American Eagle Outfitters, Inc. (AEO) Q3 2011 Earnings Report, Transcript and Summary

Greetings, and welcome to the American Eagle Third Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Judy Meehan, Vice President of Investor Relations. Thank you. Ms. Meehan, you may begin.

Good morning, everyone. Joining me today are Jim O'Donnell, Chief Executive Officer; Roger Markfield, Vice Chairman and Executive Creative Director; and Joan Hilson, Executive Vice President, Chief Financial Officer. If you need a copy of our third quarter press release, it is available on our website, ae.com. Before we begin today's call, I need to remind you that during this conference call, we will make certain forward-looking statements based upon information, which represents the company's current expectations or beliefs. The results actually realized may differ materially from those expectations or beliefs based on risk factors included in our quarterly and annual reports filed with the SEC. Now I'd like to turn the call over to Jim.

Thanks, Judy. Good morning, everyone. Today, I will begin with an overview of our third quarter results, including an update on each of the brands as well as AEO Direct. Next, I'll turn it over to Roger for a perspective on design, merchandising and marketing. And before we move on to Q&A, Joan will provide additional details on the third quarter and discuss our outlook. In the quarter, consolidated sales increased 11%, reaching a record sales level for the third quarter, and comparable store sales rose 5%. EPS of $0.27 was at the high end of our guidance. We made meaningful progress in several major areas of our business. Merchandise improvements, combined with powerful promotions during peak shopping periods, led to a strong sales results. Our inventory investments in key items were spot on, enabling us to capitalize on traffic and maximize sales. This resulted in record conversion rates and double-digit unit sales growth. Importantly, we continued to see a positive customer response to both strong value and on-trend fashion assortments. Strong sales growth enabled us to overcome significant pressure from higher cotton costs and resulted in a slight decline in gross profit of just 1%. As anticipated, cotton prices will continue to affect merchandise profit in the fourth quarter, and it will be well into the spring season before we start to see a correction. However, we do expect to benefit from lower cotton costs beginning in the second half of 2012. Looking forward, each brand has a critical role to play in our group. Through our portfolio of brands, we are reaching targeted markets. Additionally, we are leveraging our multichannel platform with technology to build awareness, loyalty and most importantly, commerce. Beginning with AE, we are set to build on current momentum. We will capitalize on the popularity of our brand and continue to offer compelling promotions that truly wow our customers. As we did this quarter, our priority is to deliver on trend key items, supported by the right inventory to drive our business and increase market share. We will design and source into items that offer compelling day in and day out value. As we look forward, the primary thrusts for the AE brand include, first, maintain and build our leadership in bottoms categories; two, build on our current momentum in tops; and three, continue to refine and expand accessories. Now moving onto aerie. Our goal over the next few years is to become a recognized force in the intimates business. There's a significant market opportunity as demonstrated by our third quarter performance. The launch of the Drew bra, along with aerie's first ever campaign, was an outstanding success. We experienced double-digit increases in bra sales and have substantial lift to store and online traffic. The launch event served to introduce new customers to the brand and reinvigorated existing customer excitement. We achieved an 8% comp overall with improved operating margins compared to last year. I remain very pleased with the progress and continue to view aerie as a unique and exciting new brand opportunity. On to kids. 77kids posted positive sales results during the third quarter, particularly in our well-developed online business. We remain very pleased with the progress to date with developing strength in key items. Adding 77kids to our Times Square flagship store is really building brand awareness as well as providing key insight into our international kids customer. We will continue to evolve the assortments, focus on innovation, both online and in the stores to build brand awareness and grow a strong customer base. Next, an update on AEO Direct. With high operating margins and strong sales, Direct is one of our most promising growth vehicles. The online business is an extension of all of our brands. We offer expanded assortments, category shops and showcase outfitting with complete lifestyle. The online shop enables us to pulse customers' preferences, fashion trends as well as promotional messages. As we look forward, the opportunity to build on current offerings and extend brand loyalty by leveraging mobile technology and social media outlets is really exciting. We are also reaching to new international customers with country-focused capabilities such as currency conversion and translation. I'd like to say a word on technology beyond our online business. One of the most rapidly growing new technologies is mobile. Our new AE app adds greater functionality and importantly drives customers to the stores with rewards tied to in-store activities. Additionally, customers can easily place online orders, put outfits together and grab additional information. It's highly functional and fully integrated with our loyalty program and promotional offerings. The AE app also features full integration with social media sites, and we have seen mobile sales more than triple over the last year, and we expect rapid growth to continue. We are committed to being at the forefront with new technologies, and we'll continue to work with a variety of partners and proprietary tools. The shopkick rewards app is a great example and has generated positive traffic and transaction growth. Our exciting new technologies include Google Wallet, which brings ease of online checkout to our stores. We were one of the launch partners for both of these new technologies. Moving onto international. We ship to 77 countries through our website with Italy being the most recent addition. And under our franchise business model, we're currently operating 17 locations in 9 countries. And our plan is to open approximately 20 international stores next year, including our entrance into Japan and Israel. We're extremely pleased with the demand for AE globally, and we will continue to pursue opportunities in new markets. I'm encouraged by the momentum in our business as well as the results of our work to drive growth and improve overall performance. We have 3 strong brands, a premium store fleet, a leading edge online business, and well-placed resources in technology and international expansion. Looking ahead, I'm pleased to welcome Robert Hanson to our company, and I look forward to watching AEO's continued success. And now, I'll turn it over to Roger.

