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Executives

Kenneth Ohashi - Vice President of Investor and Media Relations

Thomas Johnson - Chief Executive Officer

Marc Miller - Executive Vice President and Chief Financial Officer

Michael Cunningham - President

Emilia Fabricant - Executive Vice President, Aéropostale brand

Analysts

Edward Yruma - KeyBanc Capital Markets

Anna Andreeva - FBR Capital Markets

Janet Kloppenburg - JJK Research

Lorraine Hutchinson - Bank of America Merrill Lynch

Adrienne Tennant - Janney Montgomery Scott

Betty Chen - Wedbush Morgan Securities

John Morris - BMO Capital Markets

Lee Giordano - Imperial Capital

Jennifer Davis - Lazard Capital Markets

Marni Shapiro - The Retail Tracker

Kimberly Greenberger - Morgan Stanley

Roxanne Meyer - UBS

Linda Tsai - ITG

Dana Telsey - Telsey Advisory Group

Aeropostale, Inc. (ARO) Q3 2012 Earnings Call November 28, 2012 4:15 PM ET

Operator

Thank you for joining us for the Aéropostale Conference Call to review Third Quarter 2012 Financial Results. (Operator Instructions) I would like to remind everyone that this conference call is being recorded. I would now like to introduce, Ken Ohashi, the company's Vice President of Investor and Media Relations. Thank you. You may begin.

Kenneth Ohashi

Thank you all for joining us this afternoon. With me here today are Tom Johnson, our Chief Executive Officer; Michael Cunningham, our President; and Marc Miller, our Chief Financial Officer. I am also pleased to welcome our new EVP of Aéropostale brand, Emilia Fabricant. We issued a press release earlier this afternoon announcing our third quarter 2012 financial results. A copy of the release can be found on our corporate website.

Before we begin I would like to remind you that during this earnings conference call certain statements and responses to questions may contain forward-looking information such as forecasts of future performance. Forward-looking information and statements involve known and unknown risks and uncertainties which may cause our actual results in future periods to differ materially from our forecasted results. Those risks are described in our annual report on Form 10-K and our quarterly reports on Form 10-Q, all of which have been filed with the SEC and are available on our website.

We undertake no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. Listeners of this call are referred to those filings. Before I turn the call over to Tom, I would like to ask everyone to limit themselves to one question during our Q&A session to allow everyone a chance to speak. Once we have gone through a round of questions we will go back and you may queue up again at that time. I would now like to turn the call over to Tom.

Thomas Johnson

Thank you, Ken. Good afternoon everyone and thank you for joining us today. I'd like to take you through some of the highlights from the third quarter and the progress that we are making on our strategic initiatives. I'll then turn the call over to Marc who will take us through the financials.

The third quarter came in as we anticipated. Our teams navigated through an intensely promotional and competitive retail environment and were able to achieve net earnings slightly ahead of our previously issued guidance. From a merchandise perspective, we experienced similar trends to the first half. Our girl customer continued to respond positively to our fashion offering, including fashion tops and wovens, and colored and printed denim. However, our girls core basic business, particularly graphics and fleece, experienced pricing pressure and their performance fell below our expectations. Our men's and accessories businesses had solid quarter with increases in both comps and merchandise margins.

During the quarter, we also launched our fall marketing campaign with Chloe Grace Moretz. We believe that Chloe is a perfect brand ambassador to showcase our fashion and we were pleased with the positive reaction from fashion editors, customers and our store associates in response to this campaign. Additionally, last month we opened our new innovative concept store in Roosevelt Field Mall on Long Island. We believe this new store design is both warm and inviting and highlights the brand in a whole new way. We're very pleased with early feedback and the results from the store and we look forward to updating you on its progress over the next few quarters.

