Aeropostale Management Discusses Q2 2012 Results - Earnings Call Transcript

| About: Aeropostale, Inc. (ARO)

Aeropostale (NYSE:ARO)

Q2 2012 Earnings Call

August 16, 2012 4:15 pm ET

Executives

Kenneth Ohashi - Vice President of Investor and Media Relations

Thomas P. Johnson - Chief Executive Officer and Director

Marc D. Miller - Chief Financial Officer and Executive Vice President

Michael J. Cunningham - President and Director

Analysts

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Betty Y. Chen - Wedbush Securities Inc., Research Division

Janet Kloppenburg

Brian J. Tunick - JP Morgan Chase & Co, Research Division

Randal J. Konik - Jefferies & Company, Inc., Research Division

Kimberly C. Greenberger - Morgan Stanley, Research Division

Dana Lauren Telsey - Telsey Advisory Group LLC

Anna A. Andreeva - FBR Capital Markets & Co., Research Division

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

Dorothy S. Lakner - Caris & Company, Inc., Research Division

Roxanne Meyer - UBS Investment Bank, Research Division

Eric M. Beder - Brean Murray, Carret & Co., LLC, Research Division

Evren Dogan Kopelman - Wells Fargo Securities, LLC, Research Division

Marni Shapiro - The Retail Tracker

Jennifer M. Davis - Lazard Capital Markets LLC, Research Division

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

John D. Kernan - Cowen and Company, LLC, Research Division

Howard Tubin - RBC Capital Markets, LLC, Research Division

Jaime M. Katz - Morningstar Inc., Research Division

Linda Yu Tsai - ITG Market Research

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

Operator

Thank you for joining us for the Aéropostale Conference Call to review second quarter 2012 financial results. [Operator Instructions] I would like to remind everyone that this conference call is being recorded. I would now like to introduce Ken Ohashi, the company's Vice President of Investor and Media Relations.

Kenneth Ohashi

Thank you all for joining us this afternoon. With me here today are Tom Johnson, our Chief Executive Officer; Michael Cunningham, our President; and Marc Miller, our Chief Financial Officer. We issued a press release earlier this afternoon announcing our second quarter fiscal 2012 results. A copy of the release and corresponding presentation can be found on our corporate website.

Before we begin, I would like to remind you that during this earnings conference call, certain statements or responses to any questions may contain forward-looking information, such as forecasts of future performance. Forward-looking information and statements involve known and unknown risks and uncertainties, which may cause our actual results 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 to this call are referred to those filings. [Operator Instructions] I would now like to turn the call over to Tom.

Thomas P. Johnson

Thank you, Ken. Good afternoon, everyone, and thank you for joining us today. I'd like to take you through some of the highlights for our second quarter, and then I'll turn the call over to Marc, who will take us through the financials.

During the quarter, we focused on integrating fresh and relevant fashion into our assortment, in addition to launching new and exciting marketing campaigns, communicate a stronger lifestyle message to our consumer.

Similar to the trends we experienced in the spring season, our girl customer continued to respond positively to newness in silhouettes, fabrics and details. We experienced strong sell-throughs in key categories such as fashion tops, colored and printed denim, wovens and accessories.

In Men's, we continue to experience success with our broadened assortment, including short sleeve knits and wovens. Overall, our fashion categories experienced positive comps and an improvement in our average unit retail and gross margins versus last year.

While we are encouraged by the customer response to our fashion that was supported by our broader marketing initiatives, our core basics business, which includes graphics, polos and printed camis, was under significant pricing pressure. As result, we had to promote these businesses more aggressively than initially expected to end the quarter with inventories in line with our plan.

Unfortunately, these competitive pricing pressures on our core basic business has accelerated into the early back-to-school season. And we believe that both our top line and margins will be under pressure for the remainder of the third quarter. While our financial performance is clearly not up to our expectations, I believe we are focused on the right initiatives to improve our business. I'd like to review these initiatives with you in greater detail.

First, injecting more fashion into our assortment. A year ago, we had limited amount of fashion in our stores. Today, we're projecting fashion throughout our store and in our marketing, and it's resonating with our customer. To build on our progress, we continue to refine our offering while also developing and making larger investments in our fashion basics category, which fills a gap between our fashion and core basics. We believe our focus on introducing more fashion basics will allow us to strike the right balance of merchandise within our overall assortment to meet customer demand.

In our core basics category, we will continue to update our offering while leveraging our volume and buying efficiencies to remain competitive. Second, enhancing processes and technology. We're implementing new processes and investing in new technologies that will enable us to chase bestsellers and increase our speed to market. Additionally, we will further optimize the allocation of our assortment by mall type and store profile, based upon the appetite for fashion in each of our stores.

