As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Judy Meehan, Vice President of Investor Relations. Thank you, Ms. Meehan.
You may begin.
Good morning, everyone. Joining me today are Jim O'Donnell, Chief Executive Officer and Joan Hilson, Vice President, Chief Financial Officer. If you need a copy of our Q1 press release, it is available on our website ae.com. Before we begin, I need to remind everyone that during this conference call, members of management will make certain forward looking statements based upon information information, which represent 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.
And now I'll turn the call over to Jim.
Thanks, Judy. Good morning, everyone. The Q1 demonstrated real progress towards our goals. We achieved higher sales and stronger profitability. This was the 2nd consecutive quarter of We achieved higher sales and stronger profitability.
This was the 2nd consecutive
quarter of positive comps and we achieved a 55% increase in earnings per share excluding M and O. The AE brand continued to gain momentum with both women's and men's posting comp store sales. Further, we effectively capitalized on store traffic delivering a near record high conversion rate in the Q1. Both of these metrics speak to the overall consumer of the Aidy brand, the strength of the assortments as well as our value pricing. Aerie also produced strong positive comps in the Q1 and improved its bottom line results as well.
While profitability is not yet where we want it to be, we have implemented targeted initiatives this bottom line results as well. While profitability is not yet where we want it to be, we have implemented targeted initiatives, which will put us on a path to deliver improved second half results and ultimately lead to a targeted mid margin in 2011. First, we are well into the process of winding down Martinos' operations, which is within our estimates. The decision to close the brand while certainly difficult enabled us to focus talent and resources towards our most attractive opportunities, which are DAE brand, Aerie and 70,000,000 Kids. We are continuing to streamline our entire organization from top to bottom to be faster, more efficient and more productive.
We have made pivotal hires in design and merchandising for each of the brands and have forged essential alignment across creative functions. Additionally, we are looking at each aspect of the business for opportunities to reduce costs and improve processes. Our mantra is to work smart, combine a small company entrepreneurial spirit with a big company power and discipline. Specifically, we have made changes within our buying and allocation process. We have positioned more sourcing in the Western Hemisphere for both cost opportunities and shorter lead times.
We are leveraging our buying power in fabrics and expanding the vendor base where we see opportunities. In the area of store allocation, we've enhanced our process to be more precise and fluid, which will enable faster turns. The net result of these initiatives will lower inventory levels in the second half of the year. As the assortment plans are reengineered, we also expect to achieve AURs that are more appropriate for our brand positioning in the marketplace. The AE brand is right on target and it's extremely relevant to today's customers as confirmed by our annual research as well as external sources.
We continue to be top of mind with our 15 to 25 year old customers. We remain dominant in denim and we've made appropriate investments to support this brand defining business, which is a strong contributor to both sales and margins. With our denim as our foundation, we are focused on building our tops business as well as accessories. The idea is to complete the lifestyle experience for our customers through trend right fashion and alfetti. We will continue to deliver the core essentials that AE is known for, but additionally, you will see the assortments peppered with more fashion forward key items that elevate the entire brand experience.
We are being widely recognized for our unique position in the marketplace by customers and influencers alike. In fact, ABC's Nightline and the editor of People's Style Watch Magazine just featured American Eagle as a brand of choice for great fashion at affordable prices. Moving to Aerie, this is a brand with tremendous promise. We demonstrated success with our distinct brand position and we've placed a powerful stake in the ground for our bra and undie business. The next frontier though is expanding Aerie to become a full lifestyle brand, building on the early success of Aerie's fit, accessories, personal care and loungewear.
A word on 77 Kids. 77 Kids is gaining traction and steadily building brand awareness as an online business. The first seven brick and mortar stores are slated to open this year beginning in July. The retail stores will continue to raise the brand profile overall and familiarize 77 Kids product. We're excited about the launch of Little 77 for infants and babies 0 to 18 months.