Thanks, Jim, and good morning, everyone. Overall, I'm pleased with our third quarter results as we continued to face a sluggish economy and significant pressure from higher cotton costs. As we reviewed on our last conference call, we invested in core categories to accelerate our business by offering strategic and targeted promotions. We said we were going on the offense and we did just that. We started the season with positive sales and saw an acceleration with our Labor Day sale event, which drove strong traffic, double-digit volume growth and record conversion rates. Our inventory investment provided the fuel to capitalize on traffic during peak periods. The back-to-school assortment was well received. Denim continued to deliver, particularly in women's with strong positive comps even while facing significant competitive pressures. Denim achieved a high single-digit comp increase through a combination of new styles and strong demand for our heritage jeans. In fact, we gained market share in denim according to NPD data and remain the #1 leading specialty store denim brand for the 15- to 25-year-old. We're not stopping here as we continue to see denim as a powerful future growth category. Other areas of strength include men's and women's new tops and women's accessories with key items delivering extremely robust unit sales increases. We're extremely pleased to see our momentum continue into holiday. Unit sales were strong, fueled by investments in key categories. We stand for denim in a major way, yet see additional opportunity across bottoms. In tops, we are building on strength in men's core basics and fueling women's with trend-right fashion silhouettes, new fabrics and the right balance of core and fashion basics. Finally, our accessory shops give customers exciting newness and more ways to express personal style. For holiday, accessories have taken on an even more important role in the store, creating the gift destination for our customers. Our new personal care launch for holiday is also performing well and added an exciting element to holiday gifting. On the marketing front, we are driving a renewed focus on customer connections. A recent example was our social media photo contest, AE BestShot, which garnered over 0.5 million participants. Our marketing priorities include delivering a 360-degree marketing approach to achieve greater awareness of our pricing strategies and highlight key categories and brand the right way. Moving forward, we have an opportunity to improve the shopping experience by creating greater energy and excitement in our stores. We are showcasing the AE brand in new and exciting ways with greater emphasis on outfitting ideas, highlighting denim, fashion tops and using accessories as a way to make each look special. Now regarding aerie. Base on the success of our fall advertising initiative, we will invest in additional campaigns in the future. The aerie brand will drive growth through ongoing focus on its core intimate business, including frequent newness in bras, undies and fitness. Carefully selected apparel and accessories will round out the assortment and complete the aerie lifestyle. As you probably hear from my voice, I am excited. It's my favorite time of the year, and the teams are ready to rock. In fact, they're rocking. Our process is working well, and the teams are aligned and working in sync. We look forward to sharing further progress in the future. Now let me turn the call over to Joan.

