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Aeropostale, Inc. (NYSE:ARO)

F3Q08 Earnings Call

November 3, 2008 3:15 pm ET

Executives

Kenneth Ohashi – Vice President, Investor & Media Relations

Julian Geiger – Chairman and Chief Executive Officer

Mindy Meads – President and Chief Merchandising Officer

Michael Cunningham – Executive Vice President and Chief Financial Officer

Tom Johnson – Executive Vice President and Chief Operating Officer

Analysts

Betty Chen - Wedbush Morgan Securities Inc.

Christine Chen - Needham & Company, LLC

Laura Champine - Cowen and Company

Brian Tunick - J.P. Morgan

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Jeffrey Klinefelter - Piper Jaffray

Roxanne Meyer - Oppenheimer & Co.

Michelle Clark - Morgan Stanley

Kimberly Greenberger - Citigroup

Marnie Shapiro - The Retail Tracker

Janet Kloppenburg - JJK Research

Dana Telsey - Telsey Advisory Group

Linda Tsai - MKM Partners

Howard Tubin - RBC Capital Markets

Operator

Thank you for joining us for the Aeropostale conference call to review third quarter fiscal 2008 financial results. (Operator Instructions)

I would now like to introduce Ken Ohashi, the company's Vice President of Investor and Media Relations.

Kenneth Ohashi

Thank you all for joining us this afternoon. With me here today are Julian Geiger, our Chairman and Chief Executive Officer, Mindy Meads, our President and Chief Merchandising Officer, Tom Johnson, our Chief Operating Officer, and Michael Cunningham, our Chief Financial Officer.

We issued a press release earlier this afternoon announcing our third quarter financial results. A copy of the release can be found on our corporate website.

Before we begin, I'd 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 financial 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 Julian, I would like to ask everyone to limit themselves to one question during our Q&A session.

I would now like to turn the call over to Julian.

Julian Geiger

Thanks, Ken. Good afternoon, everyone, and thank you for joining us today.

As I'm sure you have already heard, earlier today we announced that Aeropostale achieved record-breaking sales and profits for the third quarter. This performance is impressive in and of itself, but when put into perspective against the uniquely challenging economic panorama with which we are faced, it is extraordinary.

Throughout this entire year we have experienced unparalleled success. I must openly how the determination and talent of our entire organization, the clarity of our strategies, the precision of our execution, and the nimbleness of our operating model have enabled us to elevate respect for the Aeropostale brand to an all-time high.

I would like to highlight some of the statistical accomplishments of the quarter for you. Net sales for the period increased 17% to $482 million and same-store sales increased 7%. Gross profit grew by 110 basis points while operating margins improved by 60 basis points. Net earnings per share grew 31% to $0.63 per share this year from $0.48 per share last year. In addition, we continue to maintain a strong balance sheet with absolutely no debt.

As we have previously discussed, we have implemented a number of strategic initiatives and have made some systemic changes to our business over the past few years that have enabled us to navigate through this currently challenging environment and generate consistently strong results.

Specifically, we have placed greater emphasis on giving the customer a more balanced merchandise assortment that is both fresh and focused; offering new and changing promotions to create excitement in our stores and to spur demand for our product; managing inventory carefully and maximizing efficiencies in product flow by making investments in people, process and systems, and creating a fun and exciting shopping environment through our new store design and innovative marketing programs. In aggregate, these initiatives have enabled us to achieve impressive brand momentum and capture significant market share.

As we look at our accomplishments in the first nine months, we are even more gratified given the unprecedented challenges everyone has encountered in the retail sector. By design, we have a nimble and responsive business model that enables us to adapt quickly to change. We have also been and will continue to be pragmatic in running our business. We will leverage our speed and agility and stay ahead of a rapidly changing environment.

Moving into our third decade, the Aeropostale brand has become an important shopping destination for its customer. As we emerge from these challenging times, we believe that Aeropostale will be even stronger and better positioned than it is even today.

Now I'd like to turn the call over to Mindy, who will take you through some of the merchandising highlights from the third quarter and discuss our performance during the start of the holiday season.