While there were encouraging bright spots during the quarter, we are clearly not satisfied with the overall trend in our business. Our entire organization is working diligently on our strategic initiatives to move the business forward. These strategic initiatives include, developing and refining our fashion offering and brand projection, enhancing processes and technology and investing in future growth drivers. The reinvigoration of our merchandise assortment is undoubtedly our most important strategic initiative. Our product teams are reading and reacting to emerging trends faster than ever. They are developing our fashion within the parameters of the Aeropostale brand to create a consistent and cohesive message to the consumer.

Additionally, as all of you know, Emilia Fabricant joined as EVP of the Aeropostale brand back in August. Emilia is an extremely talented leader with a proven track record of success and we are thrilled that she is now part of the Aeropostale family. We look forward to her many contributions as we propel the Aeropostale brand into the future.

Second, we will continue to invest in and enhance our processes that will enable us to chase fashion and increase our overall speed to market. We will leave more open to buy and leveraging our core vendor base to use greater fabric contingencies and improve lead times. We also have greater opportunity to localize our assortment by mall type and store profile based on the appetite for fashion in each of these locations. We have already started to [distort] our assortment through smaller pre-packs and will further improve the localization process through the implementation of our assortment planning and allocation tools.

Finally, we are investing in our future growth. P.S., which reached 100 stores last month, had a strong quarter with improvements in both comps and merchandise margins. The teams did a great job delivering fresh, cohesive and a well balanced assortment. We are very pleased with the momentum in this business and we are excited that both parents and kids are embracing P.S. as their destination store in the mall.

On an international front, we are continuing to develop new licensing relationships with well established partners. While we are currently trading in seven international markets, we expect the Aeropostale brand to be sold in more than 13 international markets next year. Lastly, we acquired the footwear and apparel retailer GoJane.com earlier this month. We are very excited to have found a fast-growing entrepreneurial e-tailer that complements our web business and enables us to expand into new product categories.

Before I turn the call over to Marc, I'd like to discuss fourth quarter trends with you. Trends for the first two weeks of November were highly inconsistent and the retail environment remained challenging. In contrast, we experienced positive comps and margins of the Black Friday weekend. While we are encouraged with the performance of the holiday weekend, we remain cautious for the remainder of the quarter given the inconsistencies in our business and a highly promotional environment.

We will continue to focus on delivering on our key initiatives, managing our business conservatively and ending the quarter with inventories well-controlled.

I would now like to turn the call over to Marc who will take you through the financials.

Marc Miller

Thank you, Tom. Total net sales for the quarter were up 2% versus last year reflecting an average square footage increase of 4%, offset by a negative 1% comp which includes our ecommerce channel. Including our ecommerce channel our guys business was up 3% and our girls business was down 3% for the quarter.

Our comp for the quarter was driven by a 3% increase in units per transaction and a 2% increase in transactions, offset by a 5% decline in average unit retail. During the quarter we opened five Aero stores and P.S. stores and we closed two Aero stores as well as two temporary P.S. stores.

Gross margins for the quarter were 27.9%, which was 27.1% last year. The 80 basis point increase was driven primarily by higher merchandise margins due to lower product costs, partially offset by deleverage in occupancy costs and deleverage in distribution and transportation costs.

SG&A for the quarter was 20.9% of sales versus 20.4% last year. The 50 basis point increase was driven primarily by deleverage from previously announced planned marketing investments, deleverage from store line expenses and deleverage from ecommerce transaction related expenses. These were partially offset by lower corporate related expenses driven by incentive and stock-based compensation and lower store transaction related expenses.

Our tax rate for the quarter was 41.2% versus 39% last year. This resulted in net income of approximately $24.9 million or $0.31 per diluted share. Cash and cash equivalents at the close of the quarter were $184.5 million versus $109.4 million last year.

During the quarter, we repurchased 3 million shares of common stock for $41 million. We currently have approximately $104 million of buyback availability remaining under our share repurchase program. Program to date, we have returned over 1 billion to shareholders in the form of 60 million shares repurchased. Inventory at the end of the quarter was $277 million, up 5% in total or up 1% on a retail per square foot basis. Our capital expenditures for the quarter were $16 million and depreciation and amortization was $16 million.

