex for the year is roughly $85 million.
The reduction in 2002 capex is due to lowering the number of new store openings this year to 80, and eliminating or delaying other noncritical capital projects.
During the quarter, the company repurchased 337,000 shares of our common stock, approximately 1.5 million shares remain authorized for repurchase.
As Roger noted, retail environment is difficult.
Our trend in men's is soft.
I would add, our August sales are trending below planned.
It is, however, only a week and a half into the third quarter and too early to provide specific earnings guidance at this time.
Thank you and now we will open the call for questions. 00:07:14
Operator
At this time, I would like to remind everyone if you would like to ask a question, press * and then the number 1 on your telephone keypad.
We will pause for a moment to compile the Q and A roster.
Your first question comes from Robbie Ohmes of Morgan Stanley.
Analyst
Thank you.
Two quick questions.
First, can we get guidance on the profit outlook for Bluenotes for the back half of this year, as well as '03?
Second, if Roger, could you comment on the men's business and sort of the outlook for what types of things might drive turn around in the business that would be great?
Thanks.
Laura Weil - CFO
In terms of Bluenotes, we certainly hope that it will be profitable in the back half of this year and certainly for 2003.
But, if is really too soon to make a call on their profitability this fall, we are transitioning the brand and the customer.
Roger Markfield - Chief Merchandising Officer
On men's business, last year in the third quarter, the back-to-school quarter, we had 10 comp on the men's side.
Everyone wanted to know what we were doing in men's differently than everyone else.
We said that we just more positioned with the basic core items the young guys wanted for back-to-school.
That is where we are this particular season, but unfortunately, at this point, when we look at early trends of where kids are going back to school early, it looks a hell of a lot better than where they are going back to school late.
It is too early in the forecast to say exactly where in fact men's will end up.
We don't see risk in the inventories we are carrying in men's, but we are not getting the same response at this point in time for the men's product.
As we go forward, we have some strategic fashion ideas that we are going to be pursuing.
I am not going to talk about that on the conference call.
Analyst
Great.
Thank you.
Operator
Your next question comes from Dana Cohen of Banc of America Securities.
Analyst
Hi, guys.
Couple of questions.
Laura, on inventory, you said they would be down, will they be down as much as they are now?
What is your best guess at the end of the fourth quarter?
Laura Weil - CFO
Dana, I don't think they will be down quite as much.
We are projecting they will be down less at the end of the third quarter.
I think we are looking at flattish for end of the fourth.
Analyst
Sales are below expectation, is that entirely due to men's or has women's picked up, but not where you would like it to be?
Laura Weil - CFO
Pretty much entirely due to men's.
Roger Markfield - Chief Merchandising Officer
overall woman's business was running negative on the spring side.
That really, obviously, that is the majority of our business.
That is running relatively on a flat and slightly up basis.
Analyst
Okay.
Then, Roger, you quickly went over two issues I thought were interesting.
One was changes in management.
Could you elaborate a little?
You mentioned changes to processes, can you go into that in more detail?
Roger Markfield - Chief Merchandising Officer
I will, certainly.
We thought we had a weakness in many areas, knits and sweaters, in the merchandising and design function.
And we were, as I mentioned in my beginning notes, when you are the powerful brand that we are at this point in time, we are able to attract pretty much anybody we would like to attract from other organizations where they think there is skill levels.
So, we made two changes in design.
We made two changes in merchandises.
We think we put together powerful team for knitwear at this point in time.
In terms of the changes of how to be more nimble, there is technology we will be using and process changes.
To be faster, but yet to be able to flow merchandise as we need to.
Analyst
Great.
Thank you.
Operator
Your next question comes from Emme Kozloff of Sanford Bernstein.
Analyst
Thanks.
Can you provide us with more detail on the competitive environment?
What you have been seeing lately?
Are there plans for pricing adjustments in the second half given this?
Thanks.
Jim O'Donnell
Emme, the promotional environment is very, very competitive.
I don't want to talk about individual competitors.
I won't mention who, but we all - most of us, anyway, do a money card deal, American Eagle has always done a money card deal.
We give $10 toward a future purchase on $75 purchase.
I would say that at this point in time, almost all of the competitors are doing a $25 money card on $50 purchase.
I have even received in the mail direct mail pieces for $75 purchase, we will give you $30 off, plus 10% off.
