American Eagle Outfitters, Inc. (NYSE:AEO) Q3 2023 Earnings Call Transcript

American Eagle Outfitters, Inc. (NYSE:AEO) Q3 2023 Earnings Call Transcript November 21, 2023

American Eagle Outfitters, Inc. beats earnings expectations. Reported EPS is $0.49, expectations were $0.47.

Operator: Greetings and welcome to the American Eagle Outfitters Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Judy Meehan. Thank you. You may begin.

Judy Meehan: 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; 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 our third 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 morning. Overall, I am pleased with our third quarter performance. Although the macro environment remains highly dynamic, we are seeing encouraging trends. Our brands remain stronger than ever and our strategic priorities are propelling us forward. AEO’s customers are at the center of our strategy, driving constant innovation that enables us time and time again to deliver exciting collections, and this fall was no exception. Additionally, we provide an industry-leading customer experience, reflecting our investments in data-driven insights and operational excellence. With the launch of our profit improvement program, structural initiatives to drive growth and higher margins are taking hold. Now a few financial and strategic highlights from the quarter.

Third quarter revenue hit a record of $1.3 billion, driven by 5% comp growth, reflecting growing brand momentum and terrific fall merchandise collection. Our market-leading brands are true lifestyle destinations for our customers, and that was evident this quarter. Aerie returned to double-digit revenue and comp growth, and AE generated positive revenues and comps. We also saw a significant strength across digital and stores, with new merchandise and strong execution, driving improved traffic across AE and Aerie. The digital channel was a star performer, accelerating to 10% growth. We are seeing great momentum here. Under the leadership of our new Head of Digital, David Zhang, we have introduced innovative customer engagement tactics, enhanced our user data and analytics to drive stronger KPIs. This work has yielded remarkable improvement in our e-commerce business, will receive plenty of runway ahead.

Stores were also positive in the quarter. We are pleased with early results from new store designs, including our Gateway store in SoHo. The store encompasses all of our collections across AE, Aerie, OFFL/NE, AE77, AE 24/7 and our Unsubscribed, seamlessly under one roof. New Aerie and OFFL/NE stores are also coming out of the gate positive to expectations. Turning to profit. We achieved our second highest third quarter gross margin and operating income in over a decade. This is only second only to 2021 when stimulus fueled exceptional results across the industry. Margin expansion to last year was driven by improved markup as well as numerous structural changes aligned with our ongoing focus on profit improvement. A few highlights of this work include: Maintaining tight inventory and promotional discipline, changing our clearance strategy to yield higher profit, scaling Aerie and shifting our product mix into higher margin categories, modernizing our delivery network to reduce costs, and optimizing AE’s real estate footprint.

As we continue to drive strong demand and build momentum on this work, we are raising our full year operating income guidance to the high-end of our prior range. We now expect to be in a range of $340 million to $350 million from $325 million to $350 million prior. Lastly, our capital allocation priorities remain unchanged. We are committed to investing in our brands to continue growth, while returning capital to shareholders. Our balance sheet is resilient, and we maintain a healthy liquidity position. We ended the quarter with $241 million in cash and nearly $900 million in total liquidity with no debt. Looking ahead, we remain intently focused on advancing our long-term strategic priorities. Two: One, drive consistent growth across our portfolio of brands; and two, generated efficiencies and cost savings for improved profit flow through.

We continue to advance towards our priorities and are investing in talent, which further positions us for future success. During the quarter, as part of our COO, Michael Rempell succession plan, we made two key leadership appointments. We are excited to welcome Sarah Clarke, our new Chief Supply Chain Officer, who is responsible for ensuring operational excellence across our global supply chain from sourcing through distribution and a welcome to Valerie van Ogtrop, our new Head of Brand Operations, a role we created to drive greater collaboration and synergies across AE and Aerie’s growth and profit plans. Sarah and Valerie nicely complement our teams of experienced executives and excellent bench of division leaders and associates. There is a high level of focus and energy across the organization around our profit improvement project.

We have had strong engagement from our leadership teams with great support from our Board of Directors, enhancing our innovative spirit to rethink how we operate every day, and with work streams focused on unlocking both revenue growth and efficiencies moving forward. We intend to host an investors meeting in spring of 2024 where we will unveil specifics on our go-forward strategy and provided long-term financial targets. In the near-term, with incentives fully embedded in our 2023 expense base and early benefits from our profit improvement initiatives, I am confident of our ability to leverage expenses even on modest sales growth in 2024. AEO has enduring brands, robust operations and strong talent. I am confident that with our strong foundation and new strategic direction, we have the right recipe in place to build revenue and profit from here and deliver shareholder returns.

With that, I will turn the call over to Jen.

