American Eagle Outfitters, Inc. (NYSE:AEO) Q2 2023 Earnings Call Transcript September 6, 2023
American Eagle Outfitters, Inc. beats earnings expectations. Reported EPS is $0.25, expectations were $0.15.
Operator: Greetings and welcome to the AEO Second 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: 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. 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.
Additionally, you can find the second quarter investor presentation posted on our corporate website at www.aeo-inc.com in the Investor Relations section. And now I will turn the call over to Jay.
Jay Schottenstein: Good afternoon. Thanks for joining us today. I am pleased to report second quarter revenue and operating profit that exceeded our expectations, reflecting stronger demand and improved profit flow-through. Business picked up in June across brands and channels with strength sustaining until July as our early back-to-school collections rolled out. The teams executed well during the period. We made quick product adjustments, chased into demand profitably while also maintaining healthy inventories and controlling promotions. Record revenue of $1.2 billion was up slightly to last year, while operating income of $65 million increased significantly to last year. We generated strong cash flow, ending the quarter with a healthy balance sheet and cash of $175 million, up $77 million to last year.
As previously discussed, we expect this past several months reviewing our cost structure to find areas where we can be more efficient as we continue to grow. We have identified opportunities to improve profitability over the next 12 to 24 months. We began to take action on these items in the second quarter and starting to see results, which Mike will review. Now on to a few highlights of the quarter. American Eagle continues its leadership in casual wear, and that’s evident in recent performance where demand has been strong, particularly during peak shopping periods. We are seeing encouraging results across genders as new products are introduced. Expansions like AE77, our premium capsule; and 24/7, our entry into men’s activewear, are injecting new energy and expanding our reach.
As the team will discuss, we are excited about the launch of the new store design to update and modernize the shopping experience. The online channel is also being enhanced with new features, which is driving better overall metrics. Aerie achieved yet another record revenue quarter with strong profit. As Jen will review, we saw incredible demand across our core apparel collection, and our activewear extension continues to be on prior. We are also seeing renewed momentum in intimates where we’ve introduced new collections. I see a very bright future for the Aerie and OFFLINE brands, where we are just beginning to see the real potential. I’d also like to comment on our Todd Snyder brand, where we have been seeing strong growth. Over the past year, we have selectively expanded into high-fashion metros, bringing Todd’s modern creations and upscale experience to new customers.
We expect to reach over $100 million in revenue this year. I cannot be more excited for what’s ahead. Entering the third quarter, it’s been encouraging to see sustained strength across our entire brand portfolio. As we continue to fuel this momentum with strong merchandise and innovative marketing, we will stay focused on delivering efficiencies across the business and improve profit flow-through. Before I turn the call over to Jen, I want to touch on the leadership transition announced last month. As noted, Michael Rempell, our Chief Operating Officer, has made a decision to leave the company at the end of the fiscal year. While I’m personally sad to see him go, I want to thank Michael for his incredible leadership and partnership over the last 23 years.
Michael has been a tremendous asset to the company, investing in technology and infrastructure to create our world-class operations. He will leave AEO with a strong foundation to build on from here, including excellent teams to help support a successful transition. With that, I’ll turn the call over to Jen.
Jen Foyle: Thanks, Jay, and good afternoon, everyone. I am pleased with how the second quarter shaped up, including a significant improvement in operating profit across brands. As Jay noted, June was an inflection point. Business improved as we brought in new fashion, and July was our best month with both AE and Aerie comping positively. We were able to chase into high-demand items at a strong margin. With inventory at appropriate levels, promotions and end-of-season clearance were down dramatically to last year. Our second quarter AUR was the second highest in history. Customer KPIs remained solid with growth in our total customer file as well as our loyalty customer base. Aerie continues to expand its reach with the customer file growing to another all-time high this quarter.
Turning to the brands. Aerie revenue was up to last year, led by new store growth. With the exception of swimwear and intimates, comps are very solid across categories with most major businesses up in the double digits. As we move past peak swim season, comp strengthened further as we introduce new merchandise turning positive in July and accelerated into the third quarter. Receptions in new styles in our core apparel collection has been incredible, especially in fleece, bottoms and tops. For activewear extension, OFFLINE by Aerie also had a standout quarter across tops, sports bras, active shorts and fashion items. I am also pleased to note that our intimates business turned positive with the arrival of updated collections. As discussed on previous calls, we have been focused on leading with greater innovation and offering more Macpac.
