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American Eagle Outfitters, Inc. (NYSE:AEO)

Q3 2009 Earnings Call

November 24, 2009 9:00 am ET

Executives

Judy Meehan - Vice President of Investor Relations

James O'Donnell - Chief Executive Officer

Joan Hilson - Executive Vice President, Chief Financial Officer

Analysts

Michelle Clark – Morgan Stanley

John Morris – BMO Capital

Paul Lejuez – Credit Suisse

Janet Kloppenberg – JJK Research

Kimberly Greenberger – Citigroup

Christine Chen – Needham & Company

Stacy Pak – SP Research

Lorraine Hutchison – Bank of America

Jeff Black – Barclays Capital

Dorothy Lakner – Caris & Company

Jennifer Black – Jennifer Black & Associates

Michelle Tan – Goldman Sachs

Dana Telsey – Telsey Advisory Group

Operator

Welcome to the American Eagle Outfitters’ third quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Judy Meehan, Vice President of Investor Relations. Thank you Ms. Meehan. You may now begin.

Judy Meehan

Good morning everyone. 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 third 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.

James O'Donnell

Thanks Judy. Good morning everyone. American Eagle Outfitters continued to gain ground in the third quarter despite a very cautious consumer and as we all know an economic environment that remained challenging.

Third quarter comparable store sales declined 4%, a significant improvement from the trend of the first half of the year. Store traffic remained inconsistent and yet we are pleased to have delivered slightly higher conversion rate during the third quarter. Although the results are still not up to our standards, the operating earnings decline of 26% was half of the decline in the first two quarters of this year.

The AE brand has gained momentum with its strength in a number of key merchandise categories including denim, woven tops, graphic tees and accessories. Building upon these successes and regaining market share is our top priority. Further, through grassroots campus marketing and high impact billboard campaigns, the AE brand is generating buzz among a broad base of target consumers. We are also underscoring our mission within the organization. We are staying true to our promise of great style and quality at affordable prices which will continue to guide this brand as we navigate our path to recovery.

The following are important highlights from the third quarter. The AE women’s comp improved, declining 5% compared to an 11% decline in the first two quarters this year. Women’s denim, which is so important to driving the overall performance of the brand, comped positively in the third quarter, up significantly year-over-year. Critical to market share we are pleased to see certain styles have returned to historical performance levels. Graphic tees were also strong, with women’s graphic t-shirts turning positive for the first time in several quarters. Our planned promotional strategy in this category is both compelling to consumers as well as delivering strong market performance.

AEO direct delivered another positive quarter with sales increases of 10% driven by higher traffic and conversion. We have demonstrated the ability to hit important fashion trends such as plaid flannels and woven tops. In fact, we have more than doubled our woven shirt business year-over-year. Importantly we are standing behind these fashion trends with powerful statements in the stores. You will continue to see this kind of merchandise distortion going forward which we believe in this concept and it makes sense to the consumer. While we have seen solid performance across these categories, we still have considerable opportunity for improvement in the balance of the assortment.

Finally, value. Value is top of mind for this consumer and stretching the dollar is going to be important for the foreseeable future. We continue to plan powerful promotions designed to drive growth in both top line and margin. You will examples of this starting this Thanksgiving weekend.

A brief note on our big event from last week, the grand opening of our Times Square flagship store. American Eagle Outfitters at 46th and Broadway is meant to be a destination and a landmark for AE customers around the globe as well as a shopping experience unlike anything else even by Times Square standards. Traffic and sales in the new store have been strong out of the gate and we look forward to seeing this store realize its remarkable potential in the coming months.

Importantly, new concepts are a key component of long-term growth for the company and we are pleased with their performance in the third quarter. Starting with Aerie, the Aerie brand now has 137 stand alone stores with one of the latest additions in Plaza Las Americas Mall in Puerto Rico. This store opened extremely strong with higher than average traffic and sales, demonstrating a strong appetite for the Aerie brand in a variety of markets. Overall, the Aerie brand consistently delivers double digit positive comps for the third quarter at 27%.

Martin + OSA achieved a positive 10% comp with an improvement on the bottom line. The brand continues to make progress in its merchandise assortment and targeted marketing efforts to build our brand awareness.