Jen Foyle: Thanks, Jay, and good morning, everyone. As Jay noted, we had a strong quarter with sequential improvement across brands and channels. Top collections were well received, and I am proud of how the teams executed on our brand strategies. It was incredibly exciting to see American Eagle return to growth with revenue and comps up 2%. We delivered a winning assortment that showcased our incredible brand heritage and an exciting customer experience. Women’s was particularly strong where we wrote positive comps across tops and bottoms. We are seeing strong demand for fleece, tees, skirts and newer bottoms such as swirls, cargos, and wider legs. Men saw strength in tees, sweaters, twill bottoms, and shorts. AE also delivered strong operating profit growth, up 6% to last year, aligned with the strategic plan we laid out in 2021.

We have made significant progress in improving the health of the AE brand over the last few years. We stepped away from low-margin sales, rationalized SKUs to eliminate unprofitable offerings and optimized our brand’s real estate footprint. As a proof point, third quarter brand profit is up 20% relative to third quarter 2019 levels with revenue modestly down 2%. With profit restored to a healthy level, as discussed in prior quarters, we are strategically focused on growth. Early initiatives have been highly impactful, and I am pleased to note that, AE returned to growing its customer file this quarter. Casual wear is a lifestyle that continues to evolve, providing exciting new trends for us to drive and play into. We are focused on expanding our dominance in denim, leveraging our industry-leading fits and fabrics to deliver newness.

At the same time, we are also making investments to better penetrate categories and occasions that are important to our customers with collections like AE 24/7 in men’s activewear and AE77, our premium capsule. We are also continuing to invest in our store fleet to improve productivity and ensure we put our best foot forward. We have seen a positive response to AE’s new store design with remodeled stores delivering significantly improved comps. Based on the success of these initial tests, we are expanding our remodel program next year to include additional stores, while continuing to close and reposition low-productivity locations. And we are also focused on improving inventory allocation and replenishment to better serve our customers. And lastly, we continue to leverage and innovate marketing campaigns and amplifying excitement around the AE brand.

This fall, we collaborated with the Ziegler sisters on a limited edition capsule to showcase key fashion items for back-to-school season. This included our OMJeans event, a powerful takeover on the High Line in New York City, an immersive installation that stepped many New Yorkers in their tracks. We showcased the quality and versatility of our iconic denim assortment, underscoring in our strong heritage and dominance in the category. The campaign outperformed our expectations, driving strong sales both online and in stores. Now turning to Aerie. We had an exceptional quarter with revenue and comps up 12% and profits expanding 34%. Newness and assortment changes in our core intimates business drove a nice sequential recovery. We grew market share and had our best ever third quarter performance in — We also continued to see rapid growth in our core apparel business with particular strength in fleece and sweater, where new collections are resonating very well.

And our activewear collection OFFL/NE also had a great quarter, achieving double-digit growth. Aerie has seen incredible expansion over the last few years, growing into a beloved destination for exciting fashion and comfy, cozy fits in intimates, apparel, swimwear and activewear. Since 2019, we have doubled our sales and quadrupled our profits. We are gaining new customers every season with our total customer file now over 10 million. Yet with just a low single-digit share of close to $80 billion total addressable market, we are just scratching the surface. Activewear in particular provides an attractive opportunity fueled by strong demand for athleisure. We see a unique opportunity to build share here with OFFL/NE. Aerie is vibrant and playful take on activewear as we continue to develop the assortment.

We are focused on continuing to build brand awareness as we leverage investments in our store fleet and innovative marketing strategies to grow our customer base and share of wallet. New store performance remained strong, providing a positive lift to comps, as they come into the comp base. Additionally, OFFL/NE openings are exceeding plan. On the marketing side, Aerie’s fall campaigns were focused on elevating the brand as the go through for high-quality, fashionable and comfortable intimates and apparel. We showed up across the season within the ray of notable influencer talent and programs. This included a first-to-market partnership with the popular dating app, Bumble, encouraging users to find their company match with Aerie. We also hosted the Hidden Gems Marketplace, a fun, interactive customer event in New York City that generated strong marketing KPIs. We have two of the best brands in retail.

For over a decade, we have consistently ranked in the top three brands in the Piper Sandler Taking Stock With Teen survey. AE is the market leader in denim in the age 15 to 25 cohort, the #2 brand across all ages and the #1 brand for women in particular. Aerie is one of the most exciting brand platforms and fashion, celebrating body positivity and empowering women to feel their best selves every day. It’s a strategic priority to profitably grow our portfolio of brands and driving meaningful opportunity ahead. Before I turn this call over to Mike, a big thank you to the AE and Aerie teams for their hard work in delivering a strong quarter. Our brand, category and channel strategies are gaining momentum, which is a true testament to this talented team.