Thanks, Roger, and good morning, everyone. Our third quarter performance demonstrated the strength of our brands and the benefit of many improvements we've made over the past several years in merchandising, expense control and new technologies to support top line growth and operate more efficiently. Sales were fueled by our promotional activity, targeted inventory investments and overall improved assortment. Strong sales enabled us to offset the pressure from higher cotton costs. For the quarter, we achieved operating income of $83 million versus $91 million last year. Total third quarter sales of $832 million increased 11%, and comparable store sales increased 5% compared to a 1% increase last year. We were pleased to see a continued improvement at both AE and aerie this quarter. AE brand comps increased 5% for women and 6% for men. Aerie comps increased 8%, and AEO Direct achieved record sales, rising 21%, driven by higher traffic and conversion. Including our Direct business, consolidated comps increased 7%. Looking at the third quarter metrics, we saw a strong customer reaction to our promotion and improved merchandise. Transactions grew 9%, fueled by higher traffic and conversion. While the AUR declined in the low single digits as a result of promotional offering, the transaction value was down only slightly due to strong unit selling. Consistent with our plan, the number of units sold increased in the low double digits. Now moving onto margins. As we indicated on our last conference call, our strategy was to mitigate the significant pressure from higher cotton costs by driving top line sales and to leverage business costs. Our results were in line with our plan and expectation. Gross profit of $309 million declined 1% as the rate to sales was down 450 basis points. Driven by 11% sales increase, BOW leveraged by 30 basis points. Turning now to operating expense. SG&A improved 170 basis points as a rate to sales. We continued to achieve savings across most operating items. The dollar increase resulted from strong sales, new store openings and our planned investment in advertising. Looking ahead, we continue to expect full year SG&A growth in the range of 2% to 3%. Turning to the balance sheet. As we indicated last quarter, we are investing in the key earnings strategy to expand market share and underscore our strong value offering. The quarter-end inventory position supports that initiative. As expected, ending inventory at cost per foot increased 35% with a portion of the increase related to higher costs. Additionally, ending units per foot were up 20% with about half of the increase related to our expected expansion to 400 shop-in-shops. Fourth quarter inventory is planned similar to the third quarter to support peak holiday shopping period. As we transition into next year, we expect the increase to moderate compared to the back half of 2011. CapEx for the third quarter totaled $31 million compared to $26 million last year. For the year, we expect CapEx to be approximately $100 million, which includes the holiday accessory expansion. We ended the third quarter with cash and investments of $482 million after repurchasing 1.4 million shares for a total of $15 million. Now let me review our outlook. We are pleased reporting today's sales trends and especially with business over Thanksgiving weekend, which was very strong and exceeded our plan. Sales metrics were positive across the board, including average unit retail price. We achieved outstanding unit sales growth, reflecting a positive customer response to our holiday assortment and planned promotions, supported by our inventory investments. Regarding our fourth quarter outlook, we expect EPS to be in the range of $0.40 to $0.44. Our guidance assumes sales momentum continue especially during peak holiday shopping periods. Additionally, we expect margin pressure related to higher cotton costs and our planned promotional strategy. Now I'll turn the call back to Judy.

Thanks, Joan. Now we'll move on to question and answers. [Operator Instructions] Lewis?

[Operator Instructions] Our first question comes from the line of Kimberly Greenberger from Morgan Stanley.

I was wondering if, Joan, you could look at the fourth quarter basis point decline in merchandise margin, and help us understand which piece of it was driven by higher costs and which piece of it was driven by higher markdowns.

Kimberly, the change in gross margin rate is half related to the product cost increase and about half of it related to the promotional strategy that was successful during the quarter.

