American Eagle Outfitters Inc Q4 FY2021 Earnings Call

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

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'll turn the call over to Jay.

Good afternoon, and thanks for joining us today. 2021 was a remarkable year, well exceeding our expectations. I'm incredibly grateful to our associates who worked tirelessly through the year's macro challenges to deliver outstanding results. In 2021, we had a number of significant milestones, including crossing $5 billion of revenue for the first time ever. Annual revenue has increased $1.3 billion or 33% from 2020. Additionally, compared to pre-pandemic 2019, revenue grew 16%. And we achieved significant margin expansion and profit flow-through. We saw greater consistency across the business and growth across brands, channels, and geographic regions. This was a terrific result and reflects a financially strong, agile, customer-focused, and efficient organization, fueled by strong demand for our brands, improved product margin, and cost efficiencies. We achieved adjusted operating income of $603 million. This included additional freight costs related to factory closures due to COVID, which hit largely in the fourth quarter. Despite these pressures, 2021 was our best profit result since 2007. Without additional freight costs, profits would have hit an all-time high. Momentum and strong demand continued in the fourth quarter, driving record revenue of $1.5 billion. As I mentioned, profit flow-through was constrained by elevated freight costs. I'm proud of these results, particularly in light of the supply chain challenges that hit the retail industry. With momentum across our business and key strategies working, we exceeded our 2023 financial targets, which were communicated back in January of last year. We now have our eyes set on a new target of $800 million in operating profit, including $5.8 billion in revenue and a 13.5% operating margin. Our real power, real growth plan is delivering structural improvements to our business that is enabling us to fuel growth with greater agility and focus. Starting with Aerie. Once again, we posted a record year, including the fourth quarter marking the 29th consecutive quarter of double-digit growth. Operating profits more than tripled from pre-pandemic 2019 levels as Aerie reached a turning point in its growth track. Our activewear expansion OFFLINE is hitting it out of the park. Excitement for the #AerieREAL movement is unmatched, and we see significant opportunity to continue to grow Aerie as we penetrate key markets. At American Eagle, the transformation has been nothing short of incredible. Under Jen's leadership, we're running a stronger, more focused, and more profitable brand. The numbers speak for themselves, with operating profits up over 50% from 2019 and revenue up 2%, exceeding our plan. Our product assortments have been strengthened, and inventory optimization is enabling us to prioritize our best-selling products. We've also made early progress in our real estate optimization strategy, closing unproductive stores and energizing the business around high-quality stores and digital. Supply chain innovation has been a key enabler of our strong performance across brands. The acquisition of AirTerra and Quiet Logistics are part of the transformation and will solidify many of the benefits, cost savings, and efficiencies we have seen in our P&L to date while providing a new growth platform for the company. Mike will speak about this more, but we are very excited about this opportunity and the interest we are seeing from other retailers. Lastly, social responsibility has always been woven through the fabric of AEO as we work to build a better world. This is evident through our purpose-led values, charitable giving and a commitment to fostering a workplace culture where everyone is respected and empowered. In 2021, AEO led charitable donations of over $16 million, our highest ever. Over the last several years, we pledged to accelerate sustainability efforts across our operations, and we are making great progress. We look forward to greater disclosure and transparency of our ESG practices in 2022 to highlight our work and measurable impact in these important areas. I'd like to thank our teams for their excellent execution and unwavering focus on driving our business forward. Thanks to their efforts, we have entered 2022 a stronger company. The macro environment remains challenging, which we are taking into account in our plans for the year. Yet we expect our results to reflect meaningful progress over prior years, setting a new baseline for profitability. With that, I'll turn it over to Jen.