The amount of direct mail that everyone is sending out is much greater than last year.
The price points and the signs I see in front of many stores in the competitors for back-to-school to signs outside that say 50% off most of the merchandise.
So, in my years, it is the most competitive environment I have seen in the teen space.
Analyst
Do you have plans to adjust the pricing in the second half as a result?
Jim O'Donnell
It comes down to two things.
One is being positioned as the brand of choice.
Read the surveys, we are the number one choice brand for this demographic.
The second thing is having the right product.
Because, when you look at the women's product at this point in time, which is doing just the way we would like for it to be doing, at our price point and structure, we are in good shape.
We are the brand of choice.
We are looking at it very carefully.
We don't want to give up market share, but protect the bottom line.
Analyst
Thanks.
Operator
Your next question comes from Marcia Aaron of Pacific Growth Equities.
Analyst
Good morning.
Can you talk maybe a little bit more about what your plans are on the advertising side?
It sounds like you may be making changes or trying to save money there?
Michael Leedy
It is Michael Leedy, I thought Roger did a great job talking about the environment and where we sit.
One major change for holiday, we will not be advertising on television this holiday.
We decided to take take a breather.
We may in the future go back to television, but as Roger said, as difficult as the environment is, we want to hold what we can for taxable marketing, if necessary.
Analyst
Last year were you able to see quantifiable benefits from television advertising?
Michael Leedy
It depends on how you quantify it.
The surveys we do on a regular basis show television is impacting our customer.
They are seeing the commercial, they are recognizing our brand more and more.
But, it is not in our opinion, an immediate impact on the register.
We have always looked at it as long-term brand building vehicle.
Analyst
Laura, how much money do you anticipate saving from that?
Laura Weil - CFO
I would rather not quantify the exact dollar amount.
Analyst
Okay.
Roger, on the new team for knits and sweaters, when should we expect to see products from that team?
Roger Markfield - Chief Merchandising Officer
Spring.
I will say that the plot of that team was in place before.
We made the change about five months ago.
Some of the merchandise - as I mentioned, there is a new set that goes in the beginning of September.
Initial reads on that merchandise and it is way premature.
We have a sophisticated process.
Part of the process is setting up a store with the merchandise and then moving into 10 stores and obviously to the chain.
The very first glance at the numbers are very impressive.
Analyst
Great.
In terms of trying to be more nimble, what do you anticipate being - how much time do you think you can take out of the process?
Roger Markfield - Chief Merchandising Officer
About 30 days later.
Analyst
Great.
Thank you and good luck.
Operator
Your next question comes from Jeff Klinefelter of US Bancorp Piper Jaffray.
Analyst
It is actually Dana Friedman and it is Jeff Klinefelter.
My two questions, in terms of Canada, are you seeing differences in terms of back-to-school trends there?
My other question in first call consensus guidance for the second half of the year, how do you feel about that?
Jim O'Donnell
As it relates to AE Canada, yes.
AE Canada is very solid.
It looks like first year out was the brand of choice in Canada.
I was up there on Friday of last week.
Walked the entire mall and in Toronto and Scarborough mall, exactly.
When I walked through the stores, we are the only store that has a true lifestyle brand that looks effective.
We are doing business terrific.
Analyst
Any differences in terms of how the products are trending in Canada versus the U.S.?
Roger Markfield - Chief Merchandising Officer
Women's is doing better than men's.
In Canada, men's is doing decently.
Analyst
Great.
Laura Weil - CFO
Dana, on the guidance, as I mentioned earlier, we are only 13 days into the quarter.
So, we are really think it is too early right now.
Analyst
Got you.
Thank you.
Operator
Your next question comes from Kimberly Greenberger of Lehman Brothers.
Analyst
Good morning.
Last year, looking at SG and A growth, in the first through the third quarters it grew in the 30 to 50% range, roughly.
Then, it looks like you have very impressive improvement in the fourth quarter.
So, looking at this year, it looks like there will be pretty significant opportunity on the SG and A side in the third quarter.
I am wondering if you can quantify whether or not the savings you experienced last year in fourth quarter could cause maybe a little less opportunity in the fourth quarter this year.
Laura Weil - CFO
I think there is opportunity in the fourth quarter, as we look at the numbers.
