Express Inc (EXPR) 2012 Q2 法說會逐字稿

Greetings and welcome to the Express Inc. second-quarter fiscal 2012 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Allison Malkin of ICR. Thank you, you may begin.

Thank you. Good morning everyone.

Before we get started, I would like to remind you of the Company's Safe Harbor language which I am sure you are all familiar with. The statements contained in this conference call which are not historical fact may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual future results may 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 the call, we will make reference to adjusted net income and adjusted earnings per diluted share, which are non-GAAP measures. Reconciliations of these non-GAAP measures to 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, Chairman, President and CEO of Express.

Thank you Allison, and good morning everyone. I'm joined here today by Matt Moellering, our EVP and Chief Operating Officer, and Paul Dascoli, our SVP and Chief Financial Officer. I will begin our call today with an overview of our second-quarter performance and highlight our progress against the priorities we set for the business at the start of the year. Then Paul will review our financial results and outlook in more detail. After my closing remarks, we will conduct a question-and-answer session.

We managed our business well and achieved our guidance in the second quarter, reporting increased sales, positive comp sales and delivering earnings at the high end of our expectations. As you are aware, we entered the quarter facing a couple of headwinds with softness in our knit tops category as well is slightly elevated inventory levels across certain other categories in the women's side of the business. This pressured margins, as we discussed during our first quarter call.

In total for the second quarter, net sales rose 2% with comp sales increasing 1%, including a 24% increase in e-commerce sales. This performance came on top of a 6% comp increase last year, including a 39% increase in e-commerce sales. This marks our 12 consecutive quarter of positive comps.

Earnings per diluted share increased to $0.18 compared to adjusted earnings per diluted share of $0.17 in the prior year. We ended the second quarter with a strong balance sheet with inventory aligned with sales and we generated strong cash flow, even as we invested in our long-term growth and returned value to our shareholders.

As a testament to the significant value that we believe our shares represent, we repurchased 2.7 million shares of our common stock during the quarter.

We continue to focus on our four pillars of growth. Of particular note, we made exciting progress on our international expansion.

With regard to our first pillar of growth, in women's, our business was led by increases in woven tops, denim, dresses and jackets. Our customers responded favorably to our bottoms assortment, especially color. We continue to expect color to be an important trend for us to capitalize during the remainder of the year and into spring. We saw an improvement in trend in our casual knit top performance in the quarter and see the category as back on track. We are all so well positioned to deliver opening price point fashion knit tops and sweaters in significant quantity at the end of the third quarter.

Our newer categories continue to be a bright spot with year-over-year growth in personal care and footwear. We look forward to the launch of our second women's fragrance, Express [Plan] in time for holiday.

Also new for fall, we remain on track to introduce women's watches in October.

In men's, we were pleased with the results both in the aggregate and by category. We were particularly pleased with the strength of woven and knit tops, casual pants, denim, suits, dress pants, and accessories. We continue to see a trend towards dressy and are excited about the enthusiastic response to our emphasis on color in casual pants and denim offerings. We believe our men's business continues to become more powerful and a key destination for the customer.

We generated excitement and saw strong increases in new categories within our men's business such as watches. We are currently in 50 of our stores and are being expanded to a majority of our stores as we speak. We also continue to see strength in personal care.

Turning to marketing, we continue to see strong response to direct-mail and digital marketing efforts. During the quarter, we held runway shows and photo shoots in Chicago and Savannah which will be the foundation for our fall and holiday catalogs. These events continue to drive added excitement for our brand and connect with the customer base in local markets. We also continue to optimize our media strategies in magazines and outdoors across the US and Canada while enhancing our TV advertising through strategic placement of commercials on select networks and programs at certain times during the year that appeal strongly to our key demographic. This fall, we will continue to build on our marketing efforts to connect more closely with our existing loyalty members and to reach new customers within our demographic.

Similar to last year, we will issue 2 catalogs scheduled for September and November to capitalize on the fall and holiday seasons. We are planning TV ads on the CW and MTV during such shows as Vampire Diaries and Gossip Girl.

Regarding our loyalty program, Express NEXT, we continue to be pleased with the sign-ups which have increased our membership base to nearly 4 million after only six months since the program launched. The program has built significant traction over the past several months. Initial results are promising and show increases across key customer metrics. We expect the new program to increase our connection with the target demographic, leading to increased shopping frequency and overall share of their apparel spending as points accumulate over time. We believe our program is unique in the marketplace and captures how our customers shop and interact with fashion during their daily routines.

