American Eagle Outfitters Inc Q2 FY2022 Earnings Call

Greetings, and welcome to the American Eagle Outfitters Second Quarter 2022 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 second quarter investor presentation. And now, I will turn the call over to Jay.

Good afternoon. Thank you for joining us today. This is clearly an unprecedented time in retail. We are cycling extraordinary and uneven demand patterns brought on by stimulus and COVID over the last few years, and we are navigating through a highly volatile macro environment. Our second quarter results reflected these challenges as revenue came in below our plan and markdowns weighed on profit margins. On the first quarter call, we highlighted the actions we were taking in response to changing demand and to reposition our business for an improved second half. This included a firm goal to rightsize our inventory and reset our expense base to be more in line with demand in the second quarter. Significant progress was made across both these initiatives. On the inventory side, we've cleared all excess spring and summer goods and entered the third quarter with better inventory levels and fresh back-to-school and fall merchandise. We also actioned expense reductions across the organization. As Mike will review, we are taking further steps to drive improved profitability and cash generation. This includes a hiring freeze, further reductions in noncritical expenses and lower capital spending. We have also paused our quarterly cash dividend. We have returned $265 million in cash to shareholders through a combination of dividends and share repurchases, marking our highest level of returns since 2015. While we will take the rest of this year to strengthen our cash position, we are committed to continuing to return cash to shareholders as a fundamental principle. On a separate note, we made strategic changes to our leadership structure to enhance focus on consumer experience and our growth initiatives, with combined store and digital operations, to enable a more holistic and cohesive view of the customer. The new structure will create efficiencies and strengthen the brand experience as we execute seamlessly across channels. This includes more focus on our international business, where I see tremendous opportunity for our brands. I'm pleased with the positive momentum we are building over the past few years. This change will facilitate a more strategic approach as we further optimize key markets, including Canada and Mexico, while fueling our license partners for continued expansion over the long term. As we navigate through near-term macro challenges, we have not taken our eyes off the strong potential for future growth. Aerie's incredible brand platform continues to see exceptional multiyear growth, with second quarter revenue reflecting an industry-leading 25% 3-year compound annual growth rate. I remain extremely bullish on the outlook for Aerie and OFFLINE and their future potential. American Eagle is a dominant chain brand and the go-to destination for youth, with very strong brand affinity and recognition. Innovation, new products, fueling new fashion trends and further global expansion are key areas of focus to drive profitable growth. We continue to invest in bringing our customers a seamless and engaging shopping experience across digital and stores. Our logistics business, Quiet Platforms, is providing significant benefit to our operations, while also expanding its third-party revenue base by offering innovative and more cost-efficient logistics solutions. The growth in the business so far confirms our initial investment thesis on Quiet's value proposition, to have a differentiated performance model. I'm encouraged by the business and excited about the long-term growth potential, and I'm proud of the continued progress we are making on our ESG initiatives. We look forward to publishing our first ESG report next week, introducing standardized reporting and increased transparency. Our brands are healthy, and our business is resilient. Comparisons will eventually stabilize, and the supply chain landscape will continue to improve, restoring agility in our operation. In the meantime, we will stay conservative and focused on the core fundamentals that have brought us success in the past, creating great product, compelling marketing, building unique brands with strong customer connection and chasing into demand. The actions we have taken to reset this year's were a significant undertaking. I am thankful to our teams for acting quickly and purposefully. Yet, we know there is more to do in these unprecedented times, and we are focused on driving continuous improvement across the business. With that, I'll turn the call over to Jen.