Mindy Meads

Thank you, Julian. I, too, would like to reiterate how pleased I am with our record results for both the third quarter and year-to-date. The entire product development team has done an excellent job, not just knowing our customer but also executing our merchandising strategies.

We continue to offer the customer the best combination of fashion and value in a highly promotional environment. For the quarter we experienced strength in both genders. The women's comp was up mid single digits and men's were up in the low double digits. We're very pleased with the trend in both our merchandise margins and average unit retail. These increases were driven by an overall improvement in merchandise offerings to the integration of fashion, more fashion, the emphasis in trending key classification, and the reduction in SKU counts by 30%.

Moving into holiday, which is more top driven than back-to-school, graphics, fleece and thermals will remain our key drivers. The design and merchant teams have integrated the most current treatments and textures into our tops while improving the quality of the garment. We also continue to experience significant strength in our logo business, further underscoring the vitality of the Aeropostale brand.

Our comps for Black Friday increased in the low single digits on top of the high single digits last year. Trends since then have been somewhat inconsistent. We believe that this holiday season will be highly promotional and we are ready for that environment. We will be offering compelling promotions each week that convey exceptional value to our customer. We will be aligning these promotions with our ecommerce business, which has been producing tremendous results. We have specifically targeted the cross-channel shopper, making the Aeropostale brand easily accessible to them.

Gift cards are also an important part of the gift-giving season. This year we've increased the number of locations where we sell our cards through our third-party channel. This should be a nice addition to our holiday business.

Our inventories at the end of the quarter remain lean and current. We closed the third quarter with inventories on a per square foot basis down 3%. Going into next year, we will continue to maximize the flexibility with our vendors by building even stronger contingency strategies, which will allow us to react to the business faster and smarter as we move into next year.

In any economic environment, the customer will always respond to the right merchandise for the right price, and our entire team is focused on continuing to build on our successes and brand momentum.

Now I'd like to turn the call over to Michael, who will take you through the financials.

Michael Cunningham

Thanks, Mindy.

Total net sales for the quarter are up 17% versus last year, driven by an 11% increase in average square footage coupled with the 7% comp.

We opened 26 stores during the quarter, ending with a total of 863 Aero stores in the U.S. and Puerto Rico, 28 Aero stores in Canada, and 14 Jimmy'Z stores.

Gross margins for the quarter were 36% versus 34.9% last year. The 110 basis point increase was driven by higher merchandise margins.

SG&A for the quarter was 21.4% of sales versus 20.9% last year. This 50 basis point increase was driven by higher incentive comp expense of 60 basis points, higher share-based comp expense of 30 basis points, and increased ecom fees of 20 basis points reflecting sales growth in that business. These increases were partially offset by the 60 basis points of leverage of store line and other corporate expenses.

Our tax rate for the quarter was 39.6%, which resulted in net income of $42.6 million or $0.63 per share.

Cash and cash equivalents, together with short-term investments at the close of the quarter, were $107.2 million versus $122.6 million last year. The $15 million reduction over last year is primarily due to the $125 million in share repurchase activity during the fourth quarter of 2007. As a reminder, we have no auction rate securities in our portfolio and remain very liquid, with short-term U.S. Treasury investments.

During the quarter we repurchased 115,000 shares of our stock for approximately $3.8 million. At quarter end we had approximately $127 million of remaining buyback availability.

Inventory at the close of the quarter was $206.9 million, up 8% in total but down 3% per square foot.

Our CapEx for the quarter was $25.8 million, with depreciation and amortization of $10.7 million. We expect full year CapEx of approximately $80 million. As you may have seen in our release today, we are projecting CapEx of approximately $55 million for 2009.

Our fourth quarter EPS guidance of $0.84 to $0.90 is a broader range than we have typically issued for past quarters. This increased range reflects the difficulty of forecasting in an environment of significant economic uncertainty.

I will now turn the call back to Julian for some closing comments.

Julian Geiger

Thanks, Michael.

As you know, with Thanksgiving and Black Friday behind us, we are in the midst of the holiday season. We believe that all of the initiatives and approaches that made us so successful during the first nine months of the year will continue to help us maximize our performance during the fourth quarter.