Okay, great. And any way we could understand the magnitude of the moderate in the inventory growth rate into next year? Are there some dimensions you could put around that to help us understand?

What I would tell you, Kimberly, is that as we transition into the first quarter, you will see the unit position come down about half, and the cost as a result of continued product cost increase, that will not moderate until the back half of the year.

Our next question comes from the line of Tom Filandro from SIG.

On accessories, can you provide some commentary maybe on the successes there as well as any misses? And how should we think about the positioning from both the merchandising standpoint and an inventory standpoint for the fourth quarter? And if I could just also -- I don't know if you guys said because I may have missed it, did you provide what, how accessories impacted performance in the third quarter?

Tom, we're really pleased on the feminine side of the accessory business. It kind of distinguishes us. It gives us a help on the units per transaction, and it makes, as I said before, the store much more exciting. It allows us to accessorize a complete vertical lifestyle unlike most of our competitors.

With respect to the inventory, Tom, on accessories, about half of the unit increase related to the accessory expansion.

Our next question comes from the line of Janet Kloppenburg from Jacobs Jenner & Kent.

JJK Research. Roger, I think you guys talked about the fact that your business trends improved in October up from the beginning of the back-to-school period. I'm wondering if you could outline for us the product attributes or the product categories that drove that improvement, and what categories you look to improve here in the holiday period as well. And secondly, I'm just wondering if in your guidance, you contemplated the fact that you may have pulled forward some business because your promotional strategy was so much more aggressive this year versus last.

Well, we're really pleased that pretty much across the board we were relatively strong. But obviously, the ability to grow the denim business on top of the levels of where we are, we just feel terrific about that. And it's hard for me to walk down the street and not see our signature back pocket on every other girl that's walking whatever city I happen to be in. But the real nice thing was the knit business, both in men's and in women's, really took off. We really have solved to the issue of women's knits, and the men's knit business is very powerful for us.

Okay. And you look -- could that improve as we move into the spring, Roger, as you...

When I leave, I have a board meeting after this, and then I'm on my way to Pittsburgh to sign off on the spring set. And I have Fred in here with me, who was in charge of setting it up, and he tells me it looks spectacular. But I haven't seen it myself.

And Janet, with respect to the guidance, yes, we did contemplate the fact that some of the volume would have pulled forward into the powerful Thanksgiving weekend. And we also consider the fact that there will be a lull of post-Thanksgiving shopping again peaking closer into the Christmas holiday and certainly, post-Christmas.

Our next question comes from the line of Michelle Tan from Goldman Sachs.

Great. I was wondering about 2 things. I guess, as you look at the assortment against some of the issues that you experienced at holiday last year, Roger, can you kind of talk about what the biggest opportunities you see from an overarching merchandising perspective are against some of the challenges you had last year? And then, I was wondering if there's any -- if you guys can be any more specific about the kind of momentum you saw so far in November?

Sure. Michelle, last year, we were not quite ready yet. We didn't have the teams in place, and the process was being fine-tuned. And as we came through last holiday, we were very disappointed in the performance in the month of December. And most of it quite frankly, as I said, was self-inflicted. We did a great hindsight. We knew what those errors were. We then have the right people in place. We have the marketing under our control and directing it instead of it controlling us. And we were at the mercy last year of the competition. We didn't have the inventory to drive this brand, which is the most powerful brand out there in the 15- to 25-year-old space. We were short of inventory well over $40 million on the men's side of the business. This year, we have that inventory. We have it in the key items, and those items are performing for us. Joan, do you want to take the second part?

Yes, what's important about the November momentum and the Thanksgiving weekend is that we've been running positive through prior to the Thanksgiving weekend. And the promotional cadence which began on Wednesday was very strong, and our unit sales, in fact, exceeded the unit inventory position that we came into fourth quarter. So it's a very strong momentum, which makes us feel very good about the content of our inventory and the promotional plan that we have on deck for the balance of the quarter.