And you can look for it in our stores and online in July. International International expansion is another important strategy for the company. And I'd like to emphasize again that our approach to international is one of minimal cash outlay with nearly immediate financial upside. We're extremely pleased with our first stores in Dubai and Kuwait and are proceeding with plans for additional stores in the Middle East, working with our partner, the Al Shire Group. We're also evaluating similar opportunities in various locations throughout Asia.
Looking at the year ahead, we are most optimistic about the 3rd and 4th quarters as our strategic initiatives will have had an opportunity to take a firm hold and deliver improvement to both top and bottom line. We made progress to date, we need to stay focused and disciplined. And in closing, I hope you share my excitement and enthusiasm for the opportunity in front of us. I look forward to discussing additional progress with you next quarter. Thank you.
And I'll now turn the call over to Joan.
Thanks, Jim, and good morning, everyone. First, I'll provide a few details regarding our improvement in the operating margin. I will then review our outlook. My comments will focus on results excluding Martin Enosa and please refer to the adjusted earnings statements accompanying the press release. We are pleased the press release.
We are pleased to see a continuation of the sales strength that began late last year. Total sales increased 8% and comp store sales rose 5%. Aerie comps were up 23% and direct sales increased 2% in quarter. Store traffic levels remained inconsistent, especially during non peak selling periods. However, strong on trend assortments drove a higher conversion rate and an increase in the average dollar sale.
The 1st quarter AUR declined due to a promotional knit strategy and an increase in accessories as a percent of the mix. Now let me turn your attention to gross margin. I'd like to talk about 2 major spring merchandising strategies, denim and knit tops. As you know, this spring, we made a deliberate investment in denim to support strong customer demand. This strategy was highly successful delivering growth in both margin dollars and rate.
Within this top, we entered the spring season with a unit driven planned promotional strategy designed to send a clear message of value and gain market share. This strategy did not deliver the planned margin. Beginning with the Q3, we have adjusted our assortment plans providing for a better balance between pricing and units enabling us to capture a higher margin. With that said, our Q1 merchandise margin still strengthened by 2 10 basis points driven by lower markdowns. We leveraged positive comp store sales nicely leading to a rent a rent decline of 40 basis points, which delivered a gross margin rate improvement of 2 50 basis points.
Moving on to operating expense. SG and A increased 11% due to higher compensation costs including the timing of executive equity grants. Looking ahead, we expect SG and A dollars to be in the range of up low single digit to down low single digit depending on the level of sales. As we've indicated, we are driving forward with aggressive initiatives to reduce costs and simplify our processes. We'll keep you updated as we lock down our savings.
Now turning to the balance sheet.
1st quarter
ending inventory increased 15% at cost per foot following a 4% decline last year. Our inventory position supports a year round in stock denim strategy, which we begin to anniversary in the Q3. We believe this is absolutely the right strategy entering back to school. And as we initiate the changes in our buying and allocation process, second half inventories are planned down. In keeping with our conservative spending plan, we now see CapEx of $90,000,000 to $110,000,000 for this year.
This is down $10,000,000 from our prior guidance. We ended the Q1 with cash and investments of $732,000,000 This is after share repurchases of $72,000,000 and a $13,000,000 payment on our demand line. Now $2 to 0 point early in the quarter. This guidance excludes estimated closing charges and an operating loss related to Martin Enosa of $0.13 It also excludes potential investment charges. Our clear priority is to quickly return to earnings growth.
With improvements in the areas of product or production and allocation, we have reduced our inventory for the second half of the year. A more balanced price and unit strategy will allow us to recapture margin. And our expense initiatives will enable us to drive leverage and strengthen
Thank you. Our first question is coming from the line of Christine Chen with Needham and Company. Please proceed with
your question.
Thank you. I was wondering what can you just talk to us a little bit in more detail about what changes you're making in planning out an allocation so that you'll be able to get your inventories down in the second half? And then wanted to ask about Aerie. I think you're only opening 9 locations for the year and I think previously you had said 20. What's the reason for the change?