I have tremendous confidence in our organization, in our brand, in our merchandise, and in our promotional operating model. Every reseller, however, must be respectful of the realities of the global economic situation.

As we progress to the end of this fiscal year and into the next, every one at Aeropostale will be focused on capitalizing on the many opportunities that we have. We will be doing so in a carefully conceived, clearly communicated fashion, while confident we remain controlled. We will remain committed to understanding our customer and to giving great clothes at great prices.

We will continue to strengthen our brand domestically and gain market share. We will be deliberate and measured in our approach to both the growth of our Jimmy'Z brand and the introduction of a third concept. We will open Aeropostale stores in Dubai early this spring as an initial phase of what we envision as a significant long-term international opportunity.

We will, I believe, continue to build upon a great American success story. This should be our 11th consecutive year of positive same-store sales, a feat never before accomplished in the teen specialty business. We will, I know, continue to be committed to the ideals and culture that differentiate us from our competitors.

I what to thank every member of the Aeropostale family for caring so consistently, for working so hard, and for achieving so much. I wish our entire Aero family and all of you on this call today a healthy and happy holiday and a new year of peace, promise and prosperity.

And with that, Operator, we are ready to open the lines for any questions that might exist.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Betty Chen - Wedbush Morgan Securities Inc.

Betty Chen - Wedbush Morgan Securities Inc.

I was wondering if you can maybe speak a little bit about the learnings you may have from Black Friday and how they may change or alter your approach for the balance of the holiday season as well as early 2009?

Mindy Meads

As I mentioned, the strength in the product that we experienced was our graphic business, which is not just the T-shirts but some of the [Level 2s], some of the thermals, and then also many of the graphics that we've had on our fleece. That really was the driver that we had for Black Friday. One new business that has come alive and had been more difficult is our dorm business, and that's where we really added more graphics that we got great response from the customer on.

As far as moving into next year and what trends, we really don't want to give that kind of information out for the obvious competitive reasons. And as we move to the first of the year, we'll give more information at that point.

Betty Chen - Wedbush Morgan Securities Inc.

Any comments you can add maybe in regard to pricing or promotions?

Mindy Meads

At this point we are continuing to try a variety of promotions. As you know, we are a promotional brand and this is what we do every day. And so as you go through the next couple of weeks, you're going to see a lot of new and different promotions that the customer is definitely responding to.

Betty Chen - Wedbush Morgan Securities Inc.

And will this have an - obviously inventory was very clean at the end of the quarter; should we expect that again by the end of the holiday season and are you kind of thinking about some of these holiday trends and factoring them in your spring merchandise buys?

Michael Cunningham

We don't give [inaudible] inventory guidance, so I'll let Mindy answer the other part of the question.

Mindy Meads

As we move into spring, we are going to be conservative on our inventory levels. We think that is prudent and, as I mentioned, to get more strategic with how we do contingencies, how we place our product so that we can take advantage of opportunities as they go up and, in some cases, depending upon the economic conditions, we can bring inventories down.

Operator

Your next question comes from Christine Chen - Needham & Company, LLC.

Christine Chen - Needham & Company, LLC

I wanted to ask, I guess, looking forward, where do you see some of the margin expansion opportunities? We're starting to hear that sourcing costs might actually be coming down in this environment. Are you seeing that? How does that affect how you're working with your vendors?

Mindy Meads

As we mentioned, I think, on the last call, our spring costs have come down. And there was talk six months ago how they were going to go up; we do not see that happening. We have not placed fall yet. We do anticipate having opportunities on the cost side, and we'll give you more as we go forward.

It really is an opportunity for us to look at each category and see if we want to make any adjustments to quality. Where we've put quality improvements in we have had a tremendous response from the customer. So it'll give us an opportunity to do more of that or be competitive on prices if need be.

Christine Chen - Needham & Company, LLC

And then does it also help your speed to market given that you're growing still when some of your competitors might be shrinking?

Mindy Meads

I really don't think that has any impact on the speed. There's other things that we'll do and strategies in how we place to get the speed to market. We're really getting better and better at that. We've done a lot of things this year, and we'll even do more as we move into next year.

