Greetings, and welcome to the American Eagle Outfitters First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Judy Meehan, Vice President of Investor Relations for American Eagle Outfitters. Thank you, Ms. Meehan. You may begin.

Good morning, everyone. Joining me today are Robert Hanson, Chief Executive Officer; Roger Markfield, Executive Creative Director; and our Controller, Scott Hurd. Before we begin today's call, I need to remind you that during this conference call we will make certain forward-looking statements. These statements are based on information that represents the company's current expectations or beliefs. The results actually realized may differ materially from those expectations or beliefs based on risk factors included in our quarterly and annual reports filed with the SEC. Our comments today will focus on results excluding 77kids. Please refer to the adjusted operating statements accompanying the press release. We've also posted a first quarter financial supplement on our website. And now I'll turn the call over to Robert for his opening remarks.

Thanks, Judy, and good morning, everyone. I'll start with highlights of the first quarter. After Roger and Scott give additional color on the quarter, I'll come back and provide an update on our 5 near-term priorities. We're pleased with the progress demonstrated by our first quarter performance. Net sales rose 18% and adjusted EPS increased 38%, which came in above our plan and early expectations. Strong demand enabled us to pull back on planned promotions, and top line growth helped mitigate pressure from higher cotton costs. We leveraged fixed operating expense, while also contributing to bottom line growth. The operating margin for the quarter showed year-over-year expansion to a rate of 9.1% compared to 7.3% last year. The improvement was good, yet we have plenty of opportunity relative to our historical rates which have averaged well into the double digits. Now let me run through some of the first quarter highlights. We delivered on driving a competitive top line with broad-based category strength. Our merchandise teams did a very good job identifying and executing on current trends. Higher in-store traffic and an improved conversion rate were consistent throughout the quarter. Building on the fourth quarter sales momentum, we saw a 20% increase in repeat customers and their basket increased over last year. We did a good job managing markdowns and pulling back on promotional activity, which continues to be an area of opportunity. We saw strength within aerie across each channel. We achieved greater productivity and improved operating margins in this business. American Eagle Outfitters Direct produced 22% growth this quarter and contributed an operating margin well above our average store fleet. During the quarter, we also had successful franchise store openings in Israel with 9 locations as well as Japan, where our 2 stores experienced record opening results. This provides further evidence of a global appetite for the American Eagle brand. To wrap up the first quarter, I'm appreciative and proud of the progress the teams made and want to recognize them for their success. This was a solid first step, yet our focus is 100% on stronger execution and building the capabilities to sustain consistent performance over the long term. Now, Roger, over to you.

Good morning, everyone. It was great to see our brand momentum in the first quarter, especially while pulling back on promotions. We were able to regain our position as the destination for spring break. We led with a powerful color story, which was distinct and reflected the energy and optimism of the AE brand. The teams delivered particularly well in our core bottoms businesses with denim, pants and shorts among the strongest businesses. Tops also performed well, led by color, trend and women's, a more differentiated fashion assortment. We like what we see on the horizon and how our product teams are interpreting new trends. Looking ahead to back-to-school and holiday, we will build on business momentum and apply a more disciplined and distorted approach to our assortment plans as we target higher margin. You will notice more frequent flows of merchandise into our stores. We are not going to elaborate too much on it, but the goal is to create more in-store newness and turn fashion items faster. On the marketing front, Michael and team are doing a great job aligning our marketing and imagery more strongly with our heritage of an optimistic American brand. We are excited about our upcoming marketing campaign for back-to-school, which truly captures the spirit of the AE brand lifestyle. Within aerie, we made nice progress this quarter with comps rising 20%, driven by bras and undies. The intimate teams are doing a really nice job sharpening our focus and driving newness in the bra and undie business. This year, aerie intimates is all about innovation and newness with 9 bra launches planned, which is more than double last year. Our goal is to be a dominant player in this category. And after several years of building the brand and fine-tuning the merchandise, we feel that we are on track. Lastly, a few weeks ago we sharpened the aerie brand DNA and we'll be doing the same thing for the AE brand shortly. We are committed to delivering leading assortments and will strive to elevate our brands and drive the very best customer experience. Scott will now cover the financial results.