Thanks, Jay, and good afternoon, everyone. This was clearly a challenging quarter. As we managed through the current environment, we remained focused on adjusting our assortments and rightsizing inventory. I'm pleased to note that we entered the fall season with fresh and current assortments across brands. We have significantly pulled back on fall receipts and continued to adjust forward inventory to be more in line with shopping trends. Clearly, lapping enormous demand from last year has also been a hurdle. Yet I see no letup in the consumer affinity and love for casual, comfy and active wear. It's a lifestyle, not a trend, and it's in demand. As we see comparisons to last year's season, I'm confident momentum will come back to us. And in fact, looking forward, there are great new trends emerging around silhouette, color and fabrication that will create even more excitement around the lifestyle. Now let me provide some second quarter details by brand. Aerie revenue increased 11% compared to last year driven by new store openings. Comparable sales were down 6%, following a 25% comp increase last year. Swimwear remains soft. While overall demand was below our plan, the majority of categories posted increases to last year, such as undies, leggings, apparel and accessories, all posting positive growth. Additionally, OFFLINE continues to show incredible potential and demonstrate strong customer acceptance. I'm also pleased to see that Aerie's multiyear growth trajectory remains intact. Since the second quarter of 2019, revenues have nearly doubled, growing almost $170 million. Our customer file has expanded by almost 2 million shoppers. We continue to focus on delivering innovation and newness to our customers. SMOOTHEZ is our new collection of favorite first layers that we call anti-shapewear. The launch has been extremely successful, driving incremental traffic to the brand and nearly 6 billion impressions to date. Our new BRA-ish bra features revolutionary technology, reestablishing our authority and bringing newness back to the business. We will continue to build out our SMOOTHEZ collection in upcoming seasons. On the marketing front, we launched the We Are REAL campaign, amplifying inspirational messages from women within the Aerie community with a strong customer response. Now shifting to American Eagle. Revenue declined 8% to last year. Comparable sales were down 10%. This followed 39% comp growth in 2021. Category trends were challenged as we cycled exceptional growth last year in a tougher macro environment. Our best categories included menswear overall, women's dresses, shirts, fleece and accessories. We have been highly focused on making adjustments to our buys to ensure we are better positioned for future seasons. In addition to resetting overall inventory levels to be more in line with demand, we are making adjustments across all categories. As we transition into new denim silhouettes and fashion trends, we see an opportunity to better allocate our investment. Additionally, we are beginning to see pockets of improvement in tops as our focus on outfitting yields results. Here, we are rebalancing our buys to emphasize the trends that are working very well. We are also pleased to see the supply chain begin to normalize. This is creating better inventory flows, shorter lead times and enables us to reestablish our best-in-class test and chase practice. AE remains #1 in jeans and the #2 favorite brand for females and #3 for males in our core demographic. As a dominant player, AE is continuously bringing newness to the category. This quarter, we launched our new Strigid collection, an industry-first; Strigid jeans marry the latest in fashion trends with our unwavering commitment to comfort. AE continues to be a leader in social commerce and the new realms of the metaverse as we explore new ways to engage with our customers. In the second quarter, we partnered with Twitch on a gaming tournament, which drove strong traffic to our site. Separately, our Roblox experience has become the second most popular experience on the platform. AE is second only to Gucci with 35 million unique visitors to date and exceptional engagement metrics. As I said earlier, across brands, my confidence is stronger than ever. We are focused on delivering innovation and adapting to new trends while maintaining a cautious near-term view. We are ready for the upcoming holiday season and spring is right around the corner, with plenty of exciting trends to leverage. I want to thank Aerie and the AE team for their hard work and being quick to adapt in a very dynamic macro environment. Thank you. And now, I'll turn the call over to Michael.

