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Aeropostale, Inc. (NYSE:ARO)

Q1 2014 Results Earnings Conference Call

May 22, 2014 04:15 PM ET

Executives

Susan Lewis - VP of Investor & Media Relations

Tom Johnson - Chief Executive Officer

Emilia Fabricant - Executive Vice President

Marc Miller - Chief Financial Officer

Analysts

Dorothy Lakner - Topeka Capital Markets

Matt McClintock - Barclays

Jennifer Davis - Buckingham Research Group

Betty Chen - Mizuho Securities

Janet Kloppenburg - JJK Research

Susan Anderson - FBR Capital Markets

Randy Konik - Jefferies

Steph Wissink - Piper Jaffray

Edward Yruma - KeyBanc

Kate Fitzsimons - J.P. Morgan

Simeon Siegel - Nomura Securities

Marni Shapiro - The Retail Tracker

Paul Alexander - Bank of America

Dana Telsey - Telsey Advisory Group

Howard Tubin - RBC Capital Markets

Operator

Greetings and welcome to Aeropostale First Quarter 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions).

I would now like to turn the conference over to your host Susan Lewis, Vice President of Investor & Media Relations. Thank you, you may now begin.

Susan Lewis

Thank you all for joining us this afternoon. With us today are Tom Johnson, our Chief Executive Officer; Emilia Fabricant, EVP of Aeropostale; and Marc Miller, our Chief Financial Officer.

We issued a press release earlier this afternoon, announcing first quarter fiscal 2014 financial results. A copy of this release can be found on our corporate website.

Before we begin, I would like to remind you that during this earnings conference call, certain statements and responses to questions may contain forward-looking information, such as forecasts of future 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 Tom, I would like to remind everyone that an investor presentation covering our first quarter results can be found on our corporate website. In addition, I would like to ask everyone to limit themselves to one question during our Q&A session to allow everyone a chance to speak. Once we have gone through around the questions, we will go back and you may queue up again at that time.

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

Tom Johnson

Thank you, Susan and thank you everyone for joining us today. As other retailers have experienced, the macro environment was challenging during the first quarter with aggressive promotions, lower mall traffic, and unseasonable weather. While our overall results were disappointing, we were able to exceed our guidance and end the quarter with inventories well-controlled.

In addition, we were encouraged that our AUR was positive for the first time in seven quarters. Just a few months ago on our fourth quarter call we discussed how the retail environment is changing dramatically and consumer shopping patterns are changing fundamentally. This has been particularly severe in the teen retail sector. Mall traffic remains a significant headwind as the Gen Z customer no longer needs the mall to socialize and apparel preferences continue to focus on individuality and uniqueness. Therefore these initiatives we discussed on our year-end call remain essential to our turnaround. As a reminder, these include aligning our financial structure to position us for recovery; accelerating customer adoption; changing brand sentiment; and adapting operationally to the current retail environment. Today, I would like to provide an update on these initiatives.

As we alluded to on our last call and earlier today, our organization must adapt financially to the current retail environment. Late last quarter, we made the strategic decision to close our mall-based P.S. from Aeropostale locations. Based on changing consumer shopping patterns particularly of the mom shopper, we made the difficult decision to close approximately 125 mall-based P.S. from Aeropostale stores by end of fiscal 2014.

The future development of the P.S. brand will be focused on faster growing sales channels including off-mall locations including outlets, e-commerce and international licensing. We believe focusing on these channels will lead to a profitable business model. Additionally, we have captured savings through workforce reductions of our corporate headquarters as well as reduction in our corporate indirect spend.

While there are costs associated with both of these events as mentioned on our April 30th release, we expect to save approximately $30 million to $35 million annually beginning in 2015. Through these actions, we will be better positioned financially and operationally as we execute our turnaround. Lastly, we continue to work to finalize the transaction with Sycamore Partners.

I would now like to make a few comments regarding our performance during the first quarter. While the environment continued to be difficult and sales are disappointing, we were able to clear through carryover merchandise from the fourth quarter and end the first quarter with inventories well controlled. We also experienced strength in our sub-labels such as Bethany Mota as well as new labels, Tokyo Darling and Free State. In addition, Live Love Dream remains an important part of our sub-brand strategy and will continue to grow this year. The strength we saw on our sub-labels helped contribute to the AUR expansion we achieved in the first quarter. We believe this is an early sign that our merchandising strategies are moving in the right direction.

We look forward to expanding into additional sub-labels throughout the year as we believe this product offers our customers the differentiation and uniqueness they seek.

Aero’s brand sentiment is improving as well. Our most recent social listening score rose to 85% positive from 37% positive during the same period last year and builds on the momentum that began in holiday last year indicating the team is noticing the changes we have made at Aeropostale.