As it relates to our second growth pillar, we continue to see robust growth in e-commerce sales which rose 24% in the quarter following a 39% increase in the second quarter last year. The re-platform of our website is on schedule with a soft launch this month and a cut-over for all users in September. Bringing this important business piece of our business in-house will give us more creative control, enhance our site performance, and allow us to provide more customization over time.

Following our transition to the new platform, our focus will shift to the redesign of our site and over time to providing the functionality that will create a more seamless shopping experience for our customers.

We advanced our third pillar of growth by opening new stores. During the quarter, we opened eight new stores constructed in our new design format while closing three existing locations. All of the closures were either dual-gender conversions or as a result of displacement due to mall redevelopments.

At quarter-end, we operated 611 stores, 604 in the United States and 7 in Canada. For the year, we expect to open 28 new stores, including 5 stores in Canada. Two of our previously announced planned Canadian openings are moving into early 2013. We also remain on track to remodel 15 stores in our new store design and plan to close 12 existing locations. At year-end, approximately 7% or 44 of our stores will be in our new store format.

Moving to our fourth pillar of growth, we achieved our international expansion goals in the quarter. We remain intently focused on achieving our expansion goals outside the US, having identified a $600 million long-term opportunity. We are pursuing international expansion in the same manner we have executed our three other growth pillars, by focusing our resources on high-return investments.

During the quarter, we entered into our third franchise agreement, this one in Mexico. This follows our Central and South America agreement and of course our previously established relationship with Alshaya in the Middle East. These two new geographies were selected given our strength with the Latino demographic in the US and the proven track record of our franchisees. By the end of the year, we plan to have five additional franchise stores open in the Middle East and three to four stores opened with our new franchisees in Latin America. This represents significant progress against our franchise target, delivering on the 2012 full-year goal five months ahead of schedule.

We also made exciting progress with regard to US flagships, firming up timing for Times Square New York and Union Square San Francisco. The Times Square location is situated at the corner of 46th and Broadway and will occupy 30,000 square feet on three floors. This prominent location will include a 125 foot tall 9000 square foot LED sign package on the facade of the building facing Broadway, giving us tremendous brand exposure. Times Square is expected to open in the fall of 2013. The Union Square location is equally compelling, located at 301 Geary St. and occupying 16,000 square feet with two floors plus a mezzanine and is expected to open next summer.

The flagships are perfectly situated in premier tourist areas which we believe will serve as a gateway for international expansion. We continue to believe our brand, which targets the 20 to 30 year old demographic across our four end-users, makes us uniquely suited for international expansion. We will continue our international expansion in a disciplined manner, working together with experience and proven operators and focusing our Company owned effort ongoing geographies that fit our demographic and fashion profile.

As we enter the third quarter, we remain positive about our business. As you are aware, during the second quarter, we tested our fall product by delivering small bulk quantities across all of our stores. Our tests included favorable responses to many categories of our business, including denim, dresses and suiting, casual knit tops and woven tops. In fact, woven tops, which includes both shirts and blouses, are extraordinarily strong and based on our go-to-market strategy, we have been able to capitalize on this opportunity through additional investment. That said, the reads on our sweater tests on the women's side of our business were not what we would have hoped for. This is expected to pressure sales on margins in the third quarter. While we are planning our back-half guidance in-line with the trends we saw in the second quarter, the strength of our go-to-market strategy continues to be a significant advantage as our early testing gave us important information that allowed us to recraft our sweater offering and be in position with great gift-giving styles at strong price points ahead of the all-important holiday season. Despite this optimism, again we believe it is prudent to not include this particular potential upside in our guidance.

In summary, we delivered our earnings goal for the second quarter and ended with a strong balance sheet providing us with the flexibility to continue our successful expansion. The discipline within our company has led to a market improvement in our casual knit top performance in just one quarter, and I am confident in our ability to see an equally positive reaction to the changes we are making in women's sweaters. Despite the fact that we are already seeing a positive response to our women's casual knit tops category and are equally optimistic or about the sweater assortment we are delivering ahead of holiday, we believe it is prudent to set our guidance more conservatively and in-line with the trend we currently experienced in the second quarter. We remain confident in our strategies and expect to deliver solid earnings growth in the back-half and full year.

Now I would like to turn the call over to Paul to review our second-quarter results and outlook in more detail. Thank you.

Thank you, Michael. Good morning everyone.

I will begin by reviewing the details of our second-quarter results and provide our outlook for the third quarter and update you on our full-year 2012 expectations.