Thanks, Jen, and good afternoon, everyone. As we navigate a challenging retail environment, we are leaning into the strength of our operations. We've invested in our supply chain, which is yielding greater speed, efficiency and cost benefits. We have amazing brands, and our selling channels are very strong. We operate an industry-leading store fleet and a truly best-in-class digital capability. In the second quarter, channel performance reflected macro pressures across retail. In stores, lower traffic and lower spend drove a 9% comp decline. Digital sales were down 6%. While down to last year, our digital business had seen significant growth over the past 3 years, with revenue up 60% to the second quarter of 2019. Digital penetration has also grown to 33% from 24%. Our mobile app had another strong quarter and is now our largest source of revenue in the direct channel. This is a key positive as app customers are our most engaged and valuable omnichannel customers. We are continuing to invest in the latest new technologies to enhance the customer shopping experience. In the second quarter, we introduced a new mobile point-of-sale system across our North America store base, giving our customers the flexibility to check out or return items through our store associate anywhere in the store. We expect this to improve transaction speed and minimize wait time, especially as we head into our peak fall and holiday selling seasons. As Jay mentioned, the organizational changes we have made will allow us to operate with a more integrated and channel-agnostic customer strategy, and it's going to create efficiencies and cost savings. We are continuing to rationalize the AE store base and close 7 more stores across the North America fleet in the quarter, bringing our regional store count to 858 stores. This is down from 931 at the end of fiscal 2019. We also added approximately 20 new Aerie and OFFLINE locations in the second quarter, bringing our total openings over the past 12 months to approximately 100 new stores. Aerie's store expansion strategy has been very successful in building brand awareness. After significant investment over the past few years, we are slowing down the pace of openings as we focus on maximizing these investments. As we've noted in the past, new stores grow at an accelerated rate in years 2 and 3 before approaching the comp store average in year 4. So as new stores ramp up, we expect to see very nice returns from our investments, including both the sales and profit generated within the four walls as well as the digital halo created for our online channel. Our typical payback period on Aerie stores is less than 3 years, with returns that well exceed our cost of capital and reflect the company's highest ROI. Moving on to the supply chain. After a highly challenging year, I'm very pleased to see inbound supply chain improvement. Shipping delays and bottlenecks are easing, transit times are shorter and freight costs, although still elevated to pre-pandemic history, have come off substantially from highs reached last year. As a result, our lead times have narrowed dramatically from their peak last November. Importantly, this is bringing back our ability to be more agile and responsive to changes in demand. On the inbound freight side, we expect to see markup relief in the back half of the year as we anniversary $70 million in higher airfreight related to factory disruptions in Vietnam last fall. This is going to begin to benefit the P&L in the third quarter and build significantly into the fourth quarter and into 2023 as we cycle peak usage. Cotton pricing has also moderated from peaks this past spring, and I expect we're going to see product costs look favorable into next year. Now moving on to Quiet Platforms. Our localized fulfillment model now handles one-third of our direct orders across the AE and Aerie brands and is continuing to drive efficiencies. We are fulfilling orders faster and with fewer shipments. Our cost of fulfilling orders is down compared to both last year and to 2019. The resulting savings are helping us to contain delivery costs even as rates remain elevated across the industry. Faster delivery times are contributing to a much better online shopping experience for our customers, with approximately 75% of online orders reaching customers within 3 days of checkout in the second quarter. We even see room for this rate to move higher as Quiet Platforms expands its footprint to service additional markets next year, which should enable nationwide next-day services. Over the past 8 months, we have made significant progress in scaling Quiet Platforms. Since closing the acquisition last December, we have added significant amounts of new customers and entered new markets. We expect the momentum to continue in the second half. As new customers are entering the platform, they're realizing efficiencies in their operations, resulting in greater engagement and additional business. While Mike is going to highlight the impact of the business on our consolidated financials, I want to note that it performed in line with our plan, with improved results from the first quarter. I remain very encouraged by all the interest we have received in this business as it continues to expand. As we look ahead, our focus remains on capturing even greater share of the market opportunity. And with that, I'll turn the call over to Mike.