Clearly, a lot of the initiatives we put in place will come to fruition in the back half of this year.
And as we see it, I think in the third quarter you will see continued reduction in gross and SG and A dollars.
In the fourth quarter, as well.
So, there is opportunity in the fourth quarter.
Analyst
Okay.
Great.
On the inventory side, inventory is clean.
It is clear you are chasing goods in categories that performed above your expectations.
Did you indicate you have essentially no carry-over goods from the first half?
In terms of getting into position to enter back-to-school, did you utilize off-price channel at all for some of the prior season goods?
Roger Markfield - Chief Merchandising Officer
We sell through about 98 plus percent of inventory and the last one to two percent of inventory we sell to the highest bidder of off-price.
We are not in the outlet business and don't want to be in the outlet business.
So, at the end of September, all spring merchandise that is in the clearance area of the store disappears and goes out.
We own that merchandise today at the price we sell it out the door at.
Analyst
Great, Roger.
Thanks that is helpful.
Operator
Your next question comes from Laura Levitan of SG Cowen.
Unknown Speaker
ANALYST:
Operator
Your next question comes from Richard Baum of Credit Suisse First Boston.
Analyst
Hi, guys.
I am still here.
Roger Markfield - Chief Merchandising Officer
Jim is waiting for a question.
Analyst
Couple of questions in the way of follow-up.
Early reads you have seen so far indicate women's is better than men's.
At the same time, you said you are doing much better in early back-to-school markets than in later back-to-school markets.
The question is, I assume that is true of - is that true of women's and men's, both of those?
Or is women's doing better across the board?
Roger Markfield - Chief Merchandising Officer
The relationship is similar, but women's is doing better across the board.
The ramping up, as you get closer to back-to-school, is dramatic difference.
Analyst
Do you think, come Roger, it has to do with buying patterns or merchandise assortment?
Or maybe some of both?
Roger Markfield - Chief Merchandising Officer
It is always a bit of both, never one reason.
Women's merchandise is so right and fashion right and on track, we are getting little bit better sell-throughs, even in areas where back-to-school is later.
As it gets real close to back-to-school, men's does much better.
I gave the number yesterday and I won't for one day.
It is an amazing spread.
Analyst
Let me ask this.
You indicated that denim was good in men's.
What is - what categories are not performing to your satisfaction in men's.
Roger Markfield - Chief Merchandising Officer
Two big categories in men's that are not working are sweaters, very difficult right now.
And while we are selling cargo pants in big quantities, nowhere near what it was last year, and that is a big number.
You know, it is not inventory risk.
You cut it out at the back end and flow it differently.
You don't cut the piece goods in a specialty environment.
It is not a margin risk, strictly volume risk at this point in time.
Analyst
Preliminary thoughts with regard to those two categories about why they are not - may be underperforming?
Roger Markfield - Chief Merchandising Officer
On cargo, it is not a must-have item.
It is not fresh and new.
Try to find a pant other than denim to replace it and it is impossible.
On the other hand, on cargo short business, which we didn't have to the same degree last year, because we wanted to be more wear-now, is doing terrific.
It is not nearly enough to offset long cargo pant business.
Analyst
How about on sweaters?
Roger Markfield - Chief Merchandising Officer
Sweater system just slow.
They don't want to buy sweaters at this time this year.
Analyst
Does it make any difference?
I assume they are lighter weight sweaters, maybe not?
Roger Markfield - Chief Merchandising Officer
All wear-now, cotton sweaters.
We are all wear-now.
Analyst
Okay.
The others have indicated sweaters have been a tough sell, as well for what that is worth.
Secondly, you know, you talked and I think it was interesting, Roger, your comment - what you are seeing promotionally with everybody with the direct mail.
Where are you guys right now for back-to-school in terms of what you are doing promotionally?
What can we expect without divulging any national secrets about what you are going to do for the rest of the back-to-school period?
Roger Markfield - Chief Merchandising Officer
Michael is smiling, I will let him answer.
Michael Leedy
I was smiling because you said national secret.
In the marketing world, the minute you do something these days, somebody knocks it off before it is executed.
So, direct mail has been a bit of a disappointment because of the environment out there.
The money card we started two weeks earlier this year.
So, the money card should more than make up for the small shortfall in direct mail response at this point.
