American Eagle Outfitters Inc. (AEO) Q1 2023 Earnings Call Transcript

American Eagle Outfitters Inc. (NYSE: AEO) Q1 2023 earnings call dated May. 24, 2023

Corporate Participants:

Judy Meehan — Vice President, Investor Relations

Jay L. Schottenstein — Executive Chairman of the Board and Chief Executive Officer

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Michael R. Rempell — Executive Vice President, Chief Operations Officer

Mike Mathias — Executive Vice President, Chief Financial Officer

Analysts:

Paul Lejuez — Citi — Analyst

Jay Sole — UBS — Analyst

Amanda Douglas — JPMorgan — Analyst

Adrienne Yih — Barclays — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Jonna Kim — TD Cowen — Analyst

Alex Straton — Morgan Stanley — Analyst

Janet Kloppenburg — JJK Research Associates — Analyst

Chris Nardone — Bank of America — Analyst

Marni Shapiro — Retail Tracker — Analyst

Presentation:

Operator

Greetings, and welcome to the American Eagle Outfitters First Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Judy Meehan. Thank you, Ms. Meehan. You may begin.

Judy Meehan — Vice President, Investor Relations

Good afternoon, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Executive Chairman and Chief Executive Officer; Jen Foyle, President, Executive Creative Director for AE and Aerie; Michael Rempell, Chief Operating Officer; and Mike Mathias, Chief Financial Officer.

Before we begin today’s call, I need to remind you that we will make certain forward-looking statements. These statements are based upon information that represents the company’s current expectations or beliefs. The results actually realized may differ materially based on risk factors included in our SEC filings. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Also, please note that during this call and in the accompanying press release, certain financial metrics are presented on both a GAAP and non-GAAP adjusted basis. Reconciliations of adjusted results to the GAAP results are available in the tables attached to the earnings release which is posted on our corporate website at www.aeo-inc.com in the Investor Relations section. Here, you can also find the first quarter investor presentation.

And now, I will turn the call over to Jay.

Jay L. Schottenstein — Executive Chairman of the Board and Chief Executive Officer

Good afternoon. Thanks for joining us today. Entering 2023, we’ve built our plans for the year cautiously, balancing continue optimism for our brands with the flexibility to navigate uncertainty in the macro-environment. Exiting the first quarter, I am pleased to note that the strategy delivered for us, our team successfully managed through the quarter and achieve results in line with plan.

Consolidated revenue of $1.1 billion was up to last year, and marked the new first quarter high for the company. Adjusted operating income of $44 million improved slightly to last year. We continue to make progress, strengthening the balance sheet and redeemed our outstanding convertible debt ending the quarter with healthy liquidity.

By brand, first quarter revenue declined 2% at American Eagle, and increased 12% at Aerie. Despite a tough spending environment, both brands demonstrated a sequential improvement from fourth quarter trends. We made progress at American Eagle with-profits up to last year and top-line trends moving in the right direction. We remain steadfast in our focus on healthy and profitable growth. Although still early, new extensions like AE 77, our premium capsule and 24/7, our entry into men’s activewear are seeing encouraging results.

Aerie remained a fan favorite, delivering record revenue and profitability. Our activewear extension offline continues to carve-out a unique identity in the marketplace with its high-quality assortment and vibrant spirit. Additionally, investments in new stores are increasing brand reach and awareness, providing a tremendous foundation for Aerie as it continues to scale in the coming years.

We took action to restructure Quiet platform to strengthen profitability. As I mentioned last quarter across AEO, we have initiated a formal program to find further cost savings and cover more efficient ways of working. We have a powerful portfolio of brands with tremendous value still to be unlocked. In the near-term, we are highly focused on managing through this macro-environment. As Mike will review, we’re maintaining strong disciplines and taking opportunities to optimize profitability this year and in the future.

With that, I’ll turn the call over to Jen.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Thanks, Jay, and good afternoon, everyone. I am proud of how our brands performed this quarter despite choppiness in the retail environment. We showed up well across stores and online with fresh styles and tasted the high-demand items profitably. While promotions were up to last year, we participated strategically protecting our multi-year progress in-building brand equity.

Our first quarter AUR was the second-highest in history, down 3% to last year’s record results, yet up over 20% to pre-pandemic levels across brands. Our customer KPIs were healthy. In the first quarter, we grew our total customer file and also expanded our loyalty customer base. In fact, our Real Rewards loyalty program was recognized by Newsweek as America’s fourth best program in apparel this year.

Moving onto the brands. Aerie had a strong quarter with double-digit revenue growth and positive comp growth. We saw an incredible customer response to new styles in our core apparel collection across fleet, bottoms and tops. Seasonal tops and new bottom silhouette in particular were key drivers of new customer acquisition. Demand for our activewear extension Offline by Aerie also remained healthy with strength in tops, sports bras, active shorts and fashion items.