I will now discuss our guidance and outlook. As Tom mentioned earlier, our trends for the quarter to date period have been inconsistent. While we were encouraged by our performance over the Black Friday weekend, we are seeing a very competitive and promotional retail environment. Accordingly we are providing fourth quarter guidance in the range of $0.36 to $0.41 per diluted share. This guidance excludes the impact of any potential store asset impairment charges and assumes a share count of 78.5 million and an effective tax rate of approximately 43.5% versus 35.9% last year. As a reminder last year's effective tax rate was favorably impacted by tax accrual adjustments.

Now I will turn the call over to Tom for closing remarks.

Thomas Johnson

Thank you, Marc. This year we are celebrating the 25th anniversary of the Aeropostale brand. It is truly a remarkable milestone. Over the past quarter of a century we have built one of the most highly productive, well respected and vibrant brands in the teen marketplace. While the retail business changes dramatically from year to year, season to season, the core tenants that have contributed to Aeropostale's long history have remained consistent and steadfast, deliver great product at compelling values, invest in future growth and protect our unique and special culture.

Before I turn the call over to Q&A, I would like to thank the entire organization for their responsiveness and diligence during Hurricane Sandy. Everyone at Aeropostale banded together to get our affected stores back up and running and as quickly as possible, as well as show compassion to those impacted by the disaster. I'm very proud that our charities Aero Cares and Aero Gifts were there to deploy funds and product for those in need, both internally and externally.

I would also like to thank the Aeropostale team in advance for their hard work and dedication over the holiday selling season. We thank all of you for your continued support. Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Edward Yruma with KeyBanc. Please proceed with your question.

Edward Yruma - KeyBanc Capital Markets

Could we dig a little bit into the inconsistency observed in November? Was there disproportionate impact to stores impacted by Sandy and I guess what was the magnitude of improvement that you saw over the Black Friday period? Thank you.

Thomas Johnson

Edward, this is Tom. Certainly who would have figured that we would have had a comp hurricane and certainly the magnitude of Hurricane Sandy. But the first week of the month is very difficult for us and we had a follow up encore with the nor'easter. So weather did play a pretty significant factor during the course of the month. And then as far as Black Friday is concerned, we are very positive. We had three days of very strong business, the Friday, Saturday and Sunday. And we saw a slightly different traffic patterns for Black Friday than we'd seen in the past. It seems like it's turned into a very large event with people coming out from midnight to 3 and then we had a resurgence midday on Black Friday itself. So overall we're very positive. The brand was very powerful in terms of the way we performed. We're pretty excited about it. The magnitude of the stores that were impacted...

Michael Cunningham

This is Michael. We had over 200 stores that were impacted and closed for at least one day during the course of the storm.

Operator

Thank you. Our next question comes from the line of Anna Andreeva with FBR Capital Markets. Please proceed with your question.

Anna Andreeva - FBR Capital Markets

I was hoping to follow-up with a little bit more color on Black Friday. I'm not sure if you could provide some of the AUR and transaction metrics over the weekend. I think you said margins were up and comps were up. Anyway you could quantify that and did you guys see any differences regionally or by mall type? And then just on the higher tax rate in the fourth quarter, which I'm calculating to be about $0.04 drag to the quarter, what's driving that and how should we think about tax rate going forward?

Thomas Johnson

Yeah, Anna, this is Tom, and Marc will take care of the tax, the answer or question. Sales and margins were positive, like I had mentioned. I am not going to get into too many of the details around that. Regionally, we saw broad-based strength in the regions that have continued to perform at a disproportionate level. The South and West performed better but we had strong business across the board regionally in all mall types. A, B, C and outlets did very, very well.