77kids also had a solid third quarter with success in wear-now fashions and outerwear, denim and graphics. This holiday we opened our first pop up store in the Pittsburgh area allowing us to gain key learning’s from our customers face to face. Sales are far exceeding our expectations which is very encouraging considering it is a small space and has a very limited assortment. Insights gleamed from this temporary store will help guide our plan for the permanent brick and mortar stores we plan to open in 2010.

In closing, I would like to reiterate my confidence in our brands. We have been clear about our priorities and we are doing what we said we are going to do. We have turned around key categories. We stood for fashion and value and we have exercised financial discipline. Is there still significant work to do? Most definitely. We are focused on closing out 2009 very strong and capitalizing on opportunities in the fourth quarter as we kick off the very important holiday season.

Further, we are poised to continue our momentum towards the recovery in 2010 with creativity, vision and discipline. Thank you. Now I will turn the call over to Joan.

Joan Holstein Hilson

Thanks Jim. Good morning everyone. The third quarter demonstrated an improvement from the first half of the year. Store traffic was still choppy yet we were able to leverage traffic better than in recent quarters, resulting in a higher conversion rate. Customers responded well to key merchandise categories, driving a solid full price business in a portion of the assortment. However, there were still areas of underperformance where higher mark downs were required.

Moving on to margins, more controlled mark down activity and pre-planned promotional events led to a 20 basis point increase in the merchandise margin. The gross margin decline of 90 basis points was primarily due to higher rent as a percent of sales reflecting new store growth and the negative comp.

SG&A expense in the quarter increased 6%. This was largely due to payroll costs related to new stores and the accrual of incentive compensation which was not incurred last year. Cost control initiatives remain a priority and have resulted in flat SG&A dollars through the first nine months. Continued improvement in the comp trend, a higher merchandise margin and expense discipline led to an improvement in our operating margins from the first half of the year.

Now turning to the balance sheet, consistent with our expectations third quarter ending inventory for retail stores decreased 3% at cost per foot and clearance inventory was down 15%. Looking ahead our fourth quarter average weekly inventory per foot is expected to be up in the mid single digits. This is driven by an increase in AE denim, a year-around category which has been performing extremely well. Excluding denim, fourth quarter average weekly inventories are flat to last year.

In keeping with our reduced spending plan, capital expenditures in the third quarter were $33 million compared to $69 million last year. For the year we now anticipate capital spending to be in a range of $120-130 million, about half of last year. We generated positive cash flow ending the quarter with cash and investments of $719 million.

Through the first three weeks of November comparable store sales declined 5%. Due to the importance of Thanksgiving weekend, we will provide fourth quarter guidance next week along with our November sales announcement.

In conclusion, we have tremendous opportunities still ahead. Continued sales improvement is a priority and essential to margin recovery. Our goal is to continue the momentum and expand the success we have seen in key areas of our business. Inventories are well controlled and distorted to high performing categories. We expect lower product costs to modestly benefit the merchandise margin and we also pass savings onto customers through strong value pricing.

Lastly, expense controls remain a priority. As we look ahead we will capitalize on opportunities within our business and continue to position the company for long-term success. Thanks very much and now we will open the call up to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Michelle Clark – Morgan Stanley.

Michelle Clark – Morgan Stanley

Can you just give us the weekly comp compares from November of last year? I know through the first two weeks of November of last year you comped down 17% and then for the full month of November it was down 11. The second question is there any change in promotional cadence this November versus last?

Joan Holstein Hilson

The promotional cadence for this November is relatively consistent. However, in terms of priming of events and our Thanksgiving weekend without sharing exactly what it is, we think it is loaded with value for our customers and offers a meaningful price points in key categories of our business. We have some fun events planned as well. So that cadence is one that we are excited about and we look forward to talking to you about it on our November sales call.

In week one last year, we were down low double digit. Week two, low single digit. So that is the comparison we have as we look at the first weeks of this month in aggregating.

Michelle Clark – Morgan Stanley

Then week 3 and 4 of last November?

Joan Holstein Hilson

Week three was hard to compare because of the shift of the holiday. The prior year had Thanksgiving in it. As we said last year, over Thanksgiving weekend last year we were positive low single digits.

Operator

The next question comes from the line of John Morris – BMO Capital.