Thank you.
Okay, Christine. Thanks for the question. The changes in the planning and allocation really relate to further differentiating our store allocations by volume levels. We see that we have an opportunity to turn our inventories faster than we have done in our lower volume stores and truly leverage a program that we have that we call store to door, which enables our customers to get sizes or choices from our web that they can't necessarily find in those lower volume stores. So that's number 1 and it's very important.
Secondly, we're leveraging and continue to leverage fabric platforming as well as just looking at the production improvements related to some of our top strategies that we now seeing what we see in the Q1 have third point on that is that our denim strategy is one that we anniversary in the Q3. It's one that we began last year Q3. So that's the reasons why we believe we can really turn those inventories faster. With respect to Aerie, we've shifted stores into 2011 and really feeling very good about the Aerie brand. We've seen nice improvement in the Q3 and we'll continue to evolve the lifestyle.
And I'm going to let Jim add a few comments related to that.
Basically, just to put a little more color around Joan's comments on Aerie. We looked at where we're successful in what type of markets and what type of locations within shopping centers. And so we've taken a look at where we want to place physically place the Aerie stores. And so in doing that, we decided to slow down 20 10 in order to position very strongly in 2011 and 2012 going forward in markets and centers that we deem to be appropriate based on data that we currently have where we're successful.
Next question Rob?
Yes. The next question is coming from the line of Jeff Kleinfelter with Piper Jaffray. Please proceed with your question.
Hi, good morning. It's Stephanie for Jeff Kleinfelter. I have two questions this morning. The first is, Joan, if you could just give us some further detail on your knit tops initiative. I think you mentioned that Q3 you'd be realigned in your sourcing structure there.
But what kind of effect can that category changes in that category have on your merchandise margin as we look at the model for Q3 and Q4? And then a second question, just following up on your second half inventory plans now having inventory plan down. If you could just give us some sense on what you're planning then for comp rate knowing that your inventory was up in the first half and you delivered a nice comp in Q1. How should we be thinking about the sales growth implications on a down inventory plan in the second half? Thank you.
Yes. Good question, Stephanie. Thanks. With respect to the unit strategy that we
rate of sale relative to those price points. And in addition to that, and we were able now to plan that properly within the back half of the year. So that's one. The other side of that is we're able to turn those inventories and really leverage some production improvements that enable us to bring those inventories in or mid tops in closer to need. So that's really why we can rebalance and certainly see that there is a merch margin opportunity in the Q3 and in the back half itself.
What this means to us is Stephanie is that this is a higher AUR that we can drive to in the Q3 because of this better balance and because of our ability not to take the higher level of markdowns that we've chosen to do in the first half of the year here to set ourselves up clean for the Q3. With respect to the second half in terms of comp guidance, what I would tell you there is that clearly we're planning our inventories down, really leveraging the ability to turn faster and we are remaining conservative in our approach to the year.
Thank you. We're ready. Okay.
The next question is coming from the line of Jeff Black with Barclays Capital. Please proceed with your question.
Yes, thanks. So can you shed some light on where you're seeing weakness to start the quarter? Is that what categories that might be in, etcetera? And Joan, on the kids and Aerie businesses, what kind of drag do we see from the combination of those
this year? Thanks. Thanks, Jeff.
The second quarter is really what we need to think about
here is that we've initiated guidance on a weak start to the quarter. We need to get through, a weak start to the quarter. We need to get through importantly, this is a big week. We've shifted some of our promotional cadence as well and really need to get some more sales and category selling under our belt before we would really comment on a category basis. So it's an early start to the quarter.
It's a quarter that we hope that we can play out here with some of the innovative marketing ideas that we have in our arsenal and we'll see how the quarter plays out. But that's really it's early and it's premature to really talk category selling. And with respect to the kids and Aerie business, Aerie is without really giving specifics on the bottom line impact Aerie is progressing nicely. It has improved from last year. We're in the quarter.