Our next question comes from the line of Jeff Black from Citigroup.

Joan, talking about the key item strategy, do we see -- I know we're not talking about 2012 specifically yet. But looking at next year, do we see any refinement to that strategy? What kind of merchandise margin pressure should we expect from the strategy given the higher level of promotions associated? And really, the question is just looking at the merch margins, what's possible given or against your historical levels of merchandise margins, given the key item strategy for next year?

Well, the -- as we said earlier, the unit position are improved to support the targeted promotions. But we can refine how we flow and turn that inventory, which it certainly provides margin opportunity for us. However, we need to keep in mind that the product cost, we really don't expect that to abate until the back half of the year. And we believe that the promotions that we have in place will continue to deliver strong top line sales that will enable us to offset some of this pressure, Jeff, just like we saw here in the third quarter.

Our next question comes from the line of Dana Telsey from Telsey Advisory Group.

Can you talk a little bit about IMU, and how you're thinking about IMU going forward with the mix of product costs and how you see pricing settling in? And lastly, on the accessories business, which is gaining traction, where do you see that as a percentage of sales moving forward and impact on the margin?

Dana, the impact of the cost of goods, Joan has been saying it consistently, second half of the year, there should be a dramatic improvement, and that will affect the IMU. Instead of having headwinds, we'll have tailwinds. And the pricing in Asia at this point is coming down very nicely. But that will not be felt until the third and strongly in the fourth quarter and obviously into next year ago, next spring. On the accessory business, we're really happy with where it is, and I don't want to give any percentages out.

Our next question comes from the line of Adrienne Tennant from Janney Montgomery Scott.

My first question is, I know you didn't give any Thanksgiving comp or anything, but should we think about it as -- I mean, you're using words like powerful unit growth and outstanding performance, and so I'm thinking of that in sort of that double-digit range, and then when I add the AUR price increase, I can get to sort of like a mid-teen perhaps minimum comp. So is that how we should be looking at it? And when you say momentum should continue, is that the type of momentum we should think about continuing for the fourth quarter? And then, Roger, really quickly on the inventory, can you tell us what categories are more long-lived, and what categories are sort of more holiday-specific?

So on the quarter with respect to sales, as I said, momentum in November started off positive. We have – we had that targeted promotion over the Thanksgiving weekend, which was very strong. As we move into December, we know that there will be a valley, and we expect that in terms of customer traffic. And as we then move into peak selling prior to Christmas and post-Christmas, we expect unit sales to pick up. What we should keep in mind is that last year, our December was down 11%. So we are comping a month that we fell -- we have a much stronger strategy and a better assortment to pull into the high-selling period.

Our next question comes from the line of Jeff Klinefelter from Piper Jaffray & Co.

Just 2 quick things. One, what impact has aerie and then separately, 77kids, had on the P&L year-to-date? And what do you expect it to for the year? And then also on the denim, it sounds very encouraging on the comps in that category. I'm just curious what the combination is of pricing and unit velocity in those denim comps.

So I'll take the aerie and 77kids. Aerie had a very nice quarter. As Jim and Roger both mentioned, we had our first advertising campaign launching the Drew bra, which was very effective, drove traffic and conversion in the aerie brand. And what was very important to us as a business is we need to consider aerie across all of our channels because what we saw with that promotion is a lift in the web business as well, which is very good in terms of the dual customer shopping experience. So aerie across all channels is profitable as a brand. The stand-alone stores in the quarter were very close to breakeven on a 4-wall basis, and we expect those stores to be breakeven in the fourth quarter on a fully loaded basis. So aerie has a very good story. And as a backdrop, this is with a few stores that are underperforming up against some very strong performers, so very good news in aerie.

And the unit performance in the Eagle denim is very strong. And the average unit retail interestingly, with all of the competitive pressures out there, is not dissimilar to last year.

Okay. And the 77kids?