Third, the projection of our brand proposition. We are continuing to increase the projection of our fashion and lifestyle proposition to the consumer, balanced with our traditional hard-hitting promotions. As you may have seen for back-to-school, we launched an exciting new campaign featuring actress Chloe Grace Moretz. We believe that Chloe, who has quickly become a fashion icon for today's teen, is the perfect role model to showcase our new looks. Moving forward, we will continue to deliver similar fun and exciting marketing campaigns that both connect with our consumer on an emotional level and our call to action.

Finally, investment in future growth drivers. Our P.S. and e-commerce businesses continue to post solid top line results. And we're forging ahead aggressively with our international expansion plans. We recently signed agreements with licensing partners to open up stores in Colombia and Panama. While we all understand that progress takes time, our entire organization is aligned and committed to executing on our strategic initiatives with a sense of urgency and determination.

I would now like to turn the call over to Marc, who'll take us through the financials.

Marc D. Miller

Thank you, Tom. Before I begin, I'd like to remind everyone that the following information can be found in the Investor Presentation that was issued in conjunction with today's press release. Total net sales for the quarter were up 4% versus last year, reflecting an average square footage increase of 4% and an essentially flat comp, which includes our E-Commerce channel. Including our E-Commerce channel, our Guys and Girls businesses were both approximately flat for the quarter.

Our comp for the quarter was driven by a 5% increase in units per transaction and offset by a 4% decline in transactions and a 1% decrease in average unit retail. During the quarter, we opened 7 Aero and 15 P.S. from Aéropostale stores and closed 4 Aero stores, ending the quarter with 989 Aero and 96 P. S. from Aéropostale stores.

Gross margins for the quarter were 25.3% versus 24.4% last year. As a reminder, the second quarter of fiscal 2011 included a pretax benefit to our gross margin of 170 basis points resulting from the resolution of a dispute with one of our sourcing agents. Excluding this item, gross margins for the second quarter of fiscal 2011 were 22.7%. The 260-basis point increase in gross margins was driven primarily by higher merchandise margins.

SG&A for the quarter was 25.2% of sales versus 23.2% last year. The 200-basis point increase was driven primarily by deleverage from corporate store line and increased E-Commerce transaction-related expenses due to growth in that business, as well as deleverage from marketing expenses due to planned brand investments that we disclosed in previous quarters.

Our tax rate for the quarter was skewed due to a low pretax income and adjustments to derive the year-to-date rate. This resulted in net income of approximately $0.1 million or $0.00 per diluted share. Cash and cash equivalents at the close of the quarter were $170 million versus $73 million last year. We currently have approximately $145 million of buyback availability remaining under our share repurchase program. Program to date, we have returned over $1 billion to shareholders in the form of 57 million shares repurchased.

Inventory at the end of the quarter was $247 million, down 1% in total or down 6% on a retail per-square-foot basis. Our capital expenditures for the quarter were $21 million and depreciation and amortization was $15 million.

I will now discuss our guidance outlook. As Tom mentioned earlier, our core basics business continues to be impacted by the heavily promotional and competitive retail environment. As a result, we believe that both our top line and margins will be under pressure for the remainder of the third quarter. Accordingly, we are providing third quarter guidance in the range of $0.25 to $0.30 per share. This guidance assumes a share count of 81.7 million and an effective tax rate of approximately 40%.

Regarding SG&A and inventory procurement, our plan is to manage our expenses carefully and our inventory prudently for the remainder of the year.

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

Thomas P. Johnson

Thank you, Marc. I'd like to thank the entire Aéropostale team for their continued hard work and dedication. Our team's responding to the changing needs of our consumer faster than ever, and they're interpreting current fashion trends while maintaining the spirit of the Aéropostale brand. The acceptance of our fashion offering truly underscores the opportunities that lie ahead.

While we are not yet achieving the level of consistent performance we strive towards, we remain confident in the strength of our business model and our unique positioning in the teen retail market. Aéropostale continues to be a highly productive, well-respected and vibrant brand with a solid platform for growth. We thank you all for your continued support.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Adrienne Tennant of Janney Capital markets.

Adrienne Tennant - Janney Montgomery Scott LLC, Research Division

Tom, my question for you is about the fashion content. The -- that part of the store looks great, just doesn't look like there's enough of it. It comes in, it turns, it sells out. And so I'm trying to figure out what proportion of it, of the floor set was it in spring? What is it now? And what should it be? And at what point in time? And then, really quickly for Marc, can you just give us an AUC update? Is it still negative, mid to high single-digit for the back half of the year?