Swim and intimates were soft this quarter, consistent with trends we’ve seen in recent periods as our customers focus on other categories. We are continuing to engage our customers with exciting content. In the first quarter, our find your own vendor campaign supporting our Y2K collection, including partnerships with key influencers and publications like Who What Where. This month, Aerie launched the Real You summer campaign, celebrating our new summer collection, including our fan favorite pool to party capsule.

Turning to American Eagle, revenue was down to last year, yet profits were up as we continue to focus on healthy sales. We made progress across several major categories. For example, women’s top, I’m pleased to say, returned to growth. We also continue to see exciting comps in non-denim bottoms and denim trends improved throughout the quarter. Men’s was a bit soft, where I believe we have the opportunity to lead with more newness.

As noted last quarter, following several years of work to streamline the AE brand and improve profitability, we are honing our focus on growth. I’m pleased with the response we’ve received to AE77, our premium denim collection and 24/7, the men’s active wear line. We are testing and scaling thoughtfully as we position AE for profitable growth. We are continuing to think creatively about how we leverage marketing to drive momentum for AE. In the first quarter, our organic partnership with Alix Earle, one of TikTok’s fastest-growing influencers generated strong buzz. Videos promoting AE products have received 6 million views to-date and increased sales velocity of promoted products.

Additionally, we introduced an exclusive partnership with e.l.f. cosmetics, bringing together two powerhouses in the Gen Z world. The collaboration was first of its kind and sold out within minutes of hitting our website. Looking ahead, I am excited by new trends in casual wear. While the macro is clearly tough, we will lean into high-quality innovation and marketing to draw on our customers. I’m incredibly grateful to the AE and Aerie teams for their hard work and solid execution this past quarter.

Thank you. And now I’ll turn the call over to Michael.

Michael R. Rempell — Executive Vice President, Chief Operations Officer

Thanks, Jen, and good afternoon, everyone. I am encouraged with the progress we are making across our operations, brands and channels. Given ongoing uncertainty in the macro, we’ve been very focused on making operational improvements across the business with an emphasis on finding efficiencies in labor, inventory and expenses. This is a multi-year journey, yet the early impacts we are seeing provide compelling proof point of the work underway.

In the first quarter, store revenue increased 5% as customers returned to in-person shopping and new Aerie stores continued to ramp up. I am pleased to note that store labor cost declined to last year as we achieved deficiencies in our labor model, offsetting both wage inflation and payroll related to new stores.

Our focus on the store fleet is to ensure that we are fueling the best stores in the best locations with the right inventory, the right staff and the latest new technology, all to deliver outstanding customer experiences and while finding efficiencies and cost savings at the same time. We are taking steps to enhance our operational excellence across all these areas as we focus on maximizing ROI and store productivity. This includes the RFID and AI-based technology I discussed last quarter, which provides accurate inventory and location visibility within our stores. As we roll out this new capability, I believe the benefits to our business will be meaningful, yielding efficiencies and inventory productivity.

On the digital side, revenue declined 4% as customers returned to in-person shopping and demands continued to normalize from elevated builds during the pandemic. New leadership is bringing innovative ideas to drive improvements to online KPIs. Specifically, we’re looking at greater use of analytics and testing to drive increased engagement, traffic and conversion. I remain excited about what we have in the pipeline for 2023.

We’ve also seen positives in our supply chain. On the outbound side, Quiet platform’s innovative fulfillment model continues to drive incremental benefits to our brands. Digital delivery costs in the first quarter were down to last year and leveraged as a percent of digital revenue. We reduced shipments per order and found efficiencies in fulfillment costs all while delivering orders to customers faster.

Since the first quarter of 2019, digital delivery costs have leveraged nearly 100 basis points as a percentage of digital revenue. As Mike will review, we took action this quarter to restructure the third-party side of the platform, reduce expenses and focus on core services that drive value both for American Eagle and Quiet customers. We now have a leaner organization that will position us well for the future. We see opportunities to leverage Quiet fulfillment capabilities to unlock even greater efficiencies in our operating model. This includes optimizing inventory placement, buys and replenishment as we work upstream through our supply chain.

As expected, 2023 is providing a much more stable supply chain environment with lead times and product costs normalizing back to pre-pandemic levels. This was incredibly beneficial to us in the first quarter. It enabled us to plan cautiously and successfully chase into strong items. With continued choppiness in the macro environment, we are approaching the balance of the year with a similar strategy. From where we sit today, we are leaving a sizable portion of inventory open as we focus on maintaining agility to read and react to demand signals in the market.

As I said earlier, we are early in our journey to strengthen our operating model. We still see significant opportunities across both labor and ongoing inventory efficiencies, and we are also going to be keeping a sharp focus on expense reductions.

Thanks. And with that, I’m going to turn the call over to Mike.

Mike Mathias — Executive Vice President, Chief Financial Officer

Thanks, Michael. Good afternoon, everyone. As expected, the environment remained choppy in the first quarter. Yet, I’m pleased with how we managed through monthly variability. We entered the year with a healthy inventory position, product cost favorability and renewed agility in our supply chain. This enabled us to operate with flexibility, strategically control promotions and deliver on our first quarter plan.