Operator

(Operator Instructions) Your next question comes from Laura Champine - Cowen and Company.

Laura Champine - Cowen and Company

Julian, this one's a pretty basic one but I think it's what's on everyone's mind. How do you handicap Aeropostale's chances at putting up your 12th consecutive year of positive same-store sales next year?

And then, I guess, as a follow on, that new CapEx number for next year is lower than what we would have expected. What's the store growth implied inside that CapEx assumption?

Julian Geiger

Well, this may come as a shock to you, but I'm a pretty good handicapper. I happen to be in Las Vegas, removed from the rest of the team right now - no. The 11 years of consecutive comp store increases are terrific. We are really focused well on the holiday selling season. We believe that our model, our brand, and our core competencies are extraordinary. We have the best partnerships with vendors of all of our competitors. I would never bet against the Aeropostale organization in doing anything. We understand how strong the headwinds are, but we have a very well-fueled jet here that we think can go through the turbulence and do well.

So we're not going to give you a prediction of comps in 2009, but this organization  for whom I have such enormous respect - has never failed in the past and I don't see them failing in the future.

Michael Cunningham

With regard to the CapEx, we're not going to break out the specific store component, but you can assume the same percent as this year and use the percentage reduction as a proxy.

Operator

Your next question comes from Brian Tunick - J.P. Morgan.

Brian Tunick - J.P. Morgan

I guess this sort of ties in here. You've grown SG&A faster than sales for almost three years now and I guess as we go into 2009, I guess you're still spending on the new kid's concept. Are there opportunities besides incentive comp to control your costs and could they only be up single digits in dollars next year?

And then your comp leverage point also seems to be moving higher. Mike, did you say on a 7% comp you had no occupancy leverage?

Michael Cunningham

We didn't discuss occupancy, but with regard to SG&A for the fourth quarter, based upon the scenarios that are in our guidance, we expect our SG&A basically to be flat as a percent of sales year-over-year. And again, we talk about incentive comp every quarter for the last couple of quarters, and it's been the biggest driver or one of the biggest drivers of our SG&A as a percent of sales increase. That reflects the meritocracy that we have here at Aeropostale. The nimbleness of our formula enables us to basically drive the bottom line, improve the margins, despite the mix between gross margin and SG&A.

Looking forward, we're not providing any guidance at all with regard to 2009. I think, obviously, we need to get through the holiday selling season and recap the fourth quarter, but bear in mind we, like every other retailer out there, is looking at expenses, making the appropriate cuts. Brian, you know more than anybody - you've come to our offices, you've seen how lean we are - but nonetheless there are some discretionary expenses which we will pare back on.

But we will protect the integrity of the [third] concept and we will invest in it next year. And that will be somewhat of a drag, but actually a worthwhile investment for the long-term growth of Aeropostale.

Brian Tunick - J.P. Morgan

And finally, did you guys say how much Jimmy'Z was a drag on earnings?

Michael Cunningham

Jimmy'Z, no we didn't, but Jimmy'Z was about a $0.02 negative impact in Q3.

Brian Tunick - J.P. Morgan

And how is that relative to your expectations?

Michael Cunningham

As Julian mentioned, sales in [inaudible] improved. Jimmy'Z is so small, the numbers don't move much, but it did see relative performance improvement.

Operator

Your next question comes from Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

My question is on gift cards. We've heard a lot about gift cards. I think the industry trade groups are saying they were down about 10% over the Black Friday, so can you talk to us about your gift cards and what you're seeing in trends thus far in the season?

Michael Cunningham

Sure. Well, year-to-date, I believe we had mentioned that we significantly increased the gift card distribution channel through Blackhawk which - if you know who they are.

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

Yes.

Michael Cunningham

And because of that, year-to-date our gift card dollar sales are up nearly 40%. So we expect that to be a tremendous benefit to us, especially the week after Christmas when all the kids are coming back in to redeem those gift cards.

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

How much of that is coming through Blackhawk and how much through the stores?

Michael Cunningham

Oh, we're not going to break that out.

Adrienne Tennant - Friedman, Billings, Ramsey & Co.

