Express Inc (EXPR) 2011 Q2 法說會逐字稿

Greetings, and welcome to the Express, Inc. second quarter 2011 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's now my pleasure to introduce your host, Allison Malkin of ICR. Thank you Ms. Malkin. You may now begin.

Thank you. Good afternoon, everyone. Before we get started, I would like to remind you of the Company's safe harbor language, which I'm sure you're all familiar with.

The statements contained in this conference call which are not 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 to differ materially from those suggested in such statements due to a number of risks and uncertainties, all of which are described in the Company's filings with the SEC, which includes today's press release.

In addition, during this call, we will make reference to adjusted operating income, adjusted net income, and adjusted earnings per diluted share, which are not GAAP measures. Reconciliations of these non-GAAP measures to reported operating income, net income and earnings per diluted share, have been provided in our press release.

Now, I would like to turn the call over to Michael Weiss, President and CEO of Express

Thank you, Allison, and good afternoon everyone. I am joined here today by Matt Moellering, our Chief Administrative Officer and Chief Financial Officer.

I'll begin our call today with an overview of our second-quarter performance and update you on the progress of our key growth initiatives. Matt will then review our financial results and outlook in more detail. Following my closing remarks, we will conduct a question-and-answer session.

We are pleased to continue our favorable momentum and report better-than-expected second-quarter results. In the second quarter we increased net sales by 10% with comparable sales increasing 6%. We grew e-commerce by 39%, and we expanded merchandise margins by 140 basis points. This increased adjusted operating income by 65%. And we exceeded the high-end of our guidance by $0.02, with adjusted earnings per diluted share increasing to $0.17, more than double adjusted diluted earnings per share of $0.08 reported last year.

We believe Express is increasingly viewed as a fashion authority by our target demographic as we consistently present our customers with great assortments across our end uses of wear-to-work, casual jeanswear, and going out. During the quarter, we continued to evolve our go-to-market strategy, selling more forward season merchandise than the year before. This strategy led to higher regular price sales and remains a key driver of our merchandise margin expansion.

As many of you are aware, through testing, we also gained great insight into the key styles we will offer for fall and holiday. Additionally, we saw strong response to our in-season assortments. During the quarter, we continued the successful execution of our four growth pillars and also implemented a new category, marketing and store initiatives, to further our growth potential.

In regard to our first pillar of growth we increased sales productivity and expanded gross margin in the quarter with our comp sales increase balanced across genders and categories, driven by growth in average dollar sales. In women's, our business was led by increases in knit tops, sweaters, pants, skirts, and jewelry. We were also pleased with our newer categories of footwear and fragrance.

We recently introduced boxed footwear to 40 additional stores, following a successful 10-store test and now offer the category in 50 locations.

In fragrance, our sales were driven by Love Express, which launched during the third quarter of last year. We have found that our customers view these high margin categories as add-ons to their existing purchase, which we expect to fuel increases in units per transaction and average dollar sales as these categories grow over time.

In men's, we were particularly pleased with the strength of woven and knit tops, shorts, jackets, and accessories. As demonstrated by our results, we believe men view us as a key destination for suiting. And in July, we begin to test men's expanded shirt shops in 14 of our highest producing shirt stores. These shops carry an expanded offering of men's shirts and suiting, with in-store visual marketing that highlights our fabrication styles and value across our offering. We expect to increase sales productivity as these shops present a wider assortment in an easier to shop format.

For fall we will also introduce a line of men's watches to capitalize on strong category demand. The collection will feature 14 styles in a variety of the bands and dial offerings, including three-hand, chronographs, and automatics. Prices will range from $69.90 to $148, with the watches scheduled to arrive in 50 stores and on express.com in November.

Going forward, we will continue to take advantage of opportunities to retain historical sales volume in existing, relevant categories, while seeking new product opportunities that are consistent with our brand and the needs of our consumers.

As it relates to our second growth pillar we are pleased with our e-commerce merchandise sales, which rose 39% in the quarter, following a 60% increase in the second quarter last year. We saw balanced growth across men's and women's categories consistent with our store performance. We continue to generate strong increases in traffic and conversion on the Web.

In addition, we saw growth in both our app downloads and mobile commerce sales in the quarter. And while not significant -- not significant sales driver in the short-term, our digital strategy drives customer engagements and loyalty, solidifying Express as a multichannel brand. This is an important initiative for us as multichannel shoppers are our most productive customers.

In August, we expanded shipping from express.com to more than 60 international markets, including countries in Europe, South America, and Asia. While we do not expect this to be a significant driver of sales in the short-term, we will closely monitor shipping trends and incorporate key learnings as we further develop our international expansion strategy. We advanced our third pillar by expanding our store base.