We're pleased with that. It is on a store profitability. Standalone four wall is doing far better than it did last year. We have much higher merch margins. And so, we are encouraged by that.
77 Kids has a nominal impact to our operating profit rates and dollars. And it's a brand that is truly, no pun intended in its infancy. We will look to see what retail can bring to us and we're excited about it in the July back to school timeframe. So that's truly a stay tuned Jeff.
Our next question is coming from the line of Janet Kloppenburg of JJK Research. Please proceed with your question.
Hi everybody.
Hi, Janet.
I had a couple of questions. First, I wondered on the guidance for the Q2, how much of that down forecast had to do with inventories being too high, Joan, as opposed to the weak business trends that you're seeing right now? And I wondered about the North American sourcing that Jim talked about and how that will help you improve margins because generally we think of that as a less competitive pricing market? And lastly, I think Jim mentioned that he was looking for operating margin improvement perhaps in 2011 or moving towards the goal of mid teen in 2011. So does that suggest that you're not looking for operating margin improvement in fiscal 2010?
Thanks.
So I'll take 2 and then Jim will take the production question. We have absolutely taken the markdowns that are appropriate to take in the Q1, Janet. So as we look at the Q2, our Q2 inventories reflect a similar denim position. As I said, we'll move into the Q3 and anniversary that. Without denim, we are up roughly low single digit and in terms of the balance of our inventories.
So truly what is happening in the Q2 is it's a weak start to the quarter. It's early in the quarter and we are taking the markdowns and assuming the markdowns in our guidance that we need to take to clear through the excess inventories. With respect to 2011 or 2010, pardon me, we clearly expect to get operating improvement in 2010 that lead us that leads us to the path to achieve that mid teen operating margin in 2011.
Janet, as it relates to cost competitiveness between the Western Hemisphere and the Far East. Actually, the Western Hemisphere is actually very competitive and its pricing for the type of product that we are having manufactured there. And also combined with that is that we have the ability to leverage freight. So it costs less money to get the product here to our distribution centers in the U. S.
As well as we're able to be more expeditious in our lead times. And so hopefully that will combine with faster turnover and leaner inventory. So overall, it has all the trappings to be a real margin contributor in the future.
We're ready, Rob.
Our next question is from the line of Brian Tanjik with JPMorgan. Please proceed with your question.
Thanks so much. Good morning. It's Anna Andreeva for Brian.
Hi, Anna.
Hi, guys. I had a couple of questions. First, Joan, just to follow-up on SG and A. Your comments for SG and A to be up low singles to down low singles, is that for the year or starting with the Q2?
That is for the year.
And how should we think about SG and
A dollar growth in the Q2?
The SG and A, the way
we should think about it, it was up the 11% in the Q1 that is in half or up mid single digit in the
second quarter. Again, that relates to timing related to the
relates to timing related to the equity grants. And then as we progress through the year, you should see the back half SG and A down.
Okay. Okay. That's great. That's helpful. And then just on the balance sheet, you guys bought back about 4,000,000 shares in April.
You have 26,000,000 or so left on the buyback. Just maybe talk about your and the Board's appetite towards buying back stock here in the back half?
We will continue to evaluate share repurchase. We that $26,000,000 authorization lasts throughout the year as you mentioned and it's something that we will review on an ongoing basis.
Thank you. Our next question is coming from the line of Michelle Tan with Goldman Sachs. Please proceed with your question.
Great. Thanks. I was wondering if you could talk a little bit more about the TOP strategy. Were you happy with the pricing and the initial margin and just bought too many units? Or as you look to the second half, are you thinking about buying fewer units and also taking the initial margins on the category higher?
And any kind of product changes that you're planning to go along with that? Or is it just really about the pricing?
It's 2 folds, Michelle. The way to think about NIPS is we went into the Q1 with a position with a unit value strategy. So yes, units were heavy in heavier than needed in the Q1. The response to the NIF was positive from the customer, but not to the level of our unit buy. So from that, we've been able now to evaluate the right rate of sale for that price point and also manage within our mix a bit of a price point change that will allow us in the Q3 to have modestly higher AURs on lower unit buys.