Thomas P. Johnson

Yes, Adrienne. Yes, we agree with you in terms of the look and feel of the store. We're very proud of our fashion offering, and it is checking as you said. Clearly, the first half of the year, as we had commented earlier this year, that we bought fashion light, and we've made a bit bigger bets in the back half the year, and certainly reading and reacting as quickly as we possibly we can to bestsellers. As a matter of fact, we had some really great sales in the beginning of the year. We read and reacted to that business, reordered for the back half of the spring. And we did the same thing going into the holiday trading period. So we feel good about that. And it's really an iterative process for us. The more we see the appetite of our customer and her response to our fashion, the more confidence that we feel at investing into our fashion. So as you -- as we head into the back end of fall and holiday, you'll see a bit larger bets placed on our fashion. I'm not going to get into the proportions, but the opportunity for us continues to be growing that fashion quotient.

Marc D. Miller

Adrienne, on the average unit costs, as you said, it is down back half negative mid-to-high single digits, and it's pretty consistent about -- across Q3 and Q4.

Operator

The next question is from Betty Chen of Wedbush.

Betty Y. Chen - Wedbush Securities Inc., Research Division

I was wondering if we could get a little bit more color around gross margin SG&A. I know at the start of the year, you talked about several different investments on -- that you were looking to make and certainly we saw some of that marketing continue in the second quarter. Should we continue to expect SG&A growth rate to be similar to the run rate that we saw in the first half in Q3 and as well as Q4? And now that we do have AUC coming down mid-to-high singles, how should we think about gross margin? Can we recapture the losses we saw in the second half of last year? Or are there some other elements we should keep in mind?

Marc D. Miller

Sure, Betty, it's Marc. I'll take that. Starting with SG&A, as we look to the third quarter, we do expect to see a deleverage. It's probably closer to the Q1 rate than the Q2 rate. Q2 should be the high watermark in terms of deleverage year-over-year, and we would expect to see a slight improvement versus that deleverage rate in Q4 versus Q3. In -- it's related to the planned investments that you alluded to. Marketing is a big component of it. You all have seen Chloe and her position as our brand ambassador in our stores and the investment that accompanies that. There's been systems investments as well in mobile POS, in PLM and other upgrades. So those are planned investments and fixed investments that will continue through the year. And one other piece which I should mention is the E-Commerce growth, which is worth about 30 bps of deleverage in Q2, and we expect that to continue into Q3 and Q4. Moving on to gross margin. In Q2, we did see virtually the entire, what turned out to be cost decrease in Q2 being passed along and into our gross margins, which is primarily what is responsible for our gross margin increase year-over-year. As we look to Q3 and Q4, we do expect to see continued gross margin expansion from that reduction in cost. However, we would note that our core product classifications remain under pressure. It's very promotional out there. And so some of the gains that we may see from average unit cost decreases maybe offset by that AUR pressure on our core product.

Operator

The next question is from Janet Kloppenburg of JJK Research.

Janet Kloppenburg

Just staying on the gross margin for a minute. I was just wondering directionally if you could talk about it the way you talked about SG&A. For instance, should we be expecting that the level of improvement that you saw in the second quarter could be matched in the third quarter? Or is there an opportunity for it to be more or -- is there a chance it could be less than what we saw? And second of all, for Tom, if you could talk a little bit about the timing involved in some of these system upgrades in terms of allocation and inventory planning that might aid in getting the assortments better balanced as we go forward.

Marc D. Miller

Okay, Janet, I'll start with the gross margin. The -- as we pointed out, the cost decreases are more significant in the back half than they were in Q2. But we do see some offset in terms of pricing on our core product. So the net of that is, we do believe we can achieve gross margin expansion somewhere in the neighborhood of what you experienced in Q2.

Michael J. Cunningham

And Janet, this is Michael. With regards to -- I'll give you a quick recap of the technology projects. The short answer is, we're not waiting until they're fully implemented. We have added resources, particularly in our Planning and Allocation teams, to jumpstart the metamorphosis of the business model from just mainly offering core items to having a wide variety of fashion, fashion basics and core. So what we've done with these resources is, we've already modified our fashion prepacks and that's showing up in that -- so then [ph] the prepacks have been modified to be able to increase our flexibility of allocation of fashion across the different store profiles, is starting now, will continue to grow throughout the year. In addition, we've been working very hard to update our store profiles in a path that generally was based upon store selling and not too much disparity between the different classifications. Now with the addition of fashion and fashion basics with -- we're analyzing each store, creating store profiles by mall type, by the penetration of fashion versus penetration of the core product. We're also looking at what type of store format is the scene [ph], whether it's the lifestyle format that we rolled out 5 years ago, or the classic format that's been around for a while. So we have a team of people working on this to modify the allocation to develop new profiles manually to adjust the allocation of items as they're coming in. So that's in place today. Teams in place and they've working hard and refining it. In addition, a couple updates on the technology initiatives. First one I'll talk about is PLM, which is product life cycle management, which basically automates and streamlines and creates efficiencies in the product development processes and ensuring consistency and standards are aligned. That we're piloting in our P.S. brand. This month, we'll roll it out to the Aero chain in the spring season, so that will -- major benefits will be the next year. Assortment planning, the pilot, again is going live in P.S. this quarter, we are going to roll that out, components of that out this year into Aero. And we're going to be working with the planning team, those resources, to take components of assortment planning to develop some of the initial SKU recommendations for assortments. The benefit again will be for the buyers that will show up in the springtime. And then last, we're very happy that we've managed to initiate our allocation optimization project. That will be going live, but again, it will impact spring receipts by fully automating the allocation processes based upon their profiles that right now, we're doing with our team of planners and allocators.

