American Eagle Outfitters Inc Q3 FY2023 Earnings Call

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

Good morning, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Executive Chairman and Chief Executive Officer; Jen Foyle, President, Executive Creative Director for AE and Aerie; and Mike Mathias, Chief Financial Officer. Before we begin today's call, I need to remind you that we will make certain forward-looking statements. These statements are based upon information that represents the company's current expectations or beliefs. Results actually realized may differ materially based on risk factors included in our SEC filings. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Additionally, you can find our third quarter investor presentation posted on our corporate website at www.aeo-inc.com in the Investor Relations section. And now I will turn the call over to Jay.

Good morning. Overall, I'm pleased with our third quarter performance. Although the macro environment remains highly dynamic, we are seeing encouraging trends. Our brands remain stronger than ever, and our strategic priorities are propelling us forward. AEO's customers are at the center of our strategy, driving constant innovation that enables us time and time again to deliver exciting collections. And this fall was no exception. Additionally, we provided an industry-leading customer experience, reflecting our investments in data-driven insights and operational excellence. With the launch of our profit improvement program, structural initiatives to drive growth and higher margins are taking hold. Now a few financial and strategic highlights from the quarter. Third quarter revenue hit a record of $1.3 billion, driven by 5% comp growth, reflecting growing brand momentum and terrific fall merchandise collection. Our market-leading brands are true lifestyle destinations for our customers, and that was evident this quarter. Aerie returned to double-digit revenue and comp growth and AE generated positive revenues and comps. We also saw significant strength across digital and stores with new merchandise and strong execution, driving improved traffic across AE and Aerie. The digital channel was a star performer, accelerating to 10% growth. We are seeing great momentum here. Under the leadership of our new Head of Digital, David Zhang, we have introduced innovative customer engagement tactics, enhanced our use of data and analytics to drive stronger KPIs. This work has yielded a remarkable improvement in our e-commerce business and will receive plenty of runway ahead. Stores were also positive in the quarter. We are pleased with early results from new store designs, including our Gateway store in SoHo. The store encompasses all of our collections across AE, Aerie, OFFLINE, AE77, AE 24/7 and our unsubscribed seamlessly under one roof. New Aerie and OFFLINE stores are also coming out of the gate positive to expectations. Turning to profit. We achieved our second highest third quarter gross margin and operating income in over a decade. This was only second to 2021 when stimulus fueled exceptional results across the industry. Margin expansion to last year was driven by improved markup as well as numerous structural changes aligned with our ongoing focus on profit improvement. A few highlights of this work include maintaining tight inventory and promotional discipline, changing our clearance strategy to yield higher profit, scaling Aerie and shift in the product mix into higher-margin categories, modernizing our delivery network to reduce costs and optimize AE's Real Estate footprint. As we continue to drive strong demand and build momentum on this work, we are raising our full year operating income guidance to the high end of our prior range. We now expect to be in the range of $340 million to $350 million from $325 million to $350 million prior. Lastly, our capital allocation priorities remain unchanged. We are committed to investing in our brands and continued growth while returning capital to shareholders. Our balance sheet is resilient and we maintain a healthy liquidity position. We ended the quarter with $241 million in cash and nearly $900 million in total liquidity with no debt. Looking ahead, we remain intently focused on advancing our long-term strategic priorities to drive consistent growth across our portfolio of brands and generate efficiencies and cost savings for improved profit flow-through. We continue to advance towards our priorities and investing in talent, which further positions us for future success. During the quarter, as part of our COO, Michael Rempell succession plan, we made 2 key leadership appointments. We are excited to welcome Sarah Clarke, our new Chief Supply Chain Officer, who is responsible for ensuring operational excellence across our global supply chain from sourcing through distribution. And a welcome to Valerie van Ogtrop, our new Head of Brand Operations, a role we created to drive greater collaboration and synergies across AE and Aerie's growth and profit plan. Sarah and Valerie nicely complement our teams of experienced executives and excellent bench of division leaders and associates. There's a high level of focus and energy across the organization around our profit improvement project. We've had strong engagement from our leadership teams with great support from our Board of Directors. We are harnessing our innovative spirit to rethink how we operate every day and with work streams focused on unlocking both revenue growth and efficiencies moving forward. We intend to host an Investors Meeting in Spring of 2024, where we will unveil specifics on our go-forward strategy and provide long-term financial targets. And in the near term, with incentives fully embedded in our 2023 expense base and early benefits from our profit improvement initiatives, I am confident of our ability to leverage expenses, even on modest sales growth in 2024. AEO has enduring brands, robust operations and strong talent. I am confident that with our strong foundation and new strategic direction, we have the right recipe in place to build revenue and profit from here and deliver shareholder returns.