John Morris – BMO Capital

Two pieces here; the inventory where you expect to finish up in Q4 up 5% per square foot. Obviously that is an investment in denim. Maybe a little bit of color on that. Do you feel like the higher investment in denim is because of more opportunity? Were you a little bit lower than where you wanted to be last year? Is there anything else in that mix we should be aware of? Any other timing issues or anything like that? I assume that really is kind of your spring positioning. Secondly, segueing into spring and trying to look ahead a little bit if you could talk a bit about where you see the opportunity? Where does Roger see the opportunity on the merchandising team in terms of the product compared to last year? I would expect part of that to be in the knits category but obviously woven has done better. So I want to try and get a little bit more color there. What is it you are doing to really fix and turn the knits business and update on that?

Joan Holstein Hilson

I will address the inventory and then Jim will take the assortments for spring. Looking at our fourth quarter what we said, just to clarify, is that the average inventory for the fourth quarter is expected to be up mid single digit. When you look at that without denim we expect that to be flat. That does compare to your point to a down low double digit last year. So we were somewhat lean and feel that now with a very well trending category in denim it is an important investment for us to make for holiday. So hopefully that gives you the color that you are looking for the fourth quarter.

John Morris – BMO Capital

That makes sense. Then on the spring opportunity?

James O'Donnell

Actually the emphasis is still going to continue on with denim as Joan just explained. We are making and continue to make a massive presentation of denim to ensure that we are in stock in all of our fit systems as well as all of our washes. The category that has probably the greatest upside opportunity is the one you mentioned and that is knits. What Roger and the entire team, Henry and LeAnn have done, is a strong collaboration in ensuring that the knits compared to last year are much more compelling. That is defined as much more brand appropriate. They have more of a fashion bend and there is more detailing within the product.

Having seen the line I can tell you there has been a dramatic improvement. We will be in the knit business but it will be trend right and it will be priced right. We also have some key promotions around knits that should be very exciting.

Operator

The next question comes from the line of Paul Lejuez – Credit Suisse.

Paul Lejuez – Credit Suisse

I just wanted to confirm something. The inventories will be down mid single digits that is on a dollars basis. Does that mean that units will be up somewhere in the double digit range just given lower average unit costs? Second, as far as the store closings I am just wondering what type of locations these stores are coming out of. What kind of malls and should we expect this is a pre-cursor to more store closings next year?

Joan Holstein Hilson

To clarify inventory, inventory on an average basis on a cost per foot is expected to be up mid single digit. Without denim we expect it to be flat. That is up against last year of down low double digit as an average for the quarter.

Paul Lejuez – Credit Suisse

Does that mean units up several digits and then X denim up mid singles?

Joan Holstein Hilson

No, what it means is units are up but not up double digits. Our denim inventory is clearly up unit wise because our denim inventory last year was quite low. So we are positioning inventory units and dollars up against them.

James O'Donnell

Relating to store closings, we have already committed to closing I believe around nine stores this year and we are looking in January somewhere between another 10-20 potential closings. The mix of the stores they range anywhere from stores that have just outlived their life cycle where they are in environments where they are not growing, they are actually decreasing. They are also in environments that were planned for future growth primarily in the Southwest and Western part of the United States that did not materialize where we had fortunately put in exit clauses to benefit ourselves in being able to leave the locations. There are also some lifestyle centers that are just not right for I think the future look.

Something I am not going to dwell on but I am looking at the entire American Eagle real estate portfolio in a little different manner on a go forward and I think you will see and hear some of the repositioning of how I see the portfolio evolving over the next 2-3 years.

Operator

The next question comes from the line of Janet Kloppenberg – JJK Research.

Janet Kloppenberg – JJK Research

Could you talk a little bit about your IMUs going into the fourth quarter and if you are positioned to profitably promote? A lot of other companies have talked about being well positioned to offer value but to maintain decent margins at the same time. I was also wondering if you could talk a little bit about the outlook on SG&A if we should expect it to be up about 6% again in the fourth quarter. Lastly for Jim if you would talk about your confidence level in this holiday floor set with the flannels and denim and some of the new sweater silhouettes, if you have an early enough read to be able to say you feel good about how you are positioned going in to the season?

Joan Holstein Hilson

When we look at the fourth quarter we are seeing cost improvements and much like the third quarter we expect to balance that with the value offering to our customer. So expect modest improvement related to that. Where we see meaningful improvement in the fourth quarter for us is in our mark downs and that relates to the strength of our preplanned promotions which are structured in a profitable way. As you know, last year was a bit reactive. Going in we do expect a meaningful chunk of improvement in the merch margin.