Consolidated revenue of $1.1 billion marked a new first quarter record for the company, increasing 2% to last year. Adjusted operating income of $44 million was up slightly, reflecting an operating margin of 4.1%. Compared to last year, gross profit dollars increased 6% to $413 million, with the gross margin rate up 140 basis points.

Merchandise margins increased to last year, led by a favorable transportation environment with a partial offset from higher markdowns. Markdowns remain below pre-pandemic levels as we maintain focus on healthy promotions and preserving the progress we made in rebuilding brand equity over the past several years. Within gross margin, we also leveraged compensation and delivery costs, partially offset by rent expense linked to new store openings.

SG&A expense of $312 million was up 5% to last year, driven by corporate compensation and advertising. Store compensation was down despite new store growth, driven by efficiencies in our labor model. We also saw a reduction in professional services, another area that has been a focus over the past several quarters. Depreciation increased primarily due to investments in new stores.

In the first quarter, we took measures to restructure Quiet platforms and strengthen profitability. We reset expenses to align with the current pace of growth in the third-party business. This included downsizing the workforce and streamlining costs to focus on areas where we see the greatest long-term runway. In our first year of ownership, we’ve seen significant benefits to our brands from Quiet platform’s innovative delivery and fulfillment model. From here, as Michael mentioned, we’re focused on the next layer of benefits, including rethinking how we buy, place and replenish inventory.

As noted last quarter, we began a company-wide assessment of our entire cost structure as we prioritize unlocking greater profitability in our business and rebuilding long-term operating profit margins back into the double digits over time. This includes a full review of expenses across the P&L, as well as processes such as clearance management as we continue to explore more efficient ways of working. I look forward to sharing more on this in the second half of the year.

Adjusted EPS was $0.17 per share. This excluded $0.08 of charges primarily due to two impairment and restructuring related to Quiet. Our diluted share count was 197 million, down from 220 million last year.

Turning to our brands. We are pleased to see trends for both Aerie and American Eagle improved sequentially in the first quarter. Aerie revenue increased 12% with comparable sales up 2%. As Jen noted, new product assortments resonated well. Additionally, we saw a nice lift from new stores opened over the last two years as they ramped up along the maturity curve.

Aerie’s operating margin of 15.8% improved 240 basis points to last year, driven by normalizing freight costs as well as rent and expense leverage. American Eagle revenue declined 2% and comps were down 4% to last year. As Jen noted, we have rebuilt the foundation of the AE brand over the last several years, eliminating unproductive SKUs and closing down or relocating unprofitable stores. This allowed us to deliver better profitability year-on-year despite lower sales.

With the bones of the brand in a healthier place, we’re now focused on pursuing new ideas that can drive profitable sales moving forward. Consolidated ending inventory cost was down 8% compared to last year, with units down 9%. AE and Aerie inventory across the US and Canada, in particular, ended the quarter down double-digits to last year as we continue to buy cautiously in the current environment. Looking ahead, we are maintaining inventory discipline and expect second quarter inventory to pace below revenue.

In the first quarter, we successfully redeemed the remaining balance of the principal associated with our convertible note position. We ended the quarter with $118 million in cash and continue to have healthy access to additional liquidity through our revolver with total liquidity amounting to $659 million. Capital expenditures totaled $46 million as we continue to prioritize free cash flow generation. We’re investing selectively and focusing on leveraging the infrastructure we have.

We now expect full year capex to be in the range of $150 million to $175 million, down from our prior guidance of $150 million to $190 million at the start of the year. We continue to expect our consolidated store count in 2023 to be roughly flat to last year reflecting approximately 25 new Aerie store openings, offset by approximately 25 net closures for the AE brand.

Moving on to our outlook. As the supply chain continues to normalize, we’re seeing product cost favorability and increased agility in our operations. Yet the environment for discretionary spending remains volatile. Over the last several weeks, business has slowed from the first quarter. While it remains to be seen if this trend will continue, at this time, we are guiding to second quarter revenue down in the low single digits with operating income in the range of $25 million to $35 million. We expect the gross margin recovery from last year as we cycle pressure from end of season sell-offs and elevated freight costs.

SG&A is expected to increase in the low to mid-single digits and depreciation expense is expected to be similar to the first quarter. For the year, we see revenues flat to down low single digits and operating income in the range of $250 million to $270 million. As discussed, we’re highly focused on finding efficiencies and savings across the organization, and we’ll continue to provide updates on our progress.

With that, I’ll open it up for questions.

Questions and Answers:

Operator

[Operator instructions] Thank you. Our first question comes from Paul Lejuez with Citi. Please proceed with your question.

