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Executives

Judy Meehan - Vice President of Investor Relations

Jim O’Donnell - Chief Executive Officer

Joan Hilson - Executive Vice President, Chief Financial Officer

Analysts

Michelle Tan – Goldman Sachs

Adrienne Tennant – FBR

Betty Chen – Wedbush

Jeff Klinefelter – Piper Jaffray

Dorothy Lakner – Caris & Company

Stacy Pak – SP Research

Christine Chen – Needham & Company

Todd Slater – Lazard Capital

Jeff Black – Barclays Capital

Jennifer Black – Jennifer Black & Associates

Kimberly Greenberger – Citigroup

Lorraine Hutchison – Bank of America

American Eagle Outfitters (AEO) Q2 2009 Earnings Call August 27, 2009 9:00 AM ET

Operator

(Operator Instructions) Welcome to the American Eagle Outfitters Second Quarter 2009 Earnings Conference Call. It is now my pleasure to introduce your host, Judy Meehan, Vice President of Investor Relations.

Judy Meehan

Joining me today are Jim O’Donnell, Chief Executive Officer and Joan Hilson, Executive Vice President, Chief Financial Officer. If you need a copy of our second quarter press release, it is available on our website, AE.com.

Before we begin, I need to remind everyone that during this conference call, members of management 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 would like to turn the call over to Jim.

Jim O’Donnell

Today I’ll start by saying that American Eagle Outfitters is making steady progress in a number of areas across the business. However, we continue to face challenges which led to disappointing second quarter financial results. Total sales declined 5% and comparable store sales were down 10%. We also continued to experience margin pressure, leading to a 48% decline in operating earnings.

Clearly consumers were extremely cautious with regard to spending. However, as I indicated last quarter we’re seeing signs of stabilization. The businesses continued to hold steady with conversion rates trending slightly better then last quarter.

Within the AE brand we’re seeing marked improvement in important areas. For example, denim, throughout 2008 women’s denim was comping negatively in the high teens. Today we are reporting our second consecutive quarter of positive denim comps. Earlier this year we went back to the drawing board and redesigned this critical category and have seen a tremendous response from our customers. We improved fit, fabric, quality and we added details while keeping our value pricing the same.

The success we’ve had with denim demonstrates that when our product is right and on trend the AE brand is a strong and relevant as ever. Our teams have been working to take this same approach to other important categories within our business.

Moving on to AE women’s, comps have improved from negative high teens in 2008 to negative low double digits so far this year. In addition to denim, we’ve seen strong performance in dresses, woven shirts, and accessories. A clear win for us this spring was the powerful statement we made in dresses and feminine accessories. Within these businesses we were differentiated in the marketplace. We will continue to clearly stand behind fashion trends with more powerful in store presentations. We believe we’re on track to see additional progress in women’s as we move through fall and into holiday.

Brand building and customer connection, the strength of the AE brand is one of its most powerful assets. We have reinvigorated our marketing efforts to build on this trend and to cultivate customer loyalty. For example, this fall we are launching grass roots brand building programs on major college campuses across the country. This includes on campus AE brand ambassadors and sponsorships of various student activities. Additionally, we are strategically employing a larger scale advertising initiatives where appropriate. Our current art is jean campaign is a good example, which includes high impact outdoor and mall advertising as well as a social media outreach on sites such as Twitter and Facebook.

While we’re encouraged by our forward strides there are areas of business where more work is needed. Most important is our overall drive for top line growth across all categories in this brand. Today’s AE customer expects us to be faster to trend and offer greater variety at more compelling prices. We are strengthening how we approach fashion and trends and pricing and the flow of products.

Women’s knit tops remain our biggest opportunity. Quite frankly this has been an underperforming category far too long. Roger Markfield has been highly focused here working closely with the merchandising and design teams. We also recently hired new talent design to support this area. We will look forward to the results, which we expect to see later this year and into the spring season.

Overall we were pleased with the performance of our new concepts. In the second quarter Martin + Osa delivered a positive 10% comp and strengthened its bottom line. The assortments are showing continued improvement with a distinct point of view, anchored by key categories such as denim and cashmere. aerie stand alone store compositely at 30%. Customer awareness and loyalty to this brand is strong and growing. Our research shows that passionate following and a personal connection to this brand among young women. This is evidenced in the success of AE list loyalty program which is extremely popular and approaching one million members in less than one year.