With respect to SG&A we would expect the fourth quarter range likely to be up low single digits. What that takes the year to as I look at it, at this time it is flat to up low single digits and that largely depends on the top line performance in our variable costs.

Janet Kloppenberg – JJK Research

We should be thinking about it on a dollar basis up low single digits versus last year’s fourth quarter?

Joan Holstein Hilson

In looking at the full year, just thinking about the full year I think high side range of that would be up low single digits.

Janet Kloppenberg – JJK Research

Versus last year’s total SG&A level?

Joan Holstein Hilson

Correct.

James O'Donnell

Some of the early selling, Janet, it has been a bit mixed. Without being redundant with some of the comments we have already made, women’s fleece we have been very pleased with. Accessories have been quite good. The common denominator right now is with strong promotions, very value driven, the product is very desirable. I am very cautious about the holiday season, although I do feel from an assortment, from a comprehensive point of view I think we are in a very good place. I think all of our holiday buys in our sweaters, our fleece and our woven shirts are very much on trend and I would expect them to be well received.

Again, those are all going to be centered around the promotions and how the customers perceive value. If that perception is achieved I like our chances. So we have a very good plan. As you know our company very well, we also have a plan for the plan. So we are not going in with our eyes closed so to speak. We are geared for whatever hand we are dealt.

I think the biggest thing about this year versus last year and I have been public with this comment before, last year much of what we did from a promotional cadence was very tactical. It was very necessary, if you will, to move inventory because we had no choice. This year we have been much more prudent about how we bought, where we bought. As Joan related we are distorted in the categories we feel good about. So we know where we have picked our targets and right now the early signs are they are good. We all hope they are going to be great.

Operator

The next question comes from the line of Kimberly Greenberger – Citigroup.

Kimberly Greenberger – Citigroup

I’m sorry if I missed this but can you give us the comp metrics, up from a negative four comp in the quarter, and then could you talk to us a little bit more about Martin + OSA and Aerie? You commented about some sales improvement. Could you give us some idea about the operating margins of those businesses and are they seeing significant improvement in [lines]?

Joan Holstein Hilson

I will take the comp metrics first. For the quarter if we look at ABS that would be down low single. Our average unit retail was also down low single and we saw transactions that were also down low single. Then our conversion was up and that is what contributed to the overall down four.

James O'Donnell

As it relates to Aerie, our instant apparel brand, overall we have been very public with the Aerie brand is probable. The stand alone stores have not been profitable. They run at a small loss. Hence, we feel we will continue to improve in the fourth quarter of 2009 and then our plan is for the brand to be accretive, the stand alone stores to be accretive in 2010. What we have seen from Aerie is I think continued strong positive comp. It has been north of 25% almost every quarter. But having said that we actually are driving now some additional categories of merchandise. If you have been in the stores you have seen a stronger position in our fit active line. You have seen more of a dorm wear and sleep. Those categories had to deliver their percentage component because our bra business and our underwear business has been very good and it has continued to carry the Aerie brand.

In order for the stand alones to be profitable, we need to have these other categories deliver to their planned percent of contribution. Right now the trends are very positive and we feel good without getting overly excited. We really feel the Aerie brand is headed in a very positive direction. Some of the newer stores we have opened have been quite good and have been meeting their benchmarks. We have to get our lower tier stores which number about 20% of that 137 stores to move their top line. But we have seen overall, I don’t believe we have what I would consider, maybe one or two at the most, stores that cannot meet the benchmarks we have established for the fourth quarter as well as for a very strong 2010.

As it relates to Martin + OSA, Martin + OSA has continued to improve quarter-over-quarter. Now having said that, the improvement has been very modest. The big contribution, if you will, the real tell tale will be the fourth quarter; the season we are in right now. We plan for a dramatic improvement in fourth quarter of 2009 versus 2008 and the early signs right now is that it is good. The assortments continue to get better. One of the things that have maybe been holding the brand back is we have to take some bets on some key product lines. We need to flow newness more often. We noticed that the stores we flow newness, we spike our top line. The minute the assortments start to be on the shelves after 3-5 weeks, those sales become a little more modest.