Thanks, Michael. Good afternoon, everyone. As Jay mentioned, we are taking numerous steps to improve profitability and cash flow, which I'll discuss throughout my remarks today. Let me start with a review of the quarter. Consolidated revenue for the second quarter was $1.2 billion. This was flat to last year, including 2 points of growth from our supply chain acquisitions. Brand revenue declined 2%, following record revenue supported by an exceptionally healthy consumer environment last year. Consistent with what others have said, we saw a slowdown in demand this summer. For the quarter, Aerie revenue was up 11% and American Eagle declined 8%. Compared to pre-pandemic 2019, total revenue increased 15% and brand revenue was up 12% or $130 million. Gross profit dollars declined 26% compared to last year. The gross margin rate of 30.9% contracted 1,120 basis points. Higher markdowns drove 750 basis points of the decline. I want to emphasize that as we cleared through inventory in the second quarter, our priority was to maintain the pricing integrity and brand equity built over the past few years. Our average unit retail in the second quarter was the second highest achieved in the history of the company, down only 4% to last year. We leaned on end-of-season sell-offs to fully clear out all excess spring and summer goods, which was roughly one-third of the markdown pressure in the quarter and had a $30 million impact on profitability. Higher freight costs were a 200 basis point headwind to the gross margin rate, and the integration of our supply chain acquisitions drove 60 basis points of incremental deleverage. Turning to expenses. SG&A deleveraged 110 basis points compared to the second quarter of 2021. The mid-single-digit dollar increase was in line with guidance provided last quarter, led by higher wages for store associates, new store opening expenses, as well as increased corporate compensation, advertising and professional services. This was partially offset by lower incentive accruals and expense actions announced last quarter. We remain laser-focused on resetting our expense base. Since our last update, we have expanded the scope of our expense reductions as we continued to target store and corporate compensation, professional services, travel and advertising. We have implemented a hiring freeze and paused noncritical spending. With these actions, we now expect $100 million in annualized expense reductions from our original plan, ahead of the $60 million discussed last quarter. This translates to SG&A dollars approximately flat to last year in the second half compared to prior guidance for low to mid-single-digit growth. Second quarter operating profit was $14 million, reflecting a 1% operating margin. This included a $30 million impact from incremental end-of-season inventory sell-offs mentioned earlier and a $25 million headwind from higher freight costs. It also included a $9 million loss from Quiet Platforms, reflecting a sequential improvement from the first quarter as planned and previously communicated. Margin pressure was felt across brands due to their miss to plan. Aerie's margins were more impacted as a result of several factors. Aerie saw a larger variance to plan, which was based on outsized growth over the past few years. This resulted in a larger impact from sell-offs to clear inventory, and in-season promotions fell mostly acutely in the second quarter due to the timing of Aerie's seasonal clearance activity. Additionally, we saw some pressure on margins due to a higher number of new store openings, which are still in their ramp-up period. As inventory resets and newer stores continue to build, we expect Aerie's margins to show a meaningful recovery back to double digits in the second half. Adjusted EPS was $0.04 per share and included a $1 million interest add-back to net income. Our adjusted diluted share count was 207 million. During the second quarter, we took steps to strengthen our capital structure. We exchanged $342 million or approximately 80% of the principal associated with our convertible note and upsized and extended our ABL facility. This provides additional liquidity under more favorable terms. We also completed a $200 million accelerated repurchase program. In the second quarter, we repurchased 17 million shares as part of the program. With the full benefit of these actions, we expect a third quarter weighted average diluted share count of 198 million. Consolidated ending inventory cost was up 36% compared to last year, reflecting a 10-point improvement from first quarter levels. From a brand standpoint, Aerie and AE each represented half the increase, with approximately 20% of the increase driven by black leggings, a core item that sees strong year-round demand. Total inventory units were up 22%. This reflected higher in-stocks as we lapped supply chain disruptions last year, earlier receipts of back-to-school and fall goods, reflecting improved lead times, and higher units to support new Aerie and OFFLINE store openings. Quarter-end inventory is current and fresh for the fall season. Clearance levels are in line with last year, and we do not have packaways. Given ongoing macro challenges, we have taken further action to reduce inventories for the second half of the year. As we make additional progress, we expect to end the third quarter with inventory up in the mid-single digits and fourth quarter ending inventory down to last year. We anticipate promotional intensity to remain high across retail in the back half of the year. Although we will not be in the end of this, with inventory plans more aligned with demand, we're better positioned to navigate through it. We ended the quarter with $98 million in cash and total liquidity of $453 million. Capital expenditures totaled $69 million in the quarter. As mentioned earlier, we have paused all uncommitted CapEx spend for the balance of the year as we absorb and grow into our investments. For the full year, we now expect capital expenditures of approximately $250 million. This is down from our prior guidance of $275 million, with work being done to reassess investment needs for 2023 as well. Now on to our outlook. Demand remains challenging, especially as we cycle an incredibly strong and record back-to-school season last year, with brand revenue down in the high single digits quarter-to-date. Assuming current trends continue, we expect third quarter gross margin to be in the mid-30s and fourth quarter in the low 30s. This reflects higher markdowns as a result of the current demand environment and our seasonal clearance cadence, which is more weighted to the fourth quarter. We are also anticipating freight relief as we lap significant use of airfreight linked to the Vietnam factory closures last year, especially in the fourth quarter. As I noted earlier, SG&A dollars are expected to be relatively flat in the back half, our tax rate assumption being in the high 20s and weighted average share count at approximately 198 million. 2022 is clearly shaping up very differently from what we had originally anticipated. As Jay noted, we're prioritizing liquidity and financial flexibility in the near term and pausing our quarterly cash dividend of $0.18 per share. American Eagle Outfitters has a long history of returning cash to shareholders through dividends and share repurchase. We remain committed to maintaining this precedent in the long run. In the midst of the challenges we're facing this year, we're also working hard to position 2023 for improved profitability, solidifying worker cross-expenses, CapEx and inventory. As Jay noted, our brands and operations remain strong, and I'm confident this will come through in our results next year. With that, I'll open it up for questions.