During the quarter, we opened nine new stores while closing one existing store, ending the quarter with 599 locations. We continue to be pleased with the performance of our new stores and plan to open a total of 21 new stores in the US by the end of the year.

In June, we also introduced a new design format in two stores, in the King of Prussia Mall outside of Philadelphia, and Kenwood Towne Center in Cincinnati. We believe the our new store design elevates our brand as we showcase our four end users in an easier-to-shop format, and we are very encouraged by the results. As a matter of fact, we are so encouraged by the results that even though the test is not officially over, we are planning to roll the new store format in late spring, which are the first stores we can effect.

We are also excited to introduce Express to the Canadian market with six stores scheduled to open by the end of 2011. We will unveil our first two stores in Toronto this September, followed by four additional store openings in November, including three in Calgary and one additional store in Toronto. In total, we expect to open 27 new stores in the United States and Canada this year and to close nine existing locations. To the end the year -- we will end the year with 609 locations and approximately 5.3 million gross square feet in operation.

Moving to our fourth pillar of growth, international expansion. I'm pleased to announce that we hired Ron Young as SVP of International. Ron comes to us from the Gap and will join Express in early September. We continue to make progress in developing our international strategy during the quarter and expect the addition of Ron to enable us to expedite these efforts.

Our investment in marketing continues to provide rewarding brand opportunities that elevate the brand, increase awareness, introduce new products to existing customers, and expand our customer base. Our Sidewalk Runway program provides both strong brand exposure and the opportunity to interact with fans across the country, while it also develops fashion content that can be integrated through all channels.

In the second quarter, Sidewalk Runway fashion shows were held in New Orleans and in New York's Times Square, with more than planned throughout the remainder of 2011. While we were in New York, our customers and fans helped Express become the new Guinness World Record holder for the most people modeling on a catwalk by more than doubling the previous record.

This fall, we have planned television advertising on the season premieres of a number of top shows watched by our demographic, including "Gossip Girl," "Vampire Diaries," and "Nikita" to name a few.

Further adding to our brand-building initiatives is our first ever, 48-page fall catalog which will be distributed to more than 8 million consumers at the end of August following a successful magalog test last year. Expect our combined marketing efforts to heighten brand awareness and drive traffic both in-store and online as we connect more closely with new and existing customers.

Our efforts to increase customer loyalty continue with a redesigned customer loyalty program which is scheduled to pilot this fall. The program will reward our best customers and increase engagement with the brand. It will be tender agnostic so all of our customers maybe participate and be rewarded for shopping at Express. Current Express credit card holders will receive exclusive benefits with the new program.

We believe we are positioned to manage rising product costs as we begin the second half of the year. As I mentioned previously, we believe our brand has pricing power driven by three factors. First, we compete on quality and fashion and not just price. Second, our increased marketing investment has elevated the intrinsic value of our brand. And third, given we are a fashion Company, the majority of our products are new each season, so our prices are not directly comparable as is the case with commodity-type businesses. Most important, we are not seeing resistance to our pricing, which we believe is a reflection of our ability to meet our customers desire for fashion and quality across our four end uses.

In addition to our positioning, we are implementing initiatives to further mitigate sourcing cost pressures. To this point we will strategically shift sourcing to manage costs. We will also lower the percentage of our products shipped air while maintaining our stringent quality and on-time delivery standards. Despite higher product costs and some increased cancellation fees on fabric commitments, we expect to deliver increases in gross margin dollars and essentially flat gross margin rate in the third quarter.

Moving past third quarter, our expectations for the fourth quarter includes increases in both gross margin dollars and a modest increase in gross margin rate. We are pleased to continue to deliver strong margins even as we anniversary robust gains from last year. In total, I am pleased with our performance in the second quarter and remain optimistic about our ability to continue our favorable results in the second half of the year.

We are optimistic at the start of the third quarter, given strength in our traditional back-to-school categories. We are also delighted of the positive response to our dressy business, which increases in importance as the fall season gets further under way.

In addition, we believe we have a powerful marketing program in-stored, direct mail digitally, and on TV that has us poised to increase our market share with our target audience. And while we recognize that recent, global economic events may impact consumers' spending, we believe the advantages of our business model, along with the strength of our brands and the discipline with which we manage our business, will enable us to navigate potential challenges brought on by these events.