Marc Miller

And Anna on the tax rate, we had stated, we expected to be about 43.5% for Q4. It's due to the mix of income between domestic and international as well as some potential valuation allowances for certain net operating losses and that compares to last year where we have the tax rate favorably impacted by tax accrual adjustments. So the net swing from that, you called it $0.04, it's about $0.05 year-over-year. On a full year rate we expect it to be somewhere in the range, for 2012, between 41.5% to 42%.

Operator

Thank you. Our next question comes from the line of Janet Kloppenburg with JJK Research. Please proceed with your question.

Janet Kloppenburg - JJK Research

Just a couple of questions. The first is, given the performance of Black Friday why aren't you more optimistic about the fourth quarter? And the second question is, if you could talk to us maybe about the merchandising improvements or elevations you've made for the fourth quarter that might enable the business to improve, perhaps you could talk a little bit about your inventory content being devoted to fashion versus basic. Any pricing or marketing changes? Thank you.

Marc Miller

Janet, this is Marc. I'll take the first part about extrapolating off of Black Friday versus the full month of November. The guidance range that we provided, it contemplates as always a range of comp and margin assumptions, and the explicit extrapolation that we did was one of the Q3 comp and margin trends which were kind of in line with some of the inconsistency with what we saw in November as well. So, kind of the color that I'd provide is just to say $0.36 to $0.41 includes both Q3 extrapolated as well as our actual quarter-to-date performance and extrapolating off of that with the both highs of Black Friday as well as the lows of the first three weeks that Tom had alluded to earlier.

Thomas Johnson

And then as far as holiday product, we are really excited. We just set the floor with a small refresh starting today actually and then we have another floor set dropping which anniversaries our last year floor set which is our power set, which is December 9. So very encouraged about what that looks like. It's very fresh assortment. It looks discernibly different from the Black Friday set. Typically for us, Black Friday tends to regress back to more logo driven product and then our power assortment will be much fashion oriented.

So we are very encouraged about what that will do the floor and really connecting emotionally with our customer, and we're very excited about that as we move into spring. As far as market is concerned, we will have compelling, powerful promotions that are pre-planned as normal. So we are excited and encouraged about the holiday trading period but as Marc stated, we continue to be cautiously optimistic as we look out into the future.

Operator

Thank you. Our next question comes from the line of Lorraine Hutchinson with Bank of America Merrill Lynch. Please proceed with your question.

Lorraine Hutchinson - Bank of America Merrill Lynch

You said in the beginning of the call that the third quarter was in line with your expectations, just wanted to dig into gross margin a little bit. Was that as you expected or did you have to add incremental promotions to keep up with a highly competitive environment?

Marc Miller

Sure, Lorraine, it's Marc. Q3 did come in, in line with what we were expecting on the gross margin line. We had talked about on the call the fact that while we did have the benefit of costs and gains, we were seeing a lot of pressure on some of our core classifications, in particular graphics and fleece. And that turned out, as we had flashed on the last call, to be a drag on our overall AURs.

In addition to the kind of net impact on merchandise margins we did also see deleverage in occupancy and that was in part due to the negative comp store sales as well as our opening of Quebec in Canada, and even our move of our New Jersey offices. And there was some deleverage in shipping and transportation which was due to some higher units that we brought in for some strategic inventory investments that we made to position ourselves at the end of the quarter.

Operator

Thank you. Our next question comes from the line of Adrienne Tennant with Janney Capital Markets. Please proceed with your question.

Adrienne Tennant - Janney Montgomery Scott

My question is on the penetration of fashion in the fourth quarter sort of relative to the third quarter. Is there any percentage that you can help us out with? And then I guess, Emilia, when can you start to impact for the fashion content and what's the target? Whether you want to give us the number or not, at what time will you, do you think you can get to that target penetration sometime next year? Thank you.