For the second quarter, net sales increased approximately $8.9 million, or 2%, to $454.9 million as compared to $446 million for the second quarter of 2011. Comparable sales increased 1% for the quarter following a 6% increase last year. Our e-commerce sales grew 24% and represented 10.4% of our business compared to 8.5% in 2011.

Gross margin rate was 32.2% of net sales compared to the prior-year rate of 33.6%. The 140 basis point decline in gross margin reflected a reduction in gross margin driven by increased promotional activity, especially in the latter weeks of the quarter, and a lower recovery on end-of-season clearance merchandise this year versus last year. In addition, higher product costs compared to last year dampened our merchandise margin performance.

Buying and occupancy expenses were unchanged as a percent of sales. We gained more clarity around the timing of our Times Square and Union Square locations which drove favorability and expenses versus our original expectation.

Selling, general and administrative expenses totaled $115.3 million, or 25.3% of net sales. This compares to $117.7 million, or 26.4% of net sales, in last year's second quarter. We stayed keenly focused on our expense structure and achieved a 110 basis point reduction in SG&A as a percent of sales even as we continue to invest in our business.

Operating income of $31.2 million, or 6.9% of net sales, was down slightly from $31.7 million or 7.1% of net sales in the second quarter last year. Interest expense totaled $4.8 million. That compares to an interest expense of $10.5 million in the second quarter of 2011, which included a $3.7 million loss on extinguishment of debt associated with the repurchase of $24.2 million of senior notes and the amendment of the Revolving Credit Facility.

Income tax expense was $10.4 million, representing an effect of tax rate of 39.6% compared to $8.6 million at an effective tax rate of approximately 40.6% in the second quarter 2011.

Net income for the second quarter was $15.8 million, or $0.18 per diluted share. This compares to net income for the second quarter of 2011 of $12.6 million or $0.14 per diluted share, which included a $2.2 million or $0.03 per diluted share after-tax loss on extinguishment of debt related to the repurchase of $24.2 million of senior notes and the amendment of the Revolving Credit Facility.

Weighted average shares outstanding were 88 million at the end of the quarter.

Turning to the balance sheet, we continue to maintain a strong financial position. We ended the second quarter with cash and cash equivalents of $130.2 million compared to $144.6 million at the end of the second quarter last year. As Michael mentioned, during the quarter, we invested $50 million to purchase 2.7 million shares of our common stock as we believe our share price represents a great value. We will continue to be very disciplined, evaluating in all opportunities to invest our free cash flow.

Quarter-end inventory rose 1.4% to $210.4 million compared to $207.4 million at the end of the second quarter last year. This increase was in line with our expectations of inventory levels being consistent with our overall sales growth. Inventory per square foot decreased approximately 1% compared to the second quarter of fiscal 2011.

Total debt declined by $119.7 million to $198.7 million from $318.4 million at the end of the second quarter last year. At quarter-end, no borrowings were outstanding under our Revolving Credit Facility.

For the second quarter, capital expenditures were $28.7 million compared to $21.3 million in the second quarter of 2011.

Now I would like to turn to our guidance. Our outlook for the balance of the year factors in the macroeconomic environment, consumer sentiment and current trends we have seen in our business. For the third quarter, we expect comparable sales to be in the range of a flat to a low single-digit increase which compares to a comparable sales increase of 5% in the third quarter of last year.

Our effective tax rate is expected to be approximately 41% for the third quarter of 2012.

Net income is expected to be in the range of $23 million to $28 million, or $0.27 to $0.32 per diluted share on 86.4 million weighted average shares outstanding. This compares to net income of $32.7 million, or $0.37 per diluted share, for the third quarter of last year.

For the full year 2012, we currently expect comparable sales to increase in the low single-digit range. This compares to a comparable sales increase of 6% in 2011. We expect our effective tax rate to be between 39.9% and 40.1%. Net income is currently estimated at a range of approximately $148 million to $157 million, or $1.69 to $1.79 per diluted, on 87.6 million weighted average shares outstanding. This compares to adjust net income of $147.1 million or $1.66 per diluted share last year.

Turning to our store expansion plans, for the third quarter, we expect to open eight new stores, including seven stores in the US and one in Canada. We also expect to close one location in the United States during the quarter. For the full year, we expect to open approximately 28 new stores, including 23 in the United States and five in Canada. The opening of two Canadian stores has been pushed to the beginning of Q1 2013. We plan to close 12 existing locations and expect to end the year with 625 stores and approximately 5.4 million gross square feet in operation.

Capital expenditures are currently expected in the range of $100 million to $105 million. And finally, we again expect to generate well over $100 million of positive free cash flow this year.

