Greetings, and welcome to the American Eagle Outfitters Third Quarter 2021 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Judy Meehan. Thank you. You may begin.

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 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 third quarter investor presentation. And now I'll turn the call over to Jay.

Good morning, and thanks for joining us today. I hope everyone is doing well. I'm extremely happy with the continued strength across our business. It was truly a milestone quarter in which we posted the best-ever third quarter results and announced an important strategic acquisition. I'll start with our results, which were simply outstanding. This quarter, we delivered record revenue of $1.27 billion, reflecting growth of 24% from 2020 and an increase of 19% to 2019. Healthy sales and merchandise margins, combined with cost efficiencies, drove profit flow-through, which surpassed our expectations, with record operating income of $210 million, reflecting a margin of 16.5%, our highest rate since 2007. We are extremely pleased to see sustained momentum across our brands and channels, which posted growth versus 2020 and pre-pandemic 2019 levels. Casual wear remains in high demand, and AE and Aerie are perfectly positioned to benefit. We are delivering great products and sharper marketing and brand experiences, both in-store and online, that are second to none. The AE brand is achieving exceptional results. Under Jen's leadership, the product style and quality have improved remarkably, and customers are noticing. As back-to-school came rolling back, AE received more than its fair share of growth. Shopping frequency and spend are up dramatically, and we are acquiring and reactivating more customers. It's exciting to see the consistency in our signature jean business, which continues to reach new heights across genders. At the same time, we are seeing renewed growth in categories that have been underpenetrated in recent years. Aerie's growth continues at a fast pace, with momentum across all categories, including our new activewear brand, OFFLINE by Aerie. Customers who try Aerie love it, and the brand is just beginning to unlock its true potential. Healthy acquisition and retention are fueling strong sales, and we are seeing nice reception as we expand into new markets. Our strategic pillars have provided a roadmap and instilled focus across the company. Simply put, we are running our business better than ever. Key initiatives such as inventory and real estate optimization and the transformation of our supply chain are driving significant profit flow-through. The processes, disciplines, and capabilities we have put in place over the past 18 months will continue to set us apart, fueling strong returns and taking AEO to even greater heights. As an organization, innovation is a core value and at the heart of everything we do. We clearly recognize that many of the changes in our industry over the past year are here to stay. In order to remain competitive today and in the years to come, we must pivot and think differently about our business. That brings me to our exciting plan to acquire Quiet Logistics. This acquisition marks a significant milestone for our company, which I believe will be transformative. Acquiring Quiet allows us to build on the efficiencies we've gained over the past 12 months and position us for success as we grow our business over the coming years. We also have a broader vision. We expect the combination of Quiet Logistics and the recent acquisition of AirTerra to create a unique platform that revolutionizes logistics within our business in retail. Through consolidation and pooled resources, the customer acquired in AirTerra will enjoy the agility and efficiencies that were previously only available to the world's largest brands and retailers. I believe this will create an exciting new profit center with meaningful growth opportunities for AEO. Lastly, our efforts around sustainability and building a better world through our ESG initiatives remain front and center at all times. We continue to increase our most sustainable real good styles across all merchandise categories. Additionally, we are investing to decrease emissions in our operations as we make progress towards becoming carbon neutral. AE's outperformance year-to-date was truly remarkable and exceeded our expectations. I'd like to thank our teams across AEO for how well they have executed in the quarter and throughout the year. They clearly demonstrated the agility to meet unexpected challenges while also staying the course towards our long-term goals. Our results continue to be fueled by a sound and meaningful strategy, resilient operations, and focus on innovation, coupled with a passionate world-class team. Strong demand continues, and we expect a strong close to 2021. With that, I'll turn it over to Jen.