Analyst
What you are doing on the money card, again, is $75 -
Michael Leedy
That is correct, $75 threshold and $10 money card.
The redemption period for the money card is October.
Analyst
Okay, the entire month?
Michael Leedy
That is correct.
Roger Markfield - Chief Merchandising Officer
I think the other thing we should talk about briefly and it is exciting is customization.
We have put a customization station in our stores.
Customers come in and experience the lifestyle of the brand.
What happens is that they leave with something that is unique item.
It is very individual, for them, it is all about how they wanted that product to be.
We have had a great reaction to it.
This isn't a secret, Richard, we said it in a press release.
Roger Markfield - Chief Merchandising Officer
It was in all the newspapers yesterday and the day before.
Roger Markfield - Chief Merchandising Officer
We will roll it for the weekend in the 400 top stores.
Analyst
I was too busy with earnings yesterday.
Just, what can you have customized?
Jeans and denim and stuff like that?
Roger Markfield - Chief Merchandising Officer
Pretty much anything.
For the most part, graphic t-shirts and jeans.
Jim O'Donnell
We do it in the window.
Roger Markfield - Chief Merchandising Officer
It brings the lifestyle of the brand to life.
With mall traffic where it is today, it is drawing customers.
Jim O'Donnell
We did it in 10 stores as a test.
We liked what it did and extended it to 60 stores last week and now we are expanding to 400 stores hopefully starting this Friday.
Analyst
Great.
Okay.
Thanks.
Operator
Your next question comes from Laura Levitan of SG Cowen.
Analyst
Sorry.
I don't think you could hear me before.
Couple of questions related to comments you made earlier, Roger.
First, you commented denim on the women's side, you are chasing products.
I am curious if you could give us a sense of how much that denim situation is putting pressure on the women's business and reflects disappointing trends you have seen in the early part of August?
Second, obviously the IMU improvements were very strong in the quarter.
I wonder if you could comment on the extent to which you expect it to continue and how much room you think you have left in driving the IMU improvement?
Finally, Roger, you said that we should expect it to take a while to transform a brand, like you are talking to do with Bluenotes, could you elaborate on the parts lagging your original timeframe?
Is it a pricing issue?
Is it a communication issue and you need to be in front of people or a product issue?
Thank you.
Roger Markfield - Chief Merchandising Officer
On the issue of denim.
You know that I am a big believer of becoming over a period of time, without going ahead of the customer, being there with the customer and becoming the denim destination.
That goes back to my days at Gap, a long, long time ago.
In was in '97, at the Eagle.
I joined in '93, I thought we were at that point, ready to start to become a denim destination store.
For the last three years, we went after it.
If you go into our stores today, clearly we have the strongest statement of denim, both basic and fashion, and the marketing presentation of it is outstanding.
The acceptance of the balance of the inventory that we have in women's on the - both the basic, which is fit model system, and the fashion on the women's, has been extremely well accepted.
We did not anticipate - keep in mind, we wanted to maintain lean and tight inventories.
So, the acceptance of all of our denim product has been on women's explosive.
We are - we have flow starting to come in, but we ran very lean and very light on lots of the inventory.
If I had all the inventory - this is how I know how powerful the American Eagle brand is.
If I had all the denim I could sell that want to buy it, women's would really be running high.
So, we don't.
But, we are way ahead of the game and we know what they want because we know which ones did well.
That is flowing into the stores.
So, I am delighted we are the denim destination.
It says an awful lot about the brand.
It says that we are the lifestyle of choice.
On the issue of IMU, I do believe that the cost prices will continue to drop certainly for another six months to a year.
I think we can continue to get the benefit of that.
As relates to repositioning of Bluenotes, it was like when I got to the American Eagle in 1993, it really wasn't until - I hate to say it, it is a fact.
It wasn't until 1996 that we really redefined it and defined it and redefined it.
From 19nex, until where we are now, that we became the brand of choice.
And Bluenotes is the name Bluenotes is in 25 stores.
There is 111 stores, so 86 other stores that are called Thrifty.
We have done nothing with the store design to this point in time.
We are working on a prototype store design that would reflect the kind of image and merchandising personality that we want the lifestyle to be.
It was strictly a denim promotional store under the name of Thrifty.
It is just going to take longer to build this brand the way we see it.