And with that, I will turn the call back over to Michael for some closing remarks.

Thank you, Paul. In conclusion, we believe our results for the first half of the year demonstrate the strength of our data-driven processes and dour go-to-market strategy. Continuously refining the execution of our strategy creates a tremendous opportunity for us to improve our results in the future.

Equally important is the advantages that come with these processes. Our ability to deliver our goals in the second quarter, achieve progress on our knit tops assortment as well as quickly identify and react to our tests are clear competitive advantages and integral to our strategy that has led to 12 consecutive quarters of comp sales gains.

By the end of 2012, we will approach our peak sales of $2.2 billion after the business shrank to $1.6 billion. We will do this in half the number of stores and achieve almost double the profitability. We believe there continues to be an incredible opportunity to drive further sales and profit growth in the future based on our strategy and our ability to serve the 20 to 30-year-old demographic in a unique niche.

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

(Operator Instructions). Neely Tamminga, Piper Jaffray.

Can we dig a little bit into this comp anemia issue, traffic versus ticket? Is it some sort of very specific category issue? I do have some category questions for you as a follow-up, but can we just dig a little bit more into what is driving this anemia?

Yes. As optimistic as I sound about what is going on, we knew the comp would just not match that conversation. And I will tell you I think it's a couple of things right now. The number one thing is that our business has so shifted away from the kid, the back-to-school kid, that even though our denim business is very good, it's at a much different price than the younger competition. I think that is one thing. I think that we are doing in denim what we said and planned to do, and we are doing well in denim but not clearly competitively with the real back-to-school people.

I think the other thing with the comp right now is that we started to suffer I want to say about three or four weeks after that investor conference. The early business had been excellent. I guess it was because of all of that warm weather. The questions were was business pulled up? I've never believed that happened, but apparently it did, because as soon as we came up against it, it changed.

The other thing that happened -- and it might seem like I our deliveries were negative. That is not true. Our early deliveries really added to the business and what we had left over had to be less than last year. We went into July with less old merchandise, less summer merchandise than we did last year. And one would think, if they were intent on buying it, it would have turned faster. It did not. So less merchandise turned at the same rate at cheaper prices. So it did not add up.

As I said before, we have a lot of good news in a lot of our categories, a little bit of difficult news in a very important category, and in the aggregate it is not adding up well. But as we also said, our guidance going forward does not include what we see as upside based on our adjustments.

So I guess that is the bigger question Michael. Is the guidance based on your current trends or is it truly -- you're being very specific with your language that it is based on the trend that you saw in Q2.

I would have to say, and I would ask Paul to add to this after I finish, because we have -- we don't have different -- we have different approaches although not different views. I would say that the guidance is based on the numbers. The guidance is based on what we experienced in Q2. The guidance does not include those things that we feel have been fixed.

As you well know, one of our single biggest categories which is cut-and-sew knit tops, and oh, by the way cut-and-sew and knit tops is bigger than sweaters in fall even those sweaters is very, very, very important. But that really never got totally back on track in terms of the numbers until the end of the quarter. So, the current knit top business is not really factored into the past because it is kind of suggested. We believe we have done something. We feel it is prudent not to include something that we don't yet really know about.

I will let Paul answer that if he would like.

No, I don't really have much to add. I think that is right. We based it on a trend that we saw in the second quarter. We saw continued improvement in the trend of the knit top business and we have taken steps, as we talked about, to have deliveries available more in sort of entry price point fashion knit tops as we get to the back end of the third quarter. That is all reflected in the guidance. And Michael talked a little bit about the challenges with some of the new sweaters, and that is reflected in our guidance also.

Okay, thanks. And then can I just ask one other question for you Michael on things in general for women? It seems to me that we are seeing a style shift away from traditional jackets and skirts and things like that in the workplace. How are you interpreting career now for your Express consumer? Thank you.

I would tell you that early on and through summer and into early fall, our jacket business is a hit. And it's nicely ahead even though it is not an enormous business. I think what that says to us is we are gaining credibility at those price points. The pants business has been very good and we have a new pant, our Columnist pant, that is potentially a very, very big item.

This skirt business is not so great because I think that the way they are looking at it, we -- and by we I mean this entire industry -- are not syncing out a message on skirt length, on skirt shapes. And we all understand that we can say the, oh, customer buys what she wants, but the truth of it is the customer buys fashion. And I don't think we have been good enough at defining that. There is some fun skirts that are really, really, really good, but the skirt business in total is not where it should be. We do believe, based on the few things that are really, really good which we have gone back after for third and fourth quarter, that it can be better than it currently is.