Good morning. Total consolidated first quarter sales increased 18% to $709 million compared to $603 million last year. Sales productivity was driven by a comparable store sales increase of 17%, including e-commerce. By business, AE brand comps increased 17%, aerie was up 20% and AE Direct increased 22%. Within the AE brand, men's and women's comps were equally positive. Comps were also positive across all geographic regions, including Canada. Strong traffic and conversion drove a low double-digit increase in the number of transactions. The average transaction value increased in the mid-single digits with AUR essentially flat and positive units per transaction. Gross profit of $275 million increased 18% last year. The gross margin rate was flat at 38.8%. Rent and other non-merchandise costs leveraged 220 basis points as a result of the strong comps. The merchandise margin declined 220 basis points reflecting higher product costs, primarily related to cotton. The pressure from cotton was less in the fourth quarter as we continued to sell through higher-cost product. Less promotional activity resulted in a 50 basis point improvement in our markdown rate. SG&A expense increased 15% to $179 million, leveraging 60 basis points to a rate of 25.2%. The dollar increase was primarily driven by incentive compensation and variable selling expense incremental to last year. Depreciation and amortization declined $2 million to $32 million and leveraged 120 basis points, the decline related to maturing assets and store impairments. Within other income, we received settlement recoveries of $3 million related to auction rate securities. This also favorably affected the first quarter tax rate, which was below our effective rate of 38%. The operating margin of 9.1% improved 180 basis points to last year. Robert already touched on EPS growth for the quarter, but we want to reiterate that our focus is on…

Thanks, Roger and Scott. With one quarter now behind me, I have deeper insight into the organization and an appreciation for our key strengths and where our execution and capabilities need to be improved. While still early days, we've begun prioritizing and focusing our efforts. The team and I have aligned on our top 5 goals, goals rooted in fortifying our core brands and channels to drive near-in sales and margin improvement. We are also aligned on our longer-term objective to transform American Eagle Outfitters from a leading domestic teen retailer into a distinctive, branded, multichannel retailer that can successfully and profitably compete on a global stage. There's work to be done here and this will take some time as we will have to elevate our brands, our processes and our capabilities to successfully compete outside of North America. More on this as the year unfolds. It's important that we don't get ahead of ourselves. In the near term, we have plenty of opportunities for profitable growth domestically. First, driving a competitive top line. We clearly saw good momentum in the first quarter, but to seize the sustainability over time, we need to architect our assortments more precisely. As Roger has said, we wanted to distort our talent, our investments and our focus to be the undisputed #1 leader in the marketplace in our core categories for which we are famous. In these famous core categories, we need to be relevant, on trend and top of mind. Right now we're close on some, but not as strong as we'd like to be. These categories are critical and represent the majority of our volume and profit growth. We will surround our famous core categories with on-trend and competitive execution in near-in categories that complete the American Eagle look. And in fashion…

[Operator Instructions] Our first question is coming from the line of Randy Konik with Jefferies & Company.

Robert, first on the 5 priorities, is there: one -- which one would we see the most progress on first and which one will take the longest out of the 5? And then obviously you do a good job of talking about everything through a returns lens and it's really refreshing to get the kids business closed. So when you talked about the word optimize aerie, what is that? Can you elaborate on that optimization a little bit? How can we get the margins up? Does it mean closing stores, focusing more on side-by-side or store-within-a-store? Can you just give us a little more color there?

Sure. So honestly, I want to give the team credit for the success that they're driving on the top line at the moment because obviously they've been working on that for the last year, and I would say our results in the first quarter indicate the momentum that the product teams have been able to deliver and we'll be focused on driving that moving forward. Relative to what I think we as a team can do on the agenda that we've established together since I joined the company, the second priority, which is really optimizing margin flow-through is probably the one that we are the most focused on, that we're going to go after the most aggressively, the most quickly and will deliver the greatest return to our shareholders this year. In terms of what is probably going to take more time, we are planning on rebalancing our distribution across the multichannel fleets, which combines distribution through direct, our mainline stores and outlet. We've got a very profitable store fleet. We have about 1,070 stores now with the kids' closure and all that 25 of those stores are profitable. And even within those 25 stores, many of them are cash flow-positive. So we want to get through a process of selectively rebalancing the fleet, selectively pruning and closing stores where it makes sense financially or where we have other market growth opportunities, so that will take some time. Relative to your question on aerie, I want to use an example of my recent trip out to Boston. We have a side-by-side location in Natick Mall and we have a shop-in-shop location in Quincy. And those stores are among the most productive in the fleet, delivering about 4x the average sales per square foot of the aerie fleet and among the most productive of the entire company. So our intent is to focus on how to leverage the American Eagle Outfitter customer. We know that the customer who buys -- the American Eagle customer who buys bras in aerie is worth 5x the average aerie customer. So side-by-side and shop-in-shop locations where we can secure them make a lot of sense, and our goal would be to have a multichannel distribution strategy for aerie including direct, side-by-side and shop-in-shop where we can get them and then obviously an outlet business including side-by-side outlets over time.