And then could you just give us the full year Jimmy'Z impact?

Michael Cunningham

The full year would be about $0.07 to $0.08.

Operator

Your next question comes from Jeffrey Klinefelter - Piper Jaffray.

Jeffrey Klinefelter - Piper Jaffray

My question would be on your Q4 guidance, obviously the below [inaudible] level would suggest  would mention deleveraging against occupancy with lower volumes, and I think someone earlier was trying to get to is there any change in promotional cadence or plans as a result of the environment. Would you say this is just a slightly lower volume and it's the deleveraging effect of that and that's basically the difference in that guidance versus where most people had been on the Street or is there something else going on in the fourth quarter?

Michael Cunningham

Well, I think obviously being down anywhere from 3% to 10%, which is what our guidance assumes, is probably one of the better performances of any retail's guidance that I've seen so far, so that's one point to consider.

The second is there are so many different scenarios we have between margins, gross margins and sales comp, that there is a variety of permutations that are built up into our formula. And again, Jeff, as you know, the holiday season is always backend loaded and for the last [inaudible] years I've been here, it's been more back loaded every year, particularly as people wait to the end and as gift cards become a bigger and more important factor in sales redemption.

So that end of season selling rush is going to be something that we'll wait and see and consider, and that's why we have such a wide range of assumptions in the guidance.

Jeffrey Klinefelter - Piper Jaffray

Given the current environment with leasing rates coming down, from what we're hearing from others, any changes with respect to your perspective on the overall size of the chain or the potential for you to go back and get involved in some lease renewals as more favorable rates?

Tom Johnson

Sure, Jeff. As you know, as we've mentioned a few times during the course of the year, we've had some advantageous opportunities with the C centers that's starting to happen in the A and the B.

With regard to our total growth, we still feel confident with the 900 to 1,000 stores domestically, with 80 to 100 in the country of Canada as well. So we still see quite a bit of growth happening.

The speed in which we do that and how we navigate the next 12 to 24 months will truly depend on the opportunities that we have in front of us, so we think that it's prudent to take a cautious view with regard to the Aero growth as navigate 2009, but certainly taking advantage of any opportunity that we can with the current real estate environment with the landlords.

Operator

Your next question comes from Roxanne Meyer - Oppenheimer & Co.

Roxanne Meyer - Oppenheimer & Co.

I guess I just want to understand a little bit some of the metrics you saw in November. I guess I'm wondering, in terms of your confidence just in terms of your expectations going forward and how consumers are going to behave, are you seeing a pullback in the number of units as customers are looking towards their budgets or can you provide some, I guess, qualitative anecdotal descriptions of what's going on with your consumer and what you're seeing out there?

Michael Cunningham

Well, I think UPT has been, you know, relatively flat with the prior quarter. The month of November was flat generally with Q3 and similar to Q2. So I don't think there was a real change in UPT. I think the transactions, which is obviously mall traffic driven, is really where we've seen the drop off.

Roxanne Meyer - Oppenheimer & Co.

And then just thinking about - you mentioned in your release that the Thanksgiving shift had a negative 5%, about a 5%, impact. I'm wondering how you see the calendar in December versus last year and just how you think about the fact that December comps are a lot tougher than they were in November. I know you don't want to necessarily break out too much guidance, but any kind of general thoughts that you can share would be great.

Michael Cunningham

Well, I think you're right. We did say it was about a 5 - mid-single-digit impact - and I think that, to us, was one of the tougher anniversaries to roll through. We have one less, you know, post-Thanksgiving week in November. As we look at December, obviously, it really depends upon traffic trends, so not really much more color we can disclose there for you.

Operator

Your next question comes from Michelle Clark - Morgan Stanley.

Michelle Clark - Morgan Stanley

We've seen American Eagle as of late take down price points and obviously get more promotional. Any discernable negative impact to your business from that?

And then the second question is obviously strong gross margin performance this year. You'll end at peak gross margins. Michael, I was hoping that you can just walk us through what you see as the longer-term gross margin opportunity, what the key levers are there.