But in terms of the wear-to-work our woven tops are fabulous, truly fabulous, both shirts and blouses. Not as fabulous as they could have been based on inventory, but the way we operate, as we have told you, is we reserve a whole lot of money, and we invested a bunch more in what is very good for the period of time that we are really going to need it. So we are optimistic about that. Again, that optimism is not reflected in our guidance because it is not there yet.

Great, thanks so much.

Lorraine Hutchinson, Bank of America/Merrill Lynch.

Good morning. I just wanted to maybe get some clarity on some of the issues that you saw toward the end of the quarter. What caused the more promotional stance? Was that simply just the carryover summer product? And then when we see a full 30% off the store promotions and things like that coming into the third quarter, is that on the new product, or is that simply just issues with what you had coming out of 2Q?

I think there are two answers, an answer to the first part of the question and answer to that second. In terms of the first part of the question, yes, we were more promotional on carryover summer goods because as we -- and we planned less of it and we had less of it. But as we have been saying for seasons and seasons and seasons, it becomes almost the customers want it but they want it for virtually nothing. So that was a part of it early on.

In terms of the 30% off, I have -- and I keep saying this, I keep saying that I don't know how much more promotional it can get but clearly it can get more promotional. As I said early on, our jeans wear category, which means that our August and late July business, is a younger business, and we were up against in that mall incredible promotions. I have never seen percent-off everything this early, and I saw it weekend after weekend after weekend.

What I would tell you about the 30% off the entire store is when we run something like that and take off every other promotion, it becomes 30% off the ticket which is -- the promotion is couched better and you are even more convinced by it, but in terms of the markdown, it is very little different than we do in terms of promoting lots of our items, which we always do anyway.

Okay, and then the new store productivity of the recent openings, have you been happy with those?

Yes. We are learning about that store and clearly the productivity is good enough so that we are switching over. What we have found is, in the stores that we have built, we have different configurations of the rooms and that is why we start out the way we do. And we found out that certain configurations are much more productive than other configurations. So not in the design, in the configurations of the room within the stores. And we are going forward with the more -- with the ones that are much better than the other ones.

Thank you.

John Morris, BMO Capital Markets.

Good morning everybody. So, one question was with respect to the outlook for the sweater offering and what you are doing there and the comments you made about that in your prepared remarks. I guess it is a couple of things. One is I'm just thinking, Michael, how good -- you guys are very good at reading. You are very good at understanding where the fashion direction is and what is happening, but I just wonder how good those reads, those cautious reads on the sweater category can be right now given how challenging the weather has been up until very recently. And then why -- what is it about the sweaters that you don't like, that you don't see and how are you looking to correct that?

Well, to tell you the truth, the best sweaters we had were basically continuations of the best things from last year. And the best, I'm talking about silhouette. [Dolan] sleeves continued to be very good. Our deep-V, which we have been running for a while, continues to be very good, however much better in novelty prints than in solids so far.

I think what we have adjusted is fabrications. We had tested and we had sold enormous amounts of [Lerachs] last year and it looked like we should have it this year and it is nowhere near what we expected. So it will not be the percentage going forward that it has been in the past. We do, as I said, believe we made adjustments. We are going to go into the holiday season with very strong price points on very deep, very well tested items. And as I also said, we have not put that optimism into our guidance.

And John, the other thing is with the old testing strategy one of the benefits of the way we run our testing and bringing small bulk quantities in June and July and sweaters to get a read from the customers across all of our stores, we ran those test in June and July, did not get good reads on several of the sweaters which we have re-crafted, as Michael talked about in his prepared remarks. But the good news is that we found out about that in June and July from small quantities that we could then make adjustments for. And we plan on getting the adjustments in by the middle of late September for the entire holiday season versus finding out about this in September, October, and not having any room to maneuver at that point. So we believe, from that standpoint, that the entire testing process has really helped us out here in identifying the problem very early where we've got smaller quantities to deal with and get back into things that we believe will be better.

Great, very helpful. Thanks. Good luck for fall.

Simeon Siegel, JPMorgan.

Good morning guys. Michael, first I was just wondering if you could talk about the different trends you have been seeing in the A, B and C malls? I know that clearly the conversation keeps coming back to the colored denim every now and then, but what do you guys think about the fact that several of these teen retailers, which are not your target audience, but they are talking about this big push into the fashion product. So, how do you view the competitive landscape in that regard?