Our next question is coming from the line of Anna Andreeva with FBR Group.

I guess just looking at the comp guidance for up low to mid-single digits for the year, you guys just did 16% and guiding for 5%. Obviously, very strong top line momentum. It would almost imply negative comps in the back half to get to that low single-digit number. So is there anything from the inventory constraints that would make you guys comp negatively? I understand kind of the competitive environment out there being difficult. Maybe talk about that and how should we think about inventories in the back half?

Well, let me take the first shot at it and then I would like Roger and Scott to also comment. We have always said that we were going to be providing guidance that's rooted in low to mid-single-digit comps. You clearly know, given the momentum we had in the back half of 2011, that we'll be coming up against much tougher comp comparisons in Q3 and Q4 of this year. And so we are just being thoughtful about how to compete profitably in the back half of the year. It's a competitive environment. We're prepared to compete. As we've said in past calls, we're focused on brand and product and mitigating the promotional activities that occurred last year and at the same time we're prepared to compete as we need to. We always thought that our comps will be much stronger than the first half of the year, but we still believe will be positive comping in the second half of the year. And even with our inventory strategies, which are focused on improving margin flow-through, profit flow-through, we believe we'll be in stock, in position to deliver a comp sales increase in the back half of the year. That's what we're focused on delivering, but we are conscious of the fact that we're coming up against much more tough comparisons. Roger?

No, I think you answered it quite well. The fourth quarter last year, remember, was a highly competitive environment. We promoted much more than we wanted to promote, and our inventories were a bit high. Obviously that drives volume, but it doesn't drive profitable volume. So the trend of our business is very good. We're really happy with where we stand and we'll see what happens and we think we've done all the right things at this point as we've just finished holiday for both third and fourth quarter. And perhaps it might be better than that which we want to go out on right now. But for the moment, we think this is the right guidance.

But, Anna, looking ahead to inventory, we see inventory up in the mid-single digits in Q2 and down to the mid-teens in the back half.

Our next question is coming from the line of Janet Kloppenburg with JJK Research.

A couple of questions. Roger, if you could address this colored denim trend and if you think the velocity of the business can be maintained in the back half because I think it's been a big component of your comp driver this spring. I'd also like clarification on the inventory being down mid-teens. I think that's in dollars. What's the outlook for units? And for Robert, I was wondering if you could just talk a little bit about your plans for aerie. It sounds like you want to add some carve-outs in the stores to capture the traffic you have. I'm wondering if that will happen sooner rather than later or if you'll look on further refinement of the assortments in the brand before we see expansion there.

Colored denim and colored shorts and colored capris are -- and crops are doing quite well. We see it certainly happening and continuing into the back-to-school and fall season. And our plans are, in the future, not to be talked about at this moment.

Janet, you're correct. The mid-teens was dollars. We're seeing high single-digit reductions in units in the back half.

And Janet, regarding aerie, just to set some context for aerie, I think it's important because we obviously made the decision to close the 77kids business, which was in the best interest of our shareholders. We believe in the aerie brand for a number of different reasons. But importantly, it's -- as I mentioned in the last quarter call, it's close to breakeven on a four-wall basis and profitable all-in including all channels of distribution. So our intent moving forward, now that we've sharpened of the DNA of the brand, we've got the overall customer positioning squarely rooted in intimates. As Roger said, it's all about bras, undies, sleep, lounge, swim, beauty and fragrance. Now that we've got the brand positioned with that level of focus, what we wanted to do is to look at how to take advantage of our broad and loyal American Eagle Outfitters customer base and expose aerie to them more often. That would imply a distribution strategy that would be multichannel. We've got a large direct business at the moment. It's one of the highest growth and most profitable aspects of the aerie business at the moment. We have a mainline fleet, which is mixed in its performance. We have a number of stores that don't achieve our returns goals and we have a number of stores within the fleet that do. So that will take some time to rebalance. You're aware that we impaired some stores at the end of 2011 and we're going through the process of really evaluating how to address those impairments over time, most likely to be pursuing closures of a number of those stores during -- at the time of the lease provision. But our intent would be to look at how we could execute a more robust side-by-side or shop-in-shop strategy with aerie. That will take some time. We have a number of AE stores that are large enough to accommodate either a side-by-side or a shop-in-shop, but that will take some time to execute as well as to negotiate with our landlords. Our intent would be to look at where we can execute that across our entire fleet. And as we develop the outlet business, our intent would be to look at outlets that would include a side-by-side location for aerie.