Highlighting some of our advantages, we appeal to a growing demographic that has a high discretionary spend. We have significant growth opportunities as we focus on regaining historical sales volumes in existing, relevant categories. And introduce new complementary product lines and continue our store expansion. And also, we believe our data driven strategies that include the testing of 75% of our merchandise gives us good visibility into the strong selling styles in future seasons while lengthening regular price sales windows.

Now, I would like to turn the call over to Matt to review our financial results and guidance in more detail. Matt?

Thank you, Michael. Good afternoon everyone.

As Michael stated, our business continued positively in the second quarter, driven by strong sales, margin expansion, and leverage in SG&A. I will begin by reviewing the details of our second-quarter results and then provide our outlook for the third quarter and fiscal year.

For the second quarter, net sales increased approximately $38.7 million, or 10%, to $446 million as compared to $407.3 million for the second quarter of 2010. Comparable sales increased 6% for the quarter, following an 8% increase last year, and our e-commerce sales rose 39%.

Gross profit increased $19.8 million to $149.8 million, or 33.6% of net sales as compared to $130 million or 31.9% of net sales in last year's second quarter. The 170-basis point increase in gross margin was driven by 140 basis points of merchandise margin expansion as we continue to benefit from our evolving go-to-market strategy. This, coupled with our brand relevance and strength, enabled us to increase regular price selling, expand our merchandise margin, and offset product cost pressures.

Our buying and occupancy cost included higher pre-opening rent expense as compared to last year. Despite this, we generated 30 basis points of buying and occupancy leverage. We continue to see no material resistance from the price increases we implemented during the first half of the year, and in fact, generated higher dollar sales from this move. We believe we are positioned to mitigate product cost increases given our diversified sourcing base and brand strength.

Selling, general, and administrative expenses or SG&A, totaled $117.7 million, or 26.4% of net sales. This compares to SG&A expenses of $110.9 million, or 27.2% of net sales, in last year's second quarter, which included $900,000 of non-core operating costs related to our initial public offering completed on May 18th 2010. We were pleased to generate 80 basis points of expansion in SG&A, despite increased expenses related to our continued brand-building initiatives.

Strong sales growth, expansion in gross margin, and leverage in SG&A led to a significant increase in our operating margin on both a GAAP and an adjusted basis. Operating income grew more than fivefold to $31.7 million, or 7.1% of net sales, from $5.1 million or 1.2% of net sales in the second quarter last year. Adjusted operating income increased 65%, which excludes non-core operating costs incurred in the second quarter of 2010, related to debt extinguishment.

Interest expense totaled $10.5 million, and included a $3.7 million loss on extinguishment of debt associated with the repurchase of $24.2 million of senior notes in the Opco revolving credit facility amendment. This compares to interest expense of $23.3 million in the second quarter of 2010, which included a $13.6 million loss on extinguishment of debt associated with the prepayment of our term B loan.

Our income tax expense was $8.6 million, representing an effective tax rate of 40.6%, compared to a tax benefit of $38.9 million in the second quarter of 2010. This change in tax expense is a result of our conversion to a Corporation in connection with the IPO in the second quarter of 2010. On a GAAP basis, net income was $12.6 million, or $0.14 per diluted share on 88.9 million shares outstanding, and included a $2.2 million, or $0.03 per diluted share loss on extinguishment of debt related to the repurchase of $24.2 million of senior notes in the Opco revolving credit facility amendment.

As indicated on prior calls, our guidance is based on adjusted results and excludes any costs related to future debt reduction or other non-core operating costs. Therefore, consistent with our guidance, on an adjusted basis, net income for the second quarter was $14.9 million, or $0.17 per diluted share and exceeded our guidance range of $0.12 to $0.15 per diluted share.

In comparison, net income in the second quarter of 2010 was $22.1 million or $0.25 per diluted share on 88.7 million weighted average shares outstanding and included the following non-core operating costs after-tax. $500,000 or $0.01 per share of cost related to the initial public offering, $8 million or $0.09 per diluted share of fees paid to Golden Gate Capital and Limited Brands related to the termination of advisory arrangements with them in connection with the initial public offering. And $8.2 million or $0.09 per diluted share loss on extinguishment of debt related to the prepayment of debt in connection with the initial public offering.

These costs were more than offset by one-time tax benefit of $31.8 million, or $0.36 per diluted share, recognized in connection with the Company's conversion to a Corporation. Net income, adjusted for one-time items just mentioned, was $7.1 million, or $0.08 per diluted share, in the second quarter of 2010.