And then just quickly Paul, given how quickly your inventory positioning came in, can you talk about why the comps maybe came in lighter than expectations? And then with such clean levels ending this quarter, can you talk about your third-quarter gross margin assumptions especially considering I think you are facing easier compares?

Okay, in terms of other retailers citing fashion, we love to hear this. We love to hear this. We have been saying this now for several seasons. We still believe it and we believe that really becomes the battleground. We have got -- we really do have more ammunition. We really do.

I think that in terms of the current trends, what we are seeing, as an example, is we have been seeing a dressier trend for a long time right now with casual suffering. We are seeing casual come back in a dressier way but what we are seeing most important in both men's and women's is, as when we had a combined casual pant business of $300 million which the current business is not a shadow of that and has not been for a while, that $300 million casual pant business in both men's and women's was always based on color. It was based on key items that we ran in color in casual pants. That seems to be coming back. Our casual pant business gets very little coming in -- I've got to tell you it is very little got it. But it is quite, quite good in new-looking casual pant items. So it is casual. It is not dressy. However, it is real, real fashion because if you define fashion as something this year that is not in the closet from last year, it really is. They don't own that. So we feel good about that.

In terms of the current comps, they are what they are. And as I said to you, we can -- and I don't know what the bottom is in terms of the young customer. I do know that the separation between our offerings to the younger customer and the younger competition keeps getting wider and wider in terms of price point. We understand this but we are merchandising our store towards 11 months not one month. And we would expect to see that change.

So with respect to margins in the third quarter, we would expect to see some decrease in gross margin compared to last year. But it will be a little bit better than the trend that we saw in Q2. So on a rate basis from an AUC standpoint, we are expecting to see low single-digit decreases in AUCs during the third quarter, but there are a number of other things that are going on within the margin during the quarter.

One, we are going to see -- we see some relief from the liquidation pressure we experienced in Q2 but, as Michael has been talking about with sweaters, we are still going to have to move through some sweaters that did not test well and that is going to push margins down until we get the newer product in towards the back end of the quarter.

We have also built in incremental expenses associated with pre-opening of the flagship locations. And then with the lower comp expectations in the back-half of the year, we will see a little bit of pressure in terms of leverage on B&O within the quarter. So all in all, we will see a little bit of margin pressure in Q3, but we don't expect it to be at the level that we saw in Q2.

Okay, and then so Paul, so on that line, does that -- I think you -- I think, last quarter, you guys guided the SG&A line to was it 24.7% of sales or thereabouts? So does that still hold? Is that what we are talking about with be incremental spend or is there something different from last quarter?

That would be -- that is a little bit like on a percentage basis, we moved a little bit of marketing into the third quarter at this point, so that would be just a little bit light on a percentage basis.

Alright, thanks guys and good luck.

Kimberly Greenberger, Morgan Stanley.

This is [Jay Solanz] on for Kimberly Greenberger. So just following up on SG&A, SG&A looked like it was down 2% in the quarter. Relative to square footage, it was up around 2%. It sounds like maybe there is some marketing that has shifted out from this quarter to next quarter. Were there other areas of SG&A that were reduced and what were those areas?

Yes, so a couple of things. One, yes, we moved a little bit of marketing into the third quarter. Also, they were based on results, we had a lower incentive compensation expense for the quarter and we also just really in general, as we talked about, tightened our belts with respect to expenses and really tried to manage so we could deliver the expectations on the profit front.

Okay. And then maybe just talking more about promotions that happened in Q2, is it possible to quantify maybe how much more promotion you had to do than expected, like in terms of number of days on promotion or depth of discounts?

It was more -- for Q2, it was more on depth of promotions to clear through our inventory to make sure we had a very good inventory level heading into Q3.

Okay, thanks so much.

Betty Chen, Wedbush Securities.

-- (technical difficulty) the balance sheet very well and controlled inventory. How should we think about the cash philosophy for the team versus investments and also get debt repayment? I know that you were also active in the purchasing of stock during the quarter. So, I guess how should we think about the maybe cash balance you would like to have relative to the free cash flow generation that you mentioned? And also by the end of the third quarter, can you remind us where you expect inventory to be on a per square-foot basis? Thanks.

In the beginning of your question, we could not hear anything at the very beginning. So I'm going to try to answer from what I think you asked and then if I miss it, because I missed the beginning of your question, please tell me, okay?

Okay, great. Thanks.

Okay, so from a cash perspective, we talked about the number of opportunities that we have to continue to invest in our business, either in the e-commerce front or the international front. Those will continue to be priorities for us. We've got $100 million to $105 million worth of capital this year. A big chunk of that goes towards new stores and we are also putting an emphasis behind information technology to support the growth that was particularly our multichannel and our international business. As you know, we've also recently had the board authorize us to repurchase shares which we did during the quarter also.