Paul Lejuez — Citi — Analyst

Thanks, guys. Can you talk about what has changed thus far in the second quarter and where you adjusted your expectations down for the back half as a result of that? And then, Mike, you’re talking a lot about cost savings and efficiencies. When are we going to see that hit? I’m curious if there’s anything coming in the second half or any concrete examples of where you might be finding savings to date as you go through and do that work? Thanks.

Mike Mathias — Executive Vice President, Chief Financial Officer

Yes. Thanks, Paul, it’s Mike. I can talk about the trend of the business. Obviously, we talked about first quarter revenue up 2%, comps down 1.5%, definitely choppy as we keep using that word to describe it. Felt good about how things were progressing with — through the spring break shift, Easter shifts, got to the end of April and now into May and things have slowed down a bit. So, again, May is just our smallest month of the quarter. We’re four weeks in, definitely some — for us, we’re keeping an eye when schools are letting out. It looks like it’s going to be later this year. That could have an impact. So we’re being cautious about what we’re seeing in the last few weeks. The majority of the quarters ahead of us still probably 75%-plus of the volume, but the guide is cautious is just based on what we’ve been seeing for the last several weeks.

Your second question on cost savings, we’re four, five weeks into pretty aggressively laying out a road map for opportunities, some of which we haven’t waited on. As Michael talked about, store labor was a good result in the first quarter [Technical Issues] on that since last year. Services, also a good story in the first quarter, that work continues. We’re pulling down our capital spend more to benefit to impact depreciation, looking forward past in future quarters and really next year and beyond.

And then, as I mentioned in my prepared remarks, I mentioned clearance inventory. That’s something else that is underway as we speak, could have some benefits definitely for this year, maybe even in the second quarter, a little more than we’ve provided in our guide. That’s something we’re not locking down right now in terms of plans. And it’s really just about how we manage through clearance, our end of season sell-off process. It’s basically part of the operating model like I’ve been talking about within our $4.7 billion cost base, something we’ve been looking at and we’re changing that process as we speak.

So, some of those things we think could have more second half benefit than what’s in our guidance right now, but I’ll be talking more about that on the second call to lock down things more specifically, that can answer your question with definitely more specifics at that point.

Paul Lejuez — Citi — Analyst

Got it. And then, was that slowdown at both brands or was there more one [Phonetic] than the other thus far in May?

Mike Mathias — Executive Vice President, Chief Financial Officer

It was both brands by a bit, reflecting in our guide, and that’s why we think there could be some shift happening, and we want to keep an eye on that. Cautious for now, 3.5 weeks into the quarter, is definitely a bit in both brands.

Paul Lejuez — Citi — Analyst

Got it. Thanks. Good luck.

Operator

Thank you. Our next question is from Jay Sole with UBS. Please proceed with your question.

Jay Sole — UBS — Analyst

Great. Thank you so much. Maybe I’m wondering if you can elaborate a little bit on the intimates business within Aerie. Maybe Jen can talk about what you’re seeing there and maybe what the plan is going forward? Thank you.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Sure. We’re really excited about this business actually, because the whole ceiling is lowered in intimates. We held our ground on bras for sure. There has been some shifts in silhouettes, but we’re double-downing tomorrow. In fact, I have a huge offsite with the team. I know they’re going to present me with tons of new innovation and ideas. Look, the whole category has shifted. Girls are wearing bra tops out. So there’s no need for bras, and we’re focused on that and how she’s wearing her intimates. So, I think there’s going to be a lot more exciting things to come here.

We’ve certainly seen some plus-ups in sports bras. As Mike and team mentioned, OFFLINE is certainly an exciting category for us and sports bras are really accelerating. So, we’ve got — and I don’t know if anyone’s worn our sports bras. Please do get out there because I wear mine every day to the gym. And it’s honestly the most comfortable and supportive sports bra out there. So, I get pretty excited. Look, we’re not giving up. Next year is Aerie’s anniversary, it’s our Aerie Real anniversary spring 2024. And let me tell you, we’re revving up into that year with new exciting things happening in all of our categories actually.

Jay Sole — UBS — Analyst

Great. Thank you so much.

Operator

Thank you. Our next question comes from Matthew Boss with JPMorgan. Please proceed with your question.

Amanda Douglas — JPMorgan — Analyst

Great. Thanks. It’s Amanda Douglas on for Matt. So, Jen, you mentioned a focus on driving growth at the American Eagle brand. Could you just elaborate on key initiatives in place today, timing of those initiatives and any key categories in the assortment you see as an opportunity as we look ahead into back-to-school?

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Sure, absolutely. We’ve been really rationalizing this brand, as Mike mentioned, too, closing some stores. We’ve got out of some businesses that were not profitable. We’ve been focused on the bottom line. And certainly, we’re delivering there. So, proud of the margins we’ve been delivering in American Eagle. And look, we’ve seen improvements in women’s, really exciting improvements from a comp trend into Q1, a significant shift. And so we’re really leaning in there in that category.