77Kids is performing consistent with our expectation. The brand launched its first ever back to school collection in July with all the new assortments of denim. Around the collection there was uniquely designed graphic t-shirts and hoodies along with fashion outerwear. Additionally, 77Kids has a targeted print and online advertising campaign to build awareness for traffic and sales and this crucial back half of the year. We’re still targeting mid 2010 for our retail stores.

AE direct remains a consistent bright spot for the company and is performing well across all brands. Sales increased 17% driven by higher traffic. The direct team recently launched new innovative features on AE.com including product reviews for denim, an AE blog and a customized online outfitting tool. These features are designed to create interactive elevated shopping experiences.

This month we opened our highly anticipated newly designed Garden State Plaza store. The store features new design elements and innovative product displays. Initial customer feedback has been overwhelmingly positive. In November we look forward to opening our new flagship store in Times Square.

As we look ahead to the holiday season and beyond we are optimistic about delivering steady improvements throughout our entire business, across each brand. We maintain our relentless focus on strengthening our organization with key talent and streamlined processes as well as connections to our customers.

In parallel, operating efficiency and financial discipline remain the governing principals of our business. As evidence to the financial stability of the company American Eagle Outfitters ended the second quarter with $500 million in liquid cash.

In summary, our priority is clear. Improve overall assortments across all brands to drive top line sales with a focus and urgency on AE women’s.

Now I’ll turn the call over to Joan who will review the financials in more detail.

Joan Hilson

The second quarter operating earnings decrease of 48% was due to an overall decline in sales. Our operating costs did not leverage on a 10% drop in comparable store sales. This, combined with increased promotional activity pressured profit margins. Clearly business was challenging yet sales metrics point to a stabilizing trend which began in the first quarter. For example, our conversion rate was down to last year, however, the rate of decline improved from the first quarter.

Store traffic held at a mid single digit decline similar to the first quarter trend. As we navigate through choppy store traffic patterns, customers are responding positively to our value pricing and fashion offerings. We can see this through an increase in units per transaction and units sold per average store which also showed improvement. Looking forward, the opportunity is to drive transactions and transaction value higher, both of which declined in the second quarter.

Overall gross margin fell 420 basis points compared to last year. Our merchandise margin decreased 190 basis points. This mainly reflected higher markdowns taken on spring and summer merchandise during our annual June clearance event. We also experienced higher promotional costs. In addition, rent increased a percent to sales due to new store growth as well as the 10% comp decline.

For the quarter, SG&A expense decreased $700,000. However, it increased 100 basis points as a rate to sales. We continue to experience savings in discretionary spending areas such as advertising, travel, and services purchase. Through operational efficiencies in the store SG&A per foot declined 7% to the lowest second quarter rate in five years.

As we said previously we will continue to evaluate our expenses quarter by quarter and balance expense savings with critical business investments to drive top line sales and ROI. At this time we expect annual SG&A dollars to be down in the low single digits compared to last year.

Other expense of $4.1 million including a non-operating, non-cash foreign currency loss in connection with the repatriation of Canadian earnings. In addition, investment income declined as a result of significantly lower investment rate.

Now turning to the balance sheet. Consistent with our second quarter inventory, excluding the direct business decreased 5% at cost per square foot. Overall inventory is current and within the AE brand clearance inventory was down 18% per foot at quarter end. Based on positive early selling inventory reflects and increase investment in AE denim for key back to school selling periods.

Overall for the third quarter our average weekly inventories for the AE brand are planned down in the high single digits. For aerie inventory is planned to increase driven by expansion of the assortment which is critical to the growth of this brand. As a result, consolidated third quarter inventory per square foot is planned down in the low single digits.

In keeping with our reduced spending plan this year capital expenditures in the second quarter were $38 million compared to $84 million last year. For the year we expect capital spending to be in the range of $110 to $135 million. Looking forward we are highly focused on strengthening our operating profit. To that end we must see an improvement in sales and recover from double digit negative comps. Inventories are well controlled and distorted to performing categories such as denim. We expect lower product costs to modestly benefit the merchandise margin as we also pass savings on to customers through lower pricing. Expense controls remain a critical priority.