Analyst
Roger, how do we reconcile your comments about maintaining lean inventory, extremely lean inventory for the remainder of the year with the powerful sales trends you are seeing and potential loss sales on the women's denim side?
Roger Markfield - Chief Merchandising Officer
As Laura said, we said we would end fourth quarter flat.
Obviously we are going to be running very lean in other areas, with flow where we can be as flexible as we need to be, especially in knitwear areas, where you have the ability to respond with 35 to 45-day cycle.
If you have the fabric and production waiting, you need it.
We will make investment in denim for fourth quarter.
Analyst
One last follow-up.
You mentioned a lot of things that could take time and dollars at Bluenotes.
Is the guidance suggesting additional improvement in SG and A incorporating the assumptions that will continue at Bluenotes for the foreseeable future?
Laura Weil - CFO
I am not sure I understand the question.
Analyst
You said you thought we should look for continued leverage in SG and A. I want to make sure we are including -
Laura Weil - CFO
Absolutely.
Yes, it does.
It is consolidated SG and A, including all operations.
Analyst
Thank you.
Operator
Your next question comes from Joe (inaudible) of Wachovia Securities.
Analyst
Thanks.
Hi, guys.
Two questions.
On the square footage growth for next year and one on Bluenotes.
Looks like 10% square footage growth and ramping down store openings and ramping up renovation, that signals strategy regarding real estate.
If there is more of a focus on marketing (inaudible) goal for next year to share with us?
Laura Weil - CFO
I will let Jim address the real estate estate strategy.
But, on the profitability, you know, we see that we can easily achieve 15 to 20% earnings growth on the lower new square footage with modest comp continued leveraging of SG and A and expectations of normal margin.
So, you know, I think that the earnings growth can definitely be achieved.
Jim O'Donnell
As far as real estate strategy, you are correct.
We are taking - the reason we are winding back on the new stores, we want to focus in on existing properties.
We have identified 121 properties that we feel need to be updated with our new and latest brand image.
We have metrics to reenforce this decision based on where we have our updated brand, new store design, if you will, in our prominent centers, where we compete with the best in our space.
We perform quite well.
To the contrary, we are in centers where we are not an updated brand and have an old design, either '93 or '95, with the same competitor mix, we do not perform as well.
That leads us to the conclusion, let's speed up expansions and just wind back slightly the new stores moving forward.
Analyst
Is this mean you will back away from the thousand 1200 store potential?
Jim O'Donnell
1200 stores is probably a reach.
A thousand is a reach.
We have 150 - 156 shopping centers, malls, that we know we could perform in.
We have the mix is such that we have a history that we would perform well.
Now, how do you get to 1000 is we need to start to see performance from the open air lifestyle centers and also can we do business in some of the metropolitan Urban markets, such as New York, Chicago, Washington, so forth.
If those other two vehicles show we are testing a number of different stores around the country in lifestyle and urban centers.
If they show they will be productive, we can move into probably 1000 store range.
Analyst
Quick question for Roger.
I was in Bluenotes last week myself.
They were expressing the same thoughts you are, the old customer is not finding what they used to find with the 17-year-old target customer.
They also said in the store, the women's product had been overhauled and it was different, but the men's product pretty much looked the same as last year.
Is that something you need to work on or was I getting bad information?
Roger Markfield - Chief Merchandising Officer
No, I think what you said is exactly right.
Analyst
When do you expect that to be implemented?
Roger Markfield - Chief Merchandising Officer
Being worked on.
Analyst
Thanks.
Operator
Your next question comes from Bailey Lark upon Seneca Capital.
Analyst
Two quick questions.
Laura, could you give us granularity on increasing accounts payable?
It was up 76%?
Laura Weil - CFO
You are right.
The reason that payables were so much higher in the quarter was a result of later merchandise receipts, mainly, in the quarter versus last year.
We received more product later in the quarter.
That was primary reason for the increase.
Analyst
Okay.
Second question relates to Bluenotes.
Originally, if I look back, I think we were expecting some increase in sales trends in the back-to-school and holiday period.
It sounds like it is taking longer than you had hoped.
Should we expect current sales trends to continue for back-to-school period?
Laura Weil - CFO
I think at this point that is reasonable to assume.
Obviously we think that the product gets better and better as we go into fall and then later into holiday.
We think that the customer is going to catch on as we move forward and marketing takes hold and kids go back to school.