Moving to our balance sheet, we ended the second quarter with cash and cash equivalents of $144.6 million, or a 66% increase, compared to the end of the second quarter last year. Also, quarter end inventory rose approximately 12.5 % to $207.4 million compared to $184.3 million at the end of the second quarter last year. The increase in inventory reflects funding for continued e-commerce growth, new stores, and new category growth for shoes, jewelry, and personal care.

In addition, strategic purchases of fabric ahead of anticipated cost increase, represented 1.5% of the inventory increase as compared to the end of the second quarter last year. Inventory per square foot increased approximately 4% compared to the second quarter of fiscal 2010. We remain very comfortable with the level and content over inventory position as we begin third quarter.

Total debt declined by $49.5 million to $318.4 million, from $367.9 million at second quarter end 2010. This was primarily a result of the repurchase of $49.2 million of senior notes in the first half of this year. Year-to-date capital expenditures totaled $33.6 million compared to capital expenditures of $28.2 million for the same period last year.

On July 29, we amended and restated our existing $200 million Opco revolving credit facility, which was scheduled to expire in July 2012. The new amendment extends the maturity by four years to 2016 and lowers the applicable interest rate on borrowings from between 2% and 2.25% to between 1.5% to 2%. Additionally, the unused lines the was reduced by 12.5 basis points to 0.375%. At quarter end, no borrowings were outstanding under this facility. We believe that our ability to lengthen the term of our credit facility at a reduced rate is further validation of the strength of our business model and our ongoing ability to generate positive cash flow.

Certainly, macro economic events give pause for thought as to the potential consequences on consumer confidence. Michael has outlined why we believe we are well-positioned to navigate potential challenges brought on by these events. It is important to note that our guidance is based on our current business trends, our expectations over the remainder of the year, and reflects our performance in the context of the current environment. With that as a backdrop, I will now review our guidance.

We are introducing guidance for the third quarter and raising our guidance for the full year 2011. For the third quarter, we currently expect comparable sales to increase in the mid single-digit range, which compares to a comparable sales increase of 5% in the third quarter of last year. We expect our effective tax rate to approximate 40.3% for the third quarter of 2011.

Net income is expected in the range of $29 million to $32 million, or $0.33 to $0.36 per diluted share on 89 million weighted average shares outstanding. This compares to adjusted net income of $26.4 million, or $0.30 per diluted share on 88.7 million weighted average shares outstanding in the third quarter last year.

We are raising our annual earnings guidance for 2011. We continue to expect comparable sales to increase in the mid single-digit range as compared to a comparable sales increase of 10% in 2010. We expect our effective tax rate to approximate 40.3%.

Net income is currently estimated in the range of $140 million to $145 million or $1.57 to $1.63 per diluted share on 88.9 million shares outstanding. This compares to adjusted net income of $121.8 million or $1.42 per diluted share on 86.1 million weighted average shares outstanding in fiscal 2010.

To eliminate the comparability issues related to the tax rate and share count, I would again like to point out that this guidance implies adjusted operating income growth of 21% to 25% over 2010. Again, note that net income is materially impacted given we are subject to federal taxation as a result of our conversion to a Corporation for the full year 2011, versus three quarters of the year for 2010.

Our store expansion plans for the remaining two quarters of fiscal 2011 include opening of eight new stores in the United States, six new stores in Canada. And four store closings, two of which are men-only stores that will be converted to our dual gender store format. We expect to end the year with approximately 609 stores and 5.3 million gross square feet in operation.

Our store expansion program has a higher percentage of new store openings in the third quarter, and therefore, we will absorb increased pre-opening expenses and also increased investment as we introduce our brand in Canada. As such, operating margin expansion will be greater in Q4 than in Q3 this year. Capital expenditures for the year are expected in the range of $72 million to $76 million. Finally, we expect to generate positive cash flow.

And with that, I will turn it back to Michael for some closing remarks.

In summary, we believe the sustained and consistent performance we have delivered since going public last year clearly demonstrates the success of our business model and growth strategies. We expect to maintain our fashion authority within our target demographic and see significant opportunity to drive sales productivity as we execute our expansion plans. As a result, with better inspected earnings performance in the second quarter and our positive outlook, we have raised our 2011 guidance.

With that, I would now like to turn the call over to the operator to begin the question-and-answer portion of the call.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). One moment please what we poll for questions. Our first question comes from Neely Tamminga with Piper Jaffray.

Great. Good afternoon, and let me start with the congratulations. Just a great quarter.

Thank you.

I have a product question for Michael and a modeling question here for Matt. First on the product, Michael, we are seeing here in the summer months just great success in sellthrough on knits and sweaters. I'm thinking of like the dolman sleeve sweaters with stripes and the chevrons, et cetera. Is this part of the recapture of the knit category that you guys have been articulating all along? And is there something you're seeing early on that's giving you confidence that you guys are on the right track in terms of recapturing? I will follow up with a model question.