Our next question is going to be coming from the line of Dorothy Lichtner with Karas and Company. Please proceed with your question.
Thanks. Good morning, everyone. Can you hear me?
Yes. Good morning, Dorothy.
Thanks. Just following up on the top category again. I guess, could you talk a little bit more about what worked, what didn't work, how it's going to change in the second half aside from just the unit strategy? And then also just talk a little bit more about the changes that you've made to design and merchandise teams to give us some comfort level that the strategy there on the tops can play out in the second half of the year? And then also just a little bit more color because denim has been such a strong category for you, a little bit more color on what's working there as well and how many if any changes we might see going into back to school in second half?
Thanks.
With respect to top stores, Ian, as we look at the assortment, the basic top a modest acceptance by our customer, which in some of the higher price points that was one of the strategies to offset some of this lower selling. So we've been able to make those adjustments into and build on that into the 3rd quarter assortment. And also frankly, we don't need as many choices as we were also going also going to help our merchandise margins as we progress through the year is the idea of how we transition into our back to school line. And so we've been able to put forth a strategy that helps us manage newness as and what I'd call our core systems that allows the right amount of freshness going into the 3rd quarter, but also enables us to our talent and the changes in the merchandising and design, we are very pleased with how the teams are working together and really coming together with a unified view under our new leader, our Chief Merchandising Officer for the AE brand and really seeing that come together and really believe we'll start to feel the effects of that in the back half of the year.
With respect to Aerie and we have some new design talent there and one of the things that Jim mentioned is this idea of expanding the Aerie brand to be a full fledged lifestyle brand. And the design team is showing all signs of bringing the right level of talent for us to be able to do that.
Our next question is coming from the line of Jennifer Black of Black and Associates. Please proceed with your question.
Thank you. Your new floor set looks great by the way. I wondered how you're positioned in accessories for back to school and what areas you're focused on improving in that category? And then I also wondered how you're positioned for the big khaki trend? And then lastly, you talked on the last call about trademark issues that you were working on and I wondered where you were there as far as international?
Thank you.
And do you trademark?
I'll do that Liz.
Okay. With respect to accessories, as we move into back to school, we are extremely excited about accessories. And Jennifer, you may have noticed in the stores, the expanded presentation that we have with our jewelry assortment. And we really feel that that is a business that we've truly scratched the surface on in our mix. And we're really pushing that category to be at the right price points, the right balance in our overall assortment.
So you'll see the expanded presentation. It is serving us well, nice return on that investment and really continue to push the jewelry button there with footwear as a smaller part of the assortment and getting into some of the soft accessories, we think that's important as well for the back to school period. So nice investment, nice return thus far. We're going to continue to grow.
As it relates to trademark, I recently returned from a trip to Europe where we were very successful in negotiating the in resolving the in resolving a dispute
that we had with someone
who controlled trademark in some countries that we deemed to be strategically important to us for international expansion. We resolved the matter in very favorable terms for both parties. And it has opened up the door now for us to enter into agreements with potential partners to expand in other parts of the that we're very positive that will reap some very positive gains in a very short period of time. And you'll be hearing more about that as the year progresses and we'll try to give you as much color around it as possible. But we are embarking now in a very serious and strategic way to place international on the front burner on the priority list of things that we need to do now and to go forward over the next few years.
Okay. Rob?
Yes. Thank you. Our next question is from the line of Robin Muncheson with SunTrust. Please proceed with your question.
Thanks very much. Good morning, everyone. Good morning. Just a few questions here. One, if you could possibly talk about what your inventory, how you see it at the end of the second quarter?
When back to school sets, how much of your denim is sort of year round versus fashion that you bring in by season? And then just to piggyback off of Jennifer Black's question about khaki, if there's anything to say about that and does it play into Badger School second half? Thank you.