Thomas Johnson

Sure, Adrienne, it's Tom. The fashion penetration changes slightly during the different quarters of the year obviously, and like I had mentioned earlier, certainly for the Black Friday floor set is slightly less fashion I would say in terms of total quotient. I wouldn't share the fashion percentages but suffice it to say that you'll see more fashion in the next delivery like I had mentioned earlier and we're definitely excited about the addition of Emilia joining us as our new partner with the development of the brand and as we propel forward.

Emilia Fabricant

Hi, Adrienne. We are effecting everything we can today. The teams are chasing into the first half of the year and we're focused on the full-line on the back half of the year. And as we continue to execute our fashion strategy we'll continue to address the mix as customers need and trends develop.

Operator

Thank you. Our next question comes from the line of Betty Chen with Wedbush Securities. Please proceed with your question.

Betty Chen - Wedbush Morgan Securities

Congratulations on a nice Q3. Welcome Emilia. And as a follow-up to what Adrienne said, I was curious also, coming in sort of what are some of the priorities perhaps you have set for yourself and the team in terms of now that you've been with the company for a short period of time? And then I think also related to that, I was curious in terms of the SG&A for the fourth quarter. Marc, you controlled it really nicely in the third quarter, can we expect that to continue in the fourth quarter or are there other factors that we should keep in mind? Thanks.

Emilia Fabricant

Well, Betty, the team has worked so much this year to move the company forward and as we know we still have more to do. What we will focus is on looking at what we are buying and how we are buying it to better connect with our customer. We have an opportunity to continue to increase the chase business and with that increase our fashion and fashion basics penetration, in addition to more frequent fashion deliveries.

We know our customer shops as often and we will tailor our deliveries to their needs. We are maximizing our localization strategy which is very important and we will continue to implement our speed to market strategy. We also have an opportunity to innovate and localize our core and have challenged the team to modernize new techniques, fabrications and silhouettes, and will continue to increase our test and react strategies so that we are smarter in the bets we make.

Marc Miller

And Betty, on our SG&A, we do expect to see some additional deleverage compared to the 50 basis points deleverage that we experienced in Q3. Overall the Q4 SG&A rate as a percent of sales will be lower than the Q3 rate but the deleverage will be higher. And some of the reasons for that are really investments in marketing and planned marketing expenditures as well as systems and people. So, overall expect to see a slight deleverage higher than Q3.

Operator

Thank you. Our next question comes from the line of John Morris with BMO Capital Markets. Please proceed with your question.

John Morris - BMO Capital Markets

A little bit more about the fashion and then a quick follow-up. Just theoretically, philosophically as you look forward, can you go a little bit deeper into fashion as we get out to next year versus last year? And maybe also just separately talk a little bit about the GoJane acquisition, your strategic thoughts around that and what you hope to achieve from that interesting play?

Emilia Fabricant

Well, when we speak about fashions for Aeropostale, we'll still continue to focus on speed-to-market which will make us smarter that way but we will not be fast fashion. We will be relevant fashion which speaks to the Aero DNA. We'll be looking to the streets on what they are wearing, blogs on what they are talking about and social media about what they are sharing, to get a pulse on our customer. And we will continue to grow both the fashion basics and the fashion incrementally over the year.

Thomas Johnson

John, as far as GoJane is concerned, we are obviously very excited as a tuck-in acquisition for our ecommerce business. And it’s definitely a brand in its own right and has quite a bit of marketing power while it’s still a very small business as you have seen in some of the shows, they get quite a bit of editorial. And in addition to that we feel very good about the possibility of adding it for our e-com business in terms of product extensions. So overall we feel great about the acquisition. It's something that we will definitely develop over time and we will see what the future brings.

Operator

Thank you. Our next question comes from the line of Evren Kopelman with Wells Fargo. Please proceed with your question.

Unidentified Analyst

It's [Marry Ann Casper] in for Evren Kopelman. I just wanted to quickly ask, are there any other fashion trends you are seeing in the marketplace that you want to get into going forward? Is there anything beyond bright colors, colored denim that you are seeing coming up that you are looking to execute on?