Our first question comes from Jay Sole with UBS.

I want to ask about Aerie. And if you could just talk about where in the quarter maybe the projection differed from what played out. Was it that your view on the macro was optimistic? Was it some of the styles didn't resonate? Was it some of the categories maybe that you thought would trend didn't versus other categories? If you can just sort of dive in a little bit and talk about where the differences were in that business versus your expectations, that would be great.

Yes, I can begin. I'll discuss some of the trend progression, and you can address the product side of Jay's question. Thank you, Jay. If we rewind to our first quarter call on May 24, we mentioned that our sales trend was consistently in the mid- to high-teens compared to 2019. This trend held steady from February through April. In fact, we observed an acceleration in May leading up to the call, which bolstered our confidence. However, in mid- to late June, as others have noted, we experienced a slowdown in trends as summer approached. This decline persisted through July and into early to mid-August, coinciding with the back-to-school period. Recently, we've witnessed some improvement as we entered September and following the Labor Day weekend. Nevertheless, we're maintaining a cautious outlook, guiding for a continued negative high single-digit trend based on what we've experienced so far this quarter. This shift was primarily noted from mid to late June, and we've seen a consistent slow down across the industry during that time. Jen, do you want to take it from here regarding the category?

Yes. Thanks, Mike, and you said it well. But really, it was isolated in the swim category, to be honest, Jay. We saw really incredible results in all of our other categories. And you heard from Mike how that really impacted from a seasonality standpoint. But well, I like what I'm seeing. Like look, we look forward, we look ahead, we just had one of our best launches ever, the SMOOTHEZ launch, which is highly rooted in intimate apparel, which is seasonless, so I love that category, and leggings are off to a great start. And again, we don't take a lot of markdowns on leggings. They're highly isolated in black. They do the majority of the business. So early on, and it's early to say, but we're very pleased with the results so far for back-to-school. So like I said, going back to Q1 and Q2, very isolated in swim, but other categories saw nice results.

Jay, to wrap up, Aerie has nearly doubled its 2019 results. By the end of the quarter, we believe our inventory is appropriately reset. We're in the ramp-up stage for new stores, and Michael shared our expectations for their performance. We have over 100 new or non-comparable stores entering the second half with a reset inventory. We are optimistic about Aerie for the remainder of the year, despite the uncertain macro environment. Looking ahead to the rest of this year and into 2023, we are confident in Aerie's growth potential, both in sales and profitability.

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

So Jen, could you speak to demand shifts that you're seeing across categories? What changes are you making across the assortment at Aerie and American Eagle in the third quarter? And is there a way to think about the timeline needed, in your view, for inventory completely across the board to be fully reset at this point?

Sure, Matt. Mike mentioned that we are in a great position as we move into Q4 and look ahead to 2023 concerning inventory. The teams have worked hard to ensure we are well-prepared while also focusing on the right categories. I'm really pleased with what’s happening right now. We just completed a project in 19 days and have deliveries lined up. Michael Rempell noted that we are beginning to excel again. The testing and responsiveness of our company are impressive. I learned this when I joined 12 years ago, and it's great to see logistics improving, allowing us to operate more smoothly. We are experiencing shifts in some categories, and it’s interesting to see how dominant we are becoming in bottoms, which is also happening in Aerie. We are observing shifts in denim silhouettes, and the teams are quickly entering new categories from the bottoms perspective. Additionally, with OFFLINE being a new venture for us, we are seeing excellent results, which looks promising for growth. In American Eagle, I like what I see in outfitting, although it has taken a bit longer than expected. Early insights for back-to-school show that we can respond effectively to women’s trends. The quick turnaround in our chase ability is quite impressive. We will continue to test and scale our efforts. I want to highlight that this team has been responsive and dedicated. We are committed from marketing to production, across product categories and innovation. I am really proud of our team.

Great. And then, Mike, could you just speak to the magnitude of the recent EBIT margin contraction that we've seen at Aerie? Maybe if you could just elaborate on some of the drivers of double-digit margins in the back half. And has anything changed on your multiyear view of profitability for Aerie? Or how do we maybe break down the structural versus transitory elements of the profitability of Aerie today relative to previous plans?