Kids don't go back to school in Canada until after Labor Day.
The numbers are affected by later back-to-school than the U.S., but I think to be - it is appropriate to look at the current trends and take them out for the rest of the fall.
Analyst
Despite the easier - with the easier comparison, we should see improvement in absolute sales level -
Laura Weil - CFO
We certainly hope so.
What we are saying, it is early in the process.
Analyst
Great.
Thank you very much.
Operator
Your next question comes from Stacey Pack of Prudential Securities.
Analyst
Roger, I think these are all for you.
I want to get your perspective on a few things.
First of all, on sweaters, what is up with sweaters, do you think?
It is not like sweaters was the best category in the world last year.
It is fairly broad, as Richard said.
What replaces sweaters?
What does it mean for holiday?
Are you seeing pick-up in denim jackets?
What is going on overall?
Roger Markfield - Chief Merchandising Officer
On the guy's side, I think that they are buying much more wear-now.
So, short-sleeved knit business is very strong.
Obviously not offsetting the volume you did in sweaters.
Sweatshirt business is business, but last year it was so monsterous and everyone is into the business this year that even that trend, while it is certainly not risk in terms of margin, it is not giving any plus side to where you were last year.
But, the guys are just not buying sweaters.
On the feminine side, we played inventory now and went to wear-now.
You just didn't plan to do more sweater business than last year.
On the set that is going to go in first week in September, those sweaters - and I have visibility on it, some of those sweaters look phenominal.
So, as relates to fourth quarter, you want to be very conservative.
You want to be very guided and you don't want to respond unless you know what is going to work.
But, I think we may have some insight into what might work.
Analyst
Basically what you think is up with sweaters is people just start buying short sleeve and wear-now and that it will pick up with the weather?
Roger Markfield - Chief Merchandising Officer
I think so.
Analyst
Then, on - just on the comps in the early back-to-school market, I am assuming comps are on plan in early back-to-school markets?
Roger Markfield - Chief Merchandising Officer
Pretty much.
Analyst
Again, Roger, does that suggest in your mind that the weakness you are seeing in overall numbers is the shift in back-to-school dates in Texas or tax holidays or whatever, rather than a weak consumer?
So, you think things will pick up going forward?
How are you looking at that?
Roger Markfield - Chief Merchandising Officer
I think you don't know.
I must tell you, I am not an economist, we certainly know - we open up our statements.
I don't want to pontificate being an economist.
It is a choppy buying pattern out there.
We like what we see in terms of early back-to-school, as opposed to late back-to-school.
Late back-to-school looks terrible.
Early back-to-school looks fine.
We just don't know.
Analyst
Are you seeing strength in denim jackets?
Roger Markfield - Chief Merchandising Officer
We have - yes, denim jackets are doing nicely.
What is doing better really is the lined corduroy jackets that are denim inspired, but with sharper linings.
Analyst
There goes the warm weather theory.
Roger Markfield - Chief Merchandising Officer
When you are fashion right, they respond.
Analyst
Has the average unit price or however you want to talk about women's come up?
I think we all think the women's assortment looks a lot better.
The prices look higher to me.
Are the prices up on average in women's or not?
Roger Markfield - Chief Merchandising Officer
Pretty equal.
Analyst
Last question, what about the longevity of peasant/bohemian?
Does it go into next year for you?
Roger Markfield - Chief Merchandising Officer
I know there are lots of my friends on this phone conversation. -
Analyst
So, you will call me later? thanks.
Operator
Your next question comes from Dorothy Lakner of CIBC World Markets.
Analyst
Good morning, everyone.
I don't know if you want to give more color on that, Roger, but that was one of my questions, also.
If we are seeing some kind of fashion shift in the teen business to sort of cleaner look from the overly bohemian that we saw earlier in the year given some of the issues other teen retailers have had?
I don't know if you can comment more on that.
Just, if we could go back to last year, what - give us some sense of how the women's and men's businesses were performing comp wise last year, what they are up against now.
Lastly, I wanted to get more clarity on the flow of women's denim?
I think you said earlier, Roger, you were expecting to be where you want to be in terms of in-stock in September, but you have got flow coming in now.
So, is there pretty steady flow back in or are we missing out on the month of August?
Roger Markfield - Chief Merchandising Officer
We are not going to do what we could have done in the month of August, Dorothy.
