American Eagle Outfitters, Inc. (NYSE:AEO) Q4 2022 Earnings Call Transcript March 1, 2023
Operator: Greetings, and welcome to the American Eagle Outfitters Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. 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. The results actually realized may differ materially based on risk factors included in our SEC filings. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Also, please note that during this call and in the accompanying press release, certain financial metrics are presented on both a GAAP and non-GAAP adjusted basis. Reconciliations of adjusted results to the GAAP results are available in the tables attached to the earnings release, which is posted on our corporate website at www.aeo-inc.com in the Investor Relations section. Here, you can also find the fourth quarter investor presentation. And now, I will turn the call over to Jay.
Jay Schottenstein: Good afternoon. Thanks for joining us today. 2022 was a dynamic year, with numerous external questions. As we lapped outstanding results in 2021, we face a difficult macro environment with rising inflation, higher interest rates, continued supply chain disruption, and a highly promotional retail environment. I am proud of how our teams executed throughout the year. Early on, we took swift and aggressive actions to reduce inventory levels, cut expenses and capital spending. This contributed to a significant recovery in profitability and free cash flow during the second half of the year. We also posted our second highest revenue periods on record in both the fourth quarter at $1.5 billion and the year at $5 billion.
Our fourth quarter results exceeded expectations and adjusted operating income of $96 million was above last year. We strengthened our financial position and exchange neared all of our outstanding convertible debt to end the year with a healthier balance sheet and improved liquidity. Moving to the American Eagle brand. I’m incredibly proud of the work the AE team has done over the last several years to improve profitability, rationalize unproductive SKUs and close low margin stores. As a proof point, fourth quarter adjusted operating profit for AE was up 36% to 2019. Jen has made great strides to refresh the brand, via energizing assortments to capitalize on trends, while delivering better profitability. AE is a strong and healthy brand. I’m encouraged by how customers are embracing new styles and I look forward to our continued progress.
Aerie has demonstrated exciting multi-year growth with fourth quarter revenue and adjusted operating income up over 70% in 2019. The rapid success of OFFLINE, our extension into active wear underscores the strength of Aerie’s powerful brand platform. We have significant potential as we reach more and more customers, and I cannot be more excited about the future. Our international business performed well in 2022. We will continue to fuel sales and profits, pursuing a multiyear strategy to optimize key company-owned markets and expand our license business. In 2022, I was pleased to publish our first ESG report, highlighting over two decades of actions we have undertaken to build a better world. As noted in the report, we have made tremendous progress across our water goals and continue to reduce submissions.
ESG responsibility is embedded in our brands and company culture and deeply interline with our corporate strategy. As we grow our brands and markets, we will stay disciplined and focus on profitability. Inventory management remains a key focus, and we will use the strength and agility of our supply chain to chase demand. Additionally, we have launched a formal program to further reduce expenses, gain efficiencies and prioritize high ROI projects. Given the highly volatile environment we’ve been operating in over the past several years, now is the time that we set our business. Last year, we made good progress yet opportunities remain. As we strive to break out of the mid single-digit operating margin range. On Quiet Platform, we continue to see interest from prospective customers and remain optimistic about the long-term opportunity.
Yet the demand has been pressured this past year. As Michael will review, we are adjusting our go-forward plans to strengthen profitability. Although the macro environment remains uncertain, we entered 2023 better position. I see no shortage of opportunities for this company. We will harness the power of our brands and an industry-leading operating models to drive growth and find efficiencies in processes and capabilities. I’m confident with focus and discipline we have strengthened our bottom line. We are committed to returning cash to our shareholders and are very pleased to reinstate our quarterly dividend. With that, I’ll turn the call over to Jen.
Jen Foyle: Thanks, Jay, and good afternoon, everyone. Over the past few years, the dynamic macro has battle tested us in many ways and 2022 was another roller coaster of a year. In this environment, American Eagle and Aerie displayed resilience, maintaining their status as fan favorites within our core demographic. In a year where customers pulled back on discretionary spending, we grew our loyalty customer file, further strengthening our relationships. Even in a highly competitive promotional environment, fourth quarter results exceeded our expectations. With inventory back at healthy levels, we brought exciting new innovation to our customers in stores and controlled markdowns, achieving our second highest fourth quarter AUR.
This was down 7% to last year’s record high, yet up over 20% across brands to 2019, highlighting our focus on controlling promotions and building brand equity. Aerie reached a milestone at $1.5 billion in revenue in 2022 as new stores continued to expand awareness. Since 2019, revenue has nearly doubled with operating profit up close to 150%. I am pleased with this accomplishment, especially given the unprecedented macro volatility. For the fourth quarter, Aerie continued to see good growth, yet came in below our expectations. Core apparel showed up well, and we achieved our best sweater season in the brand’s history while also continuing positive growth in fleece. Our active wear extension, OFFLINE by Aerie, remained a standout performer, led by our Leggings franchise.