Operator

The next question is from Brian Tunick of JPMorgan.

Brian J. Tunick - JP Morgan Chase & Co, Research Division

Curious, I guess 2 things. I guess last back-to-school of the third quarter, your AURs, I think, were down 7%. So just sort of wondering what kind of AUR pressure you are assuming in the guidance you're giving us now for the third quarter. And then as you increase fashion and your inventory turns faster, how does this impact how you think the normalized gross margin should be for the company, especially as we look ahead in cotton and the AUC story is no longer part of the equation? What do you think is a more normalized gross margin for the company?

Marc D. Miller

Sure, Brian, I'll take that. On the AUR piece, the Q3 guidance does contemplate continued pressure on AUR. We were down 1% in Q2, and the guidance contemplates that we may be down further than that in Q3. On the second part of the question, which was gross margin long-term opportunity. Clearly, we feel good about the impact that fashion is having in our assortments. And longer term, we do expect to see gross margin expansion as we get -- write both the depth of the fashion buys that Tom spoke about in his initial remarks, as well as really define and blow out the fashion basics part of the assortment. So as we have clarity about the new merchandise architecture and assortment architecture, we'll have a better visibility as to how high we can climb up our merchandise margins.

Operator

The next question is from Randy Konik of Jefferies.

Randal J. Konik - Jefferies & Company, Inc., Research Division

So Marc, can we get a -- forget just fashion for a second, can we go through cash flow? The numbers I'm kind of looking at show that the free cash flow should be about $100 million. And this is on very, very depressed operating margins that gives me a free cash flow yield, 10%. This market cap now back to $1 billion. So if we think about the last 10 years, the average free cash flow has been about -- over $100 million. Do you think when you look out over the next 5 years, are you pretty confident that you can produce a minimum of $100 million in free cash flow per year? And what do you think the maintenance CapEx on this business is?

Marc D. Miller

Randy, we're not going to give a projection on future cash flows or even a minimum floor. Obviously this is a year that we're trying to build upon, and we do hope, in out years, we'll see improvement over what you're -- we're experiencing this year. The idea of -- so I'll say that on free cash flow. As for just opportunities and where I think your question may be headed, which is towards buybacks, we say that we need approximately a $200 million to $250 million cushion to start the year in order to work through our working capital cycle, absorb any negative impacts to planned operating cash flows and to cover our CapEx, as well as any new ROI growth opportunities. So anything above that minimum cushion has always been our philosophy, and we will continue to return that cash to shareholders in the form of stock buybacks. Clearly, as we're looking into the back half the year, we will be building up our cash position. So we will be looking opportunistically at stock buybacks as a piece of that. The last part of your question, which went to maintenance CapEx. That number is going to vary, and I don't want to give guidance right now on CapEx. But I do remind you that this year, we didn't pull back on our store remodels. So next year when we do give guidance, it will include the impact of doing those remodels in the new store format.

Operator

The next question is from Kimberly Greenberger of Morgan Stanley.

Kimberly C. Greenberger - Morgan Stanley, Research Division

Tom, you talked about some of the categories that are struggling in the store. Can you just remind us of those categories? And if you sort of aggregate them together, what percentage of your revenue does that represent today? And then, any comment that you have on the performance in A malls versus B malls versus C malls would be appreciated.

Thomas P. Johnson

Sure, Kim. The -- our core business, as you know, historically has made up a pretty substantial part of our overall business. Within our core categories, the areas that have been pressured most is in the area of some core product in the area of bare, camis with -- and graphic T-shirts, notably, and some graphic polos and graphic henleys on the Girls side. And I'm not going to go through the percentage of the total breakdown, but what we know that we can do, is we leverage our AUC in those categories and the risk in those categories is not high for us. We can chase those categories, if necessary. So we appropriately bought down in those categories in the back half of the year, mitigating risk. And what we've done is reinvested those dollars into some of the areas that we can develop in fashion and in fashion basics. And I -- just speaking to fashion basics just for a bit, I think the area of opportunity for us really lies in the area of fashion basics. So the spring season, we know that we bet lightly in some of the fashion. The great news is, it's resonating and connecting with our customers. We do believe that we are attracting customers into our store for -- on the fashion and being more fashion-relevant. So we know that we'll -- they will recognize us for fashion over time. It does take time to develop that from our customer in their buying patterns. So we're happy about that. And we will continue to increase our fashion, but more importantly, fashion basics. So we see opportunity in regard to that.