Our next question is coming from the line of Jennifer Davis with Lazard Capital Markets.

So first question is could you talk a little bit about share repurchase plans? You talked a little bit about shareholder returns, so what's your view on that? Have you thought about that at all? And then do you have an opportunity to, I think you addressed this a little in the last question, but do you have an opportunity to expand aerie in stores where I think you had some expanded or had some accessories, components like you have an opportunity to add aerie in that position, what percent of stores have a full aerie assortment in terms of the bras and the panties? That business?

Sure. Well on capital allocation, I'm going to repeat what I said last quarter. I'll try to provide a little bit more context for it. Our first priority is to invest in our business to support future growth with a sharp focus on return on invested capital. But as a part of a comprehensive strategic review over the next several months, we'll be looking at capital allocation, which would also include dividends and share repurchases. Just a little bit of background; during 2011, we repurchased 1.4 million shares for -- at a cost of about $50 million. We -- since 2005, we've returned about $1.6 billion to our shareholders through share repurchasing. We've currently got about 13.1 million shares remaining under authorization and continue to evaluate share repurchases with our Board of Directors as a way of returning cash to our shareholders. We obviously have a nice dividend at $0.11 per quarter. That's at the highest in yield of our competitive set, so our intent would be to continue to operate in that environment. And we'll keep you posted as the plan gets further defined over the next several months. Related to aerie, we're in the process of a comprehensive fleet review right now and so I don't want to give you any percentages relative to where we think we might have those opportunities. What I will say to you is that we have about 10% of the fleet currently with side-by-side or shop-in-shop locations, a little under that. But more importantly, we have aerie products, specifically the f.i.t. product as well as undies in all of the American Eagle Outfitters fleet at the moment. So we are beginning to take more advantage of the American Eagle Outfitters customer to build momentum behind the aerie business. We saw nice improvement on all the productivity across -- the productivity metrics across the aerie brand in the first quarter and feel very confident that as we execute the strategy that I've articulated this morning, we can get that business really growing in a nice manner.

Our next question is coming from the line of John Morris with Bank of Montréal.

I think I'm -- yes, Roger, you've touched on it a little bit, but want to get a little bit more color, if I can. You said some things that were pretty intriguing in your prepared remarks, talking about the opportunity for back-to-school. You mentioned targeting higher margin. I'm wondering, is that -- I know you don't want to get into specifics, but are you talking about classifications? What's the thought process with respect to what you meant by that, in particular. And also talking about introducing maybe some -- or turning fashion items faster, I think is the term that you used, are you talking about increasing the amount of fashion content in the assortment?

John, it's 2 things, if I can address with you. It's by category where we think that we're the store, the destination for our customer. So we clearly understand that we are the destination for denim. But within denim, there are many ways for us to build this momentum. And the beauty of denim, it's a very difficult business for other people to enter into. It's a very complicated business, so -- and the dimension of silhouette, of fabric, of wash is a combination that doesn't take place in other categories or merchandise. So it's within denim, and for the first time in many, many years, we're actually embarking on a national campaign with a great marketing team that we now have back in place along with a great outside agency. And this campaign for back-to-school within, obviously, the denim sphere, we think will be quite outstanding. On the fashion front, it's all about balance. Our concept teams and our design teams have never been better and the testing processes that we have in place and the disciplines are really allowing us to have fashion that's working for us. And what Robert keeps driving at and correctly is the cycle of the fashion items should be shorter and they should be more frequent, and that will give us the fresh flows to our stores and the growth. I mean, all of our operating metrics are so positive now: the conversion factor, the traffic factor, the average unit retail factor. They're really responding to what you're all congratulating us on in terms of the balance between core items and the fashion elements of our business.