We think we have a pretty good handle. We are changing some of the merchandise flow cadence and the product continues to get better. The IMUs continue to improve. We have to get our arms around the mark down rate. When we get our arms around the mark down rate we will see a dramatic improvement in this brand.

Operator

The next question comes from the line of Christine Chen – Needham & Company.

Christine Chen – Needham & Company

Just to continue on the discussion of Martin + OSA can you talk about maybe specific categories that are doing particularly well at Martin + OSA and did you give the impact on the third quarter of Martin + OSA?

James O'Donnell

Martin + OSA’s comps for third quarter were 10%. Categories that have been contributing what we think is becoming some of the signatures of the assortment is denim. Denim is one category we should know and that is denim. Denim in both men’s and women’s, but women’s has been very strong. We have been very consistent right now in our fits which we are getting very good feedback on. Cashmere sweaters are another signature category in women’s. Accessories has been very good. We have really shown a dramatic improvement. We have almost doubled the business from a year ago in accessories.

Men’s has been very pleasantly surprising in that we have moved the needle up in the overall contribution this past year from about 2-3 points from where it had been running. The men’s assortment has been somewhat successful. I believe a major contributor. Where women’s needs to strengthen its positioning is primarily in its knits and also we have to continue to improve our outerwear category which is good but it is a category that we feel should be a major contributor in both men’s and women’s but primarily in women’s. That is about the best way I can give you the color around M&O.

Christine Chen – Needham & Company

Then the EPS impact on the third quarter from Martin + OSA?

Joan Holstein Hilson

We will give that on an annual view when we get to the fourth quarter earnings call. I would trade all of our new comps up.

Operator

The next question comes from the line of Stacy Pak – SP Research.

Stacy Pak – SP Research

I was wondering if you can just comment on how you are reading the business so far in November? Are you pleased with the build? The reason I am asking obviously is the shift that occurred at Thanksgiving last year. I am just kind of wondering how you are reading it internally. Is it kind of playing out as you would have anticipated? It sounded to me like you are pleased with all the key categories but I was just hoping you could revisit that. The second question I have is just looking at 2010, assuming a modest comp what kind of SG&A growth rate would you be comfortable with and what kind of margin recovery would you be comfortable with because there is obviously a lot of opportunity. Last question, housekeeping, can you tell us exactly how much the IMU was up in the quarter and whether there was an impact from transportation?

James O'Donnell

As far as the early read on where we are and where we are going, my crystal ball is still murky but less murky than it was a year ago. Having said that, our team right now is really right on our plan. That is a very conservative plan but right now I feel good about where we are and where we are going. I like our inventory levels and where they are positioned. I think our key categories are well protected. I think our promotions that are going to signal value to the customers as I mentioned earlier are in place. We are prepared from a logistics position as far as being able to support our stores on an ongoing basis so we are in-stock on an as-needed basis.

So I feel good. Last year, if you recall and I think Judy mentioned it, our post-Thanksgiving weekend was okay. It was good. But I think we are in a better position this year. The real key is going to be what does December look like. Is December going to be a balanced December where you find that your sales cadence is pretty much consistent week in and week out? Or is it going to be a last minute rush 12 days prior to Christmas where you are going to have to really be very, very focused and you are going to have to be very promotional? We have plans for both. We will see what happens. Overall, I feel okay about where we are. I actually like our position.

Stacy Pak – SP Research

With regards to the traffic you are seeing out there all year, has the customer…I have heard a lot about inconsistency. Does the customer come at specific times? Would you expect there to be more traffic when there are holidays, for instance, and they are eminent, they are here upon us? Or can you not even…how are you reading the traffic?

James O'Donnell

I think that is a really good question. It has been pretty consistent. You promote, the traffic improves. Weekends right now are very strong. You have to be prepared for your Friday to a degree but Saturday and Sunday have really been the drivers for the week. The balance of the week on average it is pretty quiet but I think as you get into the holiday season depending on the urgency of the consumer I would like to think maybe some of these trends will change somewhat. One of the things that we have seen though is in these outlet centers. The all-price centers that we are in. They remain very consistent in that the traffic is very strong and the performance goes right along with it. So it further validates this whole value headset of the consumer.

Stacy Pak – SP Research

The 2010, kind of gross margin recovery, SG&A and those two IMU and transport?