Emilia Fabricant

Well, we know we are still living through the woven cycle so we are capitalizing on that and we will continue doing so and, yes, denim and woven bottoms as well. So those are the strengths that we are seeing, that we are chasing into today.

Operator

Thank you. Our next question comes from the line of Lee Giordano with Imperial Capital.. Please proceed with your question.

Lee Giordano - Imperial Capital

Can you talk a little bit more about P.S.? It sounds like you're doing very well there. How about the long-term store growth potential at P.S. and would you consider accelerating that growth considering its success?

Michael Cunningham

Lee, this is Michael. Yes, we are very pleased with the results and progress of P.S. As you know we reached our 100 store plateau recently. We also have a vibrant e-com business. Some of the initiatives that are driving the result we talked about, the additional 4 to 6 sizing that we launched last October, that's becoming an important element of the offering. Adding excitement in fashion obviously to the brand also really continues to drive the business.

With regards to our new store openings, as you know, we will announce our plans for the new store openings, particularly P.S., on our March call. But again, we are very pleased with the results of Q3 as well as the Black Friday weekend and you'll hear more about our plans for P.S. in March.

Operator

Thank you. Our next question comes from the line of Jennifer Davis with Lazard Capital Markets. Please proceed with your question.

Jennifer Davis - Lazard Capital Markets

I am going to try to ask the hurricane question in another way. Can you talk a little bit about trends in the non-hurricane impacted areas during the first two weeks of November? Was there a little more consistency in those regions? And then a quick clarification. Marc, did you get the breakout between -- the breakout of merchandise margins between costs and markdowns?

Marc Miller

Jennifer, on the Hurricane question, I think what Tom said in the upfront remarks covers it, which was that the start of the month was inconsistent. It was inconsistent both because of actual weather as well as just the overall traffic patterns in the business overall, so we'll leave it there. Merchandise margins, we didn't explicitly break out the cost versus markdown component. What we did say, was we did have costing benefit in the mid to high single-digits which benefitted us in Q3 and we do expect by the way to see similar cost benefit in Q4.

Operator

Thank you. Our next question comes from the line of Marni Shapiro with The Retail Tracker. Please proceed with your question.

Marni Shapiro - The Retail Tracker

Can you just touch back on the fashion versus fleece and T-shirts conversation? Was the fleece and T-shirt issue a problem across all stores in all geographies A, B and C? Or did you see in the 250 stores that you guys have talked about that do fashion well, in those stores it was a bigger problem and fashion was selling and in some of the other stores those items were still working, or was it really across the board?

Thomas Johnson

Marni, it's Tom, actually very good question. The fleece and graphics business overall, as you guys know, we built it to, I wouldn't say unsustainable but incredibly high penetration percent of our business overall over the years. Clearly, it's becoming a little bit more normalized for us. It continues to perform for us, although the pricing pressure is more acute in those two areas overall. So, as we move through the quarters we will normalize that as we do our buys. We bought down graphics and fleece for Q4 in aggregate. So, we feel good about our direction and what we're doing. We can't take a business from 35% or 40% to zero. But we think that logo is still going to be a strong component of our business and it really anchors our business. So it's important for us to all know that.

From a localization standpoint, our A, B and C stores definitely performed differently and fashion has been checking more in the A doors than some of the other doors in B and C. So, from an indicator standpoint, we believe from an early adoption rate for fashion is a great sign for us. Now, that's a short amount of time we want to continue to develop that. We think that long-term it really lends the belief that localizing our product in a more effective way will become very, very powerful for us as we move into next year. And from the bottom stores or the bottom performing stores, they do still sell the fashion and you need to have that for that assortment to give a halo effect of the core product that's in those stores.

