American Eagle Outfitters, inc (AEO) Q2 2021 Earnings Call Transcript

American Eagle Outfitters, inc  (NYSE: AEO) Q2 2021 earnings call dated Sep. 02, 2021

Corporate Participants:

Judy Meehan — Vice President of Investor Relations

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

Jennifer Foyle — President and Executive Creative Director of AE & Aerie

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

Mike Mathias — Executive Vice President and Chief Financial Officer

Analysts:

Oliver Chen — Cowen — Analyst

Kelly Crago — Citi — Analyst

Jay Sole — UBS — Analyst

Marni Shapiro — Retail Tracker — Analyst

Matthew Boss — J.P. Morgan — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Adrienne Yih — Barclays — Analyst

Presentation:

Operator

Greetings and welcome to the American Eagle Outfitters’ Second Quarter 2021 Earnings Conference Call. [Operator Instructions]

It is now my pleasure to introduce your host, Ms. Judy Meehan. Thank you, ma’am. Please go ahead.

Judy Meehan — Vice President of Investor Relations

Good morning, 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.

Reconciliation 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 aeo-inc.com in the Investor Relations section. Here you can also find the second quarter investor presentation. As a note, our second quarter fiscal 2021 results are primarily compared to second quarter fiscal 2020 with comparisons to the second quarter of fiscal 2019 included where applicable.

And now I’ll turn the call over to Jay.

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

Thank you, Judy and good morning, everyone. I’m very proud to announce a record second quarter fueled by strong customer demand for our products and brand. Financial results exceeded our expectations. Revenue increased 45% over last year. On a comparable basis, revenue increased 19% to 2019. Sales of $1.2 billion and profits of $168 million were the highest in our history. With our renewed focus entering this year, we are running the business better than ever across the Board. As I said, in January, we have the best talent in the industry, and these results are clear evidence of that.

So I’d like to start by thanking the entire AEO family for this significant accomplishment. The passion, talent and commitment, are taken our brand and Company to new heights. As I also said at our January Investor meeting, we are on offence emerging from 2020, the strength and focus, a real power, new growth plan is our guiding light. I’m very pleased that we are making swift progress on our pillars putting us ahead of schedule on our financial targets. Today, the team will take you through the details of our performance. But I’d like to start with a few highlights.

Aerie just continues to deliver exceptional multi-year growth. As a brand new scaling, we are seeing significant profits flow through. This quarter was one more proof point of the excitement behind this brand. I couldn’t be more optimistic about the potential ahead as we make our way to the next $1 billion in revenue. American Eagle simply proving to be a powerful brand, we always knew it was. Its dominant market position, combined with a fresh focus on inventory management have resulted in the best margins and profits in years. Under Jen’s leadership, the energized product embarking are yielding results and the timing couldn’t be better. As a number 1 jeans brand, we are well positioned to capitalize on strong demand fueled by emerging trends.

Across channels, stores and digital are firing on all cylinders and driving meaningful profitability. Our multi-year investment to improve our customer shopping experience and enhance our supply chain are delivering strong returns. We’re gaining new customers and the relaunch of our loyalty program has been a success. Across operations, we are creating efficiencies, increasing our speed and agility. The supply chain deliver great results even in the face of headwinds. While we made great progress, we are just hitting our stride. I see so much opportunity for us to generate incremental value moving forward.

Our focus on ROI is also evident in the second quarter. We drove incredible margin recovery and cash flow. Our balance sheet is healthy. And we’re operating from a position of financial strength. I’m pleased that in June we raised our quarterly cash dividend by 31% reflecting our confidence in the strength and sustainability of future cash flow.

Everything we do at AEO is done with purpose. We run our day-to-day business in keeping with our values to build a better world. To that end, we are making great progress on creating more sustainable products. This year we had more than doubled the number of our most sustainable yield goods, styles across all merchandise categories. Widely energy reduction and responsible sourcing remains top priorities. I am extremely pleased by recent recognition from step — antisemitism.org for a dedication to combat racism by creating an inclusive and diverse corporate culture. This is something we strive for every day through innovative associate programs designed to build a collaborative environment.

This spring, we have raised over $1.7 million for important causes according bring change to mind and it gets better. Two organizations are making impact of lift use [Phonetic] and support mental health. I am really proud of all the work we are doing to strengthen the launching within our Company and our communities. AEOs top talent is the keystone of our great Company. Last month, AEO was named the Fast Company’s Best Places to Work For Innovators, a distinction that recognizes our deep commitment to encouraging innovation across the organization.

As the pandemic continues, our top priority is to keep our people safe. Our leading health and safety measures remain in place across all facilities. We have consistent communication support and education for our associates that strongly encourage vaccinations. Before I turn to Jen, I want to reiterate how pleased I am with our performance year-to-date and how excited I am for what’s to come.

We continue to execute well across all areas of the Company. Although the current operating environment is presenting challenges from the ongoing pandemic, the supply chain disruption, there’s a lot within our control. I’m very pleased with current business trend. We continue to see strong demand for our brands, the macro backdrop is stable. Consumers are spending and new fashion trends are positive. We will focus on leveraging the agility to gain last year and the strength of our capabilities deliver to our customers and posted strong second half. With all this in mind and confidence in our ability to achieve operating income of $600 million this year.

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

Jennifer Foyle — President and Executive Creative Director of AE & Aerie

Thank you, Jay and good morning. Wow, what a great quarter. Aerie and AE are two of the biggest brands in the market and are delivering truly exceptional results. We are making incredible progress towards the goals we laid out in January. In fact, well ahead of my expectations. We are attracting new customers and they are spending more than ever, and I’m happy to see those trends carry into the third quarter. Let me start with Aerie, our leading brand platform combined with product that continues to delight and excite our customers is delivering strong consistent performance. Revenue in the second quarter rose 34% on top of 32% growth last year. I’m proud to say, this marked our 27th consecutive quarter of double-digit growth. Sales metrics were very healthy. Strong demand led to significantly higher full price sales and we strategically removed promotions. We are also mixing the higher ticket with higher margin items.