Thanks, Jay, and good afternoon, everyone. It's been a truly sensational year for AEO. Our leading brand, Aerie and AE, continue to be a favorite with our consumers. This year, we saw a significant gain in active customers, reaching our highest level ever, and we are winning more wallet share. For the year, Aerie reached $1.4 billion in revenue, up 39% to 2020, adding over $500 million since 2019. We saw strong profit flow-through with annual operating profit over $200 million and margins in the mid-teens. Aerie's fourth quarter revenue marked another new record. Growth was spectacular, rising 27% on top of a 25% increase in fourth quarter 2020. This was Aerie's 29th consecutive quarter of double-digit growth, marking new highs. Sales metrics were healthy across the board. The average unit retail was up in the low 20s, and this was driven by higher full-price selling, more strategic promotional activity, and mix shift into higher ticket items. Demand was strong across core Aerie apparel and intimates as well as OFFLINE activewear, which is showing great momentum just 1.5 years into the launch. I'm very encouraged by the customer response, and I look forward to expanding Aerie and OFFLINE store footprint and reaching new markets. As we previously discussed, Aerie's fourth quarter profit margins were constrained by industry-wide supply chain disruptions in South Vietnam, where Aerie had a greater presence. We took on higher air freight costs to get our products here on time, and we also experienced uneven inventory flows in our high-demand leggings business, which of course is one of our higher-margin categories. Additionally, delayed new store openings due to labor and building material shortages also had an impact. These factors present opportunities for us in the coming quarters. Aerie and OFFLINE are supported by a rich brand platform, which changed the industry forever. We focus on individualized, innovative marketing campaigns that speak to real women. Authenticity and positivity are at the very heart of everything we do. We have a true 360-degree view of our customers. And now with the addition of OFFLINE, we are offering a more complete lifestyle, meeting their needs across cozy, comfy, and active. Needless to say, I'm very optimistic about our future, and I remain focused on fueling further momentum as we build to our new $2.2 billion revenue target. Turning to American Eagle. What a difference a year makes. New product assortments, stronger advertising and messaging, together with inventory and real estate optimization are having a meaningful impact. American Eagle posted a terrific year with record revenue up 30% to 2020 and up 2% to 2019. We are reactivating shoppers, attracting new customers, and seeing significant improvement in retention rates. Demand in the quarter was strong across genders. Our men's business has seen tremendous growth as we've refocused the assortment in our core best-selling items. The women's business also had a great quarter, supported by our signature denim category and focused on outfitting. With our strategic emphasis on reigniting profitability, we saw a significant recovery in margins and profits, posting the highest margin since the mid-2000s. As marketing evolves, AE remains committed to being a leader in testing and learning through new mediums. In the fourth quarter, this included TikTok challenges, partnering with Snapchat on augmented reality shopping, the launch of our first NFT digital apparel collection, and new partnerships in the gaming world. As I look ahead, I'm excited with emerging fashion trends and the continued appetite for casual and active apparel. This benefits both of our brands. Spring looks strong across brands with seasonal goods checking, and we expect to have a positive spring season. To the AE and Aerie teams, none of this would have been possible without your hard work and dedication. And a special thank you to the AE bottoms team for reaching the $2 billion mark. What an incredible effort. I am so grateful for the energy you bring to the organization every day, and I am so excited for another great year in 2022. Thank you. And now I'll turn the call over to Michael.

Thanks, Jen, and good afternoon, everyone. First, let me start by saying that 2021 was a remarkable year for AEO. It's clear that the strategies we laid out last January and our learnings over the past 2 years have truly changed how we are managing the business. I am particularly proud and impressed with how the teams delivered through a highly disrupted supply chain environment, especially in the fourth quarter. We successfully met robust holiday demand and achieved record revenue combined with strong average unit retail. We were pleased with the business across channels. In the fourth quarter, store traffic continued to rebuild, rising in the double digits and driving a 32% increase in store revenue. Mainline and factory outlets both saw healthy growth and profit improvement, reflecting strong demand as customers returned to stores. All regions in the U.S. saw double-digit growth, with our international markets also seeing very positive results. Digital revenue declined 3% from the fourth quarter 2020, yet was up over 30% from fourth quarter 2019. We've added nearly $600 million in annual e-commerce revenue since 2019, with our digital penetration growing from 29% to 36%. We have scaled our business across channels, with both stores and digital seeing revenue and profit growth over this period. We continue to prioritize enhancing the omnichannel experience by testing new tools and technologies. In stores, we successfully piloted a new mobile point-of-sale solution and have seen a significant increase in curbside pickup orders. Online, we introduced a new instant credit feature for returns, which had a tremendous impact on sales recapture. Approximately 75% of qualified customers opted for instant credit, with the bulk of them using it within 2 weeks. Additionally, we've also expanded our Afterpay capabilities to the app. It's been incredibly exciting to see our mobile app grow into such a strong shopping portal for our customers, driving approximately 1/3 of our e-commerce sales and traffic in the fourth quarter. App-based customers are the most engaged digital shoppers, spending 2.5 times more annually than our web customers and transacting with us 3 times more throughout the year. They are also more likely to be multichannel and multi-brand shoppers. Our customer data in the fourth quarter was also incredibly strong. We achieved our highest ever active customer account and our highest average annual spend. The relaunch of our loyalty program last summer is continuing to pay off. We're attracting new members and driving higher retention. On the operational side, we're transforming the business. In the fourth quarter, we enhanced our return capabilities, doubling our processing rate per hour. This has resulted in better merchandise restock rates, improved product availability for customers, and higher full-price selling. Additionally, as delivery and fulfillment costs rose across the industry, our in-market fulfillment model with Quiet Logistics continued to fuel savings for AEO. Delivery costs leveraged 190 basis points this quarter, driven by a significant reduction in shipments per order. We also shipped orders faster with an approximately 35% reduction in delivery times, bringing benefits to both our customers and our operations by utilizing Quiet Logistics to place inventory on the edge to fuel these efficiencies. And as we continue to expand the node network, we expect to see even greater savings. The combination of Quiet Logistics and AirTerra also creates a state-of-the-art supply chain platform that we will look to monetize by growing its third-party customer base. Since announcing the acquisition, we've received tremendous interest from retailers of all sizes. And as the business expands, we expect a material revenue and profit stream for AEO, and we're looking forward to sharing more about the long-term value creation opportunity. In closing, I'm incredibly proud of the quality of our execution this quarter, and I'm excited to build on the structural improvements we've made to our business. And with that, I'm going to turn the call over to Mike.