We do have flow flowing through the stores.
As it is flowing, it is selling that fast.
I wish I had - I mean, I have 400,000 units flowing in the next two weeks to give you a number.
I wish I had 650,000 units flowing.
On the issue of comp, remember last year women's was relatively flat in the back-to-school quarter and men's was running up 10 comp.
But, women's is the bulk of the business.
It represents - just to put everything in perspective, represents 60% of a business.
Bluenotes is 5 to 6% of the entire company business.
It is a small amount.
So, we feel good we have women's on track and that we don't have liability in the men's inventory.
Analyst
Okay.
Then on the fashion -
Roger Markfield - Chief Merchandising Officer
I avoided that one.
Analyst
Talk to you later.
Operator
Your next question comes from Elizabeth Pierce of (inaudible) Morgan.
Analyst
Quick question on back-to-school markets.
How many stores what percent of store base is in back-to-school market?
Laura Weil - CFO
One second, Liz.
Roger Markfield - Chief Merchandising Officer
Early states are 30% of volume.
Analyst
Great.
Roger Markfield - Chief Merchandising Officer
70% of states to come.
And the spread - I will give you numbers, spread is 15 points.
Analyst
Okay.
And then, in the Bluenotes, I don't remember how many you said, 86 are still under Thrifty and 25 under Bluenotes?
Roger Markfield - Chief Merchandising Officer
That is correct.
Analyst
They all have same merchandise?
Laura Weil - CFO
Yes.
Analyst
What are the plans to transition the Thrifty into the Bluenotes?
Roger Markfield - Chief Merchandising Officer
We are working on store prototype which will have within 30 days and we hope to have it up in Canada, one store as an example for holiday.
And from there, we will see and once again, we will reposition and redo whatever is necessary to do.
Laura Weil - CFO
Liz, obviously we want to get the merchandise right.
We want to get the brand positioned correctly before we spend a lot of capital on the stores.
We want to have the new store prototype, which is coming along really well, look at it and tweak it and roll it out.
Analyst
Great.
Finally, Roger, on the new floor set that arrived.
It is in 10 stores now?
Roger Markfield - Chief Merchandising Officer
Actually in one store now, going to 10 stores and then will roll to the chain.
Analyst
When does it go into 10?
Roger Markfield - Chief Merchandising Officer
10 stores next week.
Analyst
Are you comfortable with talking about some of the differences?
Roger Markfield - Chief Merchandising Officer
I think you go to the store.
We will give you the stores to visit.
Laura will give you the stores and you look at the merchandise.
Analyst
Thank you.
Operator
Your next question comes from Steve (Curncrout) of Berman Capital.
Analyst
Most of the questions have been answered.
One question share repurchases.
What is your stance on that now?
What kind of prices were you buying back shares earlier in the year?
Laura Weil - CFO
We will be revisiting our buyback plans on a regular basis, Steve.
And our average price was in the 16 dollar range.
Analyst
Okay.
It is the 16 dollar range.
Thanks a lot.
Good luck.
Laura Weil - CFO
I think we have time for one more question.
Operator
Your next question comes from Dana Telsey of Bear Stearns.
Analyst
Good morning.
About the number of days between Thanksgiving and Christmas this year versus last year, any differences in the way you are planning and how you see the holiday season?
Also, on corduroy, we have been hear being corduroy, how do you feel about corduroy lately?
Roger Markfield - Chief Merchandising Officer
We feel wonderful about corduroy.
If you visit our stores you know as I mentioned before, corduroy shirt for jacket, corduroy skirts, jeans, corduroy pants, stretch.
We believe strongly in corduroy.
Obviously we don't like the calendar from Thanksgiving to Christmas, obviously it is a week shorter.
So, strategically you need to do things differently.
Analyst
Any adjustment you will be making we should watch for when the holiday versus last year?
Roger Markfield - Chief Merchandising Officer
It will set at the same time.
Analyst
Thank you.
Laura Weil - CFO
Okay.
I think Valery, we would like to end the call today.
Valery.
Operator
Ladies and gentlemen, we have reached the end of the allotted time for question-and-answer session, Mr. O'Donnell, are there clozing remarks?
Jim O'Donnell
That will be it, thank you.
Laura Weil - CFO
Thank you, everyone.