I’m pleased to report broad-based strength across all product categories which are all up in the double-digits. Core intimate, bralettes and apparel and swimwear saw strong demand. We continue to gain meaningful market share in swimwear as Aerie is becoming a true destination in the category. In May, we launched our Love The Swim You’re In TikTok campaign highlighting all the ways to rock your Aerie swim. The content was extremely well received driving incremental visits and strong conversion. Aerie’s signature for legs than leggings are showing incredible growth. I’m also very pleased by the success of our OFFLINE activewear brand which continues to gain traction.

Year-to-date Aerie’s customer file has expanded over 20%. Existing customers are transacting more frequently and spending more. On the marketing front, we continue to focus on giving our customers their own platform in new and innovative ways. We just launched our real voices campaign amplifying the love of our brands and products through our customers own story. The campaign has already generated a ton of likes, generating close to 1 billion impressions in the first week, bringing the Aerie real movement to more people than ever before.

Market expansion is progressing with 16 new stores across the US and Mexico and our first store in Hong Kong. As Mike will review, we look forward to further growth as we better penetrate existing markets and expand into new ones. The profit unlocked from Aerie’s growth has been explosive. I am so proud of what this team has accomplished. Momentum has continued into the fall season as customers embrace our amazing brands and cozy company collection. I’m highly encouraged by our results and excited for upcoming seasons. We remain focused on driving consistent double-digit growth and improving profit flow-through.

Now, on to American Eagle. I’m absolutely thrilled with the progress we are making. Second quarter results clearly demonstrate the growth and value creation we are looking to unlock. Sales rose 35% compared to 2020 and demand looks positive versus 2019. Brand and product updates along with a laser focus on inventory optimization and promotional discipline drove strong AUR growth and significant merchandise margin expansion. Operating profit more than tripled. It was up over 30% to 2019. We are running the business with a clear agenda. The true-up brand profitability excite our customers and seek further growth. While results to-date have been tremendous, we are still early on this journey.

AE’s position as deep denim destination could not be stronger. Our jeans collections continue to deliver great results across genders. We believe the current trends and shifts and silhouette will be a tremendous win for the AE business. In the quarter, our women’s business reached new highs, led by ongoing strength in bottoms across both fashion and comfort silhouette. Growth in the men’s business was also strong. Our focus on great outfitting with updated bits and fabrics are certainly resonating. Together new imagery and messaging, AE remains the number 1. It is clear that our customers are choosing silhouettes transition with the new denim cycle.

Aerie’s new back-to-school campaign featuring some of the biggest cultural influencers of the moment including Jay Stokes [Phonetic] and Madison Bailey of Netflix’s number 1 Outer Banks and TikTok creator Addison Rae has already become the most organically viewed video in the history of our brands. We also launched our first digital clothing line on Bitmoji, which has generated a staggering 1 billion triumphs to date. Looking ahead, I am excited about our fall and holiday collections. Our team has had a lot of fun bringing this AE iconic heritage to light and I think our customers are really going to love what we’re doing.

Earlier this year, we welcomed Liz Brunnemer, AE’s new head of design. She has hit the ground running. The team is energized, and I know we are better positioned than ever to leverage our strong brand position. I want to thank the AE team for springing into action and driving such strong progress in such a short period of time. There is a renewed excitement around AE and I think we are at the very beginning of a great new chapter.

Thanks also to the Aerie team for being rock stars [Phonetic] quarter-in quarter-out. We have a great slate of talent between these two teams and I look forward to sharing the results of their amazing work with you in the quarters to come.

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

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

Thanks, Jen and good morning, everyone. Our record second quarter results clearly demonstrate the power of our brands and products as well as the strength and agility of our operation. Team of associates and global partners were able to successfully navigate through a highly disrupted environment. I can say with confidence that we’re running our business better than ever. Investments we’ve made to strengthen our operations, technologies and overall capabilities are yielding material efficiencies and contributed to our record profit performance.

Importantly, I believe these benefits are sustainable and we’re going to continue to build on that over time. Beginning with our laser focus on the customer experience. This spring, it was great to see customers return to stores fueling a 73% increase in store revenue with strong selling across brands. We saw strength across format at both our factory outlets and mainline stores saw healthy growth. Our stores team did a terrific job welcoming our customers back and fueling record high conversion. Digital demand also remained very strong increasing 9% following a 48% increase last year. This channel continues to expand to new heights in both revenue and profitability as we leverage our multi-year investments consolidated second quarter digital revenues are approximately a $150 million compared to 2019 with both brands seeing solid expansion. Digital represented 35% of total revenue, up from 25% pre-pandemic. Longer term, we continue to believe that digital is going to represent 50% of our sales. We are continually looking for new technologies to drive better engagement and connect customer shopping experiences across our channels. As consumers reestablish their shopping rhythm post pandemic, our business model is going to remain flexible in meeting them wherever and however they choose to shop.

For example, our mobile sales more than doubled in the quarter as we continue to enhance the customer experience. We’re thrilled to see very strong customer data, especially as we head into our key back-to-school season. We have added over 1.5 million new customers across brands since this time last year and over 2 million since 2019. The relaunch of our loyalty program last summer has been extremely successful. Customers in the loyalty program are spending more, they’re staying longer and the average customer spend is up in the double digits. This speaks to the quality of our engagement, our product, our marketing and the technology enhancements we’ve made and we still see opportunity for continual improvement and we are planning to experiment with new and interesting ways to better engage with our customers and to build the loyalty program going forward.