The fast answer is yes, yes, yes, and yes. What you are seeing in the stores right now are certainly advanced merchandise, which is outselling last year's advanced merchandise, and which gives us a great hope that we are recapturing market share in those categories.

Okay. And so you are just seeing the early reads, obviously, with your customer react, and there's just more of that potentially that can be coming here right around the corner in the back half? Is that the read?

Yes.

Okay, cool. And then, Matt, in terms of the merchandise margin gains, I think that was really the big win from our perspective, just an absolutely fabulous job. Can you remind us what that was on top of last year in the second quarter? And then, this is still not really reflecting any sort of gravitation of mix shift, right, from some of the new categories? This is still primarily just fuller price sellthrough? Is that right? And how should be thinking about the second half merchandise margin? Thanks.

Sure. The 140 basis point product margin improvement this year was on top of 190 basis point produce margin improvement last year, so we continue to make significant progress as we continue to evolve our go-to-market strategy over time. A couple of things contributed to the higher product margin, the product margin improvement this year. The first thing really is, as Michael mentioned, we did bring in more fall-side goods in June and July this year and have left the spring and summer merchandise in the store at the period of time. Which, as we talked about in the past, allows for more full-price sellthrough, fewer markdowns, and most importantly, it gives us more information about what the customer wants because that fall-side merchandise is out there, and it really is an indication of what we are going to provide for the fall and holiday season. So that certainly was 1 -- that certainly was a big benefit for us.

Great, thanks you guys. Congratulations and good luck.

Thank you.

Thank you. Our next question comes from Stacy Pak, Barclays Capital.

Hey, guys, and congrats. Michael, I was hoping you could comment, without sharing all your secrets, but if you could comment on how strong do you think the current fashion cycle is? How good is it for your customer? And then, Matt, if you could just comment, I think you mentioned that there was a hit from some fabric cancellations. What is that? And what was the hit? And also, can you quantify what the comp metrics were in the quarter, specifically AUR and AUC? And what benefit you expect from air freight in the second half?

Okay, Stacy. Yes, I think it's a very strong cycle. The new fashion cycle is very strong. And to that point, I think it's very strong for our customer. I think what is happening is especially strong to our demographic.

First and foremost is color. It's tremendously strong. When I say the strongest, not the biggest, but the fastest turning piece in jeans, and we expect that to be very important for the rest of the season, and we have lots of that coming in.

Second thing are leg shapes. New leg shapes seem to very much play to our strength. And the flares in jeans are turning fast, and the wider legs in pants generally are turning very, very well. And we believe that on a go-forward basis that should be additive.

Good news in terms of what we are selling is that our direct business is -- last year had been very good, but it had been very good on the dressy side, exclusively. And this year, we're hitting some -- and I'm sure you've seen them in the fan magazines, because we've gotten a lot of play on casual dresses, have been very good for us. Finally, on the wear-to-work side of it, pencil skirts are very good, and soft shirts and blouses are very good on both the dressy and the casual side. So we're enthused about things that were not there in this strength last year.

That's great, Michael. Thank you.

So on the other questions, Stacy, the hit on cancellations, there was 2 things mentioned in the call. 1 was on the inventory piece where, as we talked about on the Q1 call, there are some -- we had to pay cash for some of our fabric positions, and when we do that, that goes on to our balance sheet. And that represented about 2% of the increase in total inventory at the end of the quarter relative to last year. From a cancellation perspective for Q3, that will impact gross margin. There's about a 50 basis point impact. Back in October, November of last year, we put a significant number of fabric positions, we put those on to help protect pricing in the back half of this year. As we are now 9 months later to the back half of the year, there are a few of the fabric positions that we put on, that we are not going to utilize, and therefore, we will most likely have a reserve charge against those. We are still looking for ways to utilize those fabric positions, but the chances are, we may have to reserve some of those positions over the next -- course of the next couple of months. And that is where that comes from. As for your question on comps, we only give out directional information on ADF and transactions, and the comp improvement for the second quarter was primarily driven by ADF.

Okay, great. Thank you.

Thank you.

Thank you. Our next question comes Kimberly Greenberger, Morgan Stanley.

Great, thank you. And I'll add my congratulations on a nice quarter as well.

Thank you.

Michael, it sounds like August here is off to a nice start, and if I'm reading into your guidance correctly, from what Matt said, it sounded like you are running in line with this sort of mid single-digit comp guidance. Did you see any sort of wobbles or blips in your business here over the last 3 to 6 weeks at all?