Now regarding the third quarter. Based on current view of sales trends we expect third quarter earnings per share to be in the range of $0.22 to $0.25. This guidance reflects a tax benefit of approximately $0.05 associated with the repatriation of earnings from Canada. The guidance excludes the potential of additional impairments or losses related to investment securities.

Despite the challenges we faced in the first half of the year the company is highly profitable with a strong balance sheet. We look forward to our near term opportunities within the AE brand and to strengthening our profitability within new concepts.

I’d like to thank you all for your continued support and belief in our company and our brands. Now we’d like to turn the call over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michelle Tan – Goldman Sachs

Michelle Tan – Goldman Sachs

I was wondering if you could give us a little more clarity on the outlook with respect to sales trends. I think you mentioned in line with the current level, is that thinking about 2Q trends that we saw or something that you’re seeing in the business today? Also, just clarity on gross margin, I know you mentioned the merchandise margin would get a benefit but any kind of indication of directionally are you expecting gross margin to be up in third quarter?

Joan Hilson

We look at the third quarter guidance we expect modest improvement in comp based on current trends. Within gross margin we are seeing higher markdowns in certain underperforming categories, Jim mentioned knits. We would expect in the guidance given we expect to see that continue unless the sales trends shift. Remember also when we’re thinking about gross margin that within rent we need a mid single digit comp to leverage. The comments in the prepared remarks really speak to the back half of the year and we really see the up side for merchandise margin to occur in the fourth quarter. This has to come from top line sales and real acceptance of our assortment.

Operator

Your next question comes from Adrienne Tennant – FBR

Adrienne Tennant – FBR

On the fall product, how much impact did Roger have and particularly what areas was it visual product, how much impact on the product. When should we see the impact that you want us to see in fall as we go into holiday is it late October, early November?

Jim O’Donnell

Roger has had a minimum impact for the back to school collection and he has been very actively involved in our holiday collection which you’ll see towards the end of October. He is actively involved in our spring collection for 2010. Areas of concentration as I mentioned earlier in the prepared statements, is in the area of knits. Our denim teams as exemplified by our results thus far and we anticipate those to continue are well in place. I’ve had him focus his efforts in knits but also in woven categories because it seems like right now for fall and holiday that there will be a very strong woven trend. Roger has been immersed in it to a great degree.

Adrienne Tennant – FBR

When we’re in the stores what types of differences will we see in the knits and woven’s categories?

Jim O’Donnell

You should see product that’s more on trend. You should see product, use the term less predictable. We’ll always carry basics but where we’ve been missing our basics business has been fairly steady but in the more fashion which the young lady clearly wants more of and more often we’ve been very remiss, our flows have not been often enough, there hasn’t been enough newness and therefore I know from our customer feedback through our research that this young woman, they like us but they’re really disappointed that we don’t offer newness in knits and more versatility. That comes out loud and clear and it’s across the country.

Roger has been highly focused on making sure that we have more knit programs, they’re more on trend and he’s challenging the teams to be more creative. You should see that for holiday and we’re carrying that initiative into the spring and summer seasons.

Adrienne Tennant – FBR

The direction you’re going on is based on feedback and testing?

Jim O’Donnell

Based on feedback, shopping and also we test where appropriate.

Operator

Your next question comes from Betty Chen – Wedbush

Betty Chen – Wedbush

I was wondering if you can speak a little bit more about Martin + Osa, it seems like we’ve seen trends improve as you’ve mentioned comps were positive. Could you give us a little bit of color around how the comps are driven, the quality of that between clearance versus full price selling and then also any update on perhaps opening additional stores for that concept.

Jim O’Donnell

Martin + Osa it’s been a long saga for such a short period of time. We’re still very positive on Martin + Osa. Early signs for why the comps are positive and hopefully you’ll continue to see them even get better is primarily driven by a number of categories. The number on category has been denim. It’s interesting to note that both the American Eagle brand and the Martin + Osa brands are somewhat parallel so in that category of product.

We’re attributing that to both having the appropriate fit, the appropriate washes and also that we are clearly on trend we’re in stock. I think one of the most important ingredients we had, as indicative of apparel retailers you think it would be a no brainer, the product, fit and it’s very complimentary for both men and women. It’s been well received.