And with that, I will turn the call over to Mike.

Mike Mathias: Thanks, Jen. Good morning, everyone. As Jay mentioned, third quarter results marked continued progress on our strategic priorities to grow our brands and set us up for improved profit flow-through. Strong brand momentum, combined with actions taken on our profit improvement initiatives, resulted in improved gross margins and operating income year-over-year. We entered the quarter with momentum that continued into the early holiday season, fueling a strong top line result. Consolidated revenue of $1.3 billion was up 5% to last year, and comparable sales also rose 5%. Operating income of $125 million reflected a 9.6% operating margin. Gross profit of $544 million increased $64 million, representing a gross margin of 41.8%, up 310 basis points to last year.

As Jay noted, we achieved some of our highest merchandise margins on record reflecting strong demand, lower costs and a number of benefits from our profit improvement initiatives. Inventory discipline resulted in lower markdowns as we maintained healthy promotions. With the change in our clearance model announced last quarter, we continue to sell through end-of-season merchandise at better margins. We also saw leverage on rent, reflecting our focus on strengthening fleet productivity at AE and the ramp-up of new Aerie stores as well as delivery, distribution and warehousing costs with efficiencies across several key metrics, including lower shipments per order and lower cost per shipment. SG&A expense of $362 million was up 16% from last year and in line with guidance.

Consistent with strong business trends, roughly half of the increase was driven by incentive expense after zero accruals last year. As discussed last quarter, incentives are weighted to the back half of this year. Their payroll also increased largely due to higher wages. Depreciation was up year-over-year and in line with guidance provided last quarter, primarily reflecting our investment in new stores. As noted previously, we have reset incentives through reflective improvement in business performance with incentives now on our base and an ongoing focus on cost efficiencies, we’re well positioned to leverage our expense based on modest top line growth next year. EPS for the third quarter of $0.49 per share. Turning to our brands. Aerie revenue and comparable sales increased 12% in the third quarter, a positive non-comp lift from these stores was offset by lower third-party sell-offs, reflecting greater inventory control and our shift to a more profitable clearance model.

Aerie’s operating margin of 19.3% hit an all-time high, expanding over 3 points to last year as the brand continued to scale and we saw improved markups, lower markdowns and early benefits from the clearance shift. American Eagle revenue and comps increased 2% with the operating margin expanding 70 basis points to 21.5%. As we discussed on numerous occasions, our focus over the past several years has been strengthening the profitability of the AE brand. I’m extremely pleased with the progress we’ve made, expanding profit margin by 400 basis points since the third quarter of 2019. We’re now turning our echo growing the top line with a sharp eye on profit flow-through. Consolidated ending inventory cost was down 4% compared to last year with units down 3%.

Inventory levels remain healthy and controlled as we maintain buying discipline and case demand. We ended the quarter with a balance sheet in a strong position, including $241 million of cash and total liquidity of $875 million, including our revolver. Capital expenditures totaled $43 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 more color on our ongoing profit improvement work. Last quarter remained an important change to our clearance model, which is tracking in line with plan to generate $25 million in savings in 2023 and $50 million in savings on an annualized basis.

As we continue to lock down efficiencies that have supported our gross margin expansion, other significant work streams within SG&A have also been identified and are being actioned on. We are instilling an internal culture around continuous improvement and expense management, the results of which are incorporated into our 2024 plans. As a result, next year, we expect to drive continued gross margin expansion, leverage on SG&A and depreciation, operating rate expansion and healthy earnings growth, structuring the business to deliver — low single-digit revenue growth. A more positive trend would drive incremental leverage and profit flow-through. We’ll give further details in future months as we provide our specific expectations for 2024 and beyond in the spring.

Quarter-to-date, we are seeing sustained momentum across our brands with revenue up in the mid-single digits. Additionally, we continue to make good progress in executing on profit improvement initiatives. With the background, we’re raising our full year outlook for operating income to the high end of prior guidance. We now expect to be in the range of $340 million to $350 million. This reflects revenue up mid-single digits with comps up low to mid-single digits. For the fourth quarter, this implies operating income in the range of $105 million to $115 million, with revenue up in the high single digits, including a 4-point tailwind from the 53rd week. Comp sales are projected to be up in the mid-single digits. SG&A is expected to be up approximately 20%, including a 5-point impact from the 53rd week.

As previously discussed, it also includes higher incentive accruals, which are skewed to the back half of this year. As Jane mentioned, we look forward to providing more color on our long-term strategic priorities and financial goals at our spring investor meeting. With that, I’ll open it up for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from the line of Matthew Boss with JPMorgan.