Yes, the 77kids profit is, again, you need to look at that as 2 channels. We have the stand-alone stores as well as the web. And the bottom line impact at this stage is nominal.

Our next question comes from the line of Jennifer Black from Jennifer Black & Associates.

I wondered how you're doing with your midnight luxe and dress categories. They look -- it looks very different online. And also, I wondered how much early spring you will bring in for the day after Christmas in both guys and girls, and will it have a preppier twist?

We're really pleased with this luxe collection. We hit the fashion right on the note. It's a whole wall section of the stores, and it's what we're calling our fashion approach to holiday, and it is a sellout. If you want to buy it, you better buy it within the next week. Obviously, we're one of the stores that happens to make 10 floor sets a year. And the day when the store closes the night of Christmas, we will set the front of the store with an exciting transitional set.

Okay. Roger, in light of how well you're doing with the dresses, is that a section that you would expand?

For spring, absolutely.

Our next question comes from the line of Randy Konik from Jefferies. Randal J. Konik - Jefferies & Company, Inc., Research Division: Yes, Joan, if you look at the -- I'm just looking at the historical margin trends of the company both on a gross margin base and an operating margin basis. So if we're going to get the -- if we're going to trough out this year at around 36% gross margins and your peak is around, I don't know, 47% or so, 48%, how do we think about where -- the margin structure of the company from a gross margin standpoint with this new promotional kind of posturing? When does the posturing kind of end or does it? And is there some sort of range you're kind of targeting longer term for the gross margins? And then from an operating margin recovery perspective, are we supposed to be thinking about more of an SG&A leverage story going into next year versus a gross margin story? How should we be thinking about potential margin recovery?

I think there's 2 parts, and Joan will take the second part, the actual statistics. We obviously understand the strategies we need to have, and they're working for us. We're very diligent in terms of pre-planning these particular promotions, and the costing that we're going to get as we get into the second half of next year is going to be dramatically better than where we are now. As long as the competitive structure of the business allows us to own the goods at the right price, and we want to compete in the marketplace because we are the dominant player, and we don't want to lose our share of market, we will continue to be aggressive as necessary, but the costs will start to work in our favor.

And with respect to SG&A, Randy, we will continue to drive profit improvement initiatives, so that we will continue to leverage, focus on a leveraging of SG&A. But at the same time, as we develop our 2012 plan, we need to think about what investments are necessary to continue to drive the top line. And we'll talk more about that once we get to the fourth quarter conference call. Randal J. Konik - Jefferies & Company, Inc., Research Division: I mean, so does that mean, I mean, is that kind of saying, suggesting that we could continue to see just gross margin pressure continue into next year, but you'll have an SG&A leverage opportunity? I'm just trying to get a sense of if we're going to start see margin recovery, where do we see it, in the gross margin bucket or the SG&A bucket?

The gross margin recovery, you would tend to see in the back half of the year, is what we've been saying, and that we would be able to leverage our rent on a low single digit next year, so that will provide us an opportunity in gross margin as well, and that will continue to drive SG&A costs in a very disciplined way and strive for leverage.

Our next question comes from the line of Stacy Pak from Barclays Capital.

First, a follow-up on that. Just so I'm clear, Joan, are you saying then that inventories will be in line with sales in the second half of the year as well? So that's when you -- I mean, I understand you get the cost recovery in the second half, but do you also get merchandise margin from less markdowns in the second half? And then the second question is, should we expect SG&A sort of up low single digits in dollars in '12?

So we'll hold on '12 until we get to the fourth quarter call. With respect to the inventories and how we would intend to pitch those for the back half of next year, we will strive, and our goal is to position inventories and sales comparably. And as we anniversary the inventory models that we have for denim that are working for our basic tees, tanks, and in both men's and women's, we will see those, the inventory difference between sales and -- moderate, so that we will be closer to turning inventory as comparable to sales.

Our next question comes from the line of Pamela Quintiliano from Oppenheimer. Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division: Can you talk a little bit about who is shopping at Eagle, and if you're getting back that core lapsed customer or new customer, and if there's any change in the demographic you're attracting and the same thing with aerie?