When you say wobbles and slips, not really, no. I think your first statement was kind of on the money. August, we wound up selling the things we hoped we would sell, which kind of says a good thing about August. But more importantly, it says good things, in our opinion, about going forward into September and October and holiday.

Okay, fantastic. And the new store design that we saw in Philadelphia last month, I know it's still very, very early days. I'm wondering if you have any anecdotes or any sort of early reads that you're willing to share with us today?

And then, just a follow-up question for Matt. I see the cash building on your balance sheet, and at this point, looks like cash is approaching $150 million, and it's almost half of your debt balance. So if you could just talk to us as you go through your big cash generation period here in the second half of year, how are you thinking about deploying that cash? And how do you think about debt pay down versus a special dividend, and have you considered perhaps any share buybacks?

Kimberly, I am assuming that you are asking me about the King of Prussia store, the new store?

Absolutely.

Okay, yes. It's awfully good. It's not yet the end of the test period, but as I mentioned in my narrative here, we've already decided, basically, to switch in-spring stores forward. That's the earliest we can affect into the new store format. I think anecdotally, the thing that's best about the store is the part we hope would be best about the store, which is the average dollar sale based on the UPT. The store is selling outfits, and that's what we want to do. We want to be more than an item store. We want to be a brand, and to be a brand you have to be able to sell looks. So it's feeding to -- that store is feeding to all of our ends.

And the second part of your question, Kimberly, we are certainly generating a significant amount of cash as we talked about in our remarks. We will wait until the end -- toward the end of the fiscal year to determine what we want to do with the cash. We certainly have gone on record publicly stating that we are committed to reducing debt over time, and we will certainly continue down that path as -- going forward.

Thanks so much.

Thank you. Our next question is from Lorraine Hutchinson, Bank of America Merrill Lynch.

Thanks. Good afternoon. Can you talk a little bit about, maybe quantify the cost pressures that you experienced in the second quarter? And then how those will trend in 3Q in 4Q?

Sure, Lorraine. Q1 and Q2, we had low to mid increases in our AUCs. Q2 was closer to a mid -- a mid type of a number for AUC increases. As we head into the back half of the year, what we talked about on the Q1 call is a low double-digit increase in costs, and we are still holding with that statement. It looks like that where the cost will come in for us in the back half of the year. And as Michael mentioned in his remarks, we have taken pricing up in select areas of the business and have seen very little resistance to the price increases, and we think that's really attributed to the power of the brand, the fact that we complete on quality in value and not necessarily simply price. And because we've seen very little resistance, that certainly helps us offset a significant amount of increases we are seeing in AUC.

Thanks. And you give us some examples on last quarter's call, the editor pant, and I think some of the basic camis. Has your experience changed as you start setting fall with how the consumer reacts to some of those price increases?

No, it has not at all.

And then just if we could get a little bit more information on the SG&A dollar growth. I know you have some big investments in Canada this quarter. Can you talk a little bit about where you expect the percentage growth in 3Q and 4Q?

Yes, the way we talk about that, Lorraine, is that for Q3 and Q4, the leverage point on SG&A is the mid single-digit comp for us. We've been able to leverage on the last 2 quarters. Really the investment on SG&A are coming in to e-commerce, international, expansion, and as well as IT. So those are 3 of the key drivers for the SG&A growth, and it starts to lever at a mid single-digit comp.

Thank you.

Thank you.

Thank you. Our next question comes form Michelle Tan, Goldman Sachs.

Great, thanks. Michael, in your last quarter, you talked a little bit about what you are seeing in the promotional environment at the start of the summer. I was wondering if you could kind of give us your views on what's going on out there today and anything that you guys are doing differently because of what the broader market is doing?

No. I think it's just about the same as it was. We've not changed our view on promotion. We plan to be promotional. It's part of our financial plan; it's part of our promotional plans; it's part of everything that we basically do. The only difference that I can think of, was that we went from -- in jeans, we went from buy 1 get 1 50% off to buy 1 get 1 29%, and that was a change, but was basically a change in catching the deal because by and large, it was mostly the same price.

Basically, we had run but by 1 get 1 50% off for 3 years now. We decided to test a different offer to try to freshen it up, and we are just pulsing that as well as the buy 1 get 1 50%. But other than that, planned promotions are on track for us for Q3. For Q2, as we talked about, the other driver I forgot to mention as part of the margin improvement from -- in Q2 was the fact that last year, we went -- in 2010, we went from Memorial Day sale back to full price for 2 weeks and then into semiannual sale. This year, we decided to go from a Memorial Day sale to a spring sale into semi annual sale. Much more easy for the customer to understand that, and it actually helped us liquidate goods better at higher margins by doing so. And we might look at that for Q4, as well.