Matthew Boss : So Jen, could you speak to key areas of acceleration at Aerie in the third quarter and just how you see the brand position for holiday? And on the return to growth at American Eagle this quarter, how do you view sustainability of positive comps at this concept moving forward? And then, Mike, could you just elaborate on the profit improvement project and maybe the modest top line to leverage SG&A next year? Just taking a step back how that compares to historical flow-through in the model.

Jen Foyle: Sure. And happy Thanksgiving to all, by the way. Look, I’m going to take a small victory lap here. I just loved what we saw in Q3. And let me just say one thing. This team, okay, my team JC, all of our American Eagle team, they were in stores last week. We saw almost 20 stores in basically 2.5 days. This is what my team commits to. We’re in this for the long haul. That’s all I can tell you. To grow year-over-year, day-over-day, quarter after quarter, you have to have a long-term strategy. And I’d like to say we’re delivering on it. Really proud of what we accomplished in Q3. Women’s, in particular, in AE, we did double down there. Their comps definitely superseded the men’s comps and we’re going to continue that.

And I love what I’m seeing for spring, more fashion, more node to what I think is relevant in today’s trends. We went back and we decided that we needed to get same as for our nearion categories, and we’ve been up to that for 3 years now. And now it’s time to jump off in American Eagle and well, do I like what I’m seeing in the future for trends. In Aerie, well, I think this is long overdue. Keep in mind, Aerie held their market share in bras in a declining business. We held our own in Q3. It’s an $80 billion opportunity for us to grow into that category, and the team is up to it. I like what I’m seeing early on. Q4, it’s still — we have many weeks ahead of us. And as you know, the big week ahead heading into what we call Green Friday, not black.

I think we’re ready to go. Like I said, we were in 18 stores, almost 20, in 2.5 days, and we are ready to compete on our terms. And as Mike alluded to, we’re going to talk more in the spring season when we speak to you all about our long-term growth plans. But I can — I see it. I see what’s happening here, and we’re going to deliver and build this incredible brand strategy.

Jay Schottenstein: Yes. And Jen, when you were in the stores, you would agree that our stores were the best — we’re like the best looking stores out there, too.

Jen Foyle: I think so. I think the way we operate. It’s one thing to grow your business is another thing to deliver operational excellence. That’s what I have to say.

Mike Mathias: Yes. And on profit improvement work, Matt, the third quarter was another proof point on where we’ve had the focus, which has been expenses and margin improvement, all generating and providing that gross margin expansion. So now for 3 quarters now, we’ve seen gross margin expansion. We’ve leveraged the expenses in gross margin. Fourth quarter, we’ll do it again. As we talked about, this work is sort of a multiyear journey and the SG&A piece of that would take a little longer as we’ve looked at labor models, services, things type of contracts and vendors that we’re negotiating either reductions to current rates or looking to consolidate our move vendors that work we have line of sight now that we have into 2024, and we know what the benefits look like.

So on top of the gross margin expansion that we believe that will continue next year and now we’ve got the opportunity to leverage SG&A at low single-digit revenue growth next year, if that would be the result. Anything better than that, we’d see even higher leverage against that historical model.

Operator: Our next question comes from the line of Paul Lejuez with Citi.

Kelly Crago: This is Kelly on for Paul. Could you just talk about how the clearance strategy change impacted the P&L this quarter? Was it a headwind to sales? And how much of a benefit, was it the gross margin at 3Q? And how do we expect — how do you expect that to impact 4Q and F ’24 from both a sales and margin perspective? And then I have a follow-up.

Mike Mathias: Yes. I think the headwind to revenue was 1 or 2 points in the quarter just based on the sell-off revenue not being booked, which is unprofitable. And that’s the story around this improvement. The $50 million annualized benefit, that will happen over a 12-month basis. Historically, we have hits in Q2 and Q4, for the most part, selling off clearance versus clearing it ourselves now, which is what we’re doing. So we’ll see this benefit across a 12-month period. Saw some benefit in Q2. There’s some benefit in the Q3 results. Again, most of that benefit is markdown management, inventory management in total and then leverage of our expenses and gross margin in Q3. And then Q4, we’ll see another slight benefit. But again, those other pieces are bigger than the clearance benefit. So it’s a 12-month model now versus sort of Q2, Q4 sell-off model we’ll see that $50 million annualized across the 12-month period go forward.

Kelly Crago : And just on the SG&A guidance for the fourth quarter. I think coming into today, we sort of had that the SG&A up mid-teens in the fourth quarter. So I guess trying to understand what’s driving the greater growth in fourth quarter relative to your previous expectations. Is that all accrual of incentive comp? Or — and I guess, on that, I mean, we — you’ve been talking about sort of finding cost savings for a while now. Just wondering why we would be seeing more offset.