While these results are directional, we are pleased with the feedback and believe we are on the right track to accelerate customer adoption, which remains our top priority as we work diligently to change brand perception and improve sales trends.

Moving into second quarter in addition to accelerating customer adoption, we are intently focused on delivering compelling product particularly as we head into the back-to-school selling season.

This year, we're especially excited about our new brand campaign which will highlight Aeropostale in entirely new way. Our go-to-market strategy for back-to-school will target every customer touch point as we reposition our brand platform across our stores and digital channels. There will be a noticeable difference in how our brand will be portrayed. We believe this new campaign will cast a bright spotlight on all of the changes we've made to our brand as well as resonate strongly with the teen consumer.

I will now turn the call over to Emilia to elaborate on our merchandising and marketing initiatives.

Emilia Fabricant

Thank you and good afternoon everyone. As Tom mentioned earlier our teams navigated a challenging quarter as we cleared through carry over inventory in the tough retail environment. I'm pleased that we achieved positive AURs despite the highly promotional retail landscape we saw throughout the quarter. We launched two new sub-labels Tokyo Darling and Free State.

Customer response has been positive and we will continue [to push] [ph] in this product as our trend indicate a reinvigoration in the graphic business. We are also starting to see a rebound in our knit top business with our sales results more aligned with our inventory buys.

We were seeing better sales to inventory ratios in graphic there in our core three programs. In addition to the results we saw in our fashion graphic business, we also saw strength the skirts, dresses as well as sweaters and wovens for both guys and girls. Bethany Mota continues to be a standout performer and Live Love Dream continues to grow.

Our key customer preferences have changed and therefore so have we as our assortments have demonstrated over the last several months. As we approach back-to-school, we will continue to project a curated lifestyle through our merchandising and marketing to differentiate ourselves and gain market share. Our merchandise will underscore the exclusive products and choice that Aeropostale offers across the teens many moods and activities.

In addition to new sub-label tests and launches, we will be expanding into new categories within Bethany Mota and Live Love Dream. We will continue to offer our Gen Z customer authentic, unique product that no one else offers, while emphasizing quality and value.

Our marketing campaign will highlight how Aeropostale is redefining itself by blending style with current youth culture. For back-to-school we will debut a new brand platform that celebrates our teen customers’ independence and individuality. It will distinguish Aeropostale as an iconic American brand that caters to Gen Z and evokes the sense of energy and the positive spirit. Look out for the official launch at the end of the quarter.

As we discussed on our last call, in addition to our merchandising and marketing initiatives we are adopting operationally to today’s retail environment and targeting sales lift, conversions and margins. We are currently working with our outside consultants to optimize our supply chain with the focus on SKU count reduction and allocation by maximizing our in-stock position and refining our merchandising flow strategy.

We will continue to test ways to maximize conversion and optimize inventory to capture sales and margins. With each quarter, we become more educated and better equipped as we gain additional insight into our customers and the impact of our new merchandising, marketing and operational strategies. We will continue to leverage our experience, and our execution going forth will strengthen with each [event] [ph].

I will now turn the call over to Marc who will review our financial results.

Marc Miller

Thank you, Emilia. Total net sales for the quarter were down 12% versus last year, reflecting a negative 13% comp, which includes our e-commerce channel. Including our e-commerce channel, our guys business was down 12% and our girls business was down 13%.

Our comp for the quarter was driven by a 3% increase in average unit retail offset by a 10% decrease in transactions and a 5% decrease in units per transaction. During the quarter, we closed 18 Aeropostale stores and one P.S. from Aeropostale store. Accordingly we ended the quarter with 931 Aero and 150 P.S. stores.

On a GAAP basis including store asset impairment charges of 2.6 million pre-tax and lease exit cost of 0.2 million pre-tax, gross margins for the quarter were 17.8% versus 22.4% last year. On an adjusted basis, excluding these charges gross margins for the quarter were 18.5% versus 22.4% last year.

This 390 basis point decrease was driven by 140 basis points of lower merchandised margins, 210 basis points from deleveraging of occupancy, and 40 basis points from the deleveraging of other expenses on lower sales.

SG&A for the quarter was 30.2% of sales versus 27.0% last year which came in better than expected due to lower store line payroll and lower corporate expenses related to our ongoing expense reduction program as well as lower transaction related expenses.

Our GAAP operating loss for the quarter also included pre-tax restructuring charges of 30.5 million related to store asset impairment charges resulting from the planned closure of our P.S. mall based locations and other restructuring charges of 4 million. On a GAAP basis, the tax rate for the quarter was 8.4% versus 41.2% last year. On an adjusted basis the effective tax rate for the quarter excluding restructuring and other charges was 11.3% versus our original expectation of 13% and versus 41.2% last year.