Well, based on traffic number and based on the conversion, we're back to what I think the brand Jim and I were talking about that over the last few days. The power of this brand, we're seeing across every region, every district of the country, and we're really pleased in the traffic numbers, and the conversion numbers over the weekend were really superlative. Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division: Great. And then if I could just follow up one question on the promotions, just to be clear, did you break at all from your planned promotional cadence during the quarter? Or was it -- I know you were planning on being aggressive, and it just -- it worked out with what you already had set?

Right on plan.

Our next question comes from the line of Richard Jaffe from Stifel, Nicolaus. Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division: And just looking out into the future, you talked about international growth and 20 more stores in new markets. Will those continue to be in the franchise model, or will you start building bricks and mortar?

Richard, we're going to be on 2 fronts. We'll continue on the franchise license arrangement where appropriate. But we are looking at other parts of the world where we will potentially have company-owned stores. So it will be a model that, hopefully will be a little more balanced in the future. But right now, it's primarily franchise/license initiatives.

Our next question comes from the line of Dorothy Lakner from Caris & Company. Dorothy S. Lakner - Caris & Company, Inc., Research Division: A question for Roger. As you look at the success of aerie as well as the women's business at American Eagle really coming back nicely, where are the differences in sort of outside of the -- obviously the Foundations business and the bra business? What are the differences that are allowing aerie and American Eagle women's business to do well at the same time? And then just secondly, on the sourcing side of things, I'm wondering after the experience that really all apparel retailers have been through over the last year with the increases in cotton and so forth, how are you thinking about sourcing in different parts of the world? Is there any thought of transitioning to, say, more balanced between the East and West, and how you might approach that?

Okay, on the women's business, you know us very well, Dorothy. You've been following us a long time. You've been a terrific partner. We really have the process back in place. We have the right people in place, and the presentation and the marketing of the product is really in sync now. It's the way we used to run the business, and it's really working for us, and it's working across all categories within the intimate business, the foundation business and within the women's sportswear business, including sweaters. We're really, really -- in knit wear, the business for us is very good. Jim wants to make a comment or 2 on the sourcing.

Yes. On your question on sourcing, which is a good one, we've actually, over the last 1.5 years, almost 2 years now, have reevaluated and also started to reposition our whole sourcing structure as it relates to where we are going to manufacture in the world. We still have a very dominant presence in Asia, but we are continuing to explore opportunities in the Western Hemisphere, and I see that movement continuing as those countries become more competitive, and they're able to meet not only our cost expectations but as well as our quantities.

Our next question comes from the line of Jennifer Davis from Lazard Capital Markets.

First, a quick clarification. Joan, I don't know if you said this, did you see margin improvement at aerie in the third quarter? And then on inventories, I think you guys said inventory units were up 10%, so I assumed dollar per accessories, units are up 10%, so I assume dollars are also. So that would put inventory dollars in apparel up about 30%, and I guess, units up about 10%. So how much of that is denim since denim is less important in the fourth quarter versus the third quarter? And then I'm just kind of trying to understand, you guys did a great job promoting and driving traffic, so congrats on that, but there's still a delta between inventory and sales, and I'm just trying to get a little more color on that on expense.

Joan will take most of the questions. But if you take a look at the third quarter in total, the inventory units were up 20%, and our sales were up 12% in terms of units. That's a pretty good relationship where we're a very heavy bottoms-oriented business. And if you look at our turnover in a vertical retail and relationships, anyone else is in this business who's dominant in the bottoms business like we are, I think you'd find the turns pretty damn good.

With respect to aerie, aerie improved in the quarter, third quarter, and we expect continued improvement in the fourth quarter, Jennifer. With respect to Q4 inventories, the composition of the average inventory is really consistent with the third quarter. Denim continues to be an important category for us in the fourth quarter. And the content to get -- that we're comfortable with is the fact that these core basics and fashion basics make up 50% to 60% of our inventory composition. So we feel very good that we're positioned well, we can support the sales plan and importantly, it responds to what the customer wants.