And in men’s, did see some softness. I think we could be a little bit more aggressive in some of the newer categories, and we’ve tested those categories in Q1. So you’ll see as we head into the back half of this quarter because we launched back-to-school around June 30. So we’ll have some new ideas that we were able to react to in men. So Jay mentioned 24/7, that active line is incredible. I just saw all the creative for it. Some of the innovation there and the excitement around that. I think our customer is going to be very excited and delighted as we, like I said, head into back-to-school.

Also, 77, it’s a small test, albeit, but these genes are not cheap. There are premier price points, premium price points. And we like what we’re seeing early on. And definitely, that would entertain an older customer. So pretty excited about some new ideas on that side of town, too. So we’ve got opportunity in these new categories to really go after them as we get more momentum in the business. And then Aerie, the back-to-school is incredible. I just — it gets better with age, this brand. That’s all I can say.

Just to remind you, Aerie since 2019 has grown 129%. And I believe that’s better than any near-end competitors. So, this team just is an engine, and we have so much opportunity in front of us. And we’re going to keep on looking for our golden nuggets and driving it. I will say, all the teams reacted to the business early, we saw nice momentum coming out of the quarter in April. As a reminder, Easter, when we saw that shift, and we got into Easter, the momentum happened. I’m here as the optimist. We haven’t hit Memorial Day. Our stores business really performed nicely as Michael mentioned, in Q1. So when these kids get out of school, I’m hoping they like what they see.

Amanda Douglas — JPMorgan — Analyst

Great. And then, Mike, to follow up on the margin side, help us to think about the magnitude of gross margin expansion you see in 2Q relative to the first quarter? And to what extent do you see higher markdowns as a potential headwind for the balance of the year?

Mike Mathias — Executive Vice President, Chief Financial Officer

Thanks, Amanda. Yes, Q2 gross margin expansion will be — we’re assuming our projection, it would be even healthier. If you remember last year, that was our — we recover similar freight-related impacts versus last year, really every quarter. And then last year from a markdown perspective, we did some things to right-size inventory at the end of the quarter last year that we are not obviously in a position to have the anniversary.

So, gross margin expansion for the second quarter will be healthy. That’s largely what we’re expecting really every quarter from here is that product costs, freight recovery, and we do not have any intention or any plans for higher markdowns on the year. Our inventory is in great shape. Supply chains are back to normal. We have flexibility and are open to buy. So, against what we just guided to, our inventories positioned very appropriately. We can chase into trends as we see them readjust inventory still for the back half as we need to as well. So we’re not planning on higher markdowns at all.

Amanda Douglas — JPMorgan — Analyst

That’s helpful. Thank you.

Operator

Thank you. Our next question is from Adrienne Yih with Barclays. Please proceed with your question.

Adrienne Yih — Barclays — Analyst

Great. Thank you very much. Jen, I was wondering on the AE brand, how much higher are initial retails at AE versus 2019 and the ability after we get through this kind of period, the ability to hold on to that pricing based on just elevating the business and more innovation? And then, for Mike, can you talk about traffic and/or transactions versus ticket/basket for each of the brands? Thank you very much.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

I mean, I should just say both brands are significantly up to 2019, and we’re pleased with that, Adrienne. Certainly, as you see too, we’re going to have nice costing has been coming in really favorably as well. So, we’re going to do — we’re going to really have a balancing act in both brands on how we’re pricing and what our out-the-door prices look like and ensuring that we’re competing on our terms. So that’s really the answer.

I believe that we’ve really struck gold here in some of these categories, and we don’t want to give up that — all the work we’ve done, that’s where we’ve been at over the past three years during COVID, we were increasing our prices in specific categories, denim being one. I reflect back, we actually had pulled back on our promotions in denim during some of these peak tough time periods out there. And so, we believe that there’s opportunity in specific categories, like I said, in both brands. And specifically, in American Eagle, as the two new brands that we just launched in our testing, we’ve seen no resistance to the pricing. So, we’re going to use those as test points for us. And hopefully, we can scale those businesses as well.

Adrienne Yih — Barclays — Analyst

Great. Thank you.

Mike Mathias — Executive Vice President, Chief Financial Officer

Hi, Adrienne, to your traffic question. Traffic has been relatively healthy. And as Jen just said, AUR is up nicely still to pre-pandemic levels, not giving any more of that AUR back. It’s down a little bit to last year, not substantial. The average basket size really driven by AUR is down a bit then too. We have some work to do on the conversion line. We think we could — we believe it could be tied a little bit to macro conditions, that mid- to low income consumer traffic is coming through a bit, not converting maybe as heavily. That’s something we’re keeping an eye on, something we’re trying to move the needle on, but that gives you a sense of the metrics that are driving the business right now.

Adrienne Yih — Barclays — Analyst

That’s perfect. Thank you very much, and best of luck.