This resulted in a net loss of approximately 76.8% or $0.98 per diluted share. On an adjusted basis excluding P.S. impairment charges and all restructuring and other charges, the net loss for the quarter was $41.1 million or $0.52 per diluted share

Cash and cash equivalents at the close of the quarter were $24.5 million and short-term borrowings totaled $8.5 million under our current credit facility. Inventory at the end of the quarter was down -- inventory at the end of the quarter was $173 million, down 4% in total or down 3% on retail per square foot basis.

Our capital expenditures for the year were approximately $8 million, and depreciation and amortization was approximately $15 million. On our last earnings call, we spoke to three financial strategies: Maintaining appropriate levels of liquidity; optimizing our real estate portfolio; and managing our expenses prudently. I'll now provide an update on each.

Our first financial priority continues to be maintaining appropriate levels of liquidity. We have sufficient liquidity to work through our working capital needs with our $230 million revolver. In addition as Tom mentioned, we're continuing to work to finalize the transaction with Sycamore Partners regarding the $150 million capital infusion. And later this quarter, we also expect to receive the tax refund which will add approximately $45 million to our cash balances. As always, we will continue to manage our working capital tightly, which includes buying inventory down double-digits for the second and third quarters of 2014.

With respect to our real-estate portfolio, we expect to close approximately 40 to 50 Aeropostale stores in 2014 as part of the 175 stores that are being considered under our current store closure program. Including our plan to close the P.S. mall-based locations, our store closure program has expanded to approximately 300 stores.

Our real-estate consulting firm continues to evaluate the portfolio and negotiate on our behalf regarding potential early lease buyouts, potential rent relief and acceleration of store closures.

As Tom mentioned earlier, we did announce our comprehensive cost reduction plan on April 30th. Between the closure of the P.S. from Aeropostale mall-based stores and our expense reductions, we expect to generate approximately $5 million to $10 million in savings in 2014 and approximately $30 million to $35 million annually, starting in 2015. We will continue to manage cost carefully as we work to improve results.

I will now discuss our second quarter outlook. In May, while we are experiencing higher AURs and margins versus last year, transactions remain challenging. We expect the promotional environment to continue throughout the quarter and into the back to school season. We believe we are appropriately positioned for the competitive environment given our well controlled inventories at the end of the first quarter, conservative inventory buys and sequential improvement of average unit costs as we progress throughout the year.

As we noted in our prior call, we utilized the vast majority of our tax carry-backs during 2013. We currently expect the tax rate for the second quarter to be approximately 10%. Accordingly on a non-GAAP basis, we are initiating guidance for the second quarter of 2014 at an operating loss range of $49 million to $54 million which ties to a loss of $0.55 to $0.61 per diluted share at this 10% tax rate and a share count of $79.1 million.

This guidance assumes negative double-digit comps and SG&A dollars approximately flat. This guidance excludes the impact of any consulting fees, accelerated store closings, the financial or accounting impact including interest expense and professional fees related to the Sycamore transaction and the financial or accounting impact related to the P.S. small-based store closings.

As we mentioned on the last call, we expect 2014 capital expenditures to be approximately $22 million. We’re opening seven Aero stores, primarily located in highly productive outlet centers and one P.S. store in an off-mall location. We will also remodel approximately 10 stores, either partial or full compared to the 32 full remodels completed in 2013.

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

Tom Johnson

Thank you, Marc. As I said in my earlier remarks, we made a number of important developments -- we've had a number of important developments during the first quarter of this year. Some of these developments were difficult for our organization as we restructured our P.S. strategy and realigned our corporate expense structure. That said, these steps position Aeropostale more strongly as we continue executing our transformational strategies.

I also want to take this opportunity to thank all of our employees who have contributed to Aeropostale turnaround plans for their diligence and dedication. The heart and soul of the team remain uncompromised and we’re more determined than ever to return Aeropostale to profitability.

Before I turn the call over to the operator for questions, I’d like to remind everyone of my comments earlier in the call regarding our discussions with Sycamore. We will not be commenting any further on Sycamore at this time.

Operator, we’re now ready for questions.

Question-and-Answer Session

Operator

Thank you. At this time, we’ll be conducting a question-and-answer session. (Operator Instructions). Our first question comes from Dorothy Lakner from Topeka Capital Markets.