As I discussed back in January, transforming our supply chain is the major priority. And the past six months have truly underscored the importance of strong partnerships as well as leading capabilities. We are continuing to prioritize investments in these areas. During the second quarter, our product arrived without major delays and we were able to chase into high demand items. From a logistics standpoint, our hub and spoke model with regional inventory positioning and regional fulfillment is working. It’s part of what’s fueling efficiencies, allowing us to drive substantially greater sales and margin on far less inventory.

We are delivering products to customers faster, and despite industry-wide cost increases, our delivery expense is leveraged as a percent of sales. Needless to say, I believe our supply chain platform truly is a competitive advantage. The investments we’ve made to-date are paying off. As global supply chains continue to be disrupted, this is creating opportunities for us to become even faster, more agile and more efficient.

On that note, I’m excited to share that in the quarter, we acquired AirTerra, an innovative logistics provider. With this acquisition, we are also excited to welcome an experienced leadership team with deep expertise in logistics and shared passion for rethinking the status quo. We will run AirTerra independently as it supports AEO’s business as well as provide services to other retailers. On the product side, we feel good about our ability to maintain strong margins. Investments in our brands and product over the past several years are supporting our ability to successfully compete in higher ticket products. As we focused on innovation, quality and value, we have selectively raised prices with very low resistance from our customers.

In conjunction with strong inventory management, we have confidence in our ability to sustain high margins and offset inflationary pressures. There is no doubt that the global supply chain remains highly disrupted. Port shutdowns and factory closures are leading to longer delivery times and higher transportation costs across our industry. As Jay touched on, we’re very focused on the things that are within our control. We are working closely with our partners and we’re moving production wherever possible to minimize disruption. Of course, we also will leverage the significant structural improvements we’ve made over the past several years and we believe that we’re going to be well positioned during the second half of the year.

In closing, I’m very pleased with our performance year-to-date. Our results are outstanding and our teams are executing really well in all sorts of adversity. I am confident that the changes we are making to our supply chain, logistics and operations are also setting us up to succeed well into the future.

With that I’m going to turn the call over to Mike.

Mike Mathias — Executive Vice President and Chief Financial Officer

Thanks, Michael. Good morning, everyone. I’m pleased to report another record quarter bringing our year-to-date financial results to an all-time high. Our brands continue to demonstrate incredible momentum driving substantial profit to the bottom line. As we navigate through macro shifts related to COVID, our success has been fueled by the initiatives outlined in our real power, real growth plan back in January. Strong focus on our brands and product innovation, inventory and gross margin optimization and real estate and supply chain initiatives are all having a positive effect on our growth and profitability.

Second quarter revenue of $1.2 billion, operating income of $168 million and adjusted EPS of $0.60 mark second quarter records for the Company. The operating margin of 14.1% was our highest in 13 years. We also saw a nice growth across the business compared to the pre-pandemic 2019 period. Consolidated second quarter net revenue increased 35% versus second quarter 2020 and on a comparable basis increased 19% to 2019. The reported revenue increase of 15% included a $40 million benefit to revenue in 2019 from a change in our Japan license agreement. The cross brand sales metrics were favorable. Our average unit retail was up over 20% led by overall strong demand, higher full price sales and fewer promotions. This fuel a double-digit increase in our average transaction value.

As customers return to stores, we saw a material increase in traffic trends which drove a 73% increase in store revenue versus last year. Even with the meaningful shift, digital demand increased 9% hurdling last year’s very strong online demand growth to 48%. Note, the second quarter reported digital revenue declined 5% as we lapped elevated sales due to a timing shift in shipments from the first quarter into the second quarter of last year. Our digital platform, combined with our strong store footprint is a competitive advantage and the investments we’ve made continue to pay off.

As Michael pointed out, logistics, our key differentiator and give us the ability to more effectively manage our business while generating meaningful efficiencies. From a brand standpoint Aerie’s multi-year growth trajectory remains strong with revenue rising 34% from second quarter 2020 and almost 80% from second quarter 2019. Aerie’s operating profit rose 133% compared to second quarter 2020 and operating margin expanded to 21%. As I’ve consistently highlighted, Aerie is now at an inflection point in its growth story with strong sales performance translating into significant operating leverage that is exceeding our expectations. Put some numbers around it, second quarter operating profit of $71 million more than double the $30 million we realized in 2020 and was over seven times the level of operating profit in the second quarter of 2019.

Moving to the American Eagle brand performance, healthy demand, low promotions and inventory optimization drove another strong result across both revenue and profitability. We were pleased to see top line growth of 35% from 2020 and on a comparable basis, an increase of 5% from 2019. AE brand reported flat revenue versus 2019 included the 2019 benefit from the change in our Japan license agreement. AE’s operating profit jumped 234% from second quarter 2020 with margins building to 23.5%, a proof point of the significant margin opportunity for AE we reviewed back in January. I’m proud of the transformation, we have driven and how we are managing the business today. We have redefined what success means for the AE brand with clear direction and focus on consistent profit and cash generation. This is driving improved sales trends as tighter inventory controls enable higher full price sales and greater emphasis on the best selling SKUs. Work here  continues and we see additional opportunities.

Total consolidated AEO gross profit dollars were up 89% compared to the second quarter of 2020 and gross margin came in at a very healthy 42.1%. Inventory optimization and refreshed product assortments are supporting promotional discipline and higher full price selling. This is driving healthy merchandise margin expansion. Rent leveraged significantly as a result of negotiated savings, store closures and benefits from impairments. As Michael discussed earlier, delivery also leveraged reflecting efficiencies enabled by our distribution and fulfillment notes. As a result of strong sales, we saw SG&A leveraged 70 basis points versus second quarter 2020. The dollar increase to $70 million was due primarily to the reopening of our stores. We also saw increased advertising as well as incentive costs due to strong profit growth.