Sure. In the second quarter, particularly the first half, Aerie faced some challenges. The supply chain disruptions from last fall affected us, particularly with elevated freight costs in both the first and second quarters. This resulted in a 200 basis point impact for the quarter, with about half of that coming from Aerie. So, with total impacts around $20 million, Aerie's share was approximately $10 million to $15 million. Additionally, resetting inventory in the second quarter involved a $30 million charge, with Aerie contributing over half of that. The combination of these factors, along with the 20 stores we opened in the quarter and the ramp-up of new stores, could increase Aerie's operating rate from 3% to double digits in the second quarter alone. As we move into the second half, inventory has been reset, and we anticipate no further impacts from overplanning like we experienced in the first half. Freight costs are normalizing and we expect to see improvements compared to last year. The new stores will be operational without significant new store opening costs affecting us. These key factors will no longer pose challenges in the second half. We believe inventory is now positioned well, and our focus will be on the profitability of the new stores and the overall business. We're confident in achieving double-digit growth in the second half and looking forward to 2023, with over 30% growth in square footage from the 100 new locations, aiming for a mid-teen operating rate or better in our plans for next year.

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

This is Kelly Crago on for Paul. Just curious with the brand sales running down high single digits versus last year's quarter-to-date versus the down 2% you saw in 2Q. I was just wondering if you could help us think about that deceleration by brand. And then I'm just curious, given the inventory position has improved so much, is this kind of the function of having less clearance sales available that might have driven some of the sales in 2Q and you're just not expecting that? Just any thoughts there would be great.

Let me address the latter part of your question first. The $30 million effect on second quarter profitability relates to adjusting our inventory, which includes devaluing it. This mainly centers on introducing summer goods into August at traditional clearance levels. We believe we are aligned and in a solid position regarding typical historical clearance levels as we move into August and the associated sales. Regarding the trend for AE, if that was part of your inquiry, we anticipated a challenging Q3 after last year's exceptionally high back-to-school season. Since we didn't experience a back-to-school season in 2020 and had stimulus checks available starting July last year, the pent-up demand and the funds during that period heavily influenced our sales. We recognized that AE would face difficulties comparing to that period, so we planned for a slowdown in Q3 compared to the first half. I'm not surprised by this given the current macro conditions and the context of last year's back-to-school surge. Jen can now provide insights on the product perspective, including what we are observing for fall and our expectations moving forward.

I think you said it well, Mike, just really after coming off of the swim, a little bit of a hangover with the swim business in Aerie in summer. And honestly, obviously, both brands had incredible tailwinds last year. But AE is just getting going. This is a fairly new team and we did have a little bit of that benefit last year with the stimulus and lapping that, the tailwinds, that a lot of retailers benefited from. But I like what I'm seeing on the AE team. We're very conservative. We're sticking with our strategy. Like I said, we're testing and scaling new product categories. We have some excitement coming up for spring 2023. I can't tell you my secrets, but some new launches in the AE brand. And we're not going to stop there. And like I said, it's a fairly new team and I like what they're doing. They're turning into a very well-oiled machine. And the Aerie team, again, we have so many new ideas, so many new categories. I mean I mentioned it. We just launched that SMOOTHEZ category. Let me just say in one day, we saw a 30% increase in traffic to the direct site, that one day when we launched that campaign. So again, we have to keep on challenging ourselves to comp year-over-year, whether it's marketing, product, production. But that's what we're into right now, and that's what we're thinking about 2023 and beyond.

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

I actually like to take a little bit of a step back. And Jay, I want to address this to you because we've been through, and certainly, you've been through periods of time where the customer has pulled back for a moment in time. But it sounds like there's a lot of confidence still here at the company. You cleared out the inventory. You're positioning for the back half. I guess broadly speaking, knowing what you know, knowing what you've been through, what gives you the confidence for the back half of next year? Is it the brand's spring? And I guess, how do you think about holiday and further into 2023?

So let me ask you, was that question to Jen or is that a question to me? I didn't know who you asked.

That's to you. I mean you've been doing this as long as I have been doing this.