Thanks, Michael. Good afternoon, everyone. 2021 was a pivotal year for AEO as we embraced our Real Power Real Growth strategy. I'm very proud of the results we achieved. In an operating environment that presented many challenges throughout the year, we delivered record revenue of over $5 billion and exceeded $600 million in adjusted operating income, outperforming our 2023 profit target 2 years ahead of schedule. As I reflect on the past 12 months, I can confidently say that we are a stronger company and we reset the bar on long-term profitability, guided by our continued commitment to product innovation and quality, an emphasis on inventory discipline, a clear real estate strategy focused on supporting Aerie's significant expansion and optimizing AE for profitable growth and strong operations fueled by investments to improve the customer experience and build an industry-leading supply chain. Our fourth quarter performance is a testament to these initiatives. We posted record revenue of $1.5 billion, adjusted operating income of $92 million, and adjusted EPS of $0.35. This was a strong result in the face of industry-wide supply chain disruptions, which led to roughly $80 million in elevated freight costs in the quarter. Approximately $60 million of this was air freight specific to Vietnam factory closings. Without this, the fourth quarter would have marked our highest operating income since 2007, underscoring the significant underlying profit improvement in our performance. Consolidated fourth quarter net revenue increased $216 million or 17% versus fourth quarter 2020 and was up $193 million or 15% from 2019. Sales metrics were very favorable across brands. Strong demand, higher full-price sales, and fewer promotions drove the average unit retail up 17% and fueled a double-digit increase in our average transaction value. This marked our seventh consecutive quarter of AUR growth and rounded out 2 years of consistent growth in our average transaction value, fueled by our focus on product innovation across brands and inventory optimization at AE in particular. From a brand standpoint, Aerie continued its industry-leading multiyear growth. Revenue rose 27% from fourth quarter 2020 and almost 60% from fourth quarter 2019. Aerie's adjusted operating profit was $23 million, and the brand operating margin was 5.3%. As Jen discussed, elevated air freight costs of approximately $31 million in the fourth quarter translated to an over 7-point headwind to Aerie's operating margin. Although we anticipate markdown pressure into the new year, we expect margins to improve meaningfully from the fourth quarter. Moving to American Eagle's brand performance. In the fourth quarter, revenue grew 11% compared to 2020, and operating profit jumped 25% with the brand's adjusted operating margin coming in at 17.5%. This included a roughly $29 million headwind to operating profit or almost a 3-point headwind to the operating margin from elevated air freight costs. As I've said in past quarters, there's been a clear shift in priorities within AE. A renewed emphasis on inventory discipline and real estate optimization is yielding material profit unlock. Our strategy of doing more with less is working, and this is evident in our results. Fiscal 2021 brand revenue was up 2% from pre-pandemic fiscal 2019 levels, and adjusted operating income is up 51%, all with 40% lower SKU and choice counts and 69 fewer store locations. And we still have plenty of optimization opportunity across the brand. Total company consolidated gross profit dollars rose 11% compared to the fourth quarter of 2020, reflecting a 32.4% gross margin rate. Strong product demand and efficiencies in our distribution network fueled leverage and delivery. The margin rate also benefited from inventory optimization, promotional discipline, and higher full-price selling. As discussed, this was offset by close to 4 points of elevated air freight costs. SG&A deleveraged 60 basis points. The dollar increase of $58 million was due primarily to higher wages for store associates and hours to support the recovery in store operating capacity compared to last year. This was partially offset by leverage on advertising expense. Looking into 2022, we are prioritizing SG&A efficiencies. Over the past few years, we've been driving improvements to our gross margin. As we continue to focus on those areas, we're also turning our attention to optimizing our expense structure. We will update you as we see progress. Our target is a 23% annual rate of SG&A to revenue in 2023. Adjusted operating income of $92 million reflected a 6.1% operating margin, including an approximately 4-point headwind from gross margin pressure related to air freight as discussed. Adjusted EPS was $0.35 per share. Our diluted share count was 203 million and included 32 million shares of unrealized dilution associated with our convertible notes. As a reminder, we will move to recognize full dilution from the convert and our share count beginning next quarter. This is in line with the required adoption of a new accounting standard impacting all convertible issuers. As a result, for 2022, we anticipate a fully diluted share count of 227 million shares, with the impact on earnings partially offset by approximately $17 million in lower interest expense. Ending inventory at cost was up 37% compared to a 9% decrease last year. High product costs drove over half the increase due to product mix and higher transportation costs. Total inventory units were up 14%. The increase also reflected earlier deliveries of spring shipments as we manage through longer and more unpredictable transit times. Our balance sheet remains healthy, and we ended with $435 million in cash. Cash generation was strong throughout the year, providing sufficient liquidity for us to raise our dividend, fund our acquisition of Quiet Logistics and maintain a healthy cash balance. As Michael and Jay both discussed, we are very excited about the Quiet acquisition, including the benefits it brings to our brands and the long-term growth potential of the third-party business. Capital expenditures totaled $90 million in the quarter and $234 million in fiscal 2021. With regards to our real estate strategy, we are investing in Aerie's market expansion, prioritizing areas where we see the greatest opportunity. In the fourth quarter, we opened 45 new Aerie doors, including a mix of new stand-alone and side-by-side formats, with roughly half being OFFLINE doors. For AE, we have made steady progress towards our long-term target of rightsizing the brand store footprint. In North America, we've closed over 70 AE doors since 2019, reflecting a high single-digit reduction in gross square footage for the brand. Store productivity is up significantly versus 2019 despite lower traffic, supported by AUR gains and ADS gains. We maintain significant flexibility to adjust our footprint further, with 40% to 50% of our fleet coming up for renegotiations every year. And we'll continue to leverage a data-centric approach as we look to maximize brand profitability. Moving to our outlook for 2022. We are encouraged by the continued underlying strength of our brands and the pace of business so far this spring. Our strategies are delivering, and we're a stronger company following the structural changes we've made over the past 2 years. We're also cognizant of the environment we're operating in, including rising inflation, which has implications for our business and our customers, lapping the strength from last spring as we cycle stimulus, continued disruption in the global supply chain environment and the war in Ukraine. Against this backdrop, we are taking a cautious view. For 2022, we expect operating income in the range of $550 million to $600 million on revenue growth in the mid-teens. This reflects the structural improvements to our business and significant growth from pre-pandemic 2019, which posted adjusted operating profit of $314 million. The new logistics business is expected to contribute roughly 5 to 6 points of the mid-teen revenue growth and breakeven on profitability. In terms of quarterly cadence, we expect the year to be a tale of 2 halves, with operating profit down materially in the first half, followed by a recovery in the second half. This implies the operating margin building from mid- to high single digits in the first half to low double digits in the second half. Our outlook primarily reflects 3 things: the timing of stimulus lapse in the spring, our logistics business shifting from being dilutive in the first half to accretive in the second half as we fully integrate and ramp up the business, and easing cost pressure throughout the year as product and freight inflation is partially offset by the absence of elevated air freight due to factory closures in the second half. In closing, I'm really pleased with our performance in 2021. We're a stronger company today than prior to the pandemic. We've made material structural improvements in the way we run our business and have established a new baseline of profitability. Our Real Power Real Growth strategy has positioned us well for long-term revenue and profit growth. And I remain confident we can achieve our new 2023 targets of $5.8 billion in revenue, $800 million operating income, and 13.5% operating margin. With that, I'll open it up for questions.