Record operating income of $168 million reflected a 14.1% operating margin. Our highest second quarter rate since 2018. Adjusted EPS was $0.60 per share in the quarter and marked a record second quarter outcome for us. Our diluted share count was $209 million and included 36 million shares of unrealized dilution associated with our convertible notes. Ending inventory was up 20% compared to 21% decline last year. American Eagle inventory was up 10% and Aerie was up 16% compared to second quarter 2020 as we positioned inventory below current demand levels as part of our ongoing efforts to optimize inventory buys.

As Michael mentioned, we feel confident in our ability to navigate ongoing supply chain challenges and secure product for our customers. I’m very pleased with our liquidity and the health of our balance sheet. We ended the quarter with $824 million in cash and short-term investments. This compares to $899 million in second quarter 2020, which included $200 million from our revolving credit facility that we subsequently repaid in the third quarter of 2020. Capital expenditures totaled $49 million in the quarter and $86 million year-to-date. For 2021, we now expect capital expenditures to be at the low end of our previously communicated $250 million to $275 million guidance range reflecting cost savings on our planned projects.

With regards to our real estate strategy, as I mentioned last quarter. With 450 leases either come to term or warranting action in some way this year, we have significant flexibility to manage our store fleet to support our revenue and profit agenda. We are making steady progress towards our long-term goal of rightsizing AE store footprint. For Aerie, we are focused on markets with the greatest opportunity and are on track with our store-opening schedule. Focused investments in our international business are also helping us gain traction in key markets where we see compelling long-term growth opportunity. Mexico is a good example of this, where our omnichannel selling strategy is driving healthy growth and profitability in the market.

All in all, I couldn’t be more pleased with our performance year-to-date. As we look ahead into the back half of the year, supply chain disruption is creating some challenges and uncertainties. We’re putting our customers first and prioritizing product availability. While there will be incremental transportation cost, we believe we can offset a significant portion. The demand in power brand is healthy. Our inventory optimization is enabling promotional discipline and our supply chain transformation is creating cost efficiencies. Based on our record first half results. In the current strength in the business, we feel confident in our ability to achieve operating profit of $600 million this fiscal year. This is well ahead of our financial targets that we presented back in January.

We continue to execute on our real power, real growth value creation plans with speed and confidence. Our results year-to-date are a clear proof point that we are focused on the right initiatives positioning us well to drive continued strong financial results and returns to shareholders.

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

Questions and Answers:

Operator

Thank you. The floor is now open for questions. [Operator Instructions] Our first question is coming from Oliver Chen of Cowen. Please go ahead.

Oliver Chen — Cowen — Analyst

Hi, thank you. Good morning. Revenue growth was really solid, but it was below somewhat elevated street expectations. What are your thoughts on inventory availability across both brands and we’re there. Were there pockets where you may not have had enough and how are you thinking about the ability there to chase between back-to-school and then holiday depending on trends? Another follow-up on AirTerra, it sounds very innovative would love your rationale for purchasing that in terms of timing and how it may impact your financial algorithm longer term. Thank you.

Mike Mathias — Executive Vice President and Chief Financial Officer

Yeah. Thanks, Oliver. It’s Mike. I’ll take the first part of that. I like your description of maybe somewhat elevated. Revenue, I think there’s a couple of reasons for that. One, I know, facing things on 2019, but there’s a couple of points there of back-to-school shift of the July business and tax-free events shifting out of July and August. So I think that’s up and others, I think felt that in July, our business definitely accelerated into May and June and in the back half of July is, I think you can attribute it to a back-to-school shift. From an inventory perspective, we are really happy with where we’re positioned right now in the third quarter. Pleased with what we saw in August which inventory being positioned well and we think we’re in a good position for the rest of the quarter and the rest of the year.

And if I turn that piece over to Michael, in terms of where we are for the rest of the season in the AirTerra part of the question.

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

Right. Hey, Oliver. So look, clearly there is a lot of — a lot of challenges in supply chain. There is portfolio downs, we have some factories that are closed, transportation is less predictable. Our team has done a tremendous job. Supply chain transformation has been a huge focus for us, and we’re very focused on controlling everything that we can. And there is a lot that’s within our control. So we’re moving freight faster than ever. We’ve added carriers. We’ve secured our capacity. We’ve moved production out of closed factories wherever possible. And we’ve diversified the ports we’re coming into. And domestically, we’ve sped up our supply chain by almost 1.5 weeks versus how it was previously and versus how a lot of our competition is. Our goods are coming in, they’re going directly to markets and out to stores or to customers. So our supply chain speed is better than ever.

As far as chase, we really booked a lot of holiday product early based on the insight that we had from spring, summer and the test that we did for holiday. And we feel good about the assortment that’s coming in. So there is volatility, but we’re managing through it. We expect that we’re going to get all the freight that we want. We’re going to — we’re going to be, have enough product to have a robust holiday season and we are still chasing product. So we chase product and late as last week, and we expect that we’re going to get it for holiday. So there is variability, but we’re managing through it and we feel like we’re set up for a great season.

As far as AirTerra, we’re extremely excited to acquire AirTerra and to welcome their terrific management team into the AE family. AirTerra, if you think about, it’s really a relatively small purchase that has huge potential for us. It’s a company that’s focused on middle mile. And it’s really focused on bringing economies of scale and the benefits of speed and costing and diversity to shippers of all sizes. And previously, these benefits were only available to the largest shippers, to the Amazons or Target or Walmarts. And we looked at it as a company we wanted to use for the American Eagle business and as we look further, we thought it was a great acquisition opportunity.