Joan Holstein Hilson

Sure. For 2010 we have looked to the improvement to come back to the mid teen and up operating margin occurring over the next couple of years. With respect to SG&A specifically, the way I think about it is we would expect SG&A to grow somewhat with an increase in sales due to the variable costs that go along with sales. But the other expenses that are what I would call non-variable or discretionary we would expect to remain flat.

Stacy Pak – SP Research

Overall, if assuming again you actually have a modest comp?

Joan Holstein Hilson

We would expect SG&A to grow slightly with a modest comp. Now looking at IMU for the third quarter and fourth quarter we did have comp opportunities that we did cap on to give some value offerings to our customer. We did experience a decline in freight. As we look forward in the fourth quarter and as we talk about our guidance next week we are thinking about the impact of air freight and some of the small issues we are seeing today in terms of capacity for air freight and getting product to our DC’s and then to the stores. So some opportunity in third quarter and we are working through some of the costs of fourth quarter.

That said, with respect to costs, we would expect modest improvement but with respect to mark downs that is where we would expect a more meaningful lift in our merch margins.

Operator

The next question comes from the line of Lorraine Hutchison – Bank of America.

Lorraine Hutchison – Bank of America

Just to follow-up on the inventory position you are in going into holiday, if we see comps continue at the same rate that we have seen so far this month should we expect significant mark downs to clear through that up inventory or is this a season of product you can carry forward into the spring season?

Joan Holstein Hilson

The position of denim is what is driving the mid single digit comp increase. The inventory with that denim is flat on a cost per foot basis. Yes, it is year-around inventory which we have flexibility. That said, we would expect to see improvement in mark downs even with a negative comp. So we believe that the way we have planned our promotions, we have pre-planned from active that we are in a strong position to see merchandise margin improvement related to mark downs.

Lorraine Hutchison – Bank of America

Last quarter on the second quarter earnings call you had been talking about SG&A down slightly for the year and now it looks like it will be up. I am just curious what was the variance in the initial expectations versus where you are now?

Joan Holstein Hilson

The variance is related to sales and our store variable costs are a piece of that. The incentive accrual is the other piece of the increase. As I said, as we look here on an annual basis we would expect SG&A and all that would be on the high side to be up flattish to low single digit increase all related to business performance and variable costs.

Operator

The next question comes from the line of Jeff Black – Barclays Capital.

Jeff Black – Barclays Capital

If you look across the business, you listen to the call and it sounds like it is a one category business; denim. How many other categories are really percolating and waking up here and how many categories would still be underperforming and in that class that Joan said needs more promotion? On those that need more promotion, do you feel comfortable with the inventory levels here?

James O'Donnell

It does sound like we are doing a drum roll on the denim category but we have been very pleased with graphic t-shirts. Woven shirts, as I mentioned earlier, we have doubled the business year-over-year. The woven shirts has become much of a pleasant surprise and a major contributor in both top line and in margin. Our accessory business has been year-over-year very strong. The categories that need to continue to move forward, fleece is a good example. Both men’s and women’s fleece. We have a big bet on fleece for fourth quarter. Our women’s fleece has been meeting and exceeding our plan. Men’s is running slightly behind. We will see what happens as we get closer in. Both men’s and women’s fleece we have promotions planned around fleece.

Sweaters for holiday, as we all know, it is rather obvious it is a very key category. I don’t think we have really hit the sweater season yet. I think we will have a better read after this weekend but we also have promotions planned around sweaters which will be very compelling promotions. So they will really be the levers that will be the big driver. Denim, yes we are very pleased with denim but it is not going to be a one category company. It is rather obvious that we have got investments made in other categories of product. It really will center around graphic t-shirts and going forward in spring also women’s knits. We will hear and see more of that as we evolve into 2010.

Jeff Black – Barclays Capital

And you feel good enough about the traction in these other categories that we could theoretically see a positive comp?

James O'Donnell

I don’t want to go out on a limb on a positive comp but do I feel I have seen enough so far? The answer is yes. The real answer to the question will come as we run these key planned promotions. If they end up meeting the levels that we have set for them I think we will all be pleased with the results.

Operator

The next question comes from the line of Dorothy Lakner – Caris & Company.