Our first question comes from Adrienne Yih with Barclays.

Well executed throughout a very challenging year, so kudos to the team. Mike, I appreciate the annual guidance. I was wondering if you could provide some details about the quarters. It sounds like February is off to a nice start, as is the sector. How are you approaching the comp guidance for Q1? Additionally, some insights on how gross margin and SG&A will shape throughout the quarters would be wonderful.

Thanks, Adrienne. I appreciate your comment about the fourth quarter, and it's a great question. This year has been quite busy, making it challenging to prepare remarks. It's clearly going to be a tale of two halves. We have some specifics regarding our P&L, especially with the inclusion of the logistics business this year. First, I want to emphasize that the improvements to our gross margin from the end market nodes have been secured through the acquisition of Quiet Logistics, and we will continue to focus on enhancing efficiencies, as Michael mentioned. I'm genuinely pleased about that. We're also excited about the prospects of generating additional value from this new business. We're working towards making it profitable next year, which is very encouraging for us. Now, regarding your inquiries about the first and second halves, in the first half, we project a 37% gross margin rate with a low double-digit revenue increase. We're still facing pressures from product and freight costs, contributing about 200 basis points to that rate. Additionally, the logistics business is expected to negatively impact another 200 basis points as it ramps up revenue while operating at a loss in the spring due to the revenue mix. Furthermore, we anticipate higher markdowns in the spring season compared to last year's historically low rates, influenced by the demand from stimulus starting mid-March and continuing into early Q2. For the second half, we expect the gross margin to remain flat compared to last year, at around the same levels as 2021, with mid- to high teen revenue growth. The dynamics differ between quarters, with a decline in gross margin in Q3 and an increase in Q4. This mix includes improved initial markup as we compare against last year's higher air freight costs, but it's countered by the logistics business's effects as we further increase revenue while achieving profitability in the fall. In terms of SG&A, we anticipate an increase in the mid-teens in the first half, influenced by the factors I mentioned regarding the fourth quarter. Stores are operating at full capacity, and we still face constraints from last year without the planned increases in average wages. Advertising expenses will also rise compared to last year in the spring, affecting SG&A in the first half. I've noted that SG&A presents an opportunity for us this year. We expect the growth rate of expenses to decrease each quarter, with just high-single-digit growth in the second half. We remain committed to targeting a 23% rate for next year. Putting all these details together leads us to an operating guidance of $550 million to $600 million for the year, reflecting about a 10% rate, which we are pleased with, as it's still in double digits. The difference from the 12% we achieved in 2021 can be attributed to approximately 100 basis points of product cost pressure compared to 2021 and another 100 basis points from the logistics business due to revenue mix. Looking ahead, we believe there are opportunities for our guidance to outperform expectations regarding product costs in the latter half of the year, along with additional timing benefits from the SG&A expense reductions we are pursuing. I hope this detailed breakdown addresses your question.