So, we will continue to just throw goods to them but we have made adjustments to our pre-packs. We feel good about that. We're giving them the fashion but we are not giving them the quantities that we deliver to them during the course of the year. So, yes, all fashion is not created equally and it's not sold equally across the chain but it is checking and we feel very good about it overall.

Operator

Thank you. Our next question comes from the line of Kimberly Greenberger with Morgan Stanley. Please proceed with your question.

Kimberly Greenberger - Morgan Stanley

I wanted to just sit back and talk a little bit about the business model because based on the guidance that you have given for fourth quarter, it looks like your third quarter and your fourth quarter gross margin will both come in below Q1 this year, and I know Q1 this year was depressed because of higher sourcing costs. So, I'm just trying to understand what's happening in the underlying tenure of the business that's causing a real disruption in the business patterns that you've historically seen with typically a better third and fourth quarter gross margin than you do in Q1. And what is your diagnosis of the competitive position for Aero over the longer term and what do you think the right or normal kind of gross margin level would be for this business?

Thomas Johnson

Kimberly, I'll take a crack at that one. What you've seen in the Q4 margin versus Q1 is actually a trend that we've seen over the last few years. And we think it's in part due to kind of the nature of the composition of our back to school as well as holiday assortments which tend to be more core product dominated whereas we are able to bring in more fashion in kind of lighter weight mix in the spring season which have been, we've enjoyed some higher margins on. So, again, this isn't a one-year phenomenon. This has been a multiyear phenomenon that we've experiencing.

As we think about the overall business model and opportunities for expansion, I think Tom and Emilia have really outlined a lot of the path by which we think we can get improvement across the board not necessarily quarterly. And that is this idea of more open to buy, more chase, more testing, localization, we think those are all initiatives that will augment our long-term merchandise margins, and we think we are supporting that with the right structural investments. Tom had mentioned our assortment planning and allocation tools, we are investing in PLM and those should all also support higher merchandise margins long-term.

Operator

Thank you. Our next question comes from the line of Roxanne Meyer with UBS. Please proceed with your question.

Roxanne Meyer - UBS

I was just wondering if you could chat about what in fashion had worked well, where were the wins in the third quarter? And where did you see maybe some underperformance and your ability to turn that into an opportunity whether it's in the fourth quarter or in spring?

Thomas Johnson

Sure, Roxanne, it's Tom. The fashion, we are very excited about couple of specific areas that Emilia touched on earlier which was wovens. The woven category overall is very powerful for us and denim for -- it's exciting for us to talk about denim. We added the fashion denim, the colored denim and pattern denim, and all of that checked very nicely across both chains, frankly. So we are very excited about that trend and that's something that we'll continue forward.

And as I mentioned earlier, the area of biggest pressure from a sales and margins standpoint was really in the areas of the graphics and the fleece. As we head into the fourth quarter, again, excited about the fashion that we are delivering in another few weeks, and as we head into spring, the pressure from the fleece penetration abates a bit and in first half of next year it doesn't abate a bit. So we see that there is opportunity there for sales and margin expansion.

Operator

Thank you. Our next question comes from the line of [Daniel Maccoy with Brim Capital] Please proceed with your question.

Unidentified Analyst

One, I was just wondering if you could just repeat the expected share count in fourth quarter. And secondly, just switching gears a little, the new store layouts really look great. Are you guys witnessing any higher profitability in those locations?

Marc Miller

Danielle, it's Marc. I'll take those. The share count for the fourth quarter we except to be 78.5 million shares. In terms of the new store design, as many of you know, Roosevelt is my home store so I'm happy to provide that color. As Tom mentioned in the upfront remarks, we are really excited about the new design. We think that it takes our brand to the next level in terms of being relevant to our target customer and we really think it amplifies the fashion component of our assortments.