Michael J. Cunningham

Kimberly, this is Michael. With regards to the comps, breaking it down by store type. We have basically about 40% of our store base in the comp stores are in A malls. And we're very pleased to see a positive comp this quarter, as well as a positive acceleration in trend for those doors. However, where we have struggled is in B and C malls, which combined, represent more than 1/3 of the chain, and in those stores, we negative comped in the mid-single digits, and we saw a deceleration in those trends. So we're clearly seeing a bifurcation of results across the different mall types as we analyze the business.

Thomas P. Johnson

And just as a wrap up to that, so what we -- our takeaway in that area, obviously the fashion's resonating, we're very pleased with the way it's checking. It is selling disproportionately in some of our doors, as you guys could imagine. And we're deploying the resources appropriately as we go into the back half of this year. As we bought fashion and we're buying fashion deeper, we know that we can deploy it appropriately in those fashion doors. So it's a learning process for us. As you guys know, we had limited fashion last year. We've added to that. And we're going to be very efficient and thoughtful about how we deploy those assets as we go through the balance of this year.

Operator

The next question is from Dana Telsey of Telsey Advisory Group.

Dana Lauren Telsey - Telsey Advisory Group LLC

As we think about the business and what you're seeing now, how are you adjusting the expenses in this more competitive environment? And on the P.S. from Aéropostale division, how is that performing? Has that changed also?

Marc D. Miller

Yes, Dana, I'll take in the first part on the expenses and then I'll turn it over to Michael on P. S. On expenses, the biggest line item that we have that's controllable is our store line. It's about half of our overall SG&A. And so, if we've invested in systems, including workforce management, and we did the first round of piloting in Q2 of 2012, and we expect to see some benefits on that line item going forward. So that's clearly our biggest opportunity as we look forward to the remainder of the year. In addition, as you know, our incentive comp or our pay-for-performance model, so that will ebb and flow with actual performance of the business. And just as a reminder, we do have an industry-leading SG&A. And for that reason, as we look at business and the opportunities to improve the business, we are more focused on gross margin, and gross margin opportunities than opportunities on the SG&A line.

Michael J. Cunningham

With -- this is Michael. With regards to P.S., we're pleased with the growth on the top line of the P.S. business. As you know, we added the 4 to 6 sizes that's been a significant addition to the sales in P.S. stores. But we're also comping in our baseline business in the second quarter. So what we found is, P.S. is really resonating with the young customer and is obviously very well accepted and received by the moms. So we're not stopping there. In addition to the focus on growing the business, we continue to add exciting items into the assortment, and this fall we're going to have items such as NFL apparel items and then for some fun items for the kids, we're adding in, for those of you who follow this, Monster High accessory items, which is very exciting fun for the girls. We will reach the 100 store mark in the third quarter, and we are seeing a robust e-com business as well. So again, a lot of work lined up [ph] on our P.S., and we're seeing results.

Operator

The next question is from Anna Andreeva of FBR Capital Markets.

Anna A. Andreeva - FBR Capital Markets & Co., Research Division

I was hoping to follow up on the competitive set. I understand the basics space being challenging. But basics were difficult in 1Q as well, and you guys did pretty well. So what has changed from your perspective? There's still plenty of inventory in the channel. I guess, are you seeing more in 2Q and people becoming more promotional? Or is it more of a self-inflicted issue from your prospective? And then I was hoping to follow up, I think it was on Janet's question. I think you mentioned you could reach close to 280 basis points of gross margin expansion that you realized in 2Q in the back half. I guess if I put in the SG&A 130 basis points, give or take, deleveraged in the third quarter, that doesn't quite add up, so maybe we could talk about that.

Thomas P. Johnson

Yes, and I'll take the first part with regard to the competitive set. There's no question that from Q1 to Q2, there was a significant change in pricing promotion within the retail channel. And some of our competitors are very aggressive. And we know that the pricing has been very, very steep in some of the core commodity items. As some of our peer set have had more inventory than last year on a significant level, so they've been promoting it much, much heavier than we had, as a matter of fact, on a year-on-year basis. So that's really where the pressure is coming. And like we said earlier, inventory management is very key to us, and very important and we have kept that very, very nicely in control.

Marc D. Miller

And, Anna, on the second part, relating to Q3 guidance. The one variable that you didn't talk about was comp store sales. And as Tom said in his upfront remarks, the business has been inconsistent quarter-to-date. And what we did was we extrapolated off of the low end of those inconsistent comp trends and used that to come up with our range for the quarter.