Sure. We haven't given guidance for some time around quarter end inventories Robin and that was because of the timing of accruals at the end of a quarter. So what we're giving is the view of average weekly inventories on a cost per foot basis. That said, the inventories in the Q2 total up low double without denim up low single. And as I said in the back half of the year, we're anniversarying that strategy and we expect the inventories to be planned down.
And I feel very good about the work the teams have done around this inventory strategy and really driving more efficient turns in our inventory at a category level. With respect to KAKI, KAKI is a part of our assortment and a strategy that you will see from us and stay tuned on what that looks like.
Thank you. Our next question is from the line of Liz Dunn of Thomas Weisel Partners. Please proceed with your question.
Hi, good morning. Thank you. I guess, is there any sort of quantification on the level of carryover inventory right now? Anything you can add to give us some sense of the freshness of your inventory? And then, I know that it's early in the quarter, but is there any way you can say whether or not you're running negative comps now?
And what's leading to the optimism for the back half? Because if I understood it, you're saying you're more optimistic for the sales outlook for the back half, though comparisons are a bit more difficult. So if you could just provide some clarity there?
Sure. To clarify the inventories, the weakness in the Q2 relates to summer goods. And what we are in terms of this isn't about carryover of spring first product. Product. It's about the weakness in trends and that we're in the business performance that we're seeing today.
So carryover is not a part of the inventory or margin pressure that we're seeing. With respect to the back half, the optimism that you're hearing is about the management of
our inventories and the confidence that we have in our
ability to turn our position from the first half strategy. So that's the optimism you're hearing is around the inventory strategy. And what I had mentioned earlier is that there is a conservative view of business trends in the back half.
Our next question is from the line of Todd Slater with Lazard Capital Markets. Please proceed with your question. Thanks very much.
I want to start by recognizing the merchants have really done a good job delivering on the fashion product. It sounds like the message is that you're aggressively addressing the inventory issues here. I'm wondering, though, who is primarily responsible for the inventory decisions, if it's coming out of the financial function or the merchants driving the unit plans? And also with the inventory up 15% in dollars, can you give us a sense of what the inventory is up in units? And then excluding denim up low single digit in dollars, what's the relationship also in terms of units?
And how much can you give us a sense of how much the inventory is up in the denim area specifically, because that sounds like it's a big driver? And then lastly on the balance sheet, very strong balance sheet, stocks down a lot. Why is the company, the Board not really talked about deploying the cash more aggressively? Thank you.
So thanks for your comments, Todd, relative to our fashion. In terms of the inventory position, I'll state this and this is the content of our inventory speaks to denim and that is where the increase is. Our denim strategy is working. We feel very good about it. We hit our sales and margin plan.
So the denim position is a strategy that we've employed for the last year. The unit strategy was a strategic move to regain market share in our nip top category. So that's where those decisions are coming together. As it relates to 2nd quarter inventory specifically up low double without on an average weekly basis without denim up low single. And from a unit perspective for the Q2, we're seeing it up mid single on an average basis.
So that's the comments related to the Q2. And with respect to the buyback or the potential repurchase of shares, we just repurchased $72,000,000 4,000,000 shares in the Q1 and we will continue to evaluate that as we progress through the year.
All right. Thanks, Rob. Next question.
The next question is coming from the line of Kimberly Greenberger with Citigroup. Please proceed with your question.
Great. Thank you. Good morning. Good morning.
You laid out the goal of hitting a 15% operating margin in 2011. I'm wondering if you can help us understand the levers that would help you get there. What sort of sales growth assumption would you need in order to achieve that goal? And then what is the contribution from gross margin and SG and A on a relative basis? That would be helpful.
Thanks.
Sure, Kimberly. As we look at achieving that mid teen operating margin, what we need to do is drive top line and get back some of that sales productivity. So that's an important piece. Improving merchandise margin to begin to approach some of our high points or peaks in our history is something that we are driving towards. It would be unrealistic to think that we could actually get to those peaks sitting from this vantage point today.