Operator

Thank you. Our next question is from Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Dana Telsey — Telsey Advisory Group — Analyst

Hi. Good afternoon, everyone. As you think about the upcoming back-to-school period with the cadence of business currently, any shifts that you’re making, whether it’s marketing, whether it’s — when you’re bringing in goods and how you’re planning promotional levels as we go through 2Q into the back half? Thank you.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

I mean, Marni [Phonetic], all of the above. Everything has to be a full 360 approach. And when it comes to back-to-school, I think we do it best. I’m really proud of the way the stores look out there. And like I said, the store business has been very healthy. We’re focusing on stores. And I don’t know if Michael had mentioned, I know I believe mentioned on previous calls, but we have a new leader in the digital business, David Zhang who comes with tons of experience and is already unlocking opportunities for us on that side of the business, back-to-school. I got to see it live tomorrow, but I’ve obviously been through all the product categories, but I see it in our simulated stores tomorrow at our home base in Pittsburgh.

And Marni, like all — I can tell you is from Q1, we’ve shifted the businesses significantly with what we saw. I would like to say, I thought we were really aggressive on the other bottoms categories in Q1, and that continues into Q2 when we build on it. For Q3, we’re seeing some bright lights in denim that we’re able to respond to. So that’s really exciting. We’ve seen improvements in denim actually, particularly in women’s as we pace throughout the quarter and building into May. So, some bright spots there.

So, I think we’re ready, Marni. So like I said, I have to be the optimistic on this call because it’s our job to react to what’s happening in the business and push harder as we head into the balance of the year. We do not plan on promoting, we’re going to promote with intent. And Mike mentioned that we have some opportunity to really look how we clear goods in Q2, hopefully, more profitably. I think we have some good plans in place there, and we’re going to come out clean and be ready to fight.

Dana Telsey — Telsey Advisory Group — Analyst

Thank you.

Mike Mathias — Executive Vice President, Chief Financial Officer

Your markdown question or your promotional level, we don’t have any plans to be more promotional for back-to-school. As you know, we are very clean. We’re clean going into the back half and back to school last year after taking measures to clean up inventory in the spring season in July there at the end of the second quarter. So we were actually pleased with our promotional level through the third quarter last year, and we’re looking at something — we’re planning similar levels of promotion this year.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

And Dana, my phone went off. So, Dana, I know you — and I’m sorry. So, thank you…

Dana Telsey — Telsey Advisory Group — Analyst

No worries.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Thank you.

Operator

Thank you. Our next question is from Jonna Kim with TD Cowen. Please proceed with your question.

Jonna Kim — TD Cowen — Analyst

Thanks for taking my question. Just curious about what you’re seeing in the loyalty program, how the spending and retention trends have been like versus history? And what are some of the data advantages you can have by leveraging the loyalty program? Thank you.

[Technical Issues]

Operator

[Operator Instructions] Our next question comes from Alex Straton with Morgan Stanley. Please proceed with your question.

Alex Straton — Morgan Stanley — Analyst

Great. Thanks all for taking the question. I just wanted to focus on revenue here. In the sequential top line weakness you’ve observed, have you seen any variations by household income demographic? And then, secondly, I know you’re near peak AURs, and I’m just wondering, do you think that’s at all contributing to some of the challenges on the top line or how do you guys gauge price sensitivity? Thank you.

Mike Mathias — Executive Vice President, Chief Financial Officer

Yeah. If I could start on the revenue side. Really in May here, we’re 3.5 weeks and your question, this is exactly the question we’re asking ourselves. I think there’s some of this what’s happening externally and the impact on what we think is the mid- to low-end household income cost consumer, which we are susceptible to. That’s what we’re being cautious about from here. I think if you look at what everyone is reporting at this earnings period, you do see a bit of bifurcation between kind of brands that are appealing to a higher income customer versus those that are more exposed to the mid lower side. So I think that’s something that we are going to navigate.

Again, our inventory levels being flexible, supply chain, time lines, it’s back to normal. Those are things we’ll navigate as that continues to be a macro external impact that we can’t control. We’ll control everything that we can. We don’t think — I mean, back to what Michael and I just described in terms of customer base and loyalty program, AUR usually has some kind of impact on that as well. We’re not seeing any impact to those customer metrics in that way. And again, we’re well ahead of pre-pandemic levels, but we actually haven’t kind of grown AUR since last year or ’21, we’re actually down a couple of points to those peaks. So as you sit here today, maybe the combination of those factors is having a longer-term impact. It’s something we will be assessing. But again, we’ll control what we can control in that equation right now, which is really inventory and everything else around our operating model that we’re looking at. Okay. We’ll take the next question.

Operator

Thank you. Our next question is from Janet Kloppenburg with JJK Research. Please proceed with your question.

Janet Kloppenburg — JJK Research Associates — Analyst

Hi, everybody. Just a couple of quick questions. First on housekeeping, Michael, it is depreciation now looking to be at mid-teens for the year. Maybe you could help me on that. And then on the guidance cut on the operating income for the year, that includes a lower outlook for the second quarter, as well as for the back half. Could you flesh that out for me, please?