I have been around for a while and I’m confident in our team at American Eagle. Our merchants are exceptional and have consistently performed well. Jen mentioned that we’ve introduced new designers, and it takes time for our audience to get familiar with the brand. However, I’m excited about what Jen and the team are working on for the upcoming holiday season and for spring 2023. We’re not just expanding our product range; we’re also introducing fresh concepts and products that have the potential to be very appealing. Recently, we had a significant number of Aerie store openings, which should benefit us moving forward. Although I don't want to overstate things, I’m feeling optimistic about the company. Freight rates are improving, and our timing is getting back on track. The past couple of years have been chaotic due to various disruptions, including country closures and shipping delays, which have made things unpredictable. Jen noted a promising development where she was able to obtain a product in just 19 days—something we haven't experienced since early 2020. This signals a positive return to normalcy. I believe the company is set for success. While I can’t influence how investors react, I focus on our operations. We have a strong vision and are innovative in both our merchandise and technology. Our stores look excellent, and we are finding more effective ways to deliver products to customers and stores. Overall, I believe we are making significant progress, and despite the challenges we faced this past year as we compared to last year's performance, I am confident we will emerge as one of the top contenders in the market.

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

Actually, Jay, this may still be relevant for you, but I'd like to open the floor for comments from anyone. Can you discuss the evolving competitive landscape? We've previously mentioned fast fashion, but now there's faster fashion with brands like Boohoo and Asos, and super fast fashion with competitors like Shein. I'm curious about how frequently you encounter these competitors in your research and how this impacts overall pricing pressure. Additionally, Mike, when you mention a pause in the dividend, does that suggest a pause in repurchase activity as well, or are those two separate matters?

I can address that. When it comes to fast fashion and competition, there's always going to be competition. That's part of our job—competing and striving to do it better than others. We remain humble and pay close attention to emerging competitors like Shein. Our focus is on building our brand and protecting it. American Eagle is a brand we take pride in, along with Aerie, which is gaining traction. Our aim is to build and safeguard our brands rather than just making quick adjustments. I believe that a slow and steady approach is the best strategy for brand-building and how we conduct our business. We are looking at the long-term, and while the retail sector has faced challenges recently, we are committed for the long run. I'm optimistic about the future. As Jay mentioned, there is innovation on the horizon. We have exciting new concepts ready to launch. We remain focused and committed to our brands, encouraging our teams to stay in their lane, look forward, and ensure we're innovating and competing on our terms.

And Jen, you talked about concept; we have Todd Snyder, which is on fire there. Mike, do you want to talk about that a bit, Michael Rempell?

Yes, absolutely. We're actively working on American Eagle and Aerie, making significant innovations there. At the same time, we're also nurturing new brands and businesses. We take pride in the fact that we are not complacent and do not rely on a single business to drive our success. We're constantly exploring ways to grow for the future. Todd Snyder has seen over a 50% increase this year, and we are expanding its presence by opening more stores. It's primarily a digital business, but it's on track to be profitable and continue its growth. We're also developing a new concept called unsubscribed, which Jen and her team quietly launched last year. It currently has about five stores and is performing very well. Additionally, we're investing in Quiet, which not only benefits American Eagle but also has exciting potential for growth.

I can address your question about the dividend. Our priorities remain consistent. We're prioritizing reinvestment into the business, which we've done significantly over the past two years and will continue this year. We've discussed the 100-plus Aerie and OFFLINE locations and are enhancing our digital and supply chain capabilities this year alongside other initiatives. So far, we've returned $265 million to shareholders year-to-date, which includes $65 million in dividends and a $200 million ASR linked to the early convert settlement to counteract share dilution. This $265 million is the highest amount we've returned to shareholders in a year since 2015, as noted in our prepared remarks. Moving forward, we're focusing on improving profitability and generating positive free cash flow in the latter half of this year and into next year. I'm confident we'll resume a suitable level of dividend distribution and continue reinvesting in the business where appropriate, along with opportunistic share repurchases as we've done in the past. We have a strong history of returning cash to shareholders, and we will return to that once we strengthen our cash position.

Our next question comes from the line of Kimberly Greenberger with Morgan Stanley.

I wanted to check on inventory. Could you discuss how much you expect inventory to decrease by the end of the year? I'm aware that at the end of the fourth quarter last year, inventory was up around 24% compared to 2019. However, based on the revenue run rate in the second quarter, total revenue is up only about 15% compared to the second quarter of 2019. So, I'm curious about how much you think you could reduce inventory by the end of the fourth quarter and what your initial plan is for inventory reduction next year.