But we believe that we a big piece of the improvement needs to come from our merchandise margin. And that's why we're very focused in some of the strategies that Jim mentioned as well as the strategies that I mentioned around planning and allocation. SG and A is clearly a piece and why we're aggressively going after a savings initiative here and expect to be able to come back to you in the 3rd and 4th quarters with some real savings opportunities, but less so than to the margin opportunity. So it's top line margin, merch margin is a larger piece than the SG and A.
Okay. Thanks. Rob, we're next question.
Yes. Our next question is from the line of Richard Jaffe of Stifel Nicolaus. Please proceed with your question.
Thanks very much guys. And really 2 part question. You talked about average unit retail moving up in the second half and I understand the appeal of that. Is this going to be a shift in your more aggressive promotional pricing? And if so, how are you going to sort of convince the consumer to pay more?
What's your visibility on this sort of shift in product that I would assume will follow this goal? And if you could talk a little bit more about international and the financing of that business and the potential growth
of that business?
Richard, with respect to the AUR in the second half, as I mentioned, it's a modest increase. And it's one that it really is a fine tuning, a little bit of rebalancing in that unit value strategy that will drive it. And also remember that accessories is a part of that mix and something that we're growing as well. So that's really the it's more of a subtle change and an outcome of turning our inventories faster and having a more conservative view in that management.
As it relates to international, I believe I stated in my comments that as far as the American Eagle investment, it's minimal in that our arrangements, our contractual arrangements with our partners and potential partners is right now is a licensee arrangements. So the licensee bears most of the majority of all the financial aspects of the transaction. As we progress forward and we decide on how we want to progress in each of the parts of the world we deem to be appropriate, it can take on a number of different variations as to the transactional arrangement. The licensee is the minimal amount of risk and the minimal amount of investment, but it also capture your overall contribution. We're also looking at joint ventures where we would have the majority share.
We have not entered into any. We have researched that and in some cases we might do a combination of early on licensee arrangement and then eventually would graduate to a joint venture with American Eagle taking over the majority share. And there's a remote possibility in some parts of the world we may go at it ourselves, although we haven't explored that in any great detail at this time. And so I don't see that in the near future. So you'll be hearing more about the international operation and our growth plan and also the financial structure that we're going to pursue on a go forward basis.
But right now there's a there will be minimal investment on the part of American Eagle and almost zero exposure financially for any downturn.
Okay. Okay, Rob.
Our next question is from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.
Good morning. Can you talk a little bit about how you're thinking about IMU and the continued opportunity going forward and the upcoming raw material cost increases and how you're planning for that? And just any more color in terms of guys and girls, what you're seeing by product category strength in denim and tops? Thank you.
Thanks, Dana. With respect to IMU or really the way we talk about it as you do is in terms of costing of our product. We're seeing currently that product costs are down in the spring season and we've been able to pass a portion of that on to our customers. However, as we look forward, we expect to see modest benefit in costing in the Q3 and in the Q4, really expect to see that flatten out. And as far as next which is I know on the minds of many people, it's really early.
We are working with our vendor partners to optimize as best we can the position that we're seeing occur out in the market with respect to rising cost. So we are diligently working our way through that to mitigate any increases as best we can. With respect to what's the second question? The guys and girls mix and any color on the category selling, really strong, obviously in both men's and women's denim, feel very good about that. We see bright spots in our top category across.
We have fairness, we have our fashion knits, the basic knits we've been talking about as well as graphic T shirts. And we're seeing that there is a nice response to our assortment. And as we navigate away from this, the unit value strategy and approach the back half of the year, we feel that the assortment we're seeing is we feel good about it. And in the back half of the year, once we move away from that excess inventory that we will be able to flow through better margin.
Okay. Next question, Rob?
Our next question is from the line of Stacy Peck with SP Research. Please proceed with your question.