Leggings continue to be a powerful driver of new customer acquisitions, and we are seeing nice momentum across fashion and performance styles. Intimates was a bit softer than expected. And as we look forward to 2023, our plans include launching more units in intimates to build great awareness and engagement. As we continue to scale Aerie, we are leveraging creative marketing touch points to drive excitement. In the fourth quarter, our I want Aerie holiday marketing campaign centered on gifting was a strong success. Additionally this spring, we launched a new Find Your Wonder campaign with a throwback to Y2K fashion, including real life and digital experiences. Turning to American Eagle. Demand in the fourth quarter exceeded our expectations.
As we evolve our assortment with engaging fashion trends, we are seeing a nice reception to new silhouettes such as wide legs and cargo, and renewed excitement in fleece and knit tops. I look forward to capitalizing on new fashion trends as we move through the year. Over the past several years, we have been intently focused on improving the health of the AE brand, tightening our assortment, pulling back on the value disrupted promotions and selectively closing unproductive stores. These changes are driving better margins. As we maintain our focus on profitability, we are also actively exploring opportunities to drive growth. On that note, in January, we launched AE 24/7, a new men’s sub brand focused on the fast-growing active wear category.
Early reception to our limited initial assortment has been very encouraging, and we look forward to scaling the collection later this year. Last month, we also relaunched AE77 as a premium sustainable capital within the AE brand. Introduced with limited denim choices for now, the assortment spans both men’s and women’s and will be available predominantly online with bricks-and-mortar presence in select stores. The reception has been very encouraging, and I look forward to building on the early success. I’m pleased to note that AE’s customer file grew in the fourth quarter as we retained and reactivated more customers. On the marketing front, we collaborated with the cast of The Summer I Turned Pretty, a Gen Z favorite show, launching a limited edition collection that fully sold out.
Buzz around AE is continuing into spring. Last month, our newest denim silhouette, Dreamy Drape, went viral after an organic post by Alex Earl, one of TikTok’s fastest-growing influencers. We have also launched an exclusive Spring collaboration with the Outer Banks crew, which is off to a good start, drawing in new customers with great reception across social media. In fact, a recent post by one of the stars on the show became our number one Instagram post of all time. Entering 2023, while the macro remains uncertain emerging trends in casual wear continue to provide new avenues to drive growth across our brands. Innovation is our strength. We will lean into newness and continue to deliver excitement and high quality on trend styles to our customers.
Thank you. As always, to the AE and Aerie teams for their tremendous effort this past year. With every season, we are making progress, and I remain very excited about what’s to come. Thank you. And now I’ll turn the call over to Michael.
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Michael Rempell: Thanks, Jen and good afternoon everyone. As Jay noted, the past few years have been extremely volatile for the retail industry, highlighted by shift in consumer spending and operational challenges. Navigating through this period has not been easy, yet I’m very proud of how we’ve responded with both agility and speed. We’ve added significantly to our capabilities and increased our use of new technologies, which are driving benefits to our operations and the customer experience. As we continue to manage through a dynamic landscape, we will lean into these capabilities as we strive for productivity improvements and even stronger profitability. Fourth quarter channel performance largely reflected the ongoing macro volatility.
It’s notable that customers are returning to in-person shopping. Store revenue was flat to last year and up 5% to 2019. Since taking responsibility for stores last fall, I’ve had the opportunity to visit numerous locations and spend considerable time with our incredible store leadership. We have a powerful fleet and truly a world-class field team. And I’ve been very impressed with just how well we service the customer and leverage tools and technologies to drive store productivity. For example, this quarter, I am pleased to note that we were tied for the Number One Specialty Retailer for customer satisfaction in the ACSI Customer Satisfaction Survey, and actually had the largest year-to-year improvement of any company surveyed. Our new point-of-sale system is providing a better shopping experience and reducing average checkout times by 50%.
We expect this to drive improvement to sales per selling hour as we focus on further efficiency gains. I’m also very excited to share that we will start rolling out an innovative RFID and AI-based technology capability across our stores later this year. Our pilot test this holiday proved highly successful, providing visibility into inventory availability and placement at over 99% accuracy. I’m very enthused about the sales opportunities, inventory productivity improvements and labor efficiencies we can unlock moving forward. As I indicated last quarter, we are also focused on updating and modernizing our most productive stores and relocating certain stores to ensure we are in the best location. Last month, we consolidated our store footprint in Manhattan.