So it completely fits with our strategy of leveraging scale and innovation to help us manage costs and improve service. And they ship their first few packages for other customers and for us, and quite honestly, we’re blown away by the amount of interest we’ve had in this business. So they have a tremendous pipeline of brands and retailers, large and small, that all want to use AirTerra. The more people that get on, it helps to build the AirTerra business as well as support the American Eagle business providing economies of scale and transportation benefits for us. And we think this is a big idea. It’s something that we’re going to be talking now in the coming weeks and quarters and we expect that it’s going to be incremental to the profitability of the Company.

Oliver Chen — Cowen — Analyst

Thank you very much. Best regards.

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

Sure. Thanks.

Operator

Thank you. Our next question is coming from Paul Lejuez of Citi. Please go ahead.

Kelly Crago — Citi — Analyst

Hi, this is Kelly Crago on for Paul. Thanks for taking the question. Thanks for that. The clarity on the shift is with back-to-school. Just curious if you could provide a little bit more detail on what you’re seeing quarter-to-date for back to school trying to cover those again. And then just secondly on the $600 million in operating income, you feel it’s very important, but it does imply a step down in EBIT margin expansion in the back half of the year versus the first half. So, just curious, that’s going to separate or are you assuming a promotional environment. Any color there would be helpful? Thanks.

Jennifer Foyle — President and Executive Creative Director of AE & Aerie

Hi, Kelly, it’s Jen and just let me know everyone can hear me. Greetings from London, UK [Phonetic] I’m over here. So I hope everyone can hear me well. Look, we’re really pleased with the results. Certainly, if you look into the back-to-school season, it’s a tale of two stories. Last year, AE really delivered the new goods for September, and Aerie had a new delivery starting with the launch of OFFLINE in July. Now keep in mind all the shifts that are happening. Aerie for instance has more of a northeast and eastern coast penetration.

So they were impacted more by some of the shift into August, and certainly believe, our Labor Day. AE really able to ride the storm and from what I see in both brands, I see strength. Look, American Eagle, we dominate in denim. I’ve never seen a better assortment and certainly I haven’t seen a better team executing to a strategy to that. I think it’s top notch. Our denim looks phenomenal. I just get out of a testing meeting last week, look forward into the future. This is a team that doesn’t stop and we look ahead. We dominate in denim. We certainly executed to the new trend and these are all tailwinds for us. We’re currently driving new fashion silhouettes in both men’s and women’s. And look they’re checking and we’re going to get more aggressive there as we look ahead. I just saw the holiday review for some of the new shoots in American Eagle and Aerie, it’s very optimistic with the dressing, what these customers want, and just moving on Aerie.

I need to reiterate 27 exact consecutive quarters of double-digit comp. I mean, do the math, it’s almost seven years. I don’t see a lot of retailers delivering comps like that. I mean this team is firing on all cylinders. And certainly we were prepared for the back-to-school shift. We have to deliveries this year versus one last year, because we knew that it was going to happen later and we wanted to delight our customers even more as we anticipate the headwinds into September. Lots of newness coming in to help us get through that month. It’s a big month. AE too has a great strong delivery, but I think this strategy is really smart for the Aerie team in how we approached it. The goods are checking. If I reflect back into Q2, all of our key categories gain market share in Aerie. The OFFLINE business continues to thrive in a very competitive environment out there.

I think we stand out OFFLINE is a very unique approach to athletic apparel. The innovation there and certainly the store experience is winning. And all categories in Aerie are really checking for us as we speak, especially on the bralette and legging side of the business. And look, we fail to get through Q3, we’re always going to remain humble and hungry. We were aggressive, we’re getting goods here for holiday and more to come. We have few more months here to get through the balance of the year. But look, I like that $600 million number, it’s far ahead of our — what we told the Street. And here we are to deliver. So that’s what we’re going to do.

Mike Mathias — Executive Vice President and Chief Financial Officer

Yeah. Kelly, just to expand on the $600 million, totally freight-related, nothing to do with the slowdown in demand, nothing to do with anything else. We’re executing in terms of gross margin expansion and our operating rate expansion. Likely would have been higher if not for the freight and transportation costs that we’re embedding into the back half of the year Here. But we’re being aggressive — we’re going to incur these costs to make sure that our customer doesn’t feel any different storing holiday to their experience. We believe it’s definitely short-term and we’ll be coming out in January with our longer with what we think will be a significant increase to our longer-term profit targets.

Operator

Thank you. Our next question is coming from Jay Sole of UBS. Please go ahead.

Jay Sole — UBS — Analyst

Great, thank you so much. Maybe Jen, can you just talk a little bit about Aerie in terms of the different new category opportunities. You mentioned OFFLINE, but just can you give us, elaborate little bit more about where you’re seeing the growth, whether it’s obviously with the core of underwear or just beyond. Thank you.

Jennifer Foyle — President and Executive Creative Director of AE & Aerie

Yeah. Jay, like I mentioned — can you hear me now? Sorry. I’ve a little technical difficulty. Hi, Jay. Yeah, for sure, as I mentioned, all categories in Q2, we saw — we saw gains in every category, in fact all categories delivering on double-digit constant growth. So really pleased with those results. And certainly bralette is our key category for us. And good news is, they’re not only wearing them in, they’re wearing them out now. So we’re definitely addressing that trend as we look forward, undies are trending nicely. We continue to pull back on our promotional cadence in undies. And we’re seeing strong results there.

Please in sweat especially when you look at a matching set, that’s still trending for us. So we’re going to continue to address that trend. And look leggings are core in the OFFLINE business. And keep in mind, we still sell that product within Aerie. As we grow OFFLINE, we will start to sort of separate the results. But right now OFFLINE leggings are still underneath the Aerie umbrella and they’re definitely our number 1 category or up there after intimate. So we could not be more thrilled with that business and we’re going to continue to dominate there and innovate there. We have some really great ideas for the future and if this continues to strategize around the OFFLINE business and how.