It's really early to quantify, the store has only been open a little over a month, but the initial reaction is very encouraging. And anecdotally, I'm seeing the customers spending more time in our stores and I’m also seeing the return of the customer who hasn’t been shopping us as much the last two years returning to our store. So, as we think about the new store design and rollout going forward, obviously we'll make tweaks to the model as we would with any new store prototype, but we really feel excited about the promise of that new store format.

Operator

Thank you. Our next question comes from the line of Linda Tsai with ITG. Please proceed with your question.

Linda Tsai - ITG

How much was AEP down in the quarter and what would it look like headed in to the first half of '13? And then overall, how did carryover inventory look in the quarter and what's your overall inventory outlook for Q4?

Michael Cunningham

This is Michael. With regards to the inventory, the inventory levels are pretty clean compared to last year so we feel very good about our position. We'll see how, as Tom says, the rest of the holiday season rolls out. But we plan, as you know, we always plan in the year with the inventories in line for the spring season, so we'll manage our promotional activity with regards to sales activity during the remainder of the fourth quarter.

Marc Miller

And Linda on the average unit cost going to next year, we do see a slight benefit in Q1 for 2013. As you recall, we had higher product costs that trailed into Q1 of this year and then Q2 it's just a little bit early to make the call.

Operator

Thank you. Our next question comes from the line of Stephanie Wissink with Piper Jaffray. Please proceed with your question.

Unidentified Analyst

This is actually [Maria Vissate] for Stephanie. We are just wondering if you can talk a little bit more about holiday versus the back to school floor set in terms of maybe the merchandise mix by category and maybe some pricing tiers?

Thomas Johnson

Maria, we generally don't get into a lot of mix shifting. The only thing that I could tell you from an aesthetic standpoint, the penetration of logo does abate a bit into the next floor set. We're very excited about it. And there's a marked difference in the projection of the product and we're very excited about what that would do to the selling floor and we think that the customer's reaction has been incredibly positive.

Operator

Thank you. We have time for only one more question. Our last question comes from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Dana Telsey - Telsey Advisory Group

As the business model is changing and implementing the changes of fashion versus basic and what's happening with the assortment, how will systems, whether it be assortment planning, be adjusted to work with the new business model? And just lastly, as you think about the real estate profiling, how is that being adjusted given the new fashion quotient of the brands?

Michael Cunningham

Dana, hi, it's Michael. The systems that we're talking about being implemented, we talked about PLM which will enable us from the product development life cycle to basically do it quicker, better, faster. As well as the assortment planning system which will give us the ability to take the localization that Emilia talked about and automate that for each individual store at the beginning of the planning process. All geared towards helping us manage this business on a much more sophisticated and a granular level to optimize the customer's appetites across various mall types and geographies for fashion versus other items as well as the depth and breadth of the overall assortment.

So these projects are on schedule. We talked about it last quarter. PLM, summer planning and allocation optimization, we are all planning to have those three going live in spring of 2013 with benefits happening throughout 2013. And with regards to the full assortment planning, full benefits will be in 2014. So very excited about that.

As we also look at our real estate this entire year plus, as Tom has talked about business model, the customers change in fashion taste has caused us to look much more closely at all aspects of our business including our real estate portfolio. We are managing our real estate portfolio very carefully. We look at it continually by obviously not just regions, not just small types, but also by demographic data by the malls. And we are splitting the mall, the stores and assorting them according to varying demographics.

So our decisions to manage and optimize our portfolio is based again just like on a merchandise analysis and planning of assortments based on much more granular detailed level across the entire 1,000 store portfolio. It's a lot of work. We have been at it for a while now. We are seeing some of the fruits of our labor and we are going to continue to manage this business on a more refined level as we go forward into next year.

Operator

Thank you. We have no further questions at this time. I would like to turn the floor back over to management for closing comments.

Thomas Johnson

Thank you very much. Thank you everyone for your continued support. We at Aeropostale, the team, want to wish all of you happy holidays and prosperous holidays, I should add, and we'll speak to you next year. Take care.

Operator

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

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