Great. Thanks. I guess I'm going back to
the $0.12 to $0.16
because it just looks like your kitchen sinked it. And so Joan, can you I mean, I have a number of questions. I mean, what is May to date? It's almost over. I know this week's important.
But if you would tell us that, what are you assuming for the Memorial Day shift? Are you assuming any increase in the June comp? Or what is the Q2 comp assumption? What are you assuming about the summer nets in terms of markdowns? Because given your SG and A guidance, it looks like you're basically assuming they're not going to sell much at all.
What's the excess inventory in knits? And then for the second half, I think what people are asking, aren't we going to feel the impact of the new knits designer from Splendid? Or should we not get more excited about the knit assortment, how the product looks for the second half? And do you expect the gross margin to be up in the second half?
Stacy, that's a lot of questions.
Yes. So let's answer it this way Stacy. We our practice is not to give comp guidance and appreciate the interest. It is early. We have a big weekend or big week that we're in now and some shifts in our own promotional cadence.
So we need to get through this and we'll bring you sales results for May next week. And we won't talk about quarterly comp guidance, but our view of that obviously is reflected in the margin pressure and the guidance we're seeing for the Q2. With respect to the mix and the back half, clearly, we believe that we will have with better managed inventories in terms of this unit strategy and the quick turn leveraging the production cycles and bringing closer to need, we will be able to improve merch margin in the back half of the year. That is our goal, that's our target and what we're working towards. We feel that the niche strategy is improving.
I believe that in the Q3, we are offering a better balance of choice, meaning we do not have to bring at any one given time the breadth of assortment that we saw in the first half of the year. And we also have gotten good feedback in what's selling and what the customer is responding to. And that's the comment we'll have on this.
This.
Allow me to weigh in here, because I think maybe we painted a picture that you're all deeming to be much more dramatic and drastic than it really is. The knit program that was initiated for the Q1 of this year actually was some of it's in Q4 all over last year, but the nominee for Q1 this year was not a disaster. We actually lessons learned were we've had some phenomenal selling in some graphics, non branded and in branded on our graphic T shirt line. Some of our styles in women's in what we would call the on trend product was well received. We've actually lessons learned that we were able to get some higher price points on product that we probably could have hindsight being 20.20 could have bought a little heavier, but we didn't.
We've actually the problem with the knit assortment is that we might have been a little too enthusiastic and the assortment was a bit broad. And probably we could have been a little more strategic in how not only how we purchased it, but how we brought it in and landed it in quantities. So all these lessons learned, they're being course corrected for during the Q2 with some with the markdown strategy to eliminate some of the summer styles as well as bring in some what we think are some new and exciting styles for Q3 and we're very excited about holiday. The knit team that we have primarily in women's is a quite talented team. And I have all the faith that they're going to deliver
some on trend product that's
going to be that's going to be well received. Combining all of that, you're going to see that the AUR can go up somewhat in that category, whereas we were in a very much in the unit velocity mode early in the season. And bottom line is that, the season. And bottom line is it didn't work. And when some you have to try something before you know and there's some things that we did learn that we'll take advantage of as we move forward into the 3rd Q4.
Q2 will be what it's going to be. And it has to be we've been in this business for a while and we're just going to do what we have to do in order to have clean inventories going into the 2 most important quarters of the year and that's the 3rd Q4.
Okay. Bob, we're going to we have time
for one more question and I underscore one question.
Okay. That question will be coming from the line of Linda Tsai with MKM Partners. Please proceed with your question.
Yes. Good morning. Given the
Given the inconsistent traffic trends, are there any marketing initiatives or promotions that have been successful for you that could help smooth the volatility of customer traffic? So Linda, we are, as I mentioned earlier, working on some innovative marketing ideas. And clearly, we're on it and we will be bringing that to you in the back half of the year as well as late into the second quarter. So,
okay. All right, everyone. That concludes the Q1 conference call. As you know, our next announcement will be made sales, which we will report next Thursday, June 3. So thanks for your participation today and everyone have a great weekend.
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