Operator

[Operator Instructions] And the next question is from Lorraine Hutchinson of Bank of America.

Lorraine Maikis Hutchinson - BofA Merrill Lynch, Research Division

Just wanted to follow up on the P.S. question. Where are you in terms of profitability there? Or how much are you losing on that? And then, what's the store level that you expect to achieve breakeven?

Marc D. Miller

Sure, Lorraine, I'll take that one. While we don't breakout P.S. financials separately, what we said in the past is that on average, P.S. is about a $0.02 per quarter hit. Clearly, it's higher in the first half of the year, lower in the back half the year as you have the sales build. So overall, we've said also that at about 100 stores operating on a full year basis, that's our target internally for achieving breakeven.

Operator

The next question is from Dorothy Lakner of Caris & Company.

Dorothy S. Lakner - Caris & Company, Inc., Research Division

Wonder, just to sort of circle back to the fashion for a second, because I think that does seem to be the key as you build that fashion component in the mix to getting better results and not being so much subject to the pricing pressures that others are kind of causing out there. Is this, is -- what kind of in terms of just your overall store base, you talked about A malls, B malls and C malls. Obviously, I would expect you to see the most success in A malls, but are you seeing success in B or C malls? Is there room for those to build some fashion component as well? And any way you could give us a sense of how much you're building fashion and fashion basics versus core as we move through the next few quarters?

Michael J. Cunningham

Sure, Dorothy, this is Michael. I'll go first with regards to the malls. It's not a simple -- it's a very detailed slice of the malls in terms of the fashion selling. So it's not a simple matter of saying B and C doesn't sell fashion as well. I mean there are different rates of selling. And within the types of malls, there are different penetrations of stores within those mall profiles by fashion types. So it's really -- that's what we talked about. The teams are drilling down that manually, doing all the different cuts and slices to basically look at penetration of the fashion. So it's not a simple matter about A, B and C. We think it's more again, the level of malls and type of malls and the demographics that go to those malls that impacted their performance by type.

Thomas P. Johnson

And Dorothy, this is Tom. One of the things, and we've said this before, and we kind of laugh at ourselves because retailers, that retailers have a history of overreaction to different components of your business and at times, some people will completely take out an area of the business like the core business, and we would never do that. We know that we need to do, in order for us to be successful in all of our mall types across different outlet, A, B, C, like Michael said, and our lifestyle and street stores, that we need to have a nice balance of product. So we do believe that over time, we'll reduce dependency on core over time to your point about an area that won't be quite as price-sensitive and as we build our capabilities in fashion, and as we expand our vendor base and work with our vendors with their capabilities on fashion and leverage costs over time, I think that you'll see a nice increase as we move through, and it's really an iterative process for us. The one thing that we certainly don't want to do is have a peak and valley business, and make sure that we continue to have nice growth as we go through the back half of this year and into next year. But we're confident, and we're building our confidence with regard to developing that fashion. And I think team -- the teams have done a terrific job of responding to the call. They know what they needed to do. They've executed at a high level, albeit smaller, and it's an area that we need to build and build capabilities of, in addition to, as Michael said, the processes around that. As a matter of fact, we've allocated resources in areas of chasing product in the design, merchandising and planning teams and production, so we know that we can be quicker and our -- increase our speed to market. So we're very happy with that as well. So it will be a process. It just continues to build. So we're excited about it. We're not pleased with our current run rate of business as we wrap up Q2, but we're cautiously optimistic in the back half of the year.

Operator

We have a next question is from Roxanne Meyer from UBS.

Roxanne Meyer - UBS Investment Bank, Research Division

[Technical Difficulty]

Operator

The next question is from Eric Beder of Brean Murray.

Eric M. Beder - Brean Murray, Carret & Co., LLC, Research Division

Could you talk a little bit about the E-Commerce business? I know it's a bit of a drag. How do you get it to be a gainer of margin here? Is it that -- is this just a function of size? Or is it also systems, too?

Marc D. Miller

Well, Eric, as you may be aware, we do outsource our E-Commerce operation, the warehousing, the website hosting, shipping to a third-party provider in GSI. And as a result of that decision, virtually all of our e-com related expenses hit us on the SG&A line. So as that business grows disproportionately to overall store growth, you see the deleverage happen in that line item. Overall, we're very pleased with the relationship with GSI. So there are no plans for us to bring that in-house at this current time. So for the foreseeable future, as there continues to be a gap between e-com-related growth to overall growth, you will see continued deleverage. That being said, if we look at the overall contribution of e-com versus stores, they're very parallel. So we're happy with the overall financial performance of that division.

Operator

The next question is from Evren Kopelman of Wells Fargo.