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

This is Kelly Crago speaking on behalf of Paul. I wanted to follow up and ask if you could share what the comparable comps look like. If that information isn't available yet, could you provide more details by brand when you get the chance?

Yes. We're experiencing mid-teen growth in February, which is a great start to the quarter and the season. The significant stimulus benefits began in mid-March and continued throughout the quarter. Currently, we're up in the mid-teens, but we are forecasting that our brand revenue will increase in the mid- to high single digits, with an additional 4 points from the logistics business. This indicates that we expect some decline in the trend compared to last year as we approach the impact of the stimulus in the latter half of the quarter.

Got it. And then just moving over to Aerie margins. I think you called out the $31 million of air freight impacting Aerie in the fourth quarter. Could you give us a little bit more color about what the underlying margin rate looks like, excluding freight? How do the promotional cadence work at Aerie in the fourth quarter? And how should we be thinking about that in 2022?

Our markdown rates are in good shape. The margin pressure we experienced was mainly driven by IMU and freight costs. Throughout the season, our promotional activity was actually lower than in previous weeks. We reduced promotions early in the season in response to increased demand ahead of Thanksgiving, which was influenced by media reports on supply chain issues. As a result, we were able to cut back not only on the promotional rate but also on the number of promotional days. This approach was quite effective during the quarter. The pressure we faced is primarily related to IMU and product costs, including freight costs within those product costs.

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

Great. Maybe one for Jen. At Aerie and American Eagle, is there a way to maybe parse out what you're seeing in demand if we think about it by category in February, driving that mid-teens, maybe just early reception to spring at either concept. And are you seeing any pushback at all to any of your early pricing tests?

That's a great question, Matt. I'm really excited about the continued momentum. As you can see, we had a strong Q4. I’d like to highlight that we faced higher competition in both brands, yet we still achieved a solid quarter. Looking ahead to February, we experienced the lowest markdown rate I've seen historically, which indicates that we didn't carry over much excess inventory. Our clearance levels were better in both brands. When I visited the mall, I noticed an incredible assortment that has only improved today. We just launched our largest spring delivery for both brands, and they look amazing. I encourage you to check it out online. Additionally, AE has rolled out an exciting marketing campaign that just launched today. In terms of product categories, jeans continue to perform exceptionally well. I'm particularly pleased to see that some of our traditional fits remain popular. Even with the momentum surrounding new fits, our existing products, like jeggings, are still performing well, providing a healthy margin for us. We reached $2 billion in denim in Q4, and I'm eager to build on that as we move into 2022 and beyond. I'm also excited about early seasonal products; shorts are doing well for both brands, and swim is having an incredible early start. We even had lighter assortments in swim during February, and they are building each week with impressive numbers. We just released our largest assortment today, so I anticipate more growth there. I'm particularly passionate about OFFLINE; this business is thriving. We missed some opportunities in Q3 and Q4, but as Mike mentioned, despite earlier challenges, we excelled in Q1 and Q2 last year. I look forward to seeing similar positive trends in Aerie as we approach Q3 and Q4.

Great. Mike, maybe just as a follow-up. At Aerie, I think what would be really helpful is a brand-level bridge, if that was possible, meaning you outlined low 20s EBIT margin in 2023 and embedded a roughly 30% EBIT flow-through rate. How do we bridge the mid-teens EBIT margin this year to the low 20s in '23 at Aerie? It sounds like nothing has changed, but just maybe the best way to bridge would be really helpful. There is a straightforward explanation regarding the increased air freight costs in the fourth quarter. We will certainly experience cost pressures in the spring, as I mentioned earlier. However, if you consider the circumstances, particularly the shutdown in Vietnam, we made the decision to significantly increase air freight. Aerie is expected to achieve a rate close to the high teens as it did in 2021. We are targeting a high teens result, near 20%, for fiscal 2022, with a flow-through rate of 25% to 30%. Therefore, if we factor in an additional 25% to 30% growth in 2023, we anticipate being in the low 20% range.