Our next question is coming from the line of Tom Filandro with SIG.

Roger, I want to ask you a quick one on back-to-school. Can you just give us a little color -- can you tell us a little bit about how you're preparing in terms of where now and when we should see peak back-to-school this year as back-to-school continues to be pushed out later and later? And then if you guys could speak a little bit to the quarter performance in maybe accessories, shoes, jewelry, personal care and just any thoughts around those categories from Robert would be very helpful.

On the sequencing of back-to-school, Tom, I don't want to give too much information out, but let me say that we're doing 2 sets this year. One set is a bit earlier than last year and it's much more aware now and it's quite good. And when I finish this conference call, I'll be out in the lab stores reviewing -- calling back-to-school, too, which is really the denim impact. The teams didn't know, but I kind of took a sneak preview last night and it's quite exciting. So you will have 2 this year.

And in terms of our -- Tom, in terms of the question you asked about, the other categories, I want to come back to the strategy that Roger and I have been articulating for our product assortments moving forward because it's really where we intend to distort our talent and our investments and our attention moving forward. We are clearly in a nice cycle on bottoms. There's a lot of fashion trends that are being driven from the bottom side of the business at the moment, many of which Roger mentioned in his comments. We want pour fuel on that fire. We want to make sure that we're the undisputed leader in those businesses, so that's our #1 priority. Those are categories that we're famous for, in addition to the few others that Roger mentioned. Relative to the near-in categories, they would be our second priority to complete the overall look of the American Eagle Outfitters brand. The categories that you mentioned with the exception of footwear, which I'll come back to in a moment, are categories we want to compete in, but they're not categories we want to lead in. They are categories that would represent an incremental unit purchase opportunity. But fundamentally, we want to distort our investments behind the famous core categories. We want to compete aggressively in the near-ins, we want to buy fashion type and chase it, so we're chasing the future and not fixing inventory issues from the past. The exception to the categories that you mentioned would be footwear. Footwear is a huge business for us. It's a proprietary business, especially in our direct channel. We've got a unique position among our competitive set in that business and we intend to maintain it, so that would be an area of strong focus for us.

Our next question is coming from the line of Evren Kopelman with Wells Fargo.

I had a question on the outlet stores. You mentioned you plan to double the 67 that you have. Can you talk a little bit more about are the -- can one have comp trends the different at those outlet stores than the rest of the chain over the past year? Do have different product or different pricing? And also, how do the four-wall margins compare to the mall stores?

Sure, sure, Evren. Thanks for the question. So on the outlet business, just to set some context on its importance for us, relative to the competitive set, which has, on average, between kind of 15% and 20% of their business in the outlet channel, we're under-penetrated at about 7%, which is why this is an area of focus for us. And importantly, outlets are a profitable distribution opportunity for us in that they last year delivered about a 26% operating margin and -- four-wall margin, but on a run-rate basis, we expect them to be in the 30%-plus range. So it's clearly a nice opportunity. Our intent, similar to other successful outlet competitors, is to have a blend of presentation products, product that is made exclusively for the outlets and clearance. That's generally what the outlet shopper is looking for and our pricing strategies on our presentation product would be exactly the same as they would be in our mainline doors. That would probably be around 40% to 50% of the mix of the product. We would see probably 40% of the mix of the product be and made for outlet products and the balance would be in clearance. So it's a strong focus for us. We have a lot of runway, obviously, given that we're under penetrated versus competition and it's an important profit builder. We also get an incredibly strong payback and a quick return from those stores.

Our next question is coming from the line of Paul Lejuez with Nomura Group.

Can you maybe talk a little bit about comp performance by A mall versus B versus C. And also related to that have you looked at performance, comp performance, when you share a mall with an Aero, Hollister, Forever 21. And if you have, just wondering what you've learned, maybe perhaps where you performed best or worse.