Dorothy Lakner – Caris & Company

I was wondering if you could just talk a little bit more about the cadence, sort of the traffic pattern you are looking at in December if that is any different from what you have seen in previous years. I mean, clearly the Thanksgiving weekend coming up is a big one. Then I think typically we have seen sort of a lull in the first couple of weeks and your week before Christmas is big but also the week after Christmas has also been very important to you. Do you expect that to change this year? Then housekeeping could you talk about men’s performance? I think you talked about women’s early on but I’m not sure if you gave the comp for men’s and how that did. Lastly on Aerie, those lower tier stores, is there anything those have in common?

James O'Donnell

Well we will get the Aerie question out of the way. There is a common denominator. They are primarily in the smaller markets and we have looked at that very closely. When we first went out with the store rollout it was our plan, it was my plan, to have the brand represented in markets where American Eagle performed at X level which would be naturally interpreted as some of our better stores. As you know the American Eagle brand performs very well in strong B markets which are in some of what we would call secondary tier markets through the Midwest and Northeast. It has been a bit of a mixed bag with the Aerie brand.

Where we have opened in major metropolitan markets in the A centers and very strong B centers, the brand has performed very well. So that is what we are looking at right now. That is why I was out early explaining to everyone and I think hopefully you all understand where I am coming from, this is not a 600-800 store brand. I mean, this brand we will be lucky if it is a 500 store brand. I think it is right now probably looking more like 400-450 if you will throughout the United States and Canada. So I think we can be very specific about where we go and also where we don’t go.

So that is the story behind Aerie. That is really the only common denominator. That doesn’t mean that all small markets don’t perform, some do. But on average it is more of our second tier markets that have not been embraced the way that our very high profile A centers and very strong B centers, we are very pleased with the business there.

On traffic, you are kind of looking at the Jim O’Donnell play book. I happen to agree with you. I think, we will see…we don’t want to jinx this weekend, but from all the tell tale signs we have been seeing and hearing and so forth, and what happened last year this Friday, Saturday and Sunday should be quite good. The footprint and the traffic patterns should be, I think, pretty robust. Now granted it is going to be spread out over a very long period of time. Most centers are opening up at 6 a.m. You have centers now that are open 24 hours and you have other centers that are open at 10 on Thanksgiving all the way through to the following evening. So there is a real mixed bag. Some of it depends upon are we just taking the same total volume and spreading it out over longer hours or will there be incremental volume added that goes with extended hours.

I think the jury is out on that until we see what actually happens. I do think there could be a bit of a lull post Thanksgiving weekend with ramping up very dramatically 10-12 days before the Christmas holiday. Post-holiday at American Eagle, I’m sure it is others, but for American Eagle is one of our strongest weeks of the year. We will be very well prepared for that week. I think the promotion, the acceptance of promotions that we plan to run for our mid weekend business, that will be the tell tale whether we can get incremental volume more balanced throughout the month of December.

Dorothy Lakner – Caris & Company

It just seems if the traffic pattern has been inconsistent all year and the consumer has been sort of shopping that way on the weekend and not during the week, why would this December be any different from others?

James O'Donnell

I agree with you. I happen to agree.

Dorothy Lakner – Caris & Company

On the men’s business?

Joan Holstein Hilson

The men’s was down mid single digits. What happened there is while some key categories were performing well, denim, woven and graphics, we did have other categories as well in the knits that didn’t do quite as well and shorts did not meet our expectations. That is the story on them.

Operator

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

Jennifer Black – Jennifer Black & Associates

For some time now you have talked about accessories as a category and I wonder if you could talk about accessories in more detail in both men’s and women’s at all the divisions? They look much, much better. In fact, they look great.

James O'Donnell

I personally have been beating the accessories drum for a couple of years so I appreciate you asking that question. I really do. I think it is rather obvious jewelry for women has been incredible Underwear for men has been excellent. Our footwear business where we are now in with a third party vendor has been very well received. The boots have not taken off yet but we still think that season is early although we are seeing some signs that business is improving. Footwear overall has been positive and I would say our belt business has been a pleasant surprise for us.

We are looking at accessories now much more aggressively and what is it we are not in that we can be in. We devoted an additional fixture in all of our stores which is in now for holiday where we only had one accessory fixture now we are going to have two. In some of our larger stores we not only have two but we have devoted some other areas of the store, walls and so forth, have been really quite good. Then you have your winter accessories which are your gift sets of hats, gloves and so forth. Normally we do quite well with those during the holiday season. That is kind of a quick snapshot of what accessories looks like today but we are going to even be more aggressive in 2010.