Again we can differentiate because that will be key really be top of mind to our customers in the future. So the trends are looking solid and again for business. I have to continually drive comp seven years, almost double-digit year-after-year. We have to ride with the change. Right. So I know everyone very curious about an outside trend that’s happening and people going out again. Look, we’ve managed to write those storms, as well in Aerie where we dominate on some of our other categories one for sure is a go-to destination for Aerie and I’ve seen assortment for spring and summer, they are strong. And that’s a go to, that’s almost like, what are girls wearing out in the spring and summer season. So again, we’re going to continue to navigate and drive what’s working in our business for the future and remain nimble.

Jay Sole — UBS — Analyst

Got it. Thank you so much.

Operator

Thank you. Our next question is coming from Marni Shapiro of Retail Tracker. Please go ahead.

Marni Shapiro — Retail Tracker — Analyst

Hey, guys. Congrats on the — it sounds like great denim start to back to school. We talk a little bit about denim, you guys are now to guess depending on the category, the number 1 or number 2 denim player. I guess how do you think about growing that business further from where it is, with this AirTerra, you’re working with third parties would you consider wholesale or white label of your denim business to support a third party? Would you consider a premium line or premium brand under the AEO Inc. ban. I’m just curious what your thought is, because you are clearly a very powerful player in denim. So, strategy-wise, how do you take that to the next level beyond just American Eagle?

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

As we’ve always said, the statistics show it. We are the number 1 brand between the 15 to 25 year-old. We are the number 1 brand for denim standing in the country. If you look at our line up, you’ll see that we keep introducing new and new washes, new and new finishers and new and new higher price point goods to a better quality. It’s a little premature, but we’ll have a probably announcement in a few weeks about a new denim brand.Because, you asked question — because, you asked question, we are working on the new denim concept that will be introduced in the next few weeks.

Marni Shapiro — Retail Tracker — Analyst

That’s very exciting. It seems like, I think given the denim platform.

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

That’s right. This is something that we’ve been working on for the last 12 months. Without open our first test stores in the next 30 days.

Marni Shapiro — Retail Tracker — Analyst

Great. Congratulations. Looking forward to seeing that.

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

The good news about our denim is, we’re planning denim to sell, we don’t see any problems for the fall for getting all the denim. All the factories produced our denim are running. We’re getting shipments our regular basis. We have plenty of air capacity. One thing we’ve done, it is in the last two years, the internal model of this Company has been logistics. Logistics will just we’ve invested in our logistics system, as Mike was talking about the other investments that they made that we’re also BMA as we’re talking. We think we put together a world-class, not a good question, Michael didn’t go with the backgrounds. We think we have some of the best logistic people in the United States. And what we have accomplished most amazing thing is, it our cost of getting the goods to our stores.

In the last several months has been less than it was a year ago, two years ago, I don’t know another retail, we could make that statement that the cost of getting the goods to their stores less than it was before to get all the current cost today. And all of the cost increase. They will bring at the cost, amazing accomplishment. And our year 16 is world class and we’ve done that. So we’re very proud of that. We’ve done things that other retailers haven’t done. Because we know the future of this business is going to be not just marketing and the merchandising and running great stores, it’s going to be how you operate the whole flow.

And if you don’t do it efficiently, you’ll get deep. The pandemic is just speeding up everything. A lot of these things that have been put in there and work before the pandemic started speeding it up. And at the end of the day, if you don’t win in the handling of the merchandise and your cost is deep, early. And we realize that we have to be able to control as much as we can and we have to the best of it. And one thing I’m very proud is, that we put together great thing, whether it be marketing, whether it will be our merchandise team, whether it will our designing team, the store operations and definitely our logistics team.

And we’re very proud of. Another thing, we’re very proud of, if we’re able track rate down to the Company fast company just rated as one of the 25 best companies, look like innovation. So, we’re able to track like people, between our human resource area. In the whole company, we have great strides being made everywhere and really a great culture and great morale. Everybody in this Company if focused. And one thing we’ve done is, we’ve been following our strategic plan, we don’t get off track and stay focus, focus, focus and very proud of that.

Marni Shapiro — Retail Tracker — Analyst

That’s fantastic. Maybe just a follow-up on that conversation about your logistics with the AirTerra acquisition. Does that allow you guys to step up your buy online pickup in store and that element of the business that you could even further integrate your online business with your in stores business, is that part of the strategy here and take that part more official?

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

Yes. It is, this past year, we talked about our notes, a couple of years ago, they came with the concept of show me that they thought the future, it looked like. And also the pandemic started within four weeks. We had fiber more reestablished, its amazing job they did a year ago. This will give us the ability in many markets, able to get same-day delivery to the stores. Same-day delivery to the customers, been able to respond that in a way, we’re testing technology that we’re working out right now that in our stores. We can follow every item, something is missing will now immediately and be able to fill at the same day. So it always be 100% in-stock level.

Operator

Your next question is coming from Matthew Boss of J.P. Morgan. Please go ahead.

Matthew Boss — J.P. Morgan — Analyst

Great, thanks. So maybe on gross margin. So both first and second quarter, more than 500 basis points above 2019. Is there anything structurally preventing similar performance in the third quarter. And Mike, do you view this as a baseline for gross margin for which to build on, as we think about this year or are there any areas of give back for us to consider as we think about gross margins beyond this year?