Evren Dogan Kopelman - Wells Fargo Securities, LLC, Research Division

[Technical Difficulty]

Operator

The next question is from Marni Shapiro from The Retail Tracker.

Marni Shapiro - The Retail Tracker

One quick, clarifying question. Could you just talk about how many store openings you have for the back half the year in Q3 and 4, and any closures?

Michael J. Cunningham

Sure, Marni. This is Michael. We have 10 stores opening in Q3. And 5 of them are P.S. and the other 5 are Aero between domestic and Canada. We have a couple of -- we have 2 stores closing, plan to close in Q3. For Q4, we only have 1 store that's opening, and that's a Aero store in the U.S. and then we're closing 5 Aéropostale stores in the U.S. So projected store count at the end of the year is 1,089, and that's broken down by 911 domestic Aero; 78, Canada; and 100 in P. S.

Operator

The next question is from Evren Kopelman at Wells Fargo.

Evren Dogan Kopelman - Wells Fargo Securities, LLC, Research Division

I wanted to ask about, as you look at holiday, how, I guess, are you -- how do you anticipate competition to be in terms of the pricing competition on the basics? As we think about some of your peers, from Abercrombie to JCPenney, that from their comments they -- seems to -- they're probably not going to have as much inventory and maybe the environment will be -- will have a little less pressure. How are you planning for Holiday? With thinking about all that?

Thomas P. Johnson

Evren, we'd be delighted if that was the case. We've -- looking at holiday over the last few years, the competition from a price standpoint has been what I -- we would categorize as fierce. So our expectation is that there probably will still be price sensitivity dependent on macroeconomic, but more focused is retail environment with regard to inventory in the channel. So our expectation is that prices will still be fierce in terms of promotion. That's one of the reasons why we look at our marketing to have a great balance between lifestyle proposition, as well as hard-hitting promotions, to make sure that we're prepared to be able to react -- read and react and respond to the current trend of the business and the appetite for overall apparel, as well as fashion. So we feel good about our preparation. We feel very good about our assortments as we head into the back of the year. But we are certainly expecting the year to continue to be challenging from a pricing competition standpoint, certainly on basics.

Operator

The next question is from Jennifer Davis of Lazard.

Jennifer M. Davis - Lazard Capital Markets LLC, Research Division

I was wondering if you could maybe talk about what's selling on E-Commerce. Is the product -- is what's selling similar online as in stores? Or are there categories that are stronger online than in stores?

Thomas P. Johnson

Yes, Jennifer, the online business, historically has been slightly more basic-driven than the in-store. And that's been historic for us, and it continues to trend that way. As a matter of fact, to speak specifically to an area and classification, our uniform business is very strong online. So we see that, that online channel for us is probably dominated by mom, and that our expectation is to continue to be that way. But it's an opportunity for us to demonstrate fashion and fashion capabilities online as well. We've done some different things, the look and feel of the website during the course of this year, which we feel very proud of. The team's done a terrific job of changing the way the website looks and feels, and we're happy with the reaction to that. But overall, the assortment typically is a little bit more basic-driven.

Operator

The next question is from Richard Jaffe of Stifel, Nicolaus.

Richard Ellis Jaffe - Stifel, Nicolaus & Co., Inc., Research Division

I will share the belief the fashion looks good, but obviously not enough and not in enough places. And wondering if you could better explain that the fashion versus fashion basic, in terms of price points, I guess level of fashion or sophistication and then compare it to core product as well.

Thomas P. Johnson

Sure, sure, Richard. It's Tom. I think the best way that I can describe, just from a product kind of categories and how we would look at it, a year ago, we would look at colored denims as being fashion for us. And today, we look at colored denim as being a fashion basic for us. And our core would be in a blue denim, and then what we would look at today is patterned denim as fashion for us. And depending on the appetite and the adoption rate, the pattern denim could become a fashion basic for us next year, depending on, really, the adoption rate from our customer. Clearly, for us, albeit limited amount of time, our fashion has sold at a higher AUR generally. And we feel very good about the sell off percent to date. But yet, we still have a lot of work to do. We've had a good start, but this is just the beginning of what we see as something that could be very powerful over time.

Operator

The next question is from John Kernan of Cowen.

John D. Kernan - Cowen and Company, LLC, Research Division

Can you give us an update us on your international plans? And how you think about the long-term potential of this business?

Marc D. Miller

Sure, John. It's Marc. International, currently, we're sitting at 20 stores. We have stores that by the end of this quarter, will be operating in 5 different countries during -- this past quarter, Q2, we did sign a deal with Panama and Colombia to open stores there. So in terms of existing regions, we're in United Arab Emirates, Singapore, Turkey, in particular, our stores in the Middle East are performing really well, very pleased with their results, and we think it demonstrates a global appetite for our brands. Looking forward, we expect to continue to look to sign licensing deals in various regions around the world. We believe it's the right model for us to be -- to pursue international expansion. And looking towards next year, while we'll end the year, probably in the neighborhood of 25 stores this year, we're hoping to at least double that store count in 2013 and see acceleration of that growth beyond there.