Sure. Paul, the way that I would describe it is generally speaking, we saw broad-based strength in our comp performance across the entire fleet. We have been really focused, though, on making sure that we're not overinvesting inventory in the -- particularly, the sort of D and E mall locations that are out there across the country. So I would say if there was any distortion, it would be that we saw a slightly lower comp in those lower-volume doors, but that was in many ways intentional, because we're trying to flow the inventory to the higher-performing, more visible and more productive locations and make sure that we're just maximizing the profitability of those D and E doors in particular. And in terms -- we do analyze our business, although we won't report it specifically. We analyze our business relative to the competitive set out there and we are seeing, like I said, broad-based strength. So one thing I think you'll find interesting is we are very conscious of the fact that some of our competitors are looking at closing locations and we've analyzed how we perform relative to our total store fleet in mall locations where we have had a competitor close and we've actually seen the comps operating at about 1/3 higher in those locations than the balance of the fleet. So we see an opportunity out there for us as the whole sector is looking at rebalancing their distribution.

Our next question is coming from the line of Adrienne Tennant with Janney Montgomery Scott.

So I had a question. I was wondering, Robert, if you can talk about when we first met, you had said kind of maybe 90 days hence, you would have a very clear definition of who that target customer is. So I was wondering if you could share that with us. For Roger, I was wondering if you could talk about what you're going to do with fall tickets, initial tickets? And then for Scott, just a clarification on the inventory. Down high single-digit units, down mid-teen dollars. What is the mix of mid-shift to bottoms versus the AUC component of that? And can you do the same analysis for us on AUR for the back half?

Sure. So Adrienne, on the target customer, I think we're in the process of having that discussion as we're sharpening our overall approach to executing American Eagle Outfitters and aerie into the marketplace. We've updated the DNAs of the brand that we've mentioned. I think our view is we want to try to make sure we're thinking about our target more in psychographic terms, more so than in demographic terms. But if you were to ask us to pin it down, I think we're trying to slightly elevate the age range appeal to the American Eagle Outfitters brand. We have a really strong and loyal customer among the team customer. But our target, we have our male and female muses that we focused on building our line, our marketing and our customer experience around. We see them as early 20s, multiethnic, sort of the ideal teen American lifestyle customer, and as Roger said, optimistic and open. And that's how we tend to position the brand. I think very unique positioning in our sector in that we want the brand to be seen as a very democratic brand, a very open brand, a brand that is about individuality and individual style to be broadly appealing to an increasingly multiethnic customer base out there. And if we were to pin it down to that age range for American Eagle Outfitters, it would be in the low 20s.

On the front of the pricing strategy, better quality product, better fashion product gets a higher average unit retail. So keep in mind, our intent is that we're a value player with great fashion and great quality. So we're very careful on how we price products. With that being said, obviously with the product getting that much better, we're getting a higher average unit retail and obviously cost is starting to come down. So we're getting the benefit both ways.

Adrienne, related to the back-half inventories, so mid-teen on the dollars, low single on the units. Our work here is really to address the back stock that we had last year. We will continue to drive the bottoms business, as Robert stated earlier. We are planning AURs to be flat to up low single digits, but not much of a mix shift. Really, more about the inventory principles that we discussed earlier to turn faster and get to drive the bottoms business.

Our next question is coming from the line of Richard Jaffe with Stifel, Nicolaus.

I guess I've got a quick question on a -- a comment on depreciation in the fourth quarter. Were you just referring to the store impairment charge last year? Or was there something else to it that I missed?

The store impairment charge last year and as we move through the year, obviously, the kids will have an impact as well and the closing of underperforming stores or less profitable stores that you've heard about in the first quarter.

Got it. And then just a question on inventory today with it up quite a bit and the goal of having a leaner inventory and a faster-turning inventory, wondering what the content looks like today and how much change you think has to take place to get to that faster-turning fashion assortments and inventories more in line?

In terms of the inventory up today, the 14%, we made investments in shorts. We had strong selling in the first quarter, as you've heard, so we did reinvest in shorts. Our bras business was comping up 50% in the first quarter as well, so further investments to fuel that business. Then inventory then in the past would have been sent to a third-party. We're moving into our outlets to fuel the growth there as well.

And the thing I would add, Richard, is I would say that just to reinforce that we said is you'd see a linear improvement throughout the year in our ability to implement against the inventory strategies that we've articulated since we've been working together. And we're pleased with the margin flow-through that we were able to deliver in the first quarter. We intend to have that continue. You'll see, as we mentioned, the most obvious evidence of our improved inventory strategies coming through in the third and the fourth quarter. And just as a reminder, we had a tremendous amount of inventory invested in model stock and in back stock inventory in the back half of 2011, which we just did not need because we did not use any of that stock to service customer demand. So we've taken all of that investment out and that should dramatically improve our comparison starting in the third quarter.