Okay.

Because it was very effective.

Okay, interesting. Was that a material part of the merchandise margin, if you look at that period, that you were able to kind of drive in the quarter, being able to clear those clearance goods at a better margin?

No, the majority increase was driven by our go-to-market strategy improvements because that was only over a 2-week period, but it helped.

Okay, got it. And then also, I know you're lapping TV advertising later this year. What are your plans with respect to holiday? Anything new that you can share with us as you look out to this season?

There are 2 things, really. We are going to continue to do TV advertising both in Q3 and Q4. It seems to be working well for us. The other thing that is exciting for us is in September -- really at the end of August, the last couple of days of August we are dropping a catalog, a 48-page catalog, to a significant portion of our customer base. And this is the same catalog that we tested back in December of last year that performed very well. So we are going to launch that in September and then again in November.

By the same, you mean the same 48 pages, not the same merchandise.

Exactly.

Also I've gotten a couple of e-mails from a few of you who have already received it, so it's out there. I know it's out there.

Okay. And then actually, Michael, I'm going to sneak in 1 more quick 1. I have noticed a bunch of photos with celebrities actually wearing your clothes. I think there was 1 striped cotton dress

Is that casual dress. I mentioned that casual dresses were very good, and I knew you had to see that dress because it's been in every magazine.

Is that happening organically, or are you guys helping that process?

No, no, no. We help the process for everything.

Okay.

We have a PR office. They do what PR offices do. But, that dress happened because that dress happened.

We aren't paying people to wear our product. They picked that up themselves and are wearing it.

Okay, great. Thanks, guys.

Thank you. Our next question comes from Janet Kloppenburg, JJK Research.

Hi, everybody, and congratulations. Michael, just a couple of questions for you. I was wondering if you could talk a little bit about your receipts low in the second quarter. I get a lot of questions from people, and I know you said that the sweaters were selling and everything in July, but I am wondering when you look back on it, are you happy with that transition given the heat? Would it have been better to have some more light-weight product or even more clearance in the stores and just what your thinking is on that? Also, I wanted to just clarify on the cotton pricing, whether or not -- because we know it is coming down for first quarter next year. Michael, whether or not your orders for that period have been placed or whether there will be some advantage to your order placements for that period versus the first quarter of 2011? And I think Michelle touched on it, but the TV that you are doing here in the third quarter, are you anniversarying, or would you not anniversary TV until the fourth quarter? And for Matt, I just wondered about the e-commerce margins versus the in-store margins. Thanks.

Okay, let's start with receipts. We're very happy with the way we did it.

Okay.

We believe we would have done no more business with more summer goods. What we do believe we would have done was sold probably more units at cheaper prices and less margin. So we are finding that strategy to be terrific, and the truth of it is that next year, we are going to push it just a bit further. We don't want to push it much further, but we feel it could still be pushed further.

The second question was TV. Yes, we are going to be anniversarying TV. I think we are doing it in Q4. This is Q4. Yes, I think we will be doing it with more intelligence, and by that I mean very directed toward specific shows that our demographic watches.

But you're up against it in the third quarter this year?

No.

Thank you. And then on the cotton pricing, Michael?

Yes, I will take that question, Janet.

Hi, Matt.

Basically, on cotton, we haven't put guidance out yet for the first half of the year, but at a very high level, I think we'll start to see a little bit of impact, probably closer to the back half of the spring season in Q2 with some cotton prices, and a little bit will flow into Q1 as well. But along with that, there are some other cost pressures on the wage side of things that might balance some of that out. But back half of the year I think will certainly be better than the first half from a comparability standpoint there.

We are seeing some people, some companies mitigate the labor pressure by moving to other countries. Is any of that happening at Express?

Absolutely. We are very focused on that and continue to aggressively look to move out of Canada -- or move out of China and move into places like Indonesia, Vietnam, Philippines. We're shifting a good portion of -- we're working on shifting a good portion of our production there.

Okay. And e-commerce margins?

E-commerce margins are higher than the store margins. We don't disclose the differential, but it's pretty significant.

Okay, Michael, just lastly, if you could comment on the success of colored denim, how important that trend might be, and whether or not it cannibalizes the regular denim business? Thanks so much.