In terms of the repayment of debt, as you know, we have about just close to $200 million worth of debt on the balance sheet. It is primarily -- well, it is all our senior notes which have a make-whole provision until 2014. So they are very expensive and very look liquid right now. So opportunistically, we would take advantage if any of those were offered to us and it made sense. We do like to try to operate with about at least $100 million worth of cash on the balance sheet at any given point in time, so we try to prioritize where we are putting that against that objective.

In terms of inventory per square foot, we ended the quarter with a little less inventory -- with a little decrease in inventory per square foot than last year which we are comfortable with. We also -- our goal is really to have our inventory grow at a rate that is closer to our overall sales growth rate. The last couple of quarters, we had not achieved that. We put a lot of focus on that this quarter, making sure that we cleaned through the inventory that we had at the end of Q1 and delivered an inventory in a little over 1% increase right in line with our sales expectations and our goals. So that's our long-term goals for inventory.

Great. That is very helpful. And then I know you mentioned earlier that AUC will be down low singles in the third quarter. Could you remind us what kind of increase we should expect in the fourth quarter? And then also any color around the performance of the Canadian stores? Thank you.

So, in the fourth quarter, I would expect to see low to mid-single-digit decreases in AUCs in the fourth quarter of this year and that is built into our guidance.

So with respect to the Canadian stores, it's a great opportunity for us up there in Canada. We continue to learn about the stores and really how to market to the people up there because it is a different type of marketing effort.

Right now, one of the things that we do really well obviously in the US is our CRM activity based on the database there we have here of all of our customers. We are in the process of building that database up in Canada which will allow us to market more directly to our consumers up there. So, it still is a great opportunity for us up there still, and we are learning and adjusting our marketing strategies as we go.

As you know, our locations in the Middle East, it took us really 18 to 24 months for those to really start to performing at an optimal level, and down there in the Middle East this year we are seeing double-digit increases in comp sales.

Great. Thank you so much and best of luck.

Janet Kloppenburg, JJK Research.

I just had a follow-on question for Michael. Just from a bi-picture perspective, it seems like the contemporary area for the last couple of quarters is having some traffic issues. I'm wondering if you think that has anything to do with increased pressure or pricing pressure from the (inaudible) fashion retailers? And if the sweater issue that you are talking about could relate to some pricing issues, and if so, how you might address that for the fourth quarter? Thank you.

Yes, I think it is a couple of things. I really do. I think, yes, our traffic has suffered. I think it has suffered for a few reasons, some of which we are addressing. I think that opening price points are becoming more important to us, and I think they will bring back some of the traffic. At least it seems that way from our results from what we have done in the cut-and-sew knitwear. It seems that we can generate more traffic with those open price points. I would hope that is true additionally in our plan for the balance of the season in sweaters.

I do believe, however, that traffic is down. I think truly traffic is down. I know a lot of traffic is going to the low-price people, but what we have to learn how to do is not compete with them. We have got to do what we have to do to make our brand valid, give our brand value and get the traffic from our tier of price points, our tier of fashion. I don't think we can fight those people. I think it is a losing battle.

Yes, and as Michael said, we have -- there are some categories that are more competitive than others. Certainly our wear (inaudible) on the men's side of the business, things are in great shape. On the women's side of the business, when you look at the wear-to-work side of the business, the pricing that we have taken over the last couple of years has done very well. Where we are really focusing on some more opening price point type of items is more on that casual side of the business for women's wear. We are looking at that casual and dressy knit tops as well as the casual and dressy sweaters. As we talked on the last call, we are going to get into better opening price point position at the end of Q3 on the knit tops and the same will be true for sweaters, and we think that will bode well for us as we head into the fourth quarter.

Roxanne Meyer, UBS.

Thanks. First, I'm wondering if you could comment on the mix of the business by category into this 3Q versus last 3Q. Any notable changes there? And I guess in particular on denim, I'm just wondering, just given all of the trend in denim between not only blue versus color but all of the prints out there in general, you are really increasing the denim penetration? And then related to that, you mentioned that you are shifting away from the back-to-school kid. I'm just wondering if that is really new this year, new news, or if that is something that really has been going on for the past few? And does your guidance contemplate the potential for softness in denim just given the promotional environment out there?