We’ve seen increases, our cashmere program’s that you’ll see for fall and holiday, for men and women but primarily for women, has been a huge success. We’ve really gotten to be known for a place to get cashmere, great quality, great fashion, but also at very reasonable prices. You’re going to hear more about how we’re going to go after the cashmere business in a very big way for holiday.

Other areas, our men’s business has moved up dramatically in its overall contribution to the business, while we continue to maintain our women’s position. If you take those major factors we’d like to think that we’re going to continue to see not only improvement in top line but also major improvement in overall reduction and loss and increased profitability in the ensuing quarters.

Betty Chen – Wedbush

For this year, how much should we think the investment in Martin + Osa could be. I know we’ve talked about it being less then last year. What should we think about for this year?

Jim O’Donnell

I’d just as soon not get into the particulars on our investments in any of our brands. It is less then last year. Your question on stores we are looking to open stores. We’re looking at both underperforming stores and the prognosis on underperforming stores but we’re also looking now to venture out and open up some new stores. I would think that we would net out in 2010 somewhere between five to eight new stores.

Operator

Your next question comes from Jeff Klinefelter – Piper Jaffray

Jeff Klinefelter – Piper Jaffray

You indicated that gross margin would continue to be under pressure due to the de-leveraging of comps and probably ongoing clearance. Is that suggest then that we’ll continue to see SG&A down year over year in dollars and that’ll be offset by some gross margin pressure year over year, any other color you can put on those two line items would be helpful.

In terms of the denim assortments sounds like they’re trending well. Can you give us a sense too how you feel, do you feel comfortable that you’re optimizing the assortments in terms of the styles, anything that you’re chasing, any opportunities to see an even better comp in denim as we move through the second half?

Joan Hilson

With respect to margin, the third quarter we are experiencing lower product costs and we’re leveraging our value in our store and passing some of that on. The biggest piece of gross margin pressure is really markdowns related to trends that we’re currently seeing. Should that, as we get through this August and September period of major back to school tax free event shift we’ll see how that plays out. It’s really about markdowns in terms of gross margin and the rent.

When we think about SG&A for the back half I would expect the third quarter to be slightly up with the fourth quarter down slightly to get us to this low single digit view for the full year. Really the back half and the fourth quarter is really about top line growth and that is where we’re focusing a lot of our energies.

Jim O’Donnell

We started out the year, last year we really started looking at denim very critically as to what went wrong so you can figure out how to right the ship and get the assortment in a good place. What happened is that we really identified the right fits and the right washes and we didn’t narrow the assortment, if anything we broadened the assortment. Also we went to more inseams. We’re finding that our women customers they really gravitate to a jean that is the correct length depending on the silhouette there’s different looks the way they like to wear the jean. We’ve captured that.

Looking forward we’re replacing almost half of the success we have now with new and innovative products that we think will take us to another whole level. We’re looking at some different fits, I don’t want to mention exactly what they are for competitive reasons but there’s a whole trend on right now that I know that we’ve tested and it’s tested quite well that we’re on it and we’re on it in a big way. We’ll still continue to have our core styles but we’re going to be in some new silhouettes, definitely in some new washes and we’ll continue with our inseam business.

Jeff Klinefelter – Piper Jaffray

Are you also seeing a positive comp trend in your woven tops at this point?

Jim O’Donnell

We are, woven tops have been good on both sides of the aisle, men’s and women’s. We feel that that trend actually is going to get stronger for holiday. You’re going to see the fall collection and holiday collection you’re going to see a heavy emphasis on woven especially in women’s but also men’s. That bodes real well for us because our woven business has been good, its our knit business, as I mentioned earlier in the prepared statements, we continue to struggle and hopefully we’ll gain some ground there. Yes, the wovens will be a much more of a centerpiece in the collection.

Operator

Your next question comes from Dorothy Lakner – Caris & Company

Dorothy Lakner – Caris & Company

I wondered if you could add a little color, you spoke about talent being added in the tops category and where your focus really is. It sounds like there are a lot of positive trends in tops; you just spoke about the strength in woven’s and the basics part of the knits business seems to be okay as well. If you could narrow the part of the business that you’re really focused on and what talent has been added and how soon do you think we’re going to see some improvement there.

My second question relates to just a little bit more color on the aerie business which seems to be performing very, very well just if you could talk a little bit about trends there.