Thanks, Jay, and good morning, everyone. This was another amazing quarter for AEO with such immense excitement around Aerie and AE as customers turn to their favorite brands for back-to-school. Customer KPIs were very favorable as we brought in new customers and won more of their wallet. It was a great setup for the holiday season, where I'm happy to note the energy has stayed just as elevated. Starting with Aerie. We consistently reach new heights each and every quarter. A 28% revenue growth in the third quarter, following a 34% increase last year, demonstrates Aerie's strong growth path. This marked the 28th consecutive quarter of double-digit growth. Profit flow-through was also very healthy with a 16.5% operating margin, reflecting new third quarter highs for the brand. We achieved this despite some unevenness of inventory flow during factory shutdowns in South Vietnam. This occurred primarily in our high-demand legging business, which is also one of our best margin categories. Sales metrics in the third quarter were incredibly healthy. The AUR was up in the high teens, driven by higher full-price selling and more strategic decision-making around promotions. Demand was strong across the Aerie portfolio with our core intimates, bralettes, and apparel leading the charge. The OFFLINE activewear brand is continuing to generate excitement as it expands its product offering. We feel great about what's to come as we grow the store footprint and widen the customer base. Marketing is also playing a key role. In August, we launched the Voices of AerieREAL campaign. This was Aerie's largest integrated marketing campaign featured across TikTok, Connected TV, and Snapchat. This platform is giving our customers a voice and an opportunity to share what makes them real. The response was truly amazing. Hundreds of customers shared their touching and funny real stories that will be featured in our upcoming campaigns. Year-to-date, Aerie's customer file has expanded 15%. Customers are transacting more frequently and across more categories. This is driving higher spend per customer as Aerie becomes the go-to for intimates, activewear, and cozy apparel. We opened 29 new Aerie doors in the quarter, including a mix of new standalone and side-by-side formats; roughly a quarter of them are OFFLINE doors. Momentum heading into the holiday season remains strong. We are focused on driving broad-based scale recognition of Aerie as a must-stop gifting destination, and I am so excited for what we have planned and I look forward to sharing more Aerie highlights in the upcoming quarters. Now turning to American Eagle. I'm thrilled with the great progress we're making just 11 months into the launch of our new strategy. As I shop our website and walk our stores, I have to tell you, the strong AE heritage we all know and love is back. The assortment has been refreshed. Our advertising and messaging are reenergized, and it's working. Sales in the quarter rose 21% compared to 2020 and increased 8% to 2019. Reuniting our branded products together with inventory optimization and promotional discipline drove strong AUR growth and merchandise margin expansion. This resulted in significant profit flow-through and an operating margin of 27.8%, reflecting new highs. Our strength during back-to-school is a clear signal that we are the destination for jeans, which continues to hit new highs. AE's customer file is up, and here too, customers are buying more frequently and spending more. As we predicted, current trends in shifting to the web are playing right into AE's strengths as the market leader. In the quarter, our men's business saw tremendous growth across all categories; the women's business also posted strong sales, supported by our signature denim category and a focus on outfitting. AE continues to explore innovative ways to reach and broaden its audience. I'm so proud to share that AE was included in TikTok's pilot of its social commerce program this quarter. Being part of this new initiative is a true testament to the growing strength of the AE brand and its importance to customers. AE also launched a store on Snapchat and became the official partner of Twitch gaming, a new channel created by gamers for gamers. There is so much momentum across the brands as we head into the holiday season. The teams did a great job getting our product out here, and we're positioned to meet strong demand. To the teams across AE and Aerie, I can't thank you enough for all your hard work. It's paying off in spades, and I'm so happy how far we have come and how much we've accomplished in such a short period of time. More to share in the coming quarters. Thank you. And now I'll turn the call over to Michael.