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

I have another question about Aerie. Can you discuss the performance of the new stores that were added this past year? What are some indicators that suggest these stores will achieve your targets?

I can start, Jen. Yes, we're really pleased with how they look out of the gate. We didn't open that many in the second half of the year. Several of them were pushed from the third quarter to the fourth quarter, particularly the new Aerie and OFFLINE locations, especially the OFFLINE stores that we are adding. We don't have a solid run rate on OFFLINE yet, but the ones we've seen are performing at pro forma levels or better. We're noticing an increase in customer activity in the mall, particularly in the locations where we are introducing OFFLINE alongside existing Aerie stores. This is generating better performance across the brands within those centers. It's encouraging us that we are on track with what we plan to add in fiscal '22. Additionally, we are not observing any issues with the 4-wall results from those locations or with the return on the capital we are allocating, which we estimate will pay off in about 2 to 4 years.

Yes. And I just want to add one fun little tidbit. We just opened up Easton, our megastore. It's an AE OFFLINE and Aerie side-by-side, completely renovated and gorgeous. The initial reads are incredible. I think there's opportunity thinking about our businesses this way in the future, really maximizing square footage and showing up with all of our categories. It's like a mini department store. I love this format, and the teams are thrilled with it. The visuals look strong. Dollars per square foot are incredible. So really proud of what we did there as a team.

And maybe if I can just add on just related to the last question about just ramping in the flow-through. I mean how do you see the productivity of those stores increasing over time, relative to a mature store?

From a historical perspective, we have observed a maturity curve that we plan for, projecting it over the lease term with a corresponding ramp. Typically, we see first-year comparable sales growth in the high teens to around 20%, followed by low to mid-teens or possibly double-digit growth in the third year, eventually stabilizing in line with the trend. As we add new stores, this positively impacts our comparable sales mix. Additionally, we experience a digital halo effect that usually manifests 6 to 12 months later, which is part of our strategy. We are introducing Aerie and OFFLINE stores in markets where we have lower penetration to drive comprehensive omni-channel growth.

Our next question comes from the line of Marni Shapiro with The Retail Tracker.

Congrats, Jen. The stores look absolutely beautiful. It's such a significant change. So if we can actually touch on that. Your business pre-COVID you were still generating a lot of volume. And I know there was a lot of pressure on margin. If you could just walk us through, category-by-category, but sort of where the biggest chunks of opportunity margin-wise and improvement are sales-wise. Is it on the men's side? Is it denim? Is it tops? Is it fashion? Is it Aerie? Just so we have a good sense because, again, even prior, you were doing a lot of volume, but now it looks like you're doing a lot of volume at a much more profitable and structurally sounder way of doing business. Am I seeing that right?

Yes, that's a great question, Marni. I am very pleased with how we performed this year, strategically achieving impressive financial results across both brands. However, AE's margins have been exceptional, and I'm proud of how the team has leveraged the business. Looking forward, the breakdown by category shows that we excelled in men's, where we had a fantastic year with plenty of easy opportunities that we successfully capitalized on. For Aerie, we plan to further develop that brand. If our teams can maintain 29 consecutive quarters of double-digit growth, I believe we can keep expanding and managing this brand effectively. We've seen great success in attracting omnichannel customers to Aerie, and the teams have delivered remarkable results. Inside that business, there's still significant growth potential in intimates, and we have an exciting opportunity in OFFLINE focused on leggings, which we will continue to develop. The potential remains strong, especially since we aren't yet in all markets. We are experimenting with new approaches in those areas, such as side-by-side locations for Aerie and OFFLINE alongside American Eagle, and the results have exceeded our expectations. Our pro forma for Aerie in OFFLINE is performing 26% better than anticipated, which is excellent. I believe there are still some easy opportunities to explore in denim, and we are enthusiastic about that. We are looking to enhance our core assortment in both brands to improve gross margins while stabilizing our products to manage the challenges we're facing. Our focus is strategic as we think about women's fashion. We have a new designer on board, and we are gaining momentum in delivering outstanding women's fashion. I have been actively involved with the teams, and I am excited about what we have in store for spring 2023. I see more potential in women's than we have laid out so far, and we will manage that business for profitable growth. Overall, I am impressed with what the team has accomplished in their concepts for 2023. Aerie is also going to bring forth another amazing concept that I am eager to tackle for next year.

This is a great insight. And could I do one follow-up, if you don't mind?

Jen, you didn't explain one other thing. We were counting on opening 35 more stores, 35 more Aerie stores in the fourth quarter. And because of material shortages and COVID, we weren't able to open those stores.

Yes, that's true, Jay. You've made a great point. They're just starting to open up, and we're seeing positive results. We're pleased with that.