Julian Geiger

To talk about the competitive situation, for any of you who may have been in the mall on Black Friday, I don't know how we could have fit any more customers into our stores. So whatever other people are doing, there still was an avalanche of people into our stores, and I think that we were maxed out.

So we think that the customer sees product first and value second, and we think that our product offering and our merchandise mix is clearly the best we've ever had and superior to what we see others having in the marketplace. So we're confident, then, where we are. We feel at this point, with the 14 to 17-year-old customer, we're the brand of choice.

The second half was more for Michael, I think, the question.

Michael Cunningham

Sure, Michelle. With regards to margins, I mean, obviously 2009 is a big unknown. I think any goal we talk about longer term has to be post the economic downturn that we're currently in. So we would stick to previously issued comments regarding our operating margin goals of midteens and we believe, again, on a longer-term perspective we should be able to get there post the downturn.

And the makeup of that is primarily going to be driven by the top line growth. As we get continued improvements in merchandise margins and sourcing and, more importantly, the investments we've been making over the last few years within our planning allocation and supply chain [inaudible] systems, that should help us get additional sales and margin benefit going forward.

Operator

Your next question comes from Kimberly Greenberger - Citigroup.

Kimberly Greenberger - Citigroup

I just wanted to confirm you said that your fourth quarter earnings guidance contemplates a comp range in the fourth quarter of down 3% to down 10%. Is that correct?

Michael Cunningham

No. That down 3% to down 10% was our EPS guidance range compared to last year's $0.93 EPS.

Kimberly Greenberger - Citigroup

Okay, Michael, could you just talk about the range of sales that's sort of contemplated within that range of earnings guidance?

Michael Cunningham

Now, Kimberly, as you know, we typically don't give forward-looking sales guidance. As I said, there's a permutation of different ranges. Obviously, it's a trade-off between sales and margin, so we prefer not to give it on this call.

Kimberly Greenberger - Citigroup

In terms of your $55 million CapEx guidance for next year, can you just tell us what number of new stores does it include in that number?

And then secondarily, Michael, if you could just break out for us the improvement in merchandise margin versus occupancy leverage in the gross margin line, that would be really helpful.

Michael Cunningham

Well, we're not providing further details. As you know, we typically provide CapEx projections on our fourth quarter call, and that's the call where we'll break out the new store openings by concept as well as the renovations. So for right now, we just wanted to communicate to the Street and to investors that we are contemplating a reduction in our overall planned capital expenditures at this point.

With regards to the components of gross margin, the increase is primarily from the merchandise margin. We did not leverage occupancy, and that's primarily a function of our calendarization of percentage rents for the third quarter and we don't expect that to have an adverse impact on our fourth quarter rent as a percent of sales.

Operator

Your next question comes from Marnie Shapiro - The Retail Tracker.

Marnie Shapiro - The Retail Tracker

I just have two quick questions, real estate related. The first is just housekeeping, if you could just tell us how many stores you still have left to open for the rest of this year.

And then if you could talk a little bit, did the trends differ at all between A center versus B or C, street, lifestyle and a little bit on your outlets? I'm just curious what that was like.

Michael Cunningham

Sure. We have no additional stores to open post November.

Julian Geiger

We opened up a few in November, but no left after this.

Marnie Shapiro - The Retail Tracker

Any to close at year end?

Jonathon M. Singer

Sorry, any closed?

Marnie Shapiro - The Retail Tracker

Yes.

Jonathon M. Singer

No. No, we're not closing any stores.

And what was your second follow up, Marnie? I'm sorry.

Marnie Shapiro - The Retail Tracker

Just trends between A, B and C centers, street, lifestyle, outlets. You have a lot of different places your stores operate.

Julian Geiger

Sure. The trend for us really year-to-date, the spread between A and C is about 2 points. The A doors are tracking a little bit better than the C doors. The outlets continue to outperform in the range of mid single digits to the rest of the chain, so clearly we see opportunities continue to grow in the outlet venues. But overall, the good news is within A, B, and C the range is fairly narrow.

Marnie Shapiro - The Retail Tracker

And your outlets are really your full-price stores, though, essentially, in the outlet center?