Our next question comes from the line of John Morris from Bank of Montréal.

A quick update on potential store closing plan for next year, is that pretty much the same? And then, you talked a little bit about your continued investment in advertising. Maybe, Roger, if you can talk a little bit more about the approach to that, the strategy, what are the forms, and what's the plan for that continuing into 2012? And then finally, Joan, do you want to just -- you've obviously given us some guidance to how to think about inventory for Q4 in terms of the average levels expected. Do you want to just give us a heads-up on what we would expect for that quarter-end data point, especially considering some of the shifts in things like Chinese New Year, et cetera?

So we're on track with our closing plan, John, so there's really no change to what we've previously guided to. We said 75 to 100 stores as we began that closing last year. Then with respect to the ending inventories, we don't really give a quarter-end guidance due to the timing of in-transits and so forth. However, we do expect to see the inventory levels to moderate and come down both on a unit basis, less so on a cost basis because of the continued product cost increase until we get to the back half of the year.

And from the marketing aspect of the business, the #1 marketing effort we do is the visuality and presentation in our stores, and I'm sure you've all seen the stores for holiday, and I think that on a competitive basis, we really look like holiday. It's festive, it's fun, it's got a lot of energy, and it's got a lot of color. And our store presentation is pretty strong. From a marketing perspective to the outside world in terms of true marketing, we are working on some campaigns that we have not done before. But I certainly don't want to talk about that at this point in time.

Our next question comes from the line of Anna Andreeva from Friedman, Billings and Ramsey. Anna A. Andreeva - FBR Capital Markets & Co., Research Division: Okay, you bought back some stock during the quarter. I think this is the first time this year. And obviously, you guys have a pretty sizable authorization remaining. Maybe talk about how the board views share buybacks going forward. And a follow-up just on the costing, you said costing obviously will be a tailwind in the back half of 2012. Did you quantify how much you expect costing to be up in the first half?

We did not quantify that, but what we know is that the product cost increases in the back half of this year have been in the low to mid-teen, and we really don't see that abating until the back half of next year as we've said. As we think about share repurchase and our capital strategy, first and foremost, we invest in our business and in our growth plan. We are very keen on returning cash to shareholders and have done so over the past 4 to 5 years with over $1 billion of cash return to our shareholders through share repurchase, and then $400 million to $500 million in dividends, so and we'll continue to evaluate that. As you mentioned, our authorization extends through January 2013, and we will continue to evaluate that with the board.

Our next question comes from the line of Robin Murchison from SunTrust.

Roger, I wanted to get you to just talk a little more specifically about sweaters. I think that is a key opportunity for you this holiday season vis-à-vis last year especially just in terms of unit level of content and price points.

Well, we like our sweater assortment. It's doing nicely for us, and we think that we really have a terrific design group put together, and I look forward to sweaters even growing that much more as we move into 2012.

Our last question comes from the line of Roxanne Meyer from UBS.

I'm just wondering what's been driving the AUR increase that you're seeing so far in the quarter? And do you expect that trend to continue with your ramp-up accessories? And then just a follow-up on inventory, just wondering if you could just share the carryover levels of clearance from the third quarter into the fourth quarter or not necessarily clearance but older inventory.

Our inventory is very fresh, Roxanne, and the percentage of clearance remains a little bit less than 10%, which is consistent with how we've run the business in the past couple of years. The AUR is really driven by the mix of denim in our business, as well as a good response to the sweaters and the tops in the business. So overall, for the month of November, we saw this positive response, which is really what's driving across the board reception to our assortments.

That concludes our call today. We will announce holiday sales on Thursday, January 5. And our fourth quarter announcement is currently scheduled for Wednesday, March 7, 2012. Thanks for your participation today, and have a great day.