Photo by carlos aranda on Unsplash
Our newly launched SMOOTHEZ styles and extended body suit collection have been a tremendous success. Coupled with refreshed marketing, I am pleased to see the intimates attract new customers and drive higher sales. Building brand awareness and amplifying our products through unique marketing is a priority. Through our Hidden Gems campaign, we are bringing to life a more mature point of view within intimates this fall. We are emphasizing high-quality, beautiful designs while maintaining the playful spirit that makes Aerie distinctive. This is a 360-degree campaign, including partnerships with the dating app Bumble, celebrity influencers, active social campaigns and live events. Now turning to American Eagle. Revenue was down to last year, yet with a significant improvement in profitability.
Here, too, we were pleased to see trends improve sequentially throughout the quarter with AE exiting July with positive comps, which has sustained into the third quarter as well. Women’s tops had another quarter of growth with continued improvement in comp trends across denim and non-denim bottoms as well. Men’s also saw improvement in bottoms driven by pants. Over the past several quarters, with brand margins restored to healthier levels, we are now focusing on growth. As Jay noted, we are pleased with the expansion of newer collections like AE77 and 24/7, and we’ll continue to build on our learnings. I’m also very excited about the launch of our new AE store design with modern aesthetics that celebrate our strong heritage in denim and casual wear.
We’ve seen strong results so far and look forward to updating additional locations. On the marketing front, AE collaborated with the Summarize in Pretty, a Gen Z favorite, with a live shopping experience on Amazon. The campaign and collections were a strong success, and we continue to chase items. Looking ahead, I am really excited by the trends I am seeing in casualwear. Emerging new trends provide exciting opportunities to fuel growth, and I believe we will be well positioned for upcoming seasons. As we said, the business has shown material improvement this summer across brands. Recent trends have been stronger with greater consistency and performance. We are continuing to build on the areas with high demand while keeping a sharp eye on the consumer environment and planning appropriately.
Before I turn the call over to Michael, I want to say thank you to my incredible AE and Aerie teams for staying focused and delivering this quarter. We are energized, and I look forward to updating you on our performance next quarter. Thank you. And now I’ll turn the call over to Michael.
Michael Rempell: Thanks, Jen, and good afternoon, everyone. I’m very pleased with how the teams are executing against our initiatives and delivering stronger results. We are leveraging flexibility in our supply chain to chase high-demand items. Across channels, we’re making improvements and seeing a real difference in key performance metrics, which I believe will enhance the customer experience and support sales growth. For the quarter, store revenue increased 4% as customers continue to return to in-person shopping. It’s encouraging to see demand improve over the course of the quarter as our new floor set hit stores. I’m also very pleased with the progress we’re making on our store payroll model, which is creating efficiencies and allowing us to leverage expense.
Upgrading our fleet and store operations remains a top priority. Our new store design was introduced in three locations: Oakbrook in Chicago, Palisades in New York and Polaris in Columbus. In Oakbrook, we coupled the remodel with a relocation to a better area of the mall. And while it’s early days, the combination of these actions has driven a nice lift to store sales. This is a great example of this 360-degree approach we are taking to improve store productivity while also ensuring our brands are showcased in the best way possible. We also rolled out a new AI-based technology to optimize size profiling and inventory replenishment. Early results are showing quicker and more accurate placement with improved in-stock levels. This is allowing us to better service demand with lower inventory across the network.
Turning to digital. Revenue declined 7% in the quarter as demand continued to normalize from elevated builds during the pandemic. Yet here, too, we are very pleased to see the business accelerate month-to-month and turn positive in August. New leadership has brought a fresh set of eyes to how we can continue to elevate our online shopping experience. We have put new processes in place to test, learn and scale ideas with greater precision and speed. This new rhythm and the culture of experimentation is creating an exciting avenues for us to improve our KPIs. As an example, updated messaging and more strategic customer engagement are leading to higher conversion rates. We are just scratching the surface, and I see plenty of opportunity for more improvement as we build on our learnings.
We are also taking action to create a more seamless customer experience across channels as we further integrate our store and digital operations. This quarter, we enhanced our Buy Online, Pick Up in Store offering, providing increased visibility to customers and optimizing order fulfillment. The initial read has been very positive. We’ve doubled our pickup penetration, which is generating savings on shipping costs and creating additional sales. Altogether, this is allowing us to better leverage our store fleet and our associates to provide a great cross-channel customer experience. Our network of distribution centers and in-market nodes continues to drive efficiencies in our fulfillment model. Second quarter delivery costs were down year-over-year and leveraged as a percent of digital revenue.