Jim O’Donnell

On knits we brought in some new talent, we’ve actually had some people on board but it takes a good almost year before you see the fruits of their labors. Primarily in what we know as bare knits and in knits that are very complementary to jeans and our other related products. A big part of what’s going on with, Roger can speak much more in depth to it then I. There’s a real strong trend right now on how knit fits a woman and especially within our jean assortment. We think we’ve hit it and you’ll have to see the product to see if for yourself.

One of the areas that we’re looking at very aggressively is in our graphic t-shirts. We’ve really struggled in a category that we were really known for. We have incredible initiative, very aggressive initiative that we’re putting in place that you’ll see a bit for holiday but we’re really going to make a big move come spring of 2010. Those teams are in place both the designers and also the graphic artists. We need to hire just a couple more people in the graphic artist category and we’re going to be in a good place.

Those two categories can provide big dividends as we continue to grow our other businesses which we don’t speak all that much about. Our fleece business which we are coming into season on, we’re a big player in fleece and we have some great ideas and some great products that I think is going to surprise some people. Those are the areas we’re going to concentrate on.

On aerie, Joan is the voice behind the curtain. We are pleased with aerie. One of the things we are very pleased with is our customer connection. I know that sounds like apple pie and mom but we’ve worked very hard to assemble a loyal customer base that we continue to reach out to every month. We reach out to this core group and it continues to build and build. I think the single most success that we’ve had is we’ve taken some risk. Our key categories are rather predictable, bras and undies are really the cornerstone of the brand but you can’t build the aerie business without other categories.

We added the fit category which is the athletic line and it’s been incredibly successful. Now it’s on a small base but we’re very pleased about what’s going on in that particular assortment. We’re doing a much better job on bottoms right now whether its pj bottoms, whether its on a, you’ve probably seen the roll top pant and so forth, all have been very successful.

One of the challenges that Joan and I have with the team is to continue to challenge them to actually do something a little different then what we preach normally and that’s broaden the assortment a little bit. Take a few more risks, we’re there in a growth business but all signs right now as indicated by the comps and you’ll see that’ll be translating in the future into earnings will be contribution to the overall corporation all signs are positive there and it’s a great customer base to have its with a young woman that is loyal to you.

Operator

Your next question comes from Stacy Pak – SP Research

Stacy Pak – SP Research

I think you said your Q3 plan was for inventory to be down high single digits and I’m wondering if we should assume that the comp plan that you’re working off of. I was wondering if you could address dresses which I think have also been comping positively. Will those continue to be a part of the assortment in Q3 or do those wind down.

On the IMU could you just clarify are you suggesting that you’re going to pass on pretty much all of the gain in Q3 to customers or will you be holding on to part of that. Finally just so I understand really you’re saying we see Roger’s impact and the impact from these new designers in knits in bottom of October forward and not in Q3?

Joan Hilson

With respect to inventory our inventory position is based on flow as well as I stated we’re focusing on very targeted areas that we’ve spoken about denim which we said in the prepared remarks and Jim mentioned woven. We’re getting behind the categories that are really working for us and we’ve been very conservative in positioning of some of the other areas. I wouldn’t say that is guidance for comps what I said was that we’d expect a modest comp improvement from the second quarter. Inventories are clearly behind the categories that are proving themselves to be worthy of it.

The second question I think was around IMU and we expect that we will be able to pass a portion of the benefit in our value offering to our customer and we’re balancing that with the areas of the assortment that are winning and where we believe that the fashion is right on trend and relevant to our customer, hope to enjoy the opportunity there on the margin line.

Stacy Pak – SP Research

You’re assuming some improvement in comp from Q2 you’re going to pass along some of the IMU but not all of it. You would presumably given the inventory position expect better markdown rates in Q3 then Q2?

Joan Hilson

As I said, we need to drive markdown rates lower and what the initial guidance is indicating that they’re slightly higher then last year. It’s really due to the underperforming categories. If we can see comps lift from the current position as we navigate our way through all these back to school and tax free shift markdowns will improve and hopefully be better then last year. At this time really in the quarter that’s were we see it.

Jim O’Donnell

As far as Roger’s impact and the comments that we’ve made regarding our improved knit category you will see the first impact of that in late October and into holiday. You’ll see not only the initial but all also you’ll see two category flows into November as well as into December. We’re looking at it as fall and holiday and then we’re going to come in with a little bit right before Christmas and then we’ll also have our trans programs in for the post Christmas so you’ll start to see the full impact of what the knit initiative is going to look like.