Dorothy Lakner - Topeka Capital Markets

Thanks, and good afternoon everyone. Just wanted to perhaps to hear a bit more from Emilia on kind of the composition of the assortment, where you are now in terms of brands versus everything else? How many brands will you have added for back to school, are there more coming in the back half? And just in terms of how you feel in terms of moving the needle on that the very big sort of knit, knit tops graphics component of the mix?

Emilia Fabricant

Sure, as far as the sub brands we had said on the last call and it continues to be relevant, right now we are targeting about 15%, however we’ll grow the sub brands organically based on the demand and the performance. Yes, there is a couple of more coming, I am not going to get into that based on competitive -- that we are on this call and it’s public, but we believe that while the sub brands were very happy with the performance of the sub brand we are also seeing Aero knit tops performing as well. So it’s not just based on sub brand it’s based on the overall knit top performance. And as far as capitalizing on the early reads that we are seeing in knit tops, it is the area that we are keeping the most open and we are targeting very fast chases and the 21 to 121 day lead time knit tops are more towards the 21 to 45 day lead time so we have been able to capitalize on current trends.

Operator

Thank you. Our next question comes from Matt McClintock from Barclays.

Matt McClintock - Barclays

Hi, good afternoon everyone. Emilia, I was also wondering if we could focus a little bit more on the sub-brands to. Just so we can maybe understand how this is a little bit more differentiated than historically how you merchandise and plan product. Maybe could you walk us through your vision for Tokyo Darling, how you came up with the idea for that, how you saw an opportunity in the market for that, maybe just walk us through the process specifically for Tokyo Darling? Thank you.

Emilia Fabricant

Sure. I mean the whole idea for sub-brands, while we're staying true to our brands, we know the teen have an appetite for choice and fashion and part of the sub-brand strategy is giving the teens choice and Tokyo Darling is one of those elements. I'm not going to get into the strategic growth of these Tokyo Darling again for competitive reasons, but currently it is part of our fashion graphic assortment, we're very pleased with the performance and we'll continue to pulse it through the assortment going forward into back-to-school.

Tom Johnson

And Matt I would just add to that, one of the great benefits of the sub-brands strategy that Emilia’s put forward is that many times, the styles that we're carrying under the sub-brands unable us to realize higher average unit retails than we ordinarily get under the Aeropostale brand and as such these sub-brands are typically carrying a higher margin architecture.

Emilia Fabricant

Last thing I would add is the success of the sub-brands really speaks to how we are gaining creditability in the fashion area of our business.

Operator

Thank you. Our next question comes from Jennifer Davis from Buckingham Research Group.

Jennifer Davis - Buckingham Research Group

Hi. I was hoping to get a little more clarity around, I guess if you saw kind of an improvement in April and if comps are in that low double-digit range right now. And then also I was wondering, we do a lot of store checks and we saw that it seems like you’ve pulled clearance out of some stores and some of the stores that looks like clearance is pulled out of are maybe some stores in C level malls that actually drive a big clearance business. So I was just kind of wondering about the logic behind that? Thanks.

Marc Miller

Sure Jennifer. As it relates to the multi cadence of comps, what I see in Q1 is we saw a real deceleration in March, both as a combination of the Easter shift as well as bad seasonal weather trends. Of the three months, April was the least negative comp month of the quarter. I won't comment more than what I said in the upfront remarks about Q2 today other than to say that, reiterate what I said earlier that the transactions remain challenging, but both AURs and margins are up.

Emilia Fabricant

So, as far as the markdowns in some stores, because of size of the store, size of the back room we do eliminate sales, but it's not something that we are doing differently today than yesterday.

Operator

Thank you. Our next question comes from Betty Chen from Mizuho Securities.

Betty Chen - Mizuho Securities

Good afternoon everyone.

Tom Johnson

Hey, Betty.

Betty Chen - Mizuho Securities

Hi, I was wondering if you can talk a little bit about P.S. now that we're going to be divesting the mall stores, how should we think about the sales and profitability contribution of the remaining businesses. And what were you seeing in those channels versus the mall?

Tom Johnson

Sorry, you're breaking up a little bit Betty.

Betty Chen - Mizuho Securities

Sorry, you go ahead if you could comment, I'll follow up with that question later.

Marc Miller

Okay. As it relates to the strategic decisions we’ve made about P.S., clearly we looked at our overall store portfolio of a 150 stores and we have within that group a profitable subset of stores which happen to correlate with our off-mall business. So, as we’ve mentioned in the April 30th release, 125 stores that we’re exiting carry 4-wall losses of approximately $15 million but the remaining 25 are profitable on a 4-wall basis. In addition, the other two channels that we highlighted, P.S. e-com has always been a positive contribution margin business as well as international which we expect to see some rapid growth in that channel.