Thanks, Jen, and good morning, everyone. I'm very pleased with how we executed this quarter. The teams did a remarkable job managing through a highly disrupted operating environment. Strong top and bottom line results are a clear indication that our strategies are working. We are making sustained progress against the strategic pillars outlined in our Real Power. Real Growth value creation plan. With this, we are unlocking structural benefits to create the best brand experience for our customers. Our selling channels greatly delivered this quarter. We are pleased to see store traffic rebuild, rising in the double digits, driving a 29% increase in store revenue. Selling trends were robust across our factory outlets and mainline stores, with both formats also seeing significant profit improvement. Momentum was broad-based across all regions in the U.S., and all international markets also posted positive results. Our digital business continued at a healthy pace, with revenues up 10%, successfully lapping 29% growth in the prior year. I am pleased to note that both our store and digital revenues and profits in the quarter surpassed levels we achieved in the third quarter of 2019, reaffirming that we are emerging from the pandemic stronger. Year-to-date, digital penetration is 35%, and our trailing 12-month digital revenue is approximately $1.8 billion with very strong profitability. As we prioritize enhancing the omnichannel shopping experience, we are launching new tools and technologies. This quarter, we expanded our virtual selling tool, AE Live, which leverages our amazing store teams and local influencers to connect directly with customers looking for inspiration and guidance on the latest trends. We also launched Afterpay in stores, enhanced our e-gifting for a more engaging experience, and expanded both same-day delivery services and customer self-checkout to more geographies. I am very encouraged by the strength in our customer data. We closed the third quarter with the highest active customer count and highest average annual spend since 2010. Over the past 12 and 24 months, we added almost 1.75 million and 2.25 million new customers, respectively. Approximately one-third are engaging across both brands and spending approximately twice that of our average customer annually. Following a successful relaunch last summer, the royalty program is growing, with members spending more and staying longer. Now shifting gears to logistics and supply chain. We continue to reap the benefits from our in-market fulfillment model. Delivery costs leveraged 120 basis points in the quarter. In fact, delivery cost dollars were down year-on-year, led by efficiencies created in digital delivery. With product located closer to stores and customers, delivery times and the average cost per shipment declined versus last year. With greater control over inventory placement, shipments per order were also down dramatically. This created enormous cost savings and efficiencies. As Jay said, we are thrilled to announce the purchase of Quiet Logistics, which will allow us to increase these benefits over time. In particular, the ability to drive substantially greater sales and margin on far less inventory, create more precision in our inventory allocation decisions, and deliver products to customers both faster and at a lower cost. This comes shortly after our acquisition of AirTerra, which we discussed on last quarter's call. The combination of Quiet and AirTerra has meaningful growth potential, offering a one-stop shop for cost-effective transportation and fulfillment solutions to a growing customer base. A technology-led supply chain is the backbone of the successful retail business today and into the future. We believe we are demonstrating the power of this, and that Quiet and AirTerra are providing capabilities that are much needed in today's marketplace. We are going to continue to grow both of these businesses and are excited to welcome their highly skilled and experienced teams into our family. As we discussed in September, the global supply chain remains highly disrupted with core backlog and shifting production schedules, leading to longer delivery times and higher transportation costs. Overall, we managed effectively through these challenges. In the third quarter, the AE brand essentially had no disruption. However, as Jen discussed, Aerie's legging category experienced uneven inventory flows when factory closures in Vietnam created product delays. As a result, we chose to air the product to ensure we were in stock for the holidays. Although there is a related cost that Mike will discuss in more detail, we are in a healthy inventory position set up for a very strong holiday. In closing, I'm extremely pleased with our performance year-to-date, and I'm looking forward to sharing more details on our new investments in the coming quarters.