We moved Aerie from Spring Street to the second floor of our AE SoHo Broadway location and introduced our full off-line collection to this market. We will also be testing a handful of off-mall locations, which are smaller, lower cost stores in emerging neighborhood outlets. And mid-summer, we are testing a new American Eagle store design, introducing a fresh and modern take on both the aesthetics and functionality to heat stores. As we introduce these changes, we are dissecting all facets of the store channel to optimize how we operate. As we sharpen our focus on store productivity and profitability, this is revealing further opportunities, particularly within our labor model. As a result of channel shift and unnatural builds from COVID, digital revenue was down 9% to 2021, yet revenue was up 19% compared to 2019.
Digital is a healthy channel, representing 36% of total brand revenue and it continues to be highly profitable. This quarter, I’m happy to say we are hiring new talent to the team, welcoming David Zhang as our new Chief Digital Officer. David brings vast experience in building successful digital commerce, and we’re looking forward to his contributions. Now turning to the supply chain. After three years of unprecedented volatility and inflation on the inbound side, we are entering 2023 in a much more stable supply chain environment. Lead times are essentially back to pre-pandemic levels and product costs have normalized. As we manage through an uncertain macro, we are using the star advantage, planning cautiously and chasing into demand, buy for the spring season are down to last year, and a significant portion of our fall still remains open.
On the outbound side, our investment in client platforms continues to provide much needed capacity, flexibility and speed for our brands, combined with cost savings. Digital delivery costs in the fourth quarter were down to last year. We are making progress in reducing fulfillment costs and the number of shipments per order, which resulted in a lower delivery cost per order. As Jay noted, although Quiet’s third-party revenue has grown significantly to last year, acquiring new customers has been slower than anticipated due to a tougher macro. For 2023, we are focused on reducing expenses to better align with growth trends. We will streamline investments in the platform and look to leverage Quiet’s capabilities to continue to drive benefits both for our brands and for all of Quiet third-party customers.
Thanks. And now I’m going to turn the call over to Mike.
Mike Mathias : Thanks, Michael. Good afternoon, everyone. As Jay mentioned, in response to changes in the environment, we took early and aggressive actions to reset our plans. We reduced inventory, expenses and capital expenditures, which enabled us to deliver a meaningful improvement in profit and cash flow in the second half of the year. Margins rebounded, and we generated adjusted operating income of $213 million in the second half compared to $56 million in the first half. We also returned to a positive free cash flow position and further strengthened our balance sheet. Full year consolidated revenue of $5 billion was second only to last year’s record results and adjusted operating income was $269 million. Fourth quarter results exceeded our expectations, reflecting improved demand and stronger margins.
Consolidated revenue of $1.5 billion declined 1% to last year’s record results and included 1 point of growth from Quiet Platforms. Brand revenue was down 2%, coming in ahead of our outlook for a mid single-digit decline. This includes our second highest holiday sales result in the history of the company with positive momentum continuing in January. Compared to pre-pandemic fourth quarter 2019, consolidated revenue was up 14%. Adjusted operating income of $96 million reflected a 6.4% margin and was up 30 basis points to last year and 60 basis points to 2019. Quiet Platforms produced a $13 million loss, excluding a $4 million impairment and restructuring charge. Demand was lower than anticipated. As Michael reviewed, with macro challenges continuing into this year, we’ve adjusted plans to reflect a more measured pace of growth required platforms and reset expenses aimed at improving profitability this year.
The gross margin rate of 33.9% in the fourth quarter was ahead of our expected range of 32% to 33% due to stronger demand and lower markdowns versus planned as we leverage our healthy inventory position to control promotions. Compared to last year, gross profit dollars increased 4% to $507 million with a gross margin rate up 150 basis points. Merchandise margins were higher, reflecting lower product and freight costs with a partial offset from higher markdowns. Lower compensation and delivery costs also had a positive impact on margins, offset by higher distribution and warehousing costs and higher rent. Quiet Platforms had an 80 basis point impact as that business continues to scale. Despite a highly promotional operating environment, markdown levels were significantly healthier relative to 2019, reflecting our multi-year focus on improving brand equity and driving profitable growth.
SG&A dollars were approximately flat to last year in the fourth quarter, reflecting our ongoing focus on controlling expenses. As Jay noted, we’re currently undertaking a company-wide assessment to look for additional savings and efficiencies across our entire cost structure, strengthening our culture to focus on innovation and investment discipline. I’ll report on progress over the course of the year. Adjusted EPS was $0.37 per share. Our diluted share count was $197 million, down from $203 million last year. Shifting to the brands, Aerie revenue increased 8%, driven by new stores. Comparable sales declined 2%, following a 17% increase last year. The adjusted operating margin of 12.2% reflected a significant recovery from the fourth quarter of last year.
Aerie remains a strong multi-year growth and profit story. As we move past tough comparisons and new stores ramp up along the maturity curve, we anticipate comps returning to positive territory this year. American Eagle revenue declined 8% and comps were down 9%, following an 11% increase last year. Demand was ahead of our expectations and reflected a sequential improvement from the third quarter. I’m particularly pleased to see a significant improvement in the health of the brand since 2019. While revenue was down 7% compared to the fourth quarter of 2019, adjusted operating profit was up 36% over the same period and brand operating margin expanded 510 basis points to 16%. Consolidated earning inventory cost was up 6% compared to last year, with units up 4%.