So, this will be a transition year to be clear as we exit those 125 stores but as we reposition for 2015 on the basis of three individual channels that are each by themselves contributing positive operating margin contribution, we believe we set a strong foundation for a profitable P.S. business.

Tom Johnson

Yes, Betty, and we think that as we mentioned in the upfront remarks that the mom shopper in particular has defected the shopping experience of the mall for her kid. And our market research continues to tell us that that kind of movement and migration is getting more and more severe. So we just think that it makes a lot of sense for us as Marc said, not only financially but from a brand positioning for the future and the growth of that brand. We feel very good about this brand. We think that there is space for this great kids’ brand. And, but as Marc said, growth is really in the areas of off-mall as well as international e-commerce. So, make no mistake, we still feel good about the brand but we just want to make money and that’s our goal.

Operator

Thank you. Our next question comes from Janet Kloppenburg from JJK Research.

Janet Kloppenburg - JJK Research

Hi, everybody.

Tom Johnson

Hey Janet.

Janet Kloppenburg - JJK Research

Hi. So, it seems to me that the reason the comp has remained so challenged is that the traffic continues to be down significantly and that’s hurting the transaction. So, I am wondering what you guys are thinking about in terms of strategies to improve traffic to the stores and maybe to help the customer understand how the brand has changed and for the brand to better relate or resonate with the fashion customer? Thank you.

Tom Johnson

Sure Janet. Without a doubt the mall traffic has been inconsistent at best and difficult at worse. The reality -- and look, all of us are experiencing the same thing and the teen sector is just a tough place to be as we all know. But we are actually encouraged by the some of the data that we cleaned out of the first quarter. The A malls for us are out trending the Bs and Cs. Actually from an income level, the higher income consumer group actually performed very nicely overall. So we think that some of the changes that we’ve made are starting to take hold and resonate.

Specifically to the question of turning traffic for us, we know that we just have to get the word out in a more aggressive way. The social media that we have impacted, it’s been extraordinary and team has done an excellent job of pushing the social medial throughout all different avenues and channels for us. And we’ve gotten quite a bit of great buzz on that. We’re very proud of that fact. So we are going to continue to push social media to the limits and we feel great about that. We also have this extraordinary brand campaign for back to school which Emilia spoke of a few minutes ago. And that is really an opportunity for us to get the word out that we’ve changed significantly.

And additionally, we have in our typical way; we have some grassroots or grow work rather that we're planning on attacking for the back half of this quarter and the beginning of the next quarter. So we definitely have to get the word out. The people that are coming in as we have done intercepts and we continue to do that to test the viability of what we're doing, the people have been coming in say, it is really terrific and we really like what we see. We just, no question about it, you hit the nail on the head as usual we just got to get more people in the door.

Emilia Fabricant

Yes, I mean the only thing that I would add is traffic continues to be tight and tough. We're focused on maintaining our inventories and control and we believe we're going to gain more market share. There is market share to be had and we're focused on getting it.

Operator

Our next question comes from Susan Anderson from FBR Capital Markets.

Susan Anderson - FBR Capital Markets

Hi, thanks for taking my question. I was wondering if you could elaborate on just what's going to be driving the lower AUCs for the rest of the year. And then on the Bethany Mota product, I know it's been kind of not on sales for a while in the stores, so I just want to maybe get some color on the response from the consumer, any push back just by not promoting it. It sounds like it's been going really well. Thanks.

Marc Miller

Sure Susan, I'll take the lower AUCs. As you know, we have a dynamic bidding process with all of our vendors and what we also have is the benefit of hindsight from last year deliveries where for the first time we were delivering merchandise assortments that were in this new fashion direction. As we've incorporated those learnings, understood where the wins are especially from a margin perspective and as well brought there the full set of vendors bidding against those products. We have been able to achieve lower AUCs for Q3 and we anticipate the same for Q4, [this in the side], Q2 AUCs will be up low-single-digits, but that is a lower rate of increase than what we saw in Q1 or in Q4 of last year.

Emilia Fabricant

Yes, the only thing I would add is we're going to see those AUCs improve across all three buckets for fashion basics and fashion.

Tom Johnson

And as far as the Bethany Mota and the reaction to the product from a pricing standpoint. We've actually experienced very nice sell throughs with Bethany and there has been very little resistance to paying that, the product has performed nicely overall and it just kind of reinforces the fact when the product is right, the fashion is on, the people buy it.

Emilia Fabricant

And the feedback we've gotten from the mom and the teenagers is that it's priced well for the product.

Operator

Our next question comes from Randy Konik from Jefferies.

Randy Konik - Jefferies

Hi, can you hear me?