Mike Mathias — Executive Vice President and Chief Financial Officer

Thanks. I’ll answer the second part first. Yes. I think you’re describing accurately. This is a new baseline to start from. So I think, if you go back to your target for 10% operating margin, we talked about gross margin being in the high-30s. Right. And I think we’re exceeding those expectations, I think, yes, so as we talk about our targets. Again in January, and are probably what our new operating rate target would be, which will definitely be higher than 10%, probably more like the mid to high, mid to — low to mid teams operating rate. I think the new gross margin baseline is this 40% now on an annual basis. So, we’ve exceeded at the first couple of quarters. We don’t have any structural reasons why this is one quarter or two quarter and done phenomenon. It’s going to be something that is the new baseline go forward.

Matthew Boss — J.P. Morgan — Analyst

Great. And then maybe just a follow-up on the top line. As we think about back-to-school timing and the shifts that you mentioned just to be clear and relative maybe to the second quarter, which was up mid-teens relative to 2019, is it fair to say that, August has accelerated? It seems like that’s what you’re speaking to. And then maybe just any color on the third quarter, meaning sales growth, maybe relative to mid-teens growth that you saw in the second quarter, any way to help on August and third quarter?

Mike Mathias — Executive Vice President and Chief Financial Officer

Yeah. I’ll hit the first half of the year, again. So I think we were up 17% in Q1 2019, if you normalize for that Jamaican payment, if you’re comparing to ’19 for the second quarter, we actually up 19%. So we actually did pick up a few points from Q1 to Q2. The bigger point I’ll make though is that if you go back in history in the revenue, our revenue number in 2019 was a record for the Company. But I think at that point we weren’t happy with the profit you are generating from net revenue. And I’ll go back to unhealthy inventory levels, too many SKUs, too many choices we bought revenue. So we are, as much as — we’re looking at the same compared to 2019 you are. We’re not focused on that, because we — I think we are creating a new revenue baseline as well. And we are focused fully on profit generation, cash flow generation, on the revenue, we’re seeing — we’re focused on flowing through these phenomenal Aerie growth that will be a continuation, that will be baked into our targets we come back out with in January. So I guess to answer the August question, it’s a little bit apples to oranges. We’re very == we’re happy with what we saw in August. It’s on past. So we are expecting — it’s built into our guidance. And I get that earlier the guidance would have been higher without the incremental freight and transportation costs. So we’re focused on profit, we’re focused on operating rate, revenue is obviously part of that. But these maniacal compares to a history that probably doesn’t matter as much anymore is something we’re not focused on as much.

Operator

Thank you. Our next question is coming from Dana Telsey of Telsey Advisory Group. Please go ahead.

Dana Telsey — Telsey Advisory Group — Analyst

Good morning, everyone. Jay, you mentioned logistics and the strength of logistics. Do you see other acquisitions coming into the fold going forward that would continue to enhance your logistics abilities, and potentially even drive the operating margin higher? And then just lastly, as you think about the holiday season, with the extension of back-to-school, how do you see the timing and planning for the cadence of holiday this year? Thank you.

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

Okay. To your first question, yes. About the acquisitions, yes.

Dana Telsey — Telsey Advisory Group — Analyst

And what kind of framework would you want there? What other qualities would be beneficial?

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

It’s — we are working on something I can’t go into details. But there’ll be announcement probably next couple of months.

Dana Telsey — Telsey Advisory Group — Analyst

Got it. And then just on…

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

I mean, Dana, we’re looking for — everything we’re doing is focused on providing scale and speed and cost benefit and customer service benefit for the American Eagle business. But clearly, there’s a lot of opportunity with what’s happening in supply chain today, there’s a lot of disruption. But with that disruption creates a lot of opportunity. And like Jay was saying, it used to be that just if you had great brands, and you had great products, you won. In today’s world, that’s not the case. There’s a bifurcation happening in retail, where you — it’s not just great brands, it’s not just great products, but you need incredibly efficient, agile, fast operations. So AirTerra fits that mould. It’s going to serve as the American Eagle business well, it’s going to service other retailers well, it’s going to be a very successful profitable company on its own. And we are looking for other opportunities of companies that fit that mould.

Dana Telsey — Telsey Advisory Group — Analyst

Got it. And then the cadence of holiday, how you’re thinking about it?

Jennifer Foyle — President and Executive Creative Director of AE & Aerie

I can answer that if you want. Look, I think we keep on leaning on logistics here, because I think it’s mission critical. I’m getting the goods where the customers demand is in today’s world. We’re looking at countries, thinking about shutting down again, we could go into lockdown again, who knows, God forbid. So again, the demand could change versus direct or in-stores and that’s what we’re prepared to address, as a team, where our customers that we’re going to provide the product for them. Certainly, with a little bit of leadership back-to-school, I think we’re in the field a little bit of that, as we move along month to month. And then I would say, though, I do think, gifting could happen early again, with all this in mind, similar to last year. So I think the team is ready to address that.

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

Yeah, Jen, and I also — I will also add some key data. We believe that this will be an earlier Christmas shopping, holiday shopping. What we believe is that from our standpoint, we’ll have plenty of merchandise, we’ll have a lot of great new merchandise to choose from. But we believe that there are going to be problems out there for other retailers. We see there could be shortages of goods out there for all, not just for apparel, but you go out today, anything you want to buy cars, you have a shortage of cars, right now. You want to buy furniture, there is shortage of furniture out there. So anything you want to buy out there, there’s shortages. You want to go build a house, it takes longer to build a house, and it costs you a lot more money. So for those people, those retailers who are able to get their merchandise on a timely basis, it’s going to be a big opportunity.

And we feel we’re in great position, we’re going to have great selection in our store, and it’s going to be exciting place to shop, it’s going to be a great online experience where these thing would be first introduced in the United States, why retailing on our app is being introduced right now. So, we’re very optimistic and we feel in a position as far as inventory is going to be. But it’s going to be — it’s going to differentiate us from everybody, and it’s going to be a big opportunity and we’re going to get more money for our goods, because it’s going to sell or –is that could be as promotional, which is good. I think we need to sell merchandise and get paid for your effort and give good value to the customer and give them great product. It’s a win for everybody. And we will have goods and that’s the key. Having the right merchandise and having goods, we will have goods. When Michael was talking about logistics, we already have reserved airplanes that we bought up. So if there is excess air freight, we’ll be selling it.