Thanks, Michael. Good morning, everyone. In the third quarter, we built on strong momentum from the first half of the year, posting yet another record revenue and profit result. Even with the global operating environment still in flux, our teams executed with precision, guided by the initiatives we outlined in our Real Power. Real Growth value creation plan back in January. We continue to place strong emphasis on product innovation that strengthens customer affinity for our brands, inventory discipline, and real estate optimization and supply chain investments that build on our leading omnichannel capabilities. Together, these initiatives are fueling our performance and improving our gross margin for the long term. Revenue of $1.27 billion, operating income of $210 million, and adjusted EPS of $0.76 marked third quarter records for the company. Gross margin of 44.3% and operating margin of 16.5% hit their strongest levels since 2007. Growth across the business was also exceptional compared to the pre-pandemic 2019 period. Consolidated third-quarter net revenue increased $242 million or 24% versus third quarter 2020 and is up $208 million or 19% from 2019. Across brands, sales metrics were very favorable; strong demand, higher full-price sales, and fewer promotions drove the average unit retail up 15% and fueled a high single-digit increase in our average transaction value. As Michael noted, our selling strategy as an omnichannel retailer continues to be a competitive advantage fueling growth across channels. We offer customers the convenience they seek on where and how to shop and continue to work to optimize the costs associated with that convenience. From a brand standpoint, Aerie continued its industry-leading multiyear growth trajectory. Revenue rose 28% from third quarter 2020 and over 78% from third quarter 2019. Aerie's operating profit rose 46%, and the operating margin expanded to 16.5%, marking a new third quarter high. Incremental freight costs were $5 million or a 170 basis point headwind to brand operating margins in the quarter. Additionally, uneven flow of goods, particularly in our signature leggings business, put pressure on volumes as well as product mix, which is one of our highest margin categories. Despite these headwinds, Aerie posted a significant improvement in profitability compared to prior years, almost tripling versus third quarter 2019. Moving to American Eagle's brand performance, I could not be more pleased with our results here. The third quarter saw a significant profit on American Eagle as top line grew 21% and operating profit jumped 68%. Operating margins hit a remarkable 27.8%. As Jen mentioned, with improvements across key categories, the top line grew 8% against 2019. We are seeing far better profitability even beyond our expectations. Strong demand for our products is being met with healthier decision-making across all areas of the business, and we are truly benefiting from the inventory optimization work unveiled in January. Total company consolidated gross profit dollars were up 36% compared to the third quarter of 2020, reflecting a 44.3% gross margin rate. A strong top line allowed us to realize expense leverage and rent as we benefited from lease negotiations. As Michael indicated, efficiencies in our distribution network fuel leveraged delivery. Merchandise margin also expanded due to our focus on inventory optimization, promotional discipline, and higher full-price selling, partially offset by higher freight costs. As a result of strong sales, we saw SG&A leverage 190 basis points. The dollar increase of $41 million was due primarily to higher store payroll, especially as we lapped capacity constraints last year as well as new store openings and increased advertising. This was partially offset by lower incentive compensation due to accruals earlier in the year. Record operating income of $210 million reflected a 16.5% operating margin, our highest third quarter rate since 2007. Adjusted EPS was $0.76 per share, marking a record third quarter. Our diluted share count was 205 million and included 34 million shares of unrealized dilution associated with our convertible notes. Ending inventory was up 32% compared to a 13% decline last year. The increased freight costs had about a 10-point impact on ending inventory at cost. We're really happy with our inventory position. I'd like to take a minute to recognize the hard work our teams put in to get our product here on time to support strong demand this holiday season. Our balance sheet remains healthy, and we ended the quarter with $741 million in cash, up from $692 million in third quarter 2020. Capital expenditure totaled $58 million in the quarter and $144 million year-to-date. For 2021, we continue to expect capital expenditures to come in on the lower end of our $250 million to $275 million guidance range, reflecting cost savings and project timing. With regards to our real estate strategy, we have significant flexibility in managing our store fleet to support our revenue and profit goals. As we work towards our long-term target of rightsizing the AE store footprint, we are keeping a sharp eye on maximizing profitability. For Aerie, we are focused on markets with the greatest opportunity. Due to backlogs in building materials and fixtures, several of our third-quarter store openings shifted into the fourth quarter. We expect the majority of these stores to open by the end of the year. We're very excited about our recently announced acquisition of Quiet. This will improve our ability to service both channels and lock in the cost benefits and overall gross margin efficiencies we've consistently seen over the past year. To wrap up, our performance year-to-date has been phenomenal, especially in the context of challenges and uncertainties in our external environment. We're extremely pleased with our record results year-to-date and continued progress on our strategic initiatives. Sales trends remain strong heading into the key Black Friday and Cyber Week period. We have met our goal to ensure our customers do not feel any impact from supply chain disruptions, and we're well-positioned to meet holiday demand. However, that has come with additional freight costs in the range of $70 million to $80 million, which will impact the fourth quarter. Of course, we expect to exceed $600 million of operating income for the year, well above the $550 million 2023 target. We will be updating our longer-term financial targets at ICR this January. Our results year-to-date continue to reaffirm that the Real Power. Real Growth value creation plan is working and that we're focusing on the right levers to drive financial success and returns to our shareholders. With that, I'll open it up for questions.