Tom Johnson

Yes, Randy.

Randy Konik - Jefferies

Hey, how are you? So I guess the question is can you give us the various the differentials in AUR between the sub-branded product versus the non sub-branded product. And is there any kind of color between I guess the non-sub-branded products where the performance differential between how product that has the label for the Aeropostale or the logo on it versus more the product that doesn't? I'm just trying to get some perspective on the different types of your business in the basics area are performing when you are taking the label off and AUR differentials and [turn] differentials?

Emilia Fabricant

Sure. The AUR improvement is actually across the board. When it comes to the logo product, we believe we've rightsized the product and we're seeing an increased AUR and increased margins. We're not obviously making up for the decline in the business yet, but we are seeing those improvements and believe we've rightsized the products the inventories accordingly. So it really is across the board.

Tom Johnson

Yes, Randy, the first couple of questions in your question really kind of centers around to sub-brands and the strategy. Emilia talked about it a minute ago I will just kind of reinforce it again is that we continue to hear these kids want choice and we know that as an opportunity we wanted to give them more choice. And that we absolutely don’t believe that the Aeropostale brand is the damaged brand, but it’s really about adding newness. These guys want a sense of discovery and they love discovering new things. So it’s very interesting, some of the smallest things in our store right now which is the Tokyo Darling, the very small subset within the store. But we’ve got tremendous social buds because these kids discovered it at Aeropostale.

So we think that it creates this halo if you will around the brand. So we’re not walking away from the Aero brand. We absolutely think that this fits in to kind of the lexicon of our brand and understanding that we want to attract more kids into the brand as we move forward. And if you notice a lot of those new brands or the new sub-labels are in the mid category. So we feel really good about pushing the mid business, because as guys know if the mid business is right, the margins come and there is a lot of good things to come with that.

Emilia Fabricant

Yes. I want just reiterate that we’re seeing success not only in the sub-brands in the mids but also in the Aero on the top.

Tom Johnson

Yes.

Operator

Our next question comes from Steph [Winsik] from Piper Jaffray.

Steph Wissink - Piper Jaffray

Hi good afternoon everyone. I wanted to spend some time on the e-commerce business. I think you’re one of the very few that’s reported an e-com decline in excess of your comp. If you can just talk Emilia about some of the strategies there to [try spread] that business can we bring it more in line with the stores pace? Thank you.

Tom Johnson

Sure Steph. I will take the first part and I will flip it to Emilia. It’s interesting, we have obviously, we are disappointed with the run rate in the e-com business and what’s very interesting is that we modeled the last year or so by month, by quarter to understand the inflection in the business and how it’s changed and actually our e-commerce business was outperforming pretty significantly in the first half of last and the reaction to our graphics business, it’s more detail than you need but I am going to give it to you.

The reactions to the graphic business at the store level was much more severe in terms of negative and flees than it was kind of online and then as we got into the second half of the year there is a bit of a reversal. So we think there is a bit of a lag there. We think that there is the customer that shops online historically has been somebody that’s been more driven with regard to just core programs and kind of very strong pricing if you will and we’ll continue to offer that to them. But we think that there is a bit of a lag that’s happening. And some of the things that we have looked at, we are going to change some of the look and feel of the website. We are focusing on mobile and tablet and the teams are doing some nice jobs to impact that to accelerate the recovery and e-com as well.

The other thing that we did from strategic standpoint is that we have now aligned all channels under Emilia. And we have moved the e-commerce business directly under Emilia and integrated that with her merchants. So we feel good about the e-com team working hand in hand with the merchant team and they are one team right now.

Emilia Fabricant

And what that really does is allows -- we shift very quickly in the middle of a [streams]. And then by aligning the merchandising teams we are going to be seamlessly executing along all customer touch points and with one vision and one message.

Operator

Our next question comes from Edward Yruma from KeyBanc.

Edward Yruma - KeyBanc

Hi, thanks very much. When you guys did the press release and appears restructuring, I think you said that you would have a $25 million to $40 million cash hit do the restructuring. I guess with the incremental ARO stores. How should we think about cash restructuring costs this year? And then as a follow-up given your guidance for 2Q, what kind of cash burn does it in that? Thanks.

Tom Johnson

On the April 30th release, we did speak about cash expenses related to all the expense savings initiatives that we announced that they. So that was both the P.S. strategic decision as well the organizational reduction enforce that we did as well as our programs to pursue indirect spend savings and that was the total of 25 million to 40 million per lease exists.