Thanks, Jay, and good morning, everyone. As Jay noted, we had a strong quarter with sequential improvement across brands and channels. All collections were well received, and I am proud of how the teams executed on our brand strategies. It was incredibly exciting to see American Eagle return to growth with revenue and comps of 2%. We delivered a winning assortment that showcased our incredible brand heritage and an exciting customer experience. Women's was particularly strong where we wrote positive comps across tops and bottoms. We are seeing strong demand for fleece, tees, skirts and newer bottoms such as twills, cargoes and wider legs. Men's saw strength in tees, sweaters, twill bottoms and shorts. AE also delivered strong operating profit growth, up 6% to last year, aligned with the strategic plan we laid out in 2021. We have made significant progress in improving the health of the AE brand over the last few years. We stepped away from low-margin sales, rationalized SKUs to eliminate unprofitable offerings and optimize our brand's Real Estate footprint. As a proof point, third quarter brand profit is up 20% compared to third quarter 2019 levels with revenue modestly down 2%. With profit restored to a healthy level as discussed in prior quarters, we are strategically focused on growth. Early initiatives have been highly impactful, and I'm pleased to note that AE returned to growing its customer file this quarter. Casual wear is a lifestyle that continues to evolve, providing exciting new trends for us to drive and play into. We are focused on expanding our dominance in denim, leveraging our industry-leading fits and fabrics to deliver newness. At the same time, we are also making investments to better penetrate categories and occasions that are important to our customers with collections like AE 24/7 and men's activewear and AE 77, our premium capsule. We are also continuing to invest in our store fleet to improve productivity and ensure we put our best foot forward. We have seen a positive response to AE's new store design with remodeled stores delivering significantly improved comps. Based on the success of these initial tests, we are expanding our remodel program next year to include additional stores while continuing to close and reposition low productivity locations, and we are also focused on improving inventory allocation and replenishment to better serve our customers. And lastly, we continue to leverage and innovate marketing campaigns, amplifying excitement around the AE brand. This fall, we collaborated with the Ziegler sisters on a limited-edition capsule to showcase key fashion items for back-to-school season. This included our marketing event, a powerful takeover on the High Line in New York City and an immersive installation that stopped New Yorkers in their tracks. We showcased the quality and versatility of our iconic denim assortment underscoring our strong heritage and dominance in the category. The campaign outperformed our expectations, driving strong sales, both online and in stores. Now turning to Aerie. We had an exceptional quarter with revenue and comps up 12% and profits expanding 34%. Newness and assortment changes in our core intimates business drove a nice sequential recovery. We grew market share and had our best-ever third quarter performance in core brand. We also continue to see rapid growth in our core apparel business with particular strength in fleece and sweaters where new collections are resonating very well. Our activewear collection OFFLINE also had a great quarter, achieving double-digit growth. Aerie has seen incredible expansion over the last few years, growing into a beloved destination for exciting fashion and comfy cozy fits in intimates, apparel, sleepwear and activewear. Since 2019, we have doubled our sales and quadrupled our profit. We are gaining new customers every season with our total customer file now over 10 million. Yet, with just a low single-digit share of close to $80 billion total addressable market, we are just scratching the surface. Activewear, in particular, provides an attractive opportunity fueled by strong demand for athleisure. We see a unique opportunity to build share here with OFFLINE, Aerie's vibrant and playful take on activewear as we continue to develop the assortment. We are focused on continuing to build brand awareness as we leverage investments in our store fleet and innovative marketing strategies to grow our customer base and share of wallet. New store performance remained strong, providing a positive lift to comps as they come into the company. Additionally, OFFLINE openings are exceeding plan. On the marketing side, Aerie's fall campaigns were focused on elevating the brand as the go-to for high-quality, fashionable and comfortable intimates and apparel. We showed up across the season within the way of notable influencer talent and programs. This included a first-to-market partnership with a popular dating app, encouraging users to find their perfect match with Aerie. We also hosted the Hidden Gems Marketplace, a fun, interactive customer event in New York City that generated strong marketing KPIs. We have 2 of the best brands in retail. Through over a decade, we have consistently ranked in the top 3 brands in the Piper Sandler Taking Stock with Teens survey. AE is the market leader in denim in the age 15 to 25 cohort, the #2 brand across all ages and the #1 brand for women in particular. Aerie is one of the most exciting brand platforms in fashion, celebrating body positivity and empowering women to feel their best selves every day. It's a strategic priority to profitably grow our portfolio of brands, and I see meaningful opportunity ahead. Before I turn this call over to Mike, a big thank you to the AE and Aerie teams for their hard work in delivering a