And can I just follow up on more on the gross margin question because I think this is really good color. But if I think back to 2019 and that holiday season in 2018, and maybe the pendulum was swung all the way to one side on promotions. I think at that point, all your sweaters were $25 in the box, things like that. And if COVID in this last year where inventories were very lean and promotions were at all-time low levels, your go-forward promotional activity should fit somewhere in between there. Is it 25% more than what we're seeing today, not all the way swung back. I mean how do you think about that? Because you're coming from a very high promotional level, not like an average promotional level to a very clean promotional level.

In 2019, we had a lot of inventory. We weren't happy with some of the inventory and there was more promotional. We learned a lot that year. And the lessons that we learned these last 2 years we put in, we're learning how to do more with less and to maximize and give the customer more depth and less choices, but more depth and more key items.

Yes. I want to add that our markdown rate has remained in the mid-30s, which is not close to our historical best. We view this as a healthy level of promotion consistently. As Jay mentioned, the positive impact on markdowns in gross margin is evident; we are indeed selling more at full price while adjusting promotions gradually. The changes are not dramatic week-to-week. However, our inventory cleanup is significant, particularly in AE, where we've reduced inventory and SKU counts by 30% to 40%. As Jay pointed out, we are purchasing more deeply but with less variety. The markdown benefits arise from end-of-season sales, permanent markdowns, and inventory write-offs. Our point-of-sale performance is robust, and we believe there’s no competitive reason for this trend to reverse. The primary margin advantage comes from eliminating unproductive excess inventory. Looking at our brand performance, from 2019 to 2021, we increased revenue by $75 million while profit grew by $270 million. This reflects fundamental improvements from our acquisition of Quiet, along with logistical efficiencies that enhance markdown benefits by reducing in-store inventory. We're effectively managing with less inventory, which has significantly benefited the AE brand and Aerie as well. We have no intention of reverting to previous levels.

Our next question comes from the line of Oliver Chen with Cowen.

This is Jonna on Oliver. Just curious about your pricing strategy. You obviously saw strong average unit retail growth over the last few quarters. But as you think about next year, do you have room for increasing pricing to potentially offset any pressure? Any color will be helpful.

Yes. I think Jay and I are going to tag team on this. Look, we've been testing new pricing in every category. And in particular ones, denim and leggings, we're not seeing a lot of resistance as long as the customer understands the quality and the price value. But we are going to protect our opening price points. That's important. The lipstick of any category gets the order going, and that is something we will constantly look at, and we'll keep the sharp prices where we believe we want to compete. But we definitely have a strategy where we build our plans and the way we assort, Jay said it, in the way we distort it to a good, better, best strategy. I'd like to say we're leaning into better and best, but we certainly aren't going to isolate customers, new customers that may want to get into our brand and understand who we are. Certainly, categories like socks and underwear are a great place to do it. And I love our strategies. Look, we've spent a lot of time on looking at our pricing, looking at the costing for the future, knowing that there could still be some logistics and supply chain issues. And I feel like the plans are in a great place. Jay, I don't know if you have any...

And to add to what Jen is saying, to me, the sign of a healthy company is the ability to have higher price points on new items and to be able to introduce higher prices on key items and drive sales. And we've been able to do that. Our denim, we're able to introduce $89 denim, $99 denim, higher price points in the leggings and drive very good sales on it. And that's the key to the company because we're not limited to a certain price point. We have the ability to keep layering on top of that. And we're very excited about that. But we have the ability to drive that. And also, we're very proud of is that people want the American Eagle name. We see more demand for our name on products at American Eagle. We see more demand for our logo. People want it. We're not just selling jeans; we're selling American Eagle jeans, American Eagle product. And we're very proud of that. And you'll see in the campaign this year, you'll see American Eagle everywhere. We're very excited.

Our next question comes from the line of Corey Tarlowe with Jefferies.

You had mentioned an improvement in retention at core American Eagle. Just curious as to what's driving this. And you had also discussed witnessing the highest ever, I believe, active customer count and the highest ever annual spend as well. What, in your view, do you believe is the core to this development? And how sustainable do you believe this trend is?

That's a great question. The marketing teams have analyzed our customer base, and one of our strategies was to bring our customers back. The reactivated growth, especially in American Eagle, is outstanding, showing an increase of 61%. The reactivated customer rate is impressive. The same applies to Aerie, which has very strong numbers as well. One of our key focuses has been on this area. However, we’re also broadening our product assortments to attract a wider demographic. While it’s important to appeal to teenagers, who tend to shop regardless of the market conditions, we are also reaching older customers, which is fantastic. This is notable in our denim fits, where we offer a greater variety. We maintain our core products while introducing new fashion items, leading to additional growth. Our strategy has been similar in Aerie, where simple products like leggings appeal across various age groups. We are adopting the same strategy in American Eagle. Moreover, we are being very disciplined in managing our inventory and promotional strategies, ensuring we provide a great price-value equation while maintaining high quality. I am very proud of the team's efforts.

And Jen, I'd like to add to what you're saying. We're very proud of our fits. They're consistent, and they're probably the best fits in the industry.

Absolutely.