Stacy Pak – SP Research

The dresses, can you address that?

Jim O’Donnell

As I mentioned earlier in the prepared statement we’ve been very pleased with dresses. One of the things about dresses I think that everyone knows you’ve got to be careful. You don’t want to chase it too long. We were there on the front side of the dress lift and we will continue to have dresses into third quarter. We’re going to carry them into holiday but we are going to start to reduce the impact and continue to have dresses but you’re going to see that we’re going to be moving into other categories and I mentioned woven’s being one of them as well as hopefully a new and improved knitwear and actually we’re going to be in to sweaters and fleece in a big way for holiday.

The short answer is yes we’ll still be in dresses. The longer answer is we’re not going to be as heavily invested as we have been in the earlier part of this year.

Operator

Your next question comes from Christine Chen – Needham & Company

Christine Chen – Needham & Company

As you’ve embarked on increasing the assortment of fashion and the mix have you seen your sweet spot age group tick up?

Jim O’Donnell

That’s an interesting question. The short answer is no. The long answer will be we hope so. Some of the product that we have been designing in the past the research, this is from young women from middle school to sophomore year in college they feel that the younger women they do gravitate to our knit assortment. The older young women do not; they feel that we need to make some changes, especially in graphics. As we move to this new initiative we think we’re going to be moving our targeted audience up somewhat from a very young we’ll call it 13, 14, more towards our sweet spot of 20 which is really 18 to 20.

We won’t know that until we get the assortment in and we see how the customer votes. Clearly from a design aesthetic we are targeting it to an older young woman that we feel is more of our target because we really want the younger part of our consumer base to want to aspire to this older teenager and early 20 something’s.

Operator

Your next question comes from Todd Slater – Lazard Capital

Todd Slater – Lazard Capital

On improved traffic you’re seeing around the denim area, can you talk about the categories that are seeing some rub off and is that strength in denim helping to lift your average ticking going forward or units per transaction. Is the customer walking out with anything else relative to last year when the assortment wasn’t as strong?

Joan Hilson

It’s interesting I think the denim has definitely been a driver for us and clearly when the tops are relevant and on trend it’s helping in our units per transaction, units are showing that. What we really see happening from an AUR perspective is that in women’s we would expect the AUR to be up just given the improvement in the denim offering year over year. Overall we expect the quarter to be flat in AUR and it’s really largely driven around denim.

Todd Slater – Lazard Capital

How about units per transaction, like buying denim and then coming out with another unit relative to last year?

Joan Hilson

Units per transaction in the quarter they were up. What we’re seeing with the offerings that we’ve had, yes the customer is walking out with more products in terms of number of units. As I said in my remarks our opportunity is to drive up the average transaction value.

Todd Slater – Lazard Capital

On the CapEx, there’s quite a big, I think a $25 million range in your guidance for the second half. What would happen to hit the low end versus the high end?

Joan Hilson

It’s really about shifting and really understanding the completion of some of the headquarter projects. We’re completing our Times Square store as well as some additional openings in the back half of the year but it’s really about the infrastructure piece of that being pushed into the next year.

Operator

Your next question comes from Jeff Black – Barclays Capital

Jeff Black – Barclays Capital

Could you expand a little bit on Martin + Osa? I think you mentioned you had some underperforming stores, how many of these stores are in the base? When you look at the gap that you have now in store productivity between where you need to be I think you said 400 plus on the store productivity side. How wide is that now? What I’m really getting at is why is this a good use of shareholder capital at this point, are we going to end up with a bigger write down going forward? Might we just be better off using that cash for buying back shares, funding aerie, something else?

Jim O’Donnell

To give you a number on underperforming stores probably three out of a base of 28. We’ll address those at year end. We are narrowing the gap between where we need to be in dollars per square foot and where we are today. There’s a decided improvement and it’s really month by month and so far quarter by quarter where we’re continuing to see improvement. Therefore we’re staying the course.

Could the cash be used in a better manner? Maybe, maybe not, I think right now we’re invested in this brand. I’ve said this privately and I’ll say it publicly I think if we close this brand down I think three or four years from now we’d want to open it up again. This is the most underserved demographic in the retail space today and if we can get our assortments to be more appropriate across both genders as well as improve our accessories we can win and this will be a contributor.