Our first question comes from the line of Jay Sole with UBS.

Jay, I want to ask you about your comments on the recent acquisitions of Quiet and AirTerra. You called them transformative and said they'd be profitable. Can you talk about why you're using those types of words? I mean, can you give us a sense of what kind of revenue and profit these acquisitions contribute to the company? And also, why do you see this as transformative?

Alright. We have a problem—your voice came in all jumbled. We couldn't hear the question.

Yes, Jay, can you try to repeat that?

Can you hear me now?

Yes. I think he was asking about Quiet and AirTerra.

Can you hear me better now?

There you go.

Yes, yes. Now we can hear you much better.

Okay. Sorry about that. The questions were about the acquisitions. Jay, you used the word transformative and profitable. Can you elaborate on why you see this as transformative? And what kind of profit potential do you see from these businesses, as well as revenue potential?

Alright. First of all, this is an acquisition that we've been using for the last 15, 16 months ourselves. We saw this year part of our success in getting higher margins is the ability to have the right merchandise at the store at the right time in the most efficient manner. A part of it is because of using Quiet. We've had very good success with it. We've had such success that we didn't boast about it, but this past quarter, our operating costs on our logistics were lower percentages than the last couple of years. We played the best lower percentages, and actual dollars for the quarter were less dollars than the previous year. I don’t think any retailer can make that statement that their costs of handling have been lower than the year before. The systems we acquired are the most up-to-date systems. We've got the sortation robots walking around, pulling. We have the ability to deliver to the customer fast. And the big thing that we have is that this system follows our model. We were the first people when we built our distribution center a few years ago to have the ability to handle stores and direct-to-customer in the same facility. Most people build separate facilities for online and stores. We really made a true omni experience where our facilities can handle both. This same system that Quiet has gives us the ability to do it even better. If you ask me what I see? I see us expanding Quiet with more locations that will have micro centers around the country, allowing us to deliver faster, better, and more efficiently. The big thing is we already have 60 customers handling other retailers. We’re providing great service. I see us getting a platform that will allow us and our partners—different retailers—to really compete against the Amazons and Walmarts of the world efficiently. Because in the future, logistics is key. If you're not efficient there, you're not going to win. We have the best merchandise in the world, but if we don't have the ability to get it there efficiently, we're not going to win. This will give us the ability to stay on top. The quality of our teams can compete against anyone in the industry, period.

Maybe if I could just follow up. If you could offer some ideas on revenue and profit potential because you mentioned you have 60 customers. Do you see that customer count growing? And what does that mean for revenue and profit potential for the businesses?

Yes; yes. So, Jay, we're actually going to defer that answer until next year. But like Jay is saying, we see tremendous potential for this business. As we said in the Quiet release, we see this business not only being very large but very profitable and having margins that are incremental to the company. We'll give more color at the beginning of next year.

Certainly, Michael; I think the big thing we're highlighting is we're taking what's normally been a cost center and turning it into a profit center.

Our next question comes from the line of Matthew Boss with JPMorgan.

Congrats on a nice quarter.

Thanks, Matt.

Thanks, Matt.

At Aerie and American Eagle, could you speak to the demand that you're seeing across categories exiting the third quarter as we enter the holiday? How do you feel about overall momentum in each concept so far in November, and just comfort with your inventory across the assortment as we think about the fourth quarter as a whole and exit the year?