In fact, we achieved multiyear lows in both our cost per shipment and the number of shipments required to fulfill an order, all while delivering products faster to our customers. On the inbound side, we continue to see a favorable environment. We expect product cost and freight to continue to be a tailwind in the second half of 2023. Additionally, we are leveraging shorter lead times to stay nimble and chase. Before I turn the call over to Mike, I want to thank Jay for his kind words on my decision to lead the company. It’s hard to move on from a place that has been my second home for the last 23 years, especially one where I had made so many lifelong friendships. The only thing that makes it easier is knowing that I’m leaving the company in very capable hands.
It has truly been a privilege to work with such a high-caliber and talented team over the years. Thank you for your support, your hard work and your camaraderie. We will work closely together to ensure a smooth transition in the coming months. AEO has a bright future ahead. I know there’s no better team to take this company to the next level. And with that, I’m going to turn this call over to Mike.
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Q&A Session
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Mike Mathias: Thanks, Michael. Good afternoon, everyone. We are pleased with our second quarter results, which reflected early progress on our journey to improve long-term profitability. Despite a slow start, we saw a real inflection point with the arrival of new merchandise over the summer. We remain nimble, manage markdowns effectively and leverage our ability to chase into demand profitably. With the initiation of our profit improvement program, we also saw some early benefits, which I’ll touch on shortly. Overall, we managed the quarter well, and we’re able to nicely exceed our outlook provided back in May. Consolidated revenue of $1.2 billion was up slightly to the second quarter of last year. It’s important to note that we cycled approximately $22 million in revenue from last year’s excess end-of-season sell-off, which impacted second quarter revenue growth across brands and channels.
Operating income came in at $65 million for the quarter, reflecting a strong recovery year-over-year and a 5.4% operating margin. Compared to last year, gross profit dollars increased $83 million or 22% to $453 million with a gross margin rate up 680 basis points to 37.7%. The majority of the improvement was driven by better merchandise margins. Inventory discipline drove lower markdowns as we maintain our focus on healthy promotions. Additionally, we lapped $25 million of freight headwinds and $30 million of incremental markdowns related to end-of-season sell-offs last year. As I will discuss shortly, we made a structural change to our end-of-season clearance process this quarter, which we expect to positively impact gross margin over the next year.
As Michael noted, lower delivery and distribution expenses also provided tailwinds to gross margin this quarter as we drove efficiencies across our outbound network. SG&A expense of $332 million was up 8% to last year. We continue to drive efficiencies in our store labor model, providing a partial offset to incentive accruals compared to zero last year, higher costs from store growth and other corporate expense. Depreciation was up year-over-year and in line with guidance provided last quarter. EPS was $0.25 per share, and our diluted share count was 196 million. Turning to our brands. Following the lull in May, we were pleased to see trends for both Aerie and American Eagle improve sequentially through the quarter. Aerie revenue increased 2% in the second quarter.
Comparable sales were flat, and Aerie’s operating margin of 15.1% expanded approximately 12 points to last year driven by improved markup and lower markdowns. American Eagle revenue declined 1% with comps down 2%. AE’s operating margin of 16.8% expanded nearly 3 points to last year. Consolidated ending inventory cost was down 7% compared to last year with units down 11%. Inventory levels remain healthy and controlled across geographies as we continue to maintain buying discipline and chase demand. We generated strong cash flow and ended the quarter with $175 million in cash. We continue to have healthy access to additional liquidity through our revolver with current liquidity over $800 million. Capital expenditures totaled $46 million, and we continue to expect full year CapEx to be in the range of $150 million to $175 million.
Our plan for our consolidated store count in 2023 remains roughly flat to last year, reflecting approximately 25 new Aerie store openings, offset by approximately 25 net closures for the AE brand. Before I move on to our outlook, I’d like to provide an update on the positive progress being made on our profit improvement initiative. We have highly motivated cross-functional teams making structural changes to our operating model to capture permanent efficiencies. As I’ve discussed on previous calls, we’re working across all areas of the P&L. With roughly 70% of our costs spread across product, markdowns, rent, warehousing and inbound and outbound delivery, our initial actions are positively impacting our gross margin. Michael pointed out the benefits we’re seeing in distribution and warehousing.