We've never separately quantified the amount of money that we budgeted for accelerated lease exists as it relates to the Aeropostale stores. The 40 to 50 that we anticipate closing for this year were virtually all on natural lease exploration or on kick outs. So there is a very modest level of cash expenditure related to those. And the expenditures that we ultimately want to paying early these exits will be product negotiations between us and our landlords and it’s just too early to comment on that at this time.

The second question you asked related to rate of cash burn. And if you were say normalize Q1 cash burn at about 70 million and I get there by extracting double rent payment that's left into Q1 from Q4 due one day's timing. We went up with about a $70 million cash burned in Q1 and we expect to be roughly similar in Q2. That said; against that $70 millionish in cash burn in Q2 that we anticipate, we do expect to receive a $45 million tax refund which will offset some of those or cash balances.

Operator

Our next question comes from Brian Tunick from J.P. Morgan.

Kate Fitzsimons - J.P. Morgan

Yes, hi. This is Kate on for Brian. Thanks for taking my question. Just wanted to get your sense on inventory, you said it was down 3% per square foot, but comps were down 13%, just trying to rationalize that with your commentary that inventory is clean. Was it down on a unit basis? And then also is that you’re bringing it down double-digits into the back half, just wanted to get your sense as to what kind of comps that you support, should we think about comps being down double-digits in the back half? Thank you.

Marc Miller

So a little more clarity on inventory: It was 3% on a dollars basis; it was a 6% on unit basis; and as we sit here in May based on our reduced buys going forward, we are even lower than those two numbers. The idea of our back half inventory buys as we said, we have been conservative. We haven't really spoken to Q4, but Q3 we mentioned, we'll rebound mid-teens double-digits. And we have the ability through kind of open to buy and chase to chase after a trending classification. So, while we hit that target in our initial buy plans, as we see opportunities materialize, Emilia and her team will be starting to chase if there are emerging opportunities.

Emilia Fabricant

Yes. And I would add that the mid to up that we've had left us for chase, we have triggered those and are in the process of filling those as we speak.

Operator

Our next question comes from Simon Siegel from Nomura Securities.

Simeon Siegel - Nomura Securities

Great thanks. Hey guys, good afternoon.

Tom Johnson

Hey Simon.

Simeon Siegel - Nomura Securities

As the gross margin declines get smaller, what’s the right way to think about normalized margins and any thoughts on when that line could turn positive, so what’s the right way to think about that over next year? Thanks.

Marc Miller

Yes. So, in Q2 we do expect to see sequential improvement in merch margins. Already in Q1 at negative 140 merchandise margin decline that is our least negative number in a year. And as we get the benefit of average unit costs normalizing as well as the fact that we enter Q2 in a much cleaner inventory position not just in terms of total units but even in terms of composition, we have less markdown inventory in that beginning Q2 inventory.

Those factors combined will definitely lead to sequential merchandise margin improvement. I mentioned upfront that May to-date, our merchandise margins are actually up versus last year and we do believe we have the possibility for the entire quarter to sustain merchandise margins that would be up versus LY. And clearly, as we start to approach the back half of the year where we have inventory wise continue to be tightly controlled as we talked about, the benefit of the AUR reductions, the impact of the SKU reductions that Emilia spoke to upfront in her remarks as well as some of the allocation initiatives which will allow us to be better in stock in the right store groups for different product classifications as well as the benefits of just changes in our merchandise composition, we believe we have a pretty fulsome set of initiatives that will help to drive merch margin improvements both up versus LY as well as sequential improvement quarter-by-quarter throughout 2014.

Operator

Our next question comes from Marni Shapiro from The Retail Tracker.

Marni Shapiro - The Retail Tracker

Hey guys.

Tom Johnson

Hey Marni.

Emilia Fabricant

Hey Marni.

Marni Shapiro - The Retail Tracker

Hey. Can I just get a quick update on international which you seem to be a little quiet about? And Go Gene which I know is tiny but looks very different than you still, little more promotional but sexier, edgier just generally cooler?

Tom Johnson

Absolutely, Marni. International actually was a great story in Q1. We drove about $7.5 million in revenue in Q1 and over 90% of that fell through to or approximately 90% fell through to operating profit which is a big gain over LY which driven mostly by the fact Mexico was part of our business this year where as it wasn’t in Q1 last year, we did open 26 stores. Overall, we are very pleased with the growth that we are seeing in the international business. Now represents between 1% and 1.5% of total sales but with the way that those sales flow through to operating margin of that 90% rate, it’s a very lucrative business. And just to put it in context, we opened up about 26 stores in Q1 on a base of about 100 at the end of Q4. We expect the remainder of the year to open up about 50. So you should continue to see nice growth in that channel versus LY.