Jennifer Black – Jennifer Black & Associates

What percent of your business is accessories right now for the whole company and where would you like it to be?

James O'Donnell

Right now it is about 10%. I would say it is very achievable within the next year to be even 12-15% depending upon how robust the assortment is.

Operator

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

Michelle Tan – Goldman Sachs

First, just to clarify on fourth quarter SG&A the growth is going to be in line or slightly ahead of third quarter. Is that correct? Does that imply acceleration in sales versus third quarter in fourth quarter? Then I have a quick follow-up on buying and occupancy.

Joan Holstein Hilson

The SG&A relates to recognition of the improved sales trends we have seen in the third quarter so the increment of SG&A looking at the year on low single digit we were flat in the first three quarters and then looking at the year going flat to a low single digit depending on the top line sales and business performance we would incur additional variable expenses and incentive comp accrual.

Michelle Tan – Goldman Sachs

The high end of that range assumes some better sales in fourth quarter than third quarter?

Joan Holstein Hilson

That would be correct.

Michelle Tan – Goldman Sachs

On buying and occupancy, just to understand where the leverage point is there now. It de-levered a little bit more in the quarter than I thought. I think you called out some growth in the area which I think has somewhat lower productivity, higher buying and occupancy rate at this early stage. Help us think about that buying and occupancy leverage rate going forward.

Joan Holstein Hilson

As we look at 2009 that leverage point is at a higher end of the mid single digit. As we look forward into 2010 the way to think about that is a low single digit lever point.

Operator

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

Dana Telsey – Telsey Advisory Group

Can you talk a little bit about on the talent side I understand you may have added some talent on the women’s side. How do you think about that and what changes do you see in process or how do you see it working going forward? Also, the Times Square and Garden State Plaza, those look terrific. What features from those stores could be adapted to the existing stores either in remodels or new stores?

James O'Donnell

We have made some key hires. I don’t want to put the new hires under any more pressure than they are under. We are very pleased we were able to attract a very talented women’s merchant for the American Eagle brand. She is on board and has been on board for a few weeks now. That was a major addition to our team especially in a category we have mentioned ad nauseam on how much effort we have put in and we are going to continue to put in the Women’s product. We have also added, she has not joined us yet, but we have added a very talented woman to join us as head of design for our Aerie product and we look for her to make some dramatic improvements in a line that really we are very, very pleased with now. That has just tremendous upside.

Then we have added within our team some people that are not as high profile but are talented for both today and for the future and we have a few other people in queue right now we are speaking with that hopefully if things work out we will have an announcement toward the end of the year on probably two more key hires that will strengthen our organization. We are excited about that.

As far as Times Square and Garden State Plaza, I don’t know if we are giddy but we are very excited about both of those stores. Garden State, which was the precursor to Times Square is a store that we are very, very proud of yet as you know I think you have been there, we are testing some presentations. Accessories for one; footwear for another. We are going to be adopting some of our learning’s from that store into some of our other larger volume stores and hopefully even to a greater portion of the chain.

One of the things we are taking away that are probably going to be something that can be universally beneficial to all of our stores is in some of our fixtures, especially in our higher volume stores. We have fixtures in those stores that are high capacity and are enablers for us to put large quantities of product on the floor which is an enabler for us to ensure we are not only having comparable presentations but we are also mitigating against being out of stock because of product in the stock room. What you saw as far as some of the denim presentations on the denim bar, and some of the wall treatments for denim presentation, they will be adopted primarily throughout the chain. Accessories I mentioned earlier. Some of our table presentations where we think we are onto something as far as being able to show some of our knit wear, both our graphics and some of our bare knits in a much more formable way and hopefully they will benefit with improving our top line sales cadence.

Judy Meehan

Okay everyone that concludes our third quarter conference call. Our next announcement will be November sales which we will report next Thursday, December 3. Thanks again for your participation today and have a happy Thanksgiving.

Operator

This concludes today’s teleconference. You may disconnect your lines at any time. Thank you all for your participation.

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Source: American Eagle Outfitters, Inc. Q3 2009 (Qtr End 10/31/09) Earnings Call Transcript

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