And then, Jen, was there some change in category investment in May versus April? It sounds like April was a decent month. You said you had some acceleration in April, maybe after a weak March, I’m guessing. So I’d like to understand maybe how the assortment shift may be impacting the response rate right now at both plans. Thanks so much.

Jay L. Schottenstein — Executive Chairman of the Board and Chief Executive Officer

Hi, Janet. Your question on depreciation, as we said for Q2 guidance, similar dollars for Q2. It’s really similar dollars every quarter of the year based on the plan, based on the $150 million to $175 million range this year versus what we spent in previous years. Depreciation will be pretty consistent quarter-to-quarter. You get roughly a 10% increase on the year based on that. That is something we are focused on.

We pulled down capital spending for this year. Made a lot of investments the last few years, as we talked about, especially in area and offline growth. We want to grow into those investments, optimize those investments, investments in technology, supply chain capabilities. That’s part of this project this year and finding efficiencies in our operating model. Part of that is actually leveraging all those investments that we’ve kind of proactively and aggressively made in the last few years. So we are looking for depreciation to kind of normalize and even come down over time.

And then, as far as the guide goes, yeah, the full year guidance does contemplate, of course, what we just got for the second quarter and how we’re thinking cautiously, how we’re viewing the rest of the year. So we talked about flat to revenue down low single digits for the year. If you think about first quarter results, second quarter guide, you’re relatively flat through the spring season. And we’re basically saying relatively flat for the year based on what we know today. And the income guide off of that is based on that type of revenue thought process right now.

Janet Kloppenburg — JJK Research Associates — Analyst

But some greater pressure on gross margin or no?

Jay L. Schottenstein — Executive Chairman of the Board and Chief Executive Officer

Actually, gross margins…

Janet Kloppenburg — JJK Research Associates — Analyst

Not as much recovery as you had originally expected.

Jay L. Schottenstein — Executive Chairman of the Board and Chief Executive Officer

Not as much leverage on expenses then, right. But definitely recovery of all freight and related product costs, seeing that flow through. That’s going to happen every quarter. Even on this revenue expectation, our inventory levels that are planned for the year, we’re actually expecting net kind of positive impact from lower markdowns on the year still as we sit here today. So definitely gross margin expansion from those things, but to your point, yes, not as much leverage on the expenses through gross margin on the revenue that we got.

Janet Kloppenburg — JJK Research Associates — Analyst

Okay. Thank you. And Jen, on the change in assortments and what’s the…

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Hi, Janet. How are you, Janet?

Janet Kloppenburg — JJK Research Associates — Analyst

Good. Nice to hear your voice. Thank you.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Nice to hear your voice. No, actually. In fact, we built on the assortment off of April. So the only thing I would add is we do need a few of our seasonal categories to turn on right now. We’re hoping as we get into the seasonality Memorial Day weekend on that we’ll see that happen. And just to note, though, I will say some of our, in American Eagle in particular, we’ve seen bright spots in bottoms, including denim. So that’s where we really took the business going into Q3.

We feel we’re really well positioned there, Janet. So, I really — I’m looking forward to some of these after school shifts, seeing what those changes do to the business. I’m cautiously optimistic on the quarter and we’re ready to go. But no, the assortments did not significantly change. In fact, in some cases, i.e. in women’s tops, we could use more. We saw a huge shift in women’s tops, Janet. I don’t know if I mentioned that earlier, but from where we ended Q2, it’s nice to see this business turn around. In fact, we’re in the positive comp zone, healthy positive comp in women’s tops. Bottoms are very strong. So, yeah, just some of these seasonal categories we need to turn on a little bit more.

Janet Kloppenburg — JJK Research Associates — Analyst

Thank you.

Operator

Thank you. Our next question is from Chris Nardone with Bank of America. Please proceed with your question.

Chris Nardone — Bank of America — Analyst

Thanks, guys. Can you help quantify what is driving the low to mid-single-digit increase in SG&A in the first half of the year compared to last year? And then, if you can tie that into your expectations for full year SG&A growth embedded in your new EBIT guide? That would be great.

Mike Mathias — Executive Vice President, Chief Financial Officer

Hi, Chris. Thanks. The SG&A was up 5% for the first quarter. We provided second quarter direction a low- to mid-single. For the year, you can kind of get your mind around that same range, although like we’ve been talking about, that is a big piece of the initiative. We’re looking at the entire $4.7 billion cost base, not just SG&A, but they’re definitely elements of SG&A, of course, that we want to continue to work on store labor, corporate compensation, services, marketing effectiveness in terms of driving revenue for us, few other line items and categories. So, on the year guide, it is mostly compensation-related payroll taxes and benefits that are driving that low to mid-single digit increase.

And there is a reminder that it’s a 53rd week year. So, about 1 point of the growth is also just attributed to that extra week. But as I said, I think back to Paul’s question, more color on the second quarter call in terms of opportunities against that killer, things we’re working on now, laying out the priorities and the time line of how we’re going after them. Some things are already underway and a little more color on the second quarter call about potential back half benefits and what benefits we’re expecting on the go-forward.