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

As you think about the 2 new businesses that you acquired, AirTerra and Quiet Logistics, what do you see them adding in 2022? When do they become a sales and profit driver as you expand those businesses? And is there any model of what we should think of their contributions over the long term?

Dana, it's Michael Rempell, I'll answer the first part, and then I'll see if Mike wants to provide any more detail. But look, for me, and I should say, I'm really extremely proud of the delivery performance for the American Eagle business and that delivery performance. I don't think there's another retailer in the country that's lowering their delivery cost, lowering delivery as a percent of revenue and delivering to customers faster while making their inventory more productive at the same time. It's a huge accomplishment. The team has done a phenomenal job, and it's a great win. And the reason I mentioned that when you're asking about Quiet and AirTerra is it's a direct result of the work that we've done with Quiet and AirTerra. Those businesses are fueling the results that we're seeing in American Eagle. And that's why we acquired them. We saw the opportunity in our business. And it's very clear to us that in order to compete going forward, all retailers are going to want and need these kinds of capabilities. They're going to need the efficiencies of operating at scale, of being close to the customers, of making their inventory more productive, of accessing new kinds of delivery partnerships and capabilities. And that's what this enables. So look, we're only 2 months into the acquisition. It's a little early to give too much color or too much guidance. But what we do plan on giving it later this year. And what I would tell you is our initial conversations with other brands and retailers are extremely positive. I'm very encouraged by what I'm hearing. I'm very encouraged that we're going to get significant brands and retailers to want to sign up and join us in this because they see the value and they see the opportunity. And Mike gave a little bit of color earlier, but we do expect that it will be a few hundred million dollars of revenue this year, likely a breakeven business as we're investing early on. We just hired a new CTO for the business. His name is Charles Griffith. He is really a world-class player. He was in a leadership role at Amazon, where he built a lot of their transportation capabilities. He is bringing on an extremely talented team. And again, we all know how critical technology is in the success of our business and certainly running an efficient supply chain. And these businesses are allowing us to attract talent that we likely would not have otherwise been able to attract. And that's certainly a huge value to American Eagle, but it's also going to be a huge value to all the customers that we serve today and that we're going to serve in the future. So I expect that in 2023, this is going to be a profitable business for us. I said in earlier calls that it was going to be accretive to our business and accretive to our margins, and I certainly know that it's going to be that way. And Jay, do you have any...

Okay. Just to add one thing, Dana, I always tell Michael that this acquisition is going to be the anti-Amazon. It's going to give us and other retailers the ability to compete against Amazon, Target, and Walmart in the future.

Thanks, Jay. I want to add some specifics related to the story I was discussing earlier. We provided guidance of 4 to 5 points of top-line growth, which translates to $250 million to $300 million in revenue, not counting revenue from our own brands, which would actually increase that figure. The external or third-party revenue is expected to be $250 million to $300 million, which will be additional to our profit and loss statement. We anticipate a loss in the first half of the year. As Michael mentioned, we've only owned this for 2 months, and the team is working hard to grow the business. We're investing in personnel and other services. The projected loss for the spring season is about $20 million, but we expect to break even for the year. Our plan is to recover that $20 million in the second half, particularly in the fourth quarter. This positions us for profitability in 2023, as Michael noted, and we will share more details regarding our 2023 targets in the future.

Laura, I think we have time for one more question.

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

I was curious, it doesn't sound like you've seen any pushback on the higher price points. But just curious if there's any at all from the consumer, particularly on the denim wear. I think some of those higher end price points if you're seeing any pushback there?

Yes. I mean we always invest accordingly. We've tested and scaled some of these price points. And so far, so good. Obviously, they're more of the fashion-oriented fits where the customer is willing to pay, and that's how we're doing it, right, in every category, right? So we're approaching it cautiously. We still want great genuine pricing. That's so important. We are a mall-based retailer, so we'll be smart there. But I do like the quality and the innovation that I'm seeing. The innovation is just incredible with this design team. They're just not stopping. I mean I could go through every category, but looking at denim, leggings, just new fabrications and quality, we've already delivered so much in men's. So where we can get paid, we will. And that's it. That's a wrap, I guess. But we're really excited, and I look forward to what we're going to see with this next delivery.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Jay Schottenstein for closing remarks.

Okay. Thank you. Okay. I like to summarize AEO has undergone a tremendous transformation over the past 2 years. 2021 was one of AEO's best years on record. We achieved over $5 billion in revenue, and that was a first for us. By any standard, we had a spectacular year with operating profits over $600 million, one of the best results since 2007. If not for the incremental freight costs as a result of factory closures and supply chain disruptions, it would have been our best year ever. And over the past few years, we made many key structural changes to our business that are driving higher profitability. We've set a new baseline of profitability for the company. Confident in 2023 targets of $5.8 billion and $800 million of operating profit and a 13.5% operating margin. And we appreciate everyone's time and investment in our company, and thank you for joining us this afternoon. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.