Operator

The next question is from Howard Tubin with RBC Capital Markets.

Howard Tubin - RBC Capital Markets, LLC, Research Division

Maybe just one more question on the merchandise. So I think if you look back through the second half of 2006, through probably the first half of 2010, you did a really great job of bringing some more fashion to the store, getting the customer in with the fashion and then, when they're in there, selling them fashion and selling them basics as well. Is there anything that's changed meaningfully? Or anything that you see preventing that from happening as we kind of maybe move throughout the fall season and into next spring?

Thomas P. Johnson

Yes, Howard, it's interesting. We look at the 2006 and through '07, '08, '09, what we recognized as obviously a significant dependency on the logo product within the store. And at the time, the uniform for that girl was very much dependent on logo product. Everybody was selling logo product. And the one thing that we probably were at fault of is not interjecting more fashion into our assortments. And that's just -- what we have to do and what we're doing. I think the risk to the business, if not evolving that component of the business is far greater than adding to fashion. So what you're looking for and what we're anticipating and striving to do is strike that right balance. And that's what's most important to us. And we think that, even though some of those views are very strong, and it was dominated by logo product, we know that we were doing it off of quite a bit of price and the price -- because of the size of the buys we were -- was advantageous for us, and we're able to get sales from it, but on slightly lowered margins year after year. And what we needed to do is evolve. We didn't evolve fast enough, and we're evolving now. And what we're all looking for is to strike that right balance, and I think that you will see it over time and it will continue to grow.

Operator

Next question is from Jaime Katz of Morningstar.

Jaime M. Katz - Morningstar Inc., Research Division

I know you guys have back-to-school. It was a little bit lumpy. Is there -- have you guys seen any sort of difference between maybe regional performance areas? Either kind of like Midwest or Northeast? Is there a way to kind of tailor the promotion so that it's not so broad-based? Or has it just been kind of weak everywhere?

Thomas P. Johnson

Well, Jaime, we actually do, at times ,promote differently, depending on the market and they're -- when they go back to school, we do break our stores down to early, mid and late. As a matter of fact, while it's been a little bit soft overall, the early doors have been performing better than the mid and late, generally. So we do -- we allocate differently, we assort the store differently, we set the floor on a different time schedule to match up with when the kids are going back to school. So we are doing that. It's overall, it's just the business was soft overall. Like I said, the early doors were performing a little bit better than the chain.

Operator

Next question is from Linda Tsai of ITG.

Linda Yu Tsai - ITG Market Research

What percentage of your product is considered fashion in the second half of 2012 versus the first half? And where would you like to be a year from now?

Thomas P. Johnson

Yes, I'm not going to get into the percentages. But clearly, it's an opportunity for us to build upon, and we know that, if you bucket the fashion date, we call fashion basic and fashion over time that, that component of the business will continue to grow and like I said earlier, core will never go away, but it will diminish over time.

Operator

And our final question comes from Pamela Quintiliano of Oppenheimer.

Pamela Nagler Quintiliano - Oppenheimer & Co. Inc., Research Division

Can you hear me okay? I have a few questions for you. Can you give us any thoughts on the ability to cancel or reduce [Audio Gap] on the back half just to question [ph] the elevated promotional environment among your peer group that you were talking about in your cautious view on holiday reflecting that promotional environment? And on the flip side, have you been able to chase fashion for Holiday based on some of the results from the early back-to-school? And then, are you attracting the new customer with your fashion content? Or is it your existing customer who is buying beyond basics?

Thomas P. Johnson

Well, our reaction to canceling order and chasing, we've always been very, very good at buying conservatively and chasing. So that's a core competency of ours. And we have been very thoughtful about how we planned our business on the back half of the year. So we will continue to remain clean with regard to our inventory, and not be encumbered with an inventory overhang and working with our vendors, we have a very flexible model. And our Production team is incredibly responsive to be able to do what they need to do. The Merchandising and Design teams have moved, incredible speed, with incredible speed to read and react to parts of the business, in certain styles and bestsellers. And what you will see in Holiday is the reaction to some sellers that we have had, and some trend that we think have been very good in the market. And we added those into the fourth quarter buys. So we're very pleased with what we're seeing and the reaction to that.

Operator

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

Thomas P. Johnson

Sure. Thank you all for your continued support. We really appreciate your great feedback, and I will definitely pass it on to the teams about the fashion. And we are looking forward to a good balance of the rest of the year. We hope you have a great summer and look forward to catching up with you in November.

Operator

Thank you. Ladies and gentlemen this concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.

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