Yes, okay, I think it is a great question. It has been going on for a few years, which is the interesting part because it went on two years ago and we thought we had already lost them but we really had not lost them. It has been continuing. It is a continuing erosion. But given that fact, our denim business, with less dollar inventory, is ahead of last year nicely. Yes, it is on price points. Yes, it is on color. But everybody has color right now. And if you look at our competitors, they have color at much better prices than we do. But I have to say it is difficult to break down anything, if I think we look great anywhere, it is in colored denim. If I think we kill the competition anywhere, not talking about price, I'm talking about presentation and inventory, it is in colored denim. So the denim is certainly not suffering because of this loss of back-to-school business.

Now, it could be that if our colored denim was near their price points, we would be knocking it out of the ballpark. But I have got to tell you Roxanne, that is not what we are doing. As I said before, what we are doing is more geared to 11 months of the year, including December, than it is to one month of the year, which is the middle of July, 6 weeks, the middle of July and the end of August.

Okay, so you feel comfortable with your inventory investments in denim, that you are rightly positioned to get at least your share for back-to-school?

Yes, we do. And you know something, we were very conservative early on in our unit plan because of our average unit retail. And as we got more and more information -- as you know, we don't spend all of the money. As we get more and more information, we kept funding it to a higher number and we are very comfortable with the inventory. It is not scary in either direction.

Okay, great. And then this may seem like a weird question but you said your guidance for third quarter is based on 2Q trends which don't necessarily seem applicable to 3Q just given that, A, you have got cleaner inventory, B, your knit tops are fixed, and it's just an entirely new season. So I guess I'm wondering, aside from the sweater softness that you are planning for, if you actually do make your 3Q numbers as given in your guidance, what area of the business will end up having underperformed?

It will be sweaters and it will be skirts. Men's will do -- in women's sweaters, not men's sweaters. It will be sweaters, it will be skirts.

Okay great. Thanks and best of luck.

Richard Jaffe, Stifel Nicolaus.

Thanks very much. Just a look ahead into the holiday season, with sweaters being such an important category and uncertain, I'm wondering if the numbers or the inventory commitment that you're making into the other categories will be enough to offset what is usually a big driver in the fourth quarter? Or am I wrong to think about it that way?

Well, Richard, we have -- it is not like we took the inventory out a sweaters and put it in other areas. We have course corrected the sweaters based on early test results. When we bring our small bulk quantities in in June and July, we identified in July we had an issue. We have re-crafted the sweater assortment on the women's side of the business. We are still putting the inventory in there because, to your point, it is a very important part of the holiday season. We have more opening price points and we believe we have the right silhouettes and the right yarns to sell the product.

And to be very frank, Richard, we don't make the same mistake twice. We made that mistake in the spring with knit tops. We took the money away and put it other places, too much money away, so that we did not even think about doing that in sweaters. You know, sometimes you've got to shoot a little bit from the hip, but based on pretty good information, we made the investment (inaudible).

You made the investment but you are sort of cautious about it and hence the guidance downward?

Yes, because it has not been revealed in the numbers yet.

Those deliveries will be coming in, as we talked earlier, mid-to-late September, early -- first week of October, the bulk of those new deliveries will be hitting the stores.

Thank you.

Danielle McCoy, Brean Murray.

Hey guys, I guess to follow-up on how you are viewing holiday with regards to last year's warmer weather and the high promotional atmosphere, how are you viewing that this year around?

Well, I will tell you we are not planning -- we are not just taking on better weather and we are not depending on less promotion, put it that way. I mean just as we say a trend what we are forecasting is based on -- what we are forecasting for Q3 is based on Q2, what we are forecasting for holiday in terms of promotion is based on the trends for the last several years, so that we have -- we have always have built promotions into most of our merchandise and have planned better opening price points in the key categories in preparation for that.

Okay, and then how are you guys -- how has traffic been in -- with locations in high tourist areas?

Traffic --

I'm sorry, in what locations?

In tourist areas.

Oh, tourist areas. Well, it's getting -- you know something, that is an interesting question because we don't generally look at it that way. But I can talk think about stores like Las Vegas and with tourist areas, and it is getting better than it was. It is certainly coming back; the traffic is coming back in Las Vegas. In Florida, which is a tourist area, and generally Q1 is the time for Florida to do well, it did. So the traffic did (inaudible) there in the tourist areas for us. I cannot speak for the world because, as I said, there are other tourist areas that I don't even know, the panhandle of Florida, I don't really follow individual stores that (inaudible) no giant ones.

All right, thanks so much.

There are no further questions at this time. I would like to hand the floor back over to management for closing comments.

Thank you for joining us. We look forward to speaking with you when we report Q3 results in November.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.