Inventories reflect current spring product and earlier-than-expected delivery, the supply chain continues to normalize. AE and Aerie inventory across the US and Canada is down to last year, with the consolidated increase driven by expansion in Mexico where we’re experiencing growth well into the double digits. We ended the quarter with $170 million in cash and total liquidity of $862 million. Capital expenditures totaled $61 million in the quarter and $260 million for the full year, which is down significantly from our plan at the start of the year. As we focus on strengthening free cash flow and capitalize on the investments we made over the past several years, we’re reducing annual CapEx to the $150 million to $190 million range in 2023. We plan to open approximately 25 new Aerie stores next year, with net closures at AE of approximately 25 stores.
As I reflect on the fourth quarter performance, despite operating in a highly dynamic environment, I’m pleased by the multi-year improvement in the health of our business. We continue to see opportunity to drive growth and profit improvement over the long term. Moving on to our outlook. As we enter 2023, as the team has discussed, our brands are strong and inventory is healthy. The global supply chain environment continues to normalize, providing improved costs and greater agility. And we have a company-wide focus on expense reduction and operating leverage. That said, visibility into the macro and overall consumer spending behavior is still limited. As a result, we’re taking a cautious view. Regarding the current quarter, while we’ve seen good trends in February with a favorable response to new merchandise, the environment remains choppy.
Additionally, it’s early in the quarter with our most important week still ahead. At this point, our outlook for the first quarter is for revenue to be in the range of flat to up low single digits and for operating income to be approximately flat to last year. For the year, our outlook reflects annual revenue growth in the range of flat to up low single digits and operating income in the range of $270 million to $310 million. With that, I’ll open it up for questions.
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Q&A Session
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Operator: Thank you. We will now be conducting a question-and-answer session. Thank you. And our first question is from Jay Sole with UBS. Please proceed with your question.
Jay Sole: Great. Thank you so much. Maybe just a two part question. One, just first on Aerie. It sounds like there’s a lot of exciting things happening just in terms of fashion. I think in the slide deck that you talked about still you see it as a $2 billion brand. You just talked about the long-term opportunity you to continue to see with Aerie? And then maybe, Mike, just on guidance that you gave for first quarter. It sounds like February has started strong. You’re looking for flat to low single-digit growth?
Jen Foyle: Sure. Hi, Jay. How are you? As we — Mike mentioned it, as we start to hurdle these new store openings, we feel like there’s definitely some comp growth in these stores because, as you know, we go into a new market, we have to get the digital side of the business up and going. And we’re already seeing some new end results as the quarter — starting Q2, our quarters from a comp perspective, we’ve increasingly gotten better. So I think it’s proof of the pudding there that there is some upside as we hurdle these new store openings and really like let those businesses mature. So we’re excited about that. Regarding just the product side, Jay, I mean, we could not be more excited. We have so many new categories, one being OFFLINE.
This business is on fire, let me just say that. Q4 delivered incredible results over last year. We’ve been hurdling an incredible launch year-over-year of the crossover flare. It’s our first new and coming and it’s our best and nobody can comp this item because we own it, and it’s ours. The one thing I want to say about Aerie, and this is true, our customer awareness, so our customer awareness, about this — it’s up 25% year-over-year in Q4. That speaks volume. That means that the store openings are really starting to take hold. We’re introducing the brand to new customers. Don’t forget, we’re still in expansion mode. We’re about 500 stores right now. We’re opening about 20 more this year. So all these new stores hopefully pay off as far as brand awareness.
From a product standpoint, we’re all over it. We’re excited about OFFLINE. That is presenting growth for us. New businesses, including fleece, which we’ve owned, but I really think we’re dominating there from a competitive standpoint. And then for the future, we’re really going to double down on intimates. So we feel like that’s a category that we can hone in on and really innovate. Our SMOOTHEZ launch this year was incredible. In fact, some of those frames have really taken hold for us. And we’re really going to reinvent that business. So more to come. As you know, we’re never going to stop innovating this team. I can give you a little insight. Next year is Aerie’s 10-year Aerie Real anniversary. So everyone can be excited to see what’s to come because the creative team is not stopping.
Jay Sole: Great. And then — sorry, I think I got cut off there at the second — my question. But just — for Mike, just on the revenue, it sounds like for Q1, it sounds — February has been good. You said choppy, you’re looking for flat to up low single-digits. Can you just talk about if your quarter-to-date trend so far is above or below that? And then secondly, on gross margin, how do you feel about gross margin in Q1 sort of up or down year-over-year?