Okay. Yes, colored denim is really, really good, but it's really, really good on not enough individuals. We see it as going forward as being really important because nobody owns it, and apparently they like it very much. We are going to be getting regular receipts so that you will see much more of it in the near future going straight through the season. That's number 1. In terms of cannibalizing other denim, no, because -- well, maybe some of the basic denim, but we are turning fashion denim very rapidly, and by fashion denim, I am talking about new leg shapes, Janet.

You mean the flare? How is it doing?

Flare is doing -- again, it's turning very fast, but not on huge quantities. On enough. But turning fast. Wider legs are turning fast. It's really the fashion end of the business. The color, in basics, in basic silhouettes, and the fashion silhouettes in blue denim.

Great. Lots of luck, you guys. Talk to you soon.

Thanks, Janet.

Thank you. Our next question comes from Richard Jaffe, Stifel Nicolaus.

Thanks very much. Could you add some color about the ad spend and marketing? You've been in a lot of print media, and wondering how big the TV effort will be and other things you might be doing that we can watch for?

Yes, so the TV advertising isn't a huge piece of the overall budget. We are -- we're planning on being on the similar stations to what we have been on, which has been working for us with E, MTV, the CW, stations of that nature. We will be -- in the early fall season, we will have commercials running during a lot of the season premieres of some of the major shows, as Michael talked about. And then, what we are doing with additional marketing is certainly continuing the local market advertising, the runway shows that we use not only for our collateral in our CRM, but we also use that as the stand-alone marketing vehicle for the Company as well. That certainly continues to work well for us. And then, we continue to work for social media piece of the business as well. So those are all components that have been working over the last 3 quarters. We are continuing to focus on those going forward.

And the dollar or percent change in that spend this year versus last year for the second half?

It's the same on a percent of sales basis. We are targeting 4% of sales for the year in marketing spend.

Okay

The same as last year.

And just 1 more sort of a nitpicky question. Could you explain the change in the spread between comp gains and total sales gains? Is it the remodels that are taken out of the comp base?

It's a combination of the remodels taken out of the comp base and the new store openings. So we are opening, on average, right now, we are opening 20 stores a year in the US, and in the Canadian stores, openings will start as well. So it's a combination of the new store openings and the remodels, to your point.

That's great. Thanks very much.

You bet.

Thank you. Our last question comes from the line of Betty Chen from Wedbush Securities.

Thank you. Good Afternoon. Congratulations on a great quarter.

Thank you.

Thank you, Betty.

I was really impressed to see some of the new categories performing well, and it sounds like certainly also expanding, and I think you mentioned shirts as 1 example. I was just curious, is that replacing anything in the store? Or are we just trying to find more productive use of the selling space? And then, I also had a question about the loyalty program. I believe you mentioned the launch will be starting in the fall. Should we be looking for any sort of campaign to also support that initiative? And then lastly, how should we look for inventory position at the end of Q3? Thanks.

Okay, starting with the first question, which is about these new categories that seem to be doing well. I think our strategic approach to the inventory, which is 4 buckets, 4 end uses, with flexibility within the reorders, really feeds to the strategy and supports the fact that it is a very workable strategy for us. Second thing about it is that the good news is that these are by and large categories that we anticipated to be new and good categories. So it's really working out in terms of our current investment. Second question was?

The loyalty program. So to clarify, Betty, on this 1, what we've been talking about is that we are doing a loyalty pilot this fall with a launch of the program nationwide in the spring upon a successful pilot. And so, on September 25, we will pilot this in a number of different markets across the US to understand the benefits and how this operates in the store. We will make some minor adjustments and then plan to launch this in early spring, probably middle of Q1. Mid-to-late Q1 is when we would launch this loyalty program nationwide. We have high hopes for it. We've been working with Brierley, who is the leader in industry in the loyalty program space. And so we're excited about the -- what the results will look here and think it could be some positive upside over time.

The third thing you asked about was the inventory levels for Q3. We don't provide forward-looking inventory levels for future quarters, but what I will tell you is that total inventory for Q2 was up 12.5%. Approximately 2% of the increase was driven by raw material inventory we put on our balance sheet as we talked about. Sales for the Q2 were up 10% on a mid single-digit comp, and we have provided guidance for a mid single-digit comp in for the third quarter as well. So we're very comfortable with the quantity and composition of our inventory as we stated in our remarks.

Thank you, the stores look great. Best of luck.

Thank you very much.

Thanks.

Thank you. I will now turn the call back over to management for closing comments.

Thanks again for joining us, and I look forward to speaking with you on our third-quarter call in December and expect to see many of you at the upcoming Goldman Sachs conference in September. Thanks and bye.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you your participation.