Jonathon M. Singer

Essentially, with the exception of a handful of those stores being consolidation venues where we might bring in some markdowns.

Operator

Your next question comes from Janet Kloppenburg - JJK Research.

Janet Kloppenburg - JJK Research

Ken's been teaching us all year about your gross margin opportunities and they've certainly existed and we appreciate them coming through. I'm wondering if you could just talk about in light of the environment if we should continue to expect that or, as I think Michael just said, you guys always draw a balance between sales and margin?

And with respect to that as well, to sales, I'm wondering, you know, we don't know how bad this could get. The environment's very challenging. We don't know if December and February, March, will be worse than it is now, if it'll stabilize, and in light of that uncertainty I'm wondering is there room for expense control? Are there levers that can be pulled that would allow you to bring your SG&A line down in line with perhaps with a sales trend that was below your original expectations?

And then I have another question about CapEx.

Michael Cunningham

Sure. Well, again, as we relate to the Q4 guidance, the incentive comp is not going to be a driver of any increase. As a matter of fact, last year, as you recall, we had a significant accrual in the fourth quarter because our performance in Q4 was substantially higher than the beginning part of the year.

Janet Kloppenburg - JJK Research

So incentive comp will be down in the quarter, Mike?

Michael Cunningham

Incentive comp will be down under any scenario in absolute dollars and more so as a percent of sales.

Janet Kloppenburg - JJK Research

And is that because you're anniversarying last year's big uptick?

Michael Cunningham

It's basically last year, the strong performance in Q4 relative to the first three quarters, this year we've had record results in the first three quarters and obviously have a less robust guidance for Q4.

Janet Kloppenburg - JJK Research

And if the first three quarters of next year are challenging, then we may see the same trend? There was a big tick up in incentive comp this year in Q1 through Q3.

Michael Cunningham

Yes. It's been a - it was a 30 basis point increase to sales in Q1. It was an 80 basis point increase in sales in Q2 [and] 60 for Q3. So obviously, depending upon 2009, that may not be a driver.

So to your point, yes, there are many levers of expenses which we've already started to put in place throughout the organization. I think I mentioned on earlier calls last year we restructured our stock compensation expense, which is a fixed expense regardless of performance. We reduced that component and we built it more into the pay-for-performance metric, so that helps us in terms of giving us flexibility depending upon performance. And there are additional, obviously, discretionary type expenses that we will always be looking at and ready to adjust downward as business changes.

Janet Kloppenburg - JJK Research

And with respect to CapEx, for modeling purposes it would be fair to say that we should be using a lower level of square footage expansion in our fiscal 2009 models than what we experienced in '08. Is that a fair statement?

Michael Cunningham

Absolutely a fair statement, yes.

Janet Kloppenburg - JJK Research

And then just lastly for Mindy on the inventory front, you did a really good job. I guess the comp inventory's down about 3%. My guess is that maybe October sales were not as good as you might have envisioned because of what's happened in the environment and the consumer spending picture, so I'm wondering if you were able to work on your fourth quarter inventory levels, Mindy, or if you felt in October that they were comfortable even in light of sales maybe coming in a little light to expectation?

Mindy Meads

Frankly, we were very comfortable how we ended third quarter. It was very much the way we projected it and kind of comfortable coming in, very clean coming into holiday.

Janet Kloppenburg - JJK Research

So you feel good that you'll be clean coming out?

Mindy Meads

Yes.

Julian Geiger

I just wanted to give you a little bit more color. You know us as well as anybody. You know us from a statistical performance and on an emotional level also.

Janet Kloppenburg - JJK Research

Very much so, yes.

Julian Geiger

I think you know - and it's fair to reiterate to the rest of the people on the call - the determination and understanding of this organization to do what is necessary.

The success of Aeropostale over the last 10 or 12 years has been based on a really wonderful pragmatic approach. We've never been doctrinaire nor have we ever been expedient. We do what it takes to make money. And if things were to get worse in the next year, we are fully prepared to take the steps necessary to conserve both our capital and to maximize our profits.

And I think one of the reasons we have had 11 straight or will have 11 straight years of positive comps is that we do what it takes, and that's something that brings us great satisfaction and pride.