And in addition, one of the biggest drivers of that kind of incremental store growth is the fact that we’ll be launching in a big way our P.S. stores in Mexico for back to school. It will be very similar to the launch we had for Aeropostale for back to school last year. So that’s international. On Go Gene, clearly we have become a little bit more promotional in response to some of what we are seeing out there with our online competition, particularly on the apparel side. But the team has worked really hard to kind of increase the brand relevance and freshness and they are kind of working with new marketing and new internal talent on that front, which I think is really helping to drive that business. So, we're excited about the changes that are being at Go Gene as well.

Operator

Our next question comes from Paul Alexander from Bank of America.

Paul Alexander - Bank of America

Hi, thank you. Could you talk a little bit about Live Love Dream? You mentioned it was growing and important but you didn't mention it as being strong as some of the other sub-brands. And then on sustainability of some of these sub-brands like Bethany Mota, how long can you continue to work with her and is she continues to be one of the outperformers in your store? Are you afraid there could at some point be fatigue with that line or that she might want to strike out on her own?

Emilia Fabricant

As far as Live Love Dream, we are very happy with the Live Love Dream business. It does have an emotional connection directly to the teen age girl, she loves it. What we do think the opportunity for Live Love Dream is, we are now anniversary coming in July the launch of the brand and we definitely have learning from the separate categories and their strength in different seasons. And we will be capitalizing on that and gaining profitability there on top of a very successful launch. So we believe that Live Love Dream, it has been successful, we will continue to even be more successful in the time to come.

As far as Bethany Mota, she is a great partner. We intend to work with her go forward. I'm not going to get into the specifics of our agreement. But we are expanding her line and feel that there is -- we're launching the Bethany Mota fragrance collection coming in August in back-to-school. And so, we believe there is a -- much more we can do with Bethany and her customers.

Operator

Our next question comes from Dana Telsey from Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Hi. Good afternoon, everyone.

Tom Johnson

Hi Dana.

Dana Telsey - Telsey Advisory Group

Hi. We’re hearing more about the potential West Coast port strike. As you prepare for third quarter and it's going back to back -- back-to-school, how are you preparing for that? And can you give us any update in terms of when you think about inventories in your balance sheet, what -- any restrictions on the balance sheet side in terms of inventory planning or any of the reduced CapEx spend that you have? Thank you.

Tom Johnson

Sure Dana. As far as the strike is concerned, you know how these things go from season to season; there is different noise in the channel. We continue to always have backup plans and are able to flex our muscles a bit, because we have ability to receive on either coast. So, stay tuned and it's one of the things, stay tuned as far as -- your second question, Marc will hit it.

Emilia Fabricant

Yes. We just experienced a strike in Canada and we're able to work with our vendors really closely in getting the merchandise to the stores. So, I mean we have plans in place in these certain situations and we'll continue to leverage the partnership that we have with our vendors.

Marc Miller

And then as it relates to inventory and restrictions on inventory, certainly from a liquidity standpoint, there are no restrictions. We have that $230 million revolver under it. The amount that is available does flex a little bit with the total underlying inventory base but nothing that would prevent us from going after whatever inventory buys we're looking for and as well nothing that restricts our capital expenditures that's only our discretion.

Operator

Thank you. We have time for one more question. Our last question comes from Howard Tubin from RBC Capital Markets.

Howard Tubin - RBC Capital Markets

Hey guys, thanks. Well, if you could just talk for a second about the bottom spaces in general, I mean more specifically denim and how the denim is coming less important to your customary, would you (inaudible) or not?

Emilia Fabricant

Well, I mean I think the core business is still important; there is the [jiving] that’s still important. We came off of Q4 in a very tight sizing position; we mentioned it on the last call. We will be back in size position in July, at the beginning of July which I think will help our denim business. I believe we’ve rightsized it and put allocation and replenishing strategies in place that will make it more efficient and profitable. We are seeing the bottom business to be more diverse. We’re selling skirts extremely well, we’re selling legging, we’re selling woven bottoms and shorts. So it’s not just about denim, we’re seeing it across many categories. Again it comes up to the girl, the teenage mid girl, the choice and differentiation.

Operator

Thank you. I’ll now turn the call back over to the company for closing comments.

Tom Johnson

Thank you everybody for joining. We appreciate your continued support. And as you guys know, the teen retail environment is kind of challenging right now but we absolutely believe we’ve laid a great foundation. We’ve made fundamental changes in our brand and even our operating model in many levels to do the things that we know that we need to do to move this business forward to continued growth and future profitability. So, we appreciate your continued support and we look forward to talking to you in a few months. Thanks. Take care.

Operator

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Aeropostale's (ARO) CEO Tom Johnson on Q1 2014 Results - Earnings Call Transcript

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