Our next question is coming from Erinn Murphy with Piper Jaffray.

Just a quick question, actually, maybe Robert and Roger, if you could both provide your perspective on the current fashion cycle. I mean really we're seeing a lot of strength that you attributed to bottoms. Could you maybe compare what we're seeing thus far in spring to kind of the last 2 bottom cycles being back in denim, premium denim, back in 2004 period as well as the 12-cycle back in the late '90s. Are you seeing this color story really serve more as the catalyst to kind of continue on with the denim fabrication or maybe potentially switch to kind of a non-denim or a total fabrication over time?

I was around in the '70s, so the '90s is easy for me to remember. We really are in the bottom cycle. I think people are writing about it. The beauty of that is it's really a business you have to understand because once again it takes into account f.i.t., and f.i.t. is a very complicated issue. It's not like the top business that gives you a lot more room. So it's happening in all categories of bottoms. Unfortunately, the architecture of our classifications and our assortments are quite sophisticated. So we're in all of the different fabrications. We're in all of the different fits and the most important thing is not only color, but it's how you treat the color within the wash. And when you get that combination right, you win big-time and it's a very loyal customer base who loves your fit. So for companies who have not been involved in this cycle, it is very difficult for them to enter into it and get it right.

And strategically, Erinn, what I would say is, just to reinforce, our intent and Roger's given you all the evidence of how we're doing that, is to distort our talent focus, our investment resources behind being the #1 undisputed leader in our categories for which we're famous. And obviously bottoms, both jeans and in the future hopefully in the school categories, as well as in shorts are clearly driving a lot of momentum for us and we seem to be in a really nice cycle and we intend to take advantage of that cycle for the foreseeable future.

Our next question is coming from the line of Betty Chen with Wedbush Securities.

I was wondering if you can talk a little bit and remind us what we should expect in terms of AUC benefit in the second half. And then in terms of the inventory, I guess remind us, given some of the opportunities in the back half and yet plenty for units down, is it the productivity -- is that how we're expecting comps to stay positively along with the AUR gains? And then lastly, Robert, you mentioned earlier that we should expect, sounds like more frequent flows from your newness. Give us a little bit more color around what we should be expecting to happen in the stores and whether that also means we're going to see maybe shallower deliveries and kind of train that customer to buy a lot more on full price?

Okay, related to average unit cost, we're expecting the second quarter to be relatively flat. Looking to the back half, we're expecting declines in the mid to high single digits. What I would make sure we make you aware of is we've not fully booked Q4, so we still see opportunity in our Q4 numbers. Looking at the inventory, the productivity of inventory is really coming from a couple of things. Robert touched on the fact that we had a considerable amount of back stock last year that did not service the customer. It was unproductive. And we're set up to turn faster in the back half and sell out on fashion, which we think will help drive our AURs.

And in terms of the flow, Betty, what we're intending to do is really buy fashion to sell out. What Roger and the team have been focusing on is making sure that in our famous core categories, we're leading on trend and we're in stock to do business at the size level, that we take a similar approach in how we both design and execute our near-in categories. But on fashion, we want to be extremely competitive. We want to be on trend, but we're going to buy essentially to sell the majority of our fashion ideally as a ticket or first mark, sell a lot less at 35% to 50% off. Our ideal plan would be to be constantly chasing into the next delivery on fashions so that we can have more frequent flows to the store, keep the store looking extremely fresh and keep the customer coming back and, as you've said, buying at ticket. And so far, we've seen some really nice results in the first quarter and it's our intent to continue that momentum throughout the year.

Our next question is coming from the line of Roxanne Meyer with UBS.

When you think about the back half and the planning for the bottoms business, you talked about really putting fuel on that fire, how do you think about alternatively how much you're potentially planning the tops business to be down, just knowing that overall, your inventory investments are going to be down?

Right. Roxanne, it's a ratio. So the bottoms business is somewhat inventory-intensive, so we have to be very much sharper in terms of how we chase the top business. The beauty of the top business is the cycle is a much shorter cycle. And remember, we have a speed-sourcing organization in place so we can do, from a point of order, tops at a much faster frequency that we can do bottoms. So our ability to chase there is quite big.