Chris Nardone — Bank of America — Analyst

Got it. And then, just one follow-up on the gross margin. Are the opportunities around freight and cotton recapture, is that just a fiscal ’23 thing or do you expect some of the cost reversal will help you looking out into fiscal ’24? I’m just trying to understand the cadence of when you expect to fully recuperate that $60 million to $80 million in incremental freight costs you guys have talked about in the past?

Michael R. Rempell — Executive Vice President, Chief Operations Officer

Yeah. We’ll get most of that back this year. There is some spillover into ’24 as goods that we sourced in 2022, we’re selling in ’23. Goods that we’ll be sourcing this year will spill into ’24. So, look, the sourcing environment is very favorable right now, demand is weak, commodities are stable, transportation is available and back to pre-pandemic levels. So, I expect, like Mike was saying, we’ll see recapture all this year, but we’ll also see benefit into early ’24.

Chris Nardone — Bank of America — Analyst

Got it. Thank you.

Operator

Thank you. And our final question is from Marni Shapiro with Retail Tracker. Please proceed with your question.

Marni Shapiro — Retail Tracker — Analyst

Hey, guys. Jen, now you have me for real. But you should know that Dana and I grew up in the same neighborhood, and we shopped at the same bakery, so mixing assumption being such a big deal.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

I don’t think you’re shopping at American Eagle.

Marni Shapiro — Retail Tracker — Analyst

I don’t think it existed back then. We’re the older generation. I just want to dig a little bit into the gross margin to make sure I understand the puts and takes here because there’s obviously the freight recovery and it sounds like the sourcing environment is better. So, were you able to get those AUCs for the back half of this year or is that for next year? And then, when you talked about promotional pressure, was that pressure coming on mostly the seasonal goods? So was that primarily in places like swimwear, for example, where you’ve had some issues or is that across the board? Because I’m wondering if — is denim as promotional or go forward or the knit tops and things where you’ve seen the improvement in women, do you have to be promotional in those areas too or are the promotions a little bit more specific?

Mike Mathias — Executive Vice President, Chief Financial Officer

Yeah, Marni, I can start. I don’t think we really talked about promotional pressure. Markdowns were up a little bit in the first quarter compared to last year, but last year was definitely on the low end of history. So they’re just more kind of appropriate [Phonetic] in the first quarter. As I said earlier, we’re not looking at a higher level of promotional activity really any quarter throughout the year based upon how we’re — I think we’re at a good level now, a healthy level now. We like the mix of what that’s driving. There’s no inventory reasons or cause to overpromote to get through units, to manage inventory. So, I don’t know if there’s any color you want to add, but…

Marni Shapiro — Retail Tracker — Analyst

Was the pressure in AUR, I guess, maybe — was it just versus very high AUR last year? Is that what it really is?

Mike Mathias — Executive Vice President, Chief Financial Officer

Yes. We were — again, obviously, not 2021 peaks, but last year’s AUR in the first quarter was still historically high, yes.

Marni Shapiro — Retail Tracker — Analyst

Yeah Got it.

Michael R. Rempell — Executive Vice President, Chief Operations Officer

Yeah. And we do expect both transportation and product cost benefits similar, if not greater, to first quarter throughout the year.

Marni Shapiro — Retail Tracker — Analyst

And then, can I just follow up on the seasonal products? Are you seeing the same slowdown in those sales across the country? Are there any regions where the weather — I hate to have these conversations about weather, but where the weather has kicked in earlier or is it across the board?

Mike Mathias — Executive Vice President, Chief Financial Officer

We’re definitely seeing better results out of the South and the West. So we don’t like to talk about weather either, but at the same time, there’s a reality to looking at the geographic results every single week, and there’s definitely more life in the South and West where those seasonal categories would kick in earlier. So, again, the guide is cautious, some of that the results in the other areas of the country are definitely embedded in our thinking, but we are thinking with, again, hopefully even more improved weather. We don’t like to use the word. And there is something to, I think, our customer, the timing of school getting out and mindset around summer vacations, etc, where we think some of these things will kick in for us differently as we move further into the second quarter.

Marni Shapiro — Retail Tracker — Analyst

That makes sense. Thanks, guys. I’ll take the rest offline.

Jennifer Foyle — President, Executive Creative Director – AE & Aerie

Thanks, Marni.

Operator

Thank you. I would like to turn the floor back over to Jay Schottenstein for closing comments.

Jay L. Schottenstein — Executive Chairman of the Board and Chief Executive Officer

Okay. In conclusion, we are staying focused on navigating the near term. Our brands are in good shape, and we know there is an opportunity to unlock growth and profit from here. We’re seeing discipline on inventory and expenses and looking for additional efficiencies. Thank you for joining the call. I look forward to updating you all on the progress next quarter. Thank you.

Operator

[Operator Closing Remarks]