Hi, Kimberly. In the fourth quarter, we still have a lot of volume and business opportunities ahead. As of now, our projections indicate we could be down in the double-digit range, likely low-double to possibly mid-teen percentages. However, this is just a preliminary estimate that may change as we progress. For next year, we plan to remain conservative since the environment is still uncertain. We're excited to be back to a timeline that allows us more flexibility. Previously, we had to commit to inventory three to six months in advance, which contributed to our challenges in the spring season. Currently, we are discussing our spring plans and have placed some initial purchase orders, but we are keeping many options open to maintain our flexibility now that timelines are more aligned with historical patterns.

That's really great color. And on the $70 million in freight relief in the back half, I'm wondering if you can help us understand how that portions out between Q3 and Q4. You also alluded to some savings you anticipate in the first half of the year next year. Any numbers you can help us with on that, that would be great.

I believe it was $10 million in Q3 and $60 million in Q4 for airfreight.

That's right, Mike.

Yes.

Our next question comes from the line of Janet Joseph Kloppenburg with JJK Research Associates.

I was wondering, Jen, if you could talk a little bit about this shift in denim. We're hearing a lot of mixed weeds on denim right now and maybe some disappointment in back-to-school performance. If you could talk about that and if there's a shift towards something dressier or maybe pants and how American Eagle might be positioned for that. And as we look to the future, and you talk about introducing new concepts, I'm just wondering if some of this dress-up trend that we're seeing prevalent today is something that American Eagle can participate in and perhaps that some of your new concepts are built around that, or if you think the dress-up trend is just a temporary moment.

How are you, Janet, by the way.

Yes, I'm great. How are you?

Yes, I'm doing well. I believe the casual trend is here to stay, and our generation, along with future generations, loves casual and comfortable sportswear, which we excel at. Regarding denim, there are certainly shifts occurring, and we are responding to them. We have been focusing on our inventory as part of our inventory rationalization efforts. Within denim, we are identifying promising trends and experimenting with different baggier fits and flares, in addition to our staple jeggings. We are also observing a shift toward other types of bottoms and testing various silhouettes. We are implementing new testing scenarios based on logistics improvements that will help us make smarter decisions for the future. Results from these tests will be available soon, allowing us to implement findings for spring and beyond. There are exciting new trends emerging in bottoms, which we are eager about. As for our new idea, I can't share too much, but it's very exciting and will be launched for spring 2023. It represents a new concept for us, and early feedback on product categories has been very positive. One secret I can share is that it is part of the American Eagle brand, which is very exciting.

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

As you think about the Aerie business and the rate of growth, can you talk a little bit about store openings? Obviously, you've opened a lot of stores over the past few years. How do you think of current store metrics? And how do you think of the growth of existing stores and what you're doing and adding on the product front?

We know Jen can answer part of it, but the part of it also is like we're very excited about Aerie. And OFFLINE, is a new concept for us. It's being very well-received. We think it's a big opportunity there too. And Mike, what do you want to add?

It's a good question, Dana. We're very focused on this, not just for the second half of the year but also as a major opportunity for us next year to improve profitability for the brand and the company. We understand that when we open many stores, there is a short-term impact as markets adjust to these new locations and digital shoppers begin to visit them. We anticipate a ramp-up in customer traffic and what we call the digital halo effect within six to twelve months. Regarding the 100 stores we just opened, we will carry these into the second half of the year, align our plans accordingly, and focus on this in 2023 as the digital aspects take off. You can estimate the potential revenue growth from these stores. If we position inventory conservatively yet appropriately, we can achieve mid- to high-teen operating rates, which is our goal for the brand. Based on this year's projected profitability, we foresee a significant positive impact for next year. We want to grow into these investments, having set aside $250 million in capital last year and the same amount this year, much of which is related to our Aerie and OFFLINE stores. From a cash flow standpoint, we aim to generate positive free cash flow and focus on the profitability of our investments. Therefore, we anticipate a smaller new store count next year to prioritize this focus, but we still see opportunities for store growth over the next three years. We believe there are substantial benefits to concentrating on the profitability of our existing investments in the upcoming four to six quarters.

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 for joining us today. And hopefully, next earnings call we have more positive news.

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