Operator

Thank you. Our next question is coming from Adrienne Yih of Barclays. Please go ahead.

Adrienne Yih — Barclays — Analyst

Yes, good morning. My question is, this is such a different Company today versus two years ago and I know you’ve gone through all the reasons why. But as we look at that, sort of the early look toward the low to mid-teen, we haven’t seen those types of margins for pre-2008. And I’m just wondering last two quarters, you’ve come in sort of in line with the street expectation. But I’m wondering if the street from our perspective needs to appreciate on a two-year basis, 14% over ’19, at 7% for each year, how should we think about the algorithm of top line growth? Should it be mid to high single-digits with low double-digit EPS growth — leverage growth to the bottom line? Because it really sounds like you’re driving this business for quality sales at higher and higher profits. And then, Mike, my second follow-up question is can you quantify on basis points the freight impact to Q2? What’s embedded for the second half, and how much have you been able to offset that with AIR increases? Thank you very much.

Mike Mathias — Executive Vice President and Chief Financial Officer

Thanks, Adrienne. I think you just told the story for me a bit. But yes, I think the — this is a different Company, a different focus. We’re not chasing revenue targets. We’re very focused on I guess in the way I could say is, you think about the two brands, we’re looking at area that 30% plus CAGR continuously AE’s modest growth. We saw a plus 5% increase in 2019. In the second quarter, again normalizing for that payment.

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

But Mike, you saw tremendous growth in margin dollars at the American Eagle side.

Mike Mathias — Executive Vice President and Chief Financial Officer

That’s where I’m headed. So I think when I talked about 2019 baseline and the fact we drove a lot of unhealthy sales, it was the AE brand, it wasn’t Aerie. So we are — we’ve changed the business model, we’re operating differently. Inventory is healthy top line node. So to be honest with you to hit a 5% over ’19, for the AE brand that is a new record again, because 2019 was a record. I’m actually ecstatic about the fact that we’re driving similar to higher revenue with this income flow through that we’re seeing. I mean it’s an amazing baseline that we’re creating here. So for the go-forward, I think we’re looking at probably modest top line growth in AE, 30% plus CAGR in Aerie continuing and the focus is the flow through on both the revenue from both brands. So when you think about operating margin go-forward, I think we’ll be coming out in January talking about and this is just round numbers, 40% gross margin, low to mid 20 SG&A, 3 points to 4 points of D&A, and a new target that’s in the low to mid teens we’re operating, right.

And maybe exceeding that as we continue to optimize how we’re flowing through especially Aerie’s revenue growth. And we have some other growth stories, we’ll probably be telling too. We hit on Mexico a bit. And in our prepared remarks, we think there’s some other international opportunity that we can flow through at a very healthy rate as well. On the freight costs, Adrienne, that’s a moving target every day. We think we have in our guidance accounted for everything we know to date. It could get better. So we’re going to see how that comes to fruition. But as we all — we’ve all been saying, our intent is we’re going to be aggressive on getting our product here and making sure the customer does not feel any different from us in holiday and I think that can be a competitive advantage, we all do. But it’s a bit of a moving target. So it’s hard for me to give you the exact basis point. So I’ll just say it’s embedded in our $600 million for now and again, could get better.

Adrienne Yih — Barclays — Analyst

Great. Thank you very much and best of luck for back-to-school and holiday.

Mike Mathias — Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. At this time, I would like to turn the floor back over to Mr. Schottenstein for closing comments.

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

Okay. Thank you. First of all, I want to say I’m very proud of the great team that we’ve been able to assemble. Whether it’s in the marketing, whether it’s in the merchandising, design, store operations, logistics side, we have world class players that we were able to attract and still attract that type of caliber. So we’re very excited about that. As we said early, we worked hard to make better product, get better selection to the customers and we could see it in the improvement of the performance, whether it be American Eagle, and as Jen emphasized 27 straight double-digit comp quarter increases for Aerie. I don’t know another retailer, if you go back 7.5 years, almost 8 years you could say, every quarter, a double-digit comp growth and still going double-digit comp growth. So — and have a new exciting brand like OFFLINE introduced now to and to have that potential to grow like Aerie. We are very excited about that. We’re very excited about the other brands that we’ll talk later about whether it be Todd Snyder, whether it be Unsubscribed, whether it be the new denim concept, we see a lot of opportunities for us.

The other thing that is, we had our Investor Day last January, we gave a three-year strategy. And a little bit we realized when we gave that three-year profit strategy, that in the same year, we’d already be breaking the three-year strategy. It puts us on the three years ahead, and we’ll have another Investor Day probably next January where we will reset the goal for the next three years, and we’re very optimistic.

And as we said, we’re very well-positioned for back-to-school. We like the way the month of August started. We like the way September starting and we’re very excited for the second half of the year, and we think that with the systems that we have in place, and what we have going on for us, they differentiate us from everybody else. At the end of the day, we have to be different than everybody else. We have product that customer loves. We have great brands with great loyalty. We didn’t talk about it. Really they drive this back, but the — but our strategy in marketing, at the relaunch our loyalty program, we have the largest enrollment of loyalty members that this company has ever seen in the last few months. So we’re very optimistic about the second half.

So we want to thank everyone for their support. And I could just tell you, this team is laser focused. And like Jen says, we’re humble. And we just know we got to keep driving and keep the innovation, the technologies and be able to put it all together and we push ourselves. This is a great team we have. So thank you for all your support.

Operator

[Operator Closing Remarks]