We have a financial plan as well as a merchandise and marketing plan that will get us to where we want to be. As fast we would like to go, no not really. I would like to be accretive now and so would everyone who holds our shares of stock. Unfortunately some things take a little longer then others. We’re spoke about aerie and you’ll hear more about kids as we embark on 2010. Hopefully we are lessons learned from Martin + Osa that we can attribute hopefully some of the success that aerie has and hopefully that will translate into 77Kids.

Martin + Osa is a challenge but it’s a welcome challenge. I still feel strongly that we’re making the right decision and we should stay the course. We are monitoring it very, very closely I must tell you. We do not allow very much wiggle room as it comes to spending as well as getting outside what the framework is for us to achieve our ultimate profitability over the next couple years.

As recently as in the next hour or two Joan and I will sit down and evaluate the plans for the balance of this year as well as where we’re going to be next year. We monitor this very, very closely and we continue to show progress. As long as we show progress we’ll stay the course. If we don’t show progress the answer is rather obvious.

Operator

Your next question comes from Jennifer Black – Jennifer Black & Associates

Jennifer Black – Jennifer Black & Associates

I wondered if you could talk a little bit about accessories as a category are you doing anything as far as gift sets for holiday. I noticed too that you’ve expanded your footwear assortment with the ballet flats. Also if you could talk about how the aerie sneakers are doing?

Jim O’Donnell

Great category because its one of the categories that’s near and dear to my heart. Someone asked, I think Todd asked about UPT and so forth. This is a way to not only improve UPTs but also improver overall profit margins as well as top line. We’ve been pleased with jewelry, that’s the one big call out right now in accessories that we continue to be month in and month out positive comps.

Footwear your observation is a good one. We’ve made some dramatic changes in footwear to be more brand appropriate, to be priced right and also to be assorted properly. Our footwear business has been good and we’re pleased and we’ll continue to improve. We made some major changes on how we do business in footwear. Those changes have really been positive for us and hopefully we’ll continue to see it.

The underperforming piece of accessories that we’re very unhappy with is bags and we continue to struggle there and hopefully at some point we’ll be able to put our finger on how to get a bag assortment that this young woman will really gravitate to. When it comes to things like belts and so forth our business has been good. We’re going to continue to have a keen focus on accessories.

As far as gift sets, it’ll be a cornerstone of aerie, a big piece of aerie holiday which we viewed just recently had some great gift sets for Christmas and we think much improved over last year, lots of fun stuff as well as product that is very relevant. We look at that in a big way. Less of that for American Eagle maybe you’ll see a little bit in Martin + Osa but its more about its just related product. Gift sets for aerie in a big way.

Sneakers, one of my favorite. I think if you’ve seen the sneaker you’ll see that we went out with a very prominent national brand and we have a sneaker design just for aerie, it’s co-branded and we expect it to do quite well. We tested it in a handful of stores and over one weeks period I think we tested it in four or five stores we sold 17 pair. I’m 17 pieces ahead of everyone else that maybe wouldn’t be as good. I’m a big fan of the sneaker. We only have it in two colors right now but I think its going to be an interesting venture and it could have some larger scale ramifications down the road.

Jennifer Black – Jennifer Black & Associates

New Balance is a great company. My follow up question is about logos it seems like the consumer has moved away from logos and I’m just curious as to what your stance is?

Jim O’Donnell

That’s another good call and a valid observation. Its not just so much logo as it is for what you would call oversize or blown up graphics. The kids are looking for things that are either cleaner and on the branded side, not as strong as it has been in the past. What we’re looking at is a number of different approaches; one is a little cleaner look in knit. Graphics though are a little bit of a different animal in that they gravitate to right now the big things are the love and the peace symbols, the hope and so they’ve been very successful.

We’ve seen that the blown up graphics, the blaring out of the branded graphics, not well received. We’re really looking at a number of different things. There’s more of a clean look and then there’s more of what we call fun graphics. We’re going to have both and we’re also going to be very competitively priced when you see the collection in spring of 2010.

Operator

Your next question comes from Kimberly Greenberger – Citigroup

Kimberly Greenberger – Citigroup

I know that starting in the fall of 2008 you were going after more of a value equation in the stores. I’m wondering with the incremental passing on of savings you’re talking about here in the second half of ’09 how will we see that in the stores is it reduced initial ticket, is it an increase in planned promotions? How is the customer going to feel this incremental increase in value?