It's Jen. And happy Thanksgiving to everybody. Look, I first want to start with inventory and congratulate the team. I'm hearing from the competition that they really leaned on direct, which is indicative to me that they could probably support their store base. Keep in mind that we have a decent-sized store fleet across our chain, and we were able to not only meet the customer demands there but also on direct. Our store business was fantastic. With real discipline in inventory, we were able to get that product based on some of what Jay just spoke about to the customer at the right time. I want to add in one thing there. When I think about doing that, I love the reactivation rates we're seeing on our customer base. We're at plus 40% in both brands on customer reactivation, which tells me our customers are highly engaged. They're excited to go to the store and see what we have to offer. We're in great supply, and I think we're ready to hit the road into holiday. I love what I'm seeing. I was just in the mall; I saw all three brands, excuse my voice, I'm a little under the weather today. I saw an OFFLINE store in the area and Aerie, and I saw American Eagle Outfitters, and I must tell you, we are ready for the holiday season. It looks like there wasn't a bump in the road as far as I'm concerned. I think we look best in show. I'm really proud of what these teams have been able to deliver to ensure a successful season. This momentum continues so far; we have a few weeks ahead of us, meaning this week is our big one. So we're buckling up, and I'm pretty excited about our execution to date. That said, look, in American Eagle, we have reignited that customer. We set out a strategy a year ago, and look at these results. The earnings are spectacular, and the execution is on low inventory levels. Of course, there’s a denim trend out there, and those cycles last for a long time. It’s not just one fit; that’s the best part. We're seeing that our customers are aging up with us. I’m pretty excited about that. I love where we are, and I see what spring is going to bring us. I saw early on some of the early-on photo shoots and what our marketing campaigns are going to be; it’s better with age. And lastly, I will say, don’t forget, we have a brand-new design team and a new head merchant, and they’re really putting together a fabulous assortment strategy for the future. I could not be more proud of that team. And looking at Aerie, well, number one, we have a whole new business category OFFLINE. You heard about the leggings; they are incredible, with one of our highest demand categories in our highest margin category. We were able to hurdle through that potential bump in the road, and I think we did a great job doing so. Watch out because those leggings are here and ready for the holiday. The new brand is certainly exceeding expectations. We have a lot of learnings; I always love a learning because it means there's upside for next year. The team is really disciplined right now and focused on delivering incredible results in Aerie. All categories have fired, though. In Q3, we've seen a nice acceleration in our core intimates business as well as lounge. Many people scratch their heads and wondered if lounge was still going to be a desired category, and certainly it is; we're really excited about what we've been seeing. So more to come, and we're thrilled about the holiday and the future.

That's great color, Jen. Maybe Mike, just as a follow-up on profitability. So kind of twofold. Can you speak to the drivers of AE's operating margin expansion? I think it was up over 1,000 basis points in the third quarter relative to two years ago? And then just with Aerie, are we still looking at a 20% operating dollar flow-through rate as we move forward?

Yes, thanks, Matt. I’ll answer the second question first. I think we talked about 25% for our longer-term targets. We flowed through about 25% in Aerie this quarter over a two-year basis. If you do the math on the freight that we incurred in the brand, which on a proportionate basis was a bigger deal to Aerie, we definitely missed business in leggings that Jen was just talking about, to the tune of probably around $15 million in the quarter, slightly over a million a week in the leggings business. If you do that math, you’d be close to a 20% operating rate or so for the quarter versus the 16.5%. If you think about the flow-through, then it would have been probably 30% or higher in the quarter versus the 25%. We'll talk about the longer-term goals in January again. 25% is what we communicated last January. We got the question around that being conservative. The answer is it was likely conservative. We've been flowing through more like 40% in the first half of the year. So we’ll talk about it. I think 30% is a realistic number to have in your mind now, and we’ll refine that for January at ICR. And then on the operating margin expansion in AE, it’s truly the overarching story of everything we’re discussing at the company level. We saw some nice merchandise margin gains on top of really strong gains last year. The bigger story is through the gross margin, delivery, and rent. The majority of our leverage and gross margin expansion, benefiting AE on some strong revenue growth, were primarily in those two areas. Again, AE is growing at 21% versus last year, and up 8% versus 2019. That’s also leveraging other expenses. But rent and delivery were standouts for us.