So within the quarter -- within any one quarter, within the third quarter, for example, you could get into the position if you want.

Right. So we'll give you an example and I don't want to give too much detail. We have an extraction where we're quite sophisticated, an extraction where we have 10 stores that get set for back-to-school earlier than all the other stores. We read that information. And based on what we see in terms of rates of sale on a competitive basis within our own store, we immediately react to the last 2 to 3 weeks of this cycle. That's what drives margins up when you get that right.

Okay, great. And then just thinking going about going after more of the fashion, are you planning some of your core graphic tees or other more basic items down as a result, I guess, how should we think about shifting out of some categories if you distort fashion?

Right. By design, we have brought down the volume of the graphic business and that's really working in our favor. It's getting a bit of the older age customer. What we're driving for is allowing us to have more fashion and the whole balance of the store is that much better looking.

Our next question is coming from the line of Dana Telsey with Telsey Advisory Group.

A lot of good changes happened in the past quarter. How do you think of -- when you think of sourcing, when you think of product design and development, where are we on the continuum of where we can be maybe by holiday and how are you thinking about next year? And does it differ by product category? Does it differ by online versus in-stores?

You know what, Dana, I would say that the team has done a really terrific job in executing within a very tough environment. Everybody was hit with unfavorable cotton economics, and I think this team did a great job facing into that with a focus on maximizing shareholder return. As we've been looking forward, the challenge Michael Rempell, who runs our Indian supply chain and his team have been focused on is not only recovering the cost of cotton that Scott talked about, but through consolidating our store space, through having a raw materials platform that we can more effectively leverage, putting in place an opportunity to not only gain cotton back, but also have incremental opportunities for margin improvement by leveraging just a more effective use of our total store space. And so we have that being implemented through the back half of this year. It'll be a really strong opportunity as we move into 2013. And frankly, it will be something we'll always be focused on delivering against. Relative to the single greatest opportunity, I think we have -- Roger mentioned earlier in one of his answers about the very disciplined process we have of extracting kind of as much data as we can about what the consumer is reacting to in terms of product. The other thing that I think this team is great at that we're just going to pour kind a little bit more focus against is having differentiated supply lanes for our customer choices. We're going to put our famous core product categories down a continuous supply lane, and then in near-in or fashion categories, we're going to have differentiation between what we test and scale, what we read and react to and we'll put a lot more of fashion around -- through a supply lane, which is really about delayed development so that we can be reacting to what the customer is demanding at the moment and making sure that we're chasing into future ticket or first mark sales. That's really the intent and feel very confident the teams really pull together the focus on executing that for the foreseeable future.

Our last question is coming from the line of Lorraine Hutchinson with Bank of America.

You've just had 4 quarters of outsized e-commerce growth. I was wondering if you could just talk little bit about what drove that acceleration and then how you plan to continue to maintain that momentum going forward.

Sure. So we -- as I mentioned, Lorraine, when we -- when I first got to know the company, I was very impressed with the early and competitive lead that was established both in e-commerce as well as in social media. And so we have about 12% of our business in the e-commerce area at the moment. We have a robust platform and a really effective distribution capability within the e-commerce business. So what's been driving our business is really very much like Roger and I have been talking about relative to the product assortment strategies. We have distorted our focus on our famous core categories. We've got a much broader assortment of products that we can carry in the near-in categories, as well as in fashion and our online assortments. We have some unique web-only products, particularly if you take a look at our leadership position within footwear. I mentioned that earlier. We've got a marquee position competitively in the footwear category where we carry not only our own branded products, but also partner products and that's been a really strong driver of growth. And then we have a really strong CRM program and loyalty program. As I mentioned, we have seen a really significant increase in the loyalty engagements as we've executed a much stronger focus on increasing the size of our loyalty program and the active customer base of about 80 million customers, so we're really leveraging that well. And we also carry extended sizes in our offerings online. So it's a combination of the product assortment, the way we execute the assortment, the way we're leveraging our database and our loyal customer base and how we're building upon that loyalty through our CRM program is really driving momentum. Our intention is to gain share above the competitive growth rate of the market and direct for the foreseeable future.

Okay, that concludes our call today. Thanks for your participation. As a note, we are currently scheduled to report second quarter results on Wednesday, August 22. Thanks, and have a great day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.