Jim O’Donnell

It’s actually both. We will and have been but we will continue to take a look at ticket prices at retail and where appropriate probably move them down somewhat. We will continue to factor in pre-planned promotions that we buy into. We know basically if we’re going to run a 2/4 or a bogo, we know that we’re going to run it, we have our plan of unit purchase, we know what our margin implications are. We’re out there right now looking at getting reduced costs in order to fund some of these promotions.

Can you get enough reduced costs? It depends on the product. Some you can negotiate in a much more dramatic way then some other products. We will do both. I think to just arbitrarily drop retails would be wrong because there’s products and hopefully some of the comments that Joan and I have made on some of the product we’ve got product right now and we’ve been pretty disparaging to our knit team and our knit product but we’ve had some styles within knitwear where we’ve been correct and we have no problem getting ticket on those and we’ve sold them out. The problem is there hasn’t been enough of them.

It’s really picking your shot. When we have product that’s on trend and remember we’re still a value house, we’re not out there selling expensive products. If it’s on trend and it looks great and it fits we think we can tell ticket. You have to be very sensitive to what seen right now as basic or commodity versus what seems to be fashion. Commodity you’ve got to watch your ticket prices. With fashion if you’re right you can get your ticket and if you’re wrong it’s called a markdown. We’ll continue to put pressure on our manufacturers for as much as we can.

We have seen, as Joan comment, some reduced costs. Are they low enough? No. Are they continuing to move downward? The answer is yes. How far they’ll go it remains to be seen. We still have something called that we put into our products and its called that has to be a certain quality. We’re going to continue to maintain it. I think people who take short cuts on quality they win over a short period of time I think it’s a losing proposition over the long haul.

It’s a fine line between what the product is going to cost us, still maintain quality but commodity ticket prices you probably will see come down, fashion where its right hopefully we can hit ticket.

Kimberly Greenberger – Citigroup

Any sort of quantification on average of the savings that you’re seeing in the third quarter and it sounds like you’re expecting even greater savings into the fourth quarter, is that correct?

Jim O’Donnell

I would say yes.

Kimberly Greenberger – Citigroup

Any range for savings in the third quarter on average?

Jim O’Donnell

No, unfortunately I do know but I can’t say.

Operator

Your last question comes from Lorraine Hutchison – Bank of America

Lorraine Hutchison – Bank of America

I was hoping to hear a little bit more about the flagship that you’re planning to open in November. Should we expect any costs this quarter associated with the opening? How big will the store be? Will you have any special product in there? Any details you could provide us on that flagship?

Jim O’Donnell

Near and dear to my heart. Also my checkbook. Let’s talk about the store, the store will be very unique, it’s going to be 24,000 square feet over four floors, there is one below grade, three above grade. It will house American Eagle men’s and women’s through three floors and the fourth floor will be aerie floor. We will have product that’s unique and only in Times Square, 46th and Broadway in both American Eagle and aerie. I think it will be product that is rarely visible for those who shop the store.

We’re going to put some better product in the store also. I think it’s going to be a great testing ground too for product for us because of the diversity of customer that will attract to that shopping environment. The cost for the store as far as the build out costs we’re tracking and we expense it as we’re invoiced. As far as some of the hoopla on the grand opening so forth we’ve already set that money aside and it’s all baked into our earnings. It will be properly in our fourth quarter statements.

We have a very conservative, what I think is conservative, pro-forma it has all indications for those that look to me that I put the conservative estimate up there to like a gen year of way too conservative. We prefer to err on the conservative side. We have a financial plan that’s very beautiful and I must tell you we have an incredible comprehensive plan on how to run that store. It’s going to be very different from any store we have in the chain. It will be different hours of opening, we’ll have about 400 employees working there and we’ll have merchandise flowing everyday new product flowing in and we’ll be pulling certain product out so the store will always have a fresh new appeal to it.

Judy Meehan

That concludes today’s conference call. Our next announcement will be August sales which we will report next Thursday, September 3rd. Thanks for your participation today and have a great day.

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Source: American Eagle Outfitters Q2 2009 (Qtr End 08/01/09) Earnings Call Transcript
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