Janet Kloppenburg - JJK Research

Well, I totally agree with that. And you certainly have the caliber of product to help you along. I think the product looks fantastic and I think you'll be highly competitive going forward.

Julian Geiger

So do we. Thanks, Janet.

Operator

Your next question comes from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Tax rate, how do you see the tax rate going forward given that it was a little different than expected this third quarter?

And as you think about the environment out there and given your competitive price positioning, how are you thinking about any pricing adjustments for '09? Do you see your pricing at all changing in this environment?

And also on veneer, just veneer in basics and core, any thoughts in terms of any shifts there, both in terms of percentage of the mix and pricing?

Michael Cunningham

Dana, with regard to tax rate, the 39.6% is a rate similar to what we've been experiencing. It's down a little bit. I would assume probably that same rate for Q4 and then going forward for next year. We're obviously vigorously chasing any tax savings we can get and we would try to take advantage of those, but I would model out the 39.6% for now on.

Mindy Meads

And Dana, on the pricing, I'm very comfortable the balance we have between our core fashion and veneer. That strategy will continue going forward. It is a tiered situation and when we have the best product we are not having problem at all with the pricing, so I consider doing exactly as we're doing. I think that it will be relatively flat based on the economy going forward, but I think over time then we'll be able to raise it up a bit. So no changes.

Operator

Your next question comes from Linda Tsai - MKM Partners.

Linda Tsai - MKM Partners

Are you seeing any surprises as you move through the holiday season, either positively or negatively, beyond what you've already discussed?

Julian Geiger

We're literally days into the holiday season. I think we are not surprised by anything that we see. We think we have contingencies in place to woo the customers into our stores as we go on. We love the merchandise, we love the shopping environment, so no, we don't see any unusual surprises, but do think we're ready to meet any contingency as it comes up.

Linda Tsai - MKM Partners

And so when you talk about contingencies, is that kind of relating to your marketing programs?

Julian Geiger

Potentially. We have a variety of weapons in our promotional arsenal. And we always assess when we pull what triggers on a certain promotion, and that's one of the reasons we're able to be so fast and so nimble. And we're looking forward to the rest of the holiday season.

Linda Tsai - MKM Partners

And then just as it pertains to your customer mix, are you seeing any evidence of casting a wider net, maybe attracting a younger or older customer?

Tom Johnson

We are an equal opportunity seller and we are seeing a wider range of customers, both younger and older in the store in addition to our target customer.

Linda Tsai - MKM Partners

So you think this is kind of a change since last year or just over the course of this year?

Tom Johnson

It's a marginal change in degree, not in direction.

Linda Tsai - MKM Partners

And then would it be more skewed towards male or female?

Tom Johnson

There's no evidence to indicate any change on a gender basis.

Linda Tsai - MKM Partners

And then could you just give us a little more detail on any IT initiatives that might help drive efficiencies next year?

Michael Cunningham

The IT initiatives that Tom has talked about previously are what we expect to help with the allocation system. We have a couple different phases of it going in, so that's going to be - that's our biggest supply chain investment that we're going to see come to fruition in the near term.

I think we need to move on to another questioner?

Kenneth Ohashi

Operator, I think we have time for one more question.

Operator

(Operator Instructions) Your last question comes from Howard Tubin - RBC Capital Markets.

Howard Tubin - RBC Capital Markets

Just one question on performance of the new stores - how are new stores performing and are you still getting a good response to the new store prototype?

Tom Johnson

Sure, Howard, absolutely. We're very pleased with obviously the brand presentation and the store environment overall. With the market research that we've gotten - you know, soft information - back, the customers love it. In addition, the stores are performing at mid single digits above the chain average, so we're very pleased so far.

Julian Geiger

All right. At this point I guess we would like to thank all of you for your interest and your time and your continued support. We wish you a very, very happy holiday. We look forward to speaking to you next year with the results of the fourth quarter. Thanks.

Operator

This does conclude today's conference. We thank you for your participation. Have a wonderful day.

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Source: Aeropostale, Inc. F3Q08 (Qtr End 11/1/08) Earnings Call Transcript
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