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

This is Kelly Crago on for Paul. I'm just curious if you could elaborate on your outlook for the gross margin line in the fourth quarter, just in light of the $70 million to $80 million in additional freight costs? And what are your AUR assumptions in the fourth quarter? Are you expecting as strong AUR as you saw so far this year?

Thanks, Kelly. I'll take the gross margin pieces, and maybe Michael can take some of the ’22 questions. So at first AUR, we're expecting similar type of results in AUR. Again, we have a lot of business ahead of us in the fourth quarter here, navigating week-to-week, but our expectations are similar to what we saw in the third quarter. For the gross margin piece of your question for the fourth quarter, we disclosed the $70 million to $80 million of freight cost. The number for the year is over $90 million. We discussed in the Aerie comments that we incurred some incremental freight costs in the third quarter. You can think about maybe 100 basis points of impact there to the company. But for the fourth quarter, it’s $70 million to $80 million. If you do the math on rounding what you would expect in revenue and what we’re probably expecting in revenue, it’s close to 500 points of gross margin. So I think the benefits we’re seeing in rent and delivery, we expect many of those to continue. However, we did what we said we would do, which was ensure our inventory was here to avoid impacts from supply chain disruptions in Vietnam, and we spent money to get it here. So that’s about 500 basis points of impact in the fourth quarter, as it relates to guidance. If you model out what you would expect us to probably have been guiding to in the fourth quarter and subtract $70 million to $80 million, you’d be in the right place. And just to say it proactively, it would be around a $700 million number higher if not for those freight costs.

Our next question comes from the line of Adrienne Yih with Barclays.

Congrats. And I just have to say from personal experience, the digital and store processes are remarkably fast, like a day. It's crazy. So good for you.

You're experiencing the efficiency first-hand then. Thank you.

Yes. Thanks, Amy.

Can you talk about AE brand's second position in the denim category in the U.S.? How has that changed from five years ago? I seem to recall it was in the 20% of sales range, but it seems like it’s significantly higher than that now. So if you can talk about where that is? And any comments on fourth quarter-to-date holiday sales would be helpful.

Yes, in denim, we still remain #1 in women's for all ages, and we sit #1 in men's for our age demo. A 20% market share or still in that zone. However, I’d like to say it’s really about the health of the business. I mentioned in my prior answer that the AURs and denim are at record highs and they have surpassed the total AE brand AURs. It’s pretty impressive as a percentage growth. Our ability to sell full-price denim is impressive. It’s about time because the love and the detail and the workmanship in our denim at this price value equation is like no other. I’d like to say that we’re in this for the long haul. I like what we’ve done over the past year, and we’re demanding the retails that merit the quality I just spoke about. It bodes well for our future where many retailers are going to face a lot of headwinds. We deliver quality for less, and we’re always looking at what else we can offer customers and grow the AUR where warranted. Importantly, we’re seeing no resistance. If they love the fit and silhouette, they’re spending. This will give us leverage in the future. Eventual headwinds will dissipate. Our costs will be more advantageous. I think we’re in a good position to take advantage of that and continue to enhance our quality year-over-year. We’re trending up over the past five years in market share, and our customer is aging with us, which I mentioned as well. I love that because in the past, we used to see the customers jump out around 19 or 20 years old. We are the #1 solid denim offering in specialty from ages 15 to 25. So really excited about that. As we head into the holiday, we’re continuing this momentum. I like what I’m seeing, but again, it’s early to tell. It’s a big quarter, but we saw some acceleration early in the quarter.

That’s great color, Jen. Maybe Mike, just as a follow-up on profitability. So kind of twofold. Can you speak to the drivers of AE's operating margin expansion? I think it was up over 1,000 basis points in the third quarter relative to two years ago? And then just with Aerie, is 20% operating dollar flow-through still the right rate to think about for the concept as we move forward?

Yes, thanks, Matt. I'll address the second question first. We previously indicated that we’d target a 25% flow-through rate for the longer term. We achieved about a 25% flow-through in Aerie this quarter compared to two years ago. If you account for freight costs in the brand, which were a bigger concern for Aerie with product flow, you could estimate that we might have lost around $15 million in leggings business this quarter due to that. If you calculate the flow of business, you might get closer to a 20% operational rate as opposed to the existing 16.5%. If you factor in the flow, it would have likely been around a 30% figure or higher against the 25% target. We plan to update our long-term goals in January, and yes, we might lean towards a 30% figure at this time. Regarding the operating margin expansion, it’s really the culmination of efforts discussed at the company level. We benefited from strong merchandise margins on top of past gains, but the bigger story lies in the networks of delivery and rent. Delivery and rent provided much of our leverage amidst the growth in AE topline sales, which increased by 21% compared to last year and 8% compared to 2019, leveraging other expenses.

Our next question comes from the line of Dana Telsey with Telsey Advisor Group.

Congratulations on the nice results. I think the acquisitions of Quiet and AirTerra are very interesting. As you think of this becoming a separate business line in your income statement and potentially a revenue and profit driver, does this lead to more acquisitions? What qualifies for future business lines, and how do you see the margin profile compared to the base business? Does the base business grow because of having these businesses that help drive logistics leverage?

Dana, it's Michael. I'll answer that. First, just to reiterate what Jay said, clearly, this is working. Our total delivery leverage in digital delivery has improved significantly as a percent of sales, down in delivery dollars and getting packages to customers 10% to 15% faster. We couldn't be more pleased with these acquisitions and partnerships, and we anticipate that they will have a significant impact on our business. We're excited about the synergy created by Quiet and AirTerra, and we believe there’s considerable potential behind these holdings. As we previously mentioned, we didn't acquire Quiet solely to support our American Eagle business, but also because we foresee this evolving into an independent, profitable operation. We anticipate considerable top-line growth alongside nice margin additions. We look forward to discussing this in greater detail at the beginning of next year.

I’d like to add to what Michael said. We believe that logistics play a critical role in attracting larger volumes, which in turn helps secure better shipping rates. This platform is something we envision as developing into a godsend for not just our company but others who may choose to avail themselves of it. The success of this initiative can bolster other retailers and draw more customers into malls, ultimately benefiting our stores. I see this as a method to counteract some of the negative forces in the retail environment today, and we’re ready to seize that opportunity.

Our final question comes from the line of Susan Anderson with B. Riley Securities.

Nice job on the quarter. Just a follow-up on the denim AUR. It sounds like you've been quite pleased with what you're seeing there. I'm curious if the consumers are shopping for your middle price point denim or if they're also tempted by those higher price points, which we’re seeing in stores approaching $80 at full price?

We have been seeing impressive traction in both segments. When we analyze price points, we are assessing everything carefully. Regarding the higher price points, we’ve experienced no resistance thus far, which signals potential for growth. We continually invest in ensuring commercial viability, so we expect to maintain solid value perceptions. Additionally, I think the denim category will remain strong and have an impressive holiday season.

And just out of curiosity, how do you see sales playing out for this holiday? We are hearing that consumers will shop earlier. Do you think the results you've seen so far in Q4 reflect some early shopping and potentially foreshadow a December lull?

I believe we are entering Q4 with momentum. Certainly, at the beginning of this month, we experienced that. I predict we will also see success throughout the season. We are in a great position with goods ready to sell this week, and in December, we will have new arrivals to keep customers engaged. While I can’t predict the future, I am confident in our positioning to maximize potential.

Ladies and gentlemen, this concludes our question-and-answer session. I'll turn the floor back to Mr. Schottenstein for any final comments.

In closing, this was an excellent quarter for AEO with record revenue and profit performance. The strategic initiatives we laid out as part of our Real Power. Real Growth value creation plan are clearly working. Momentum heading into the holidays is strong, and we feel confident with sufficient inventory to meet the very healthy demand we are seeing from our customers. We want to thank everyone for believing in our company and for joining us this morning. At this time, we want to wish everyone a happy holiday. Everyone should stay safe. We look forward to seeing everyone in January at the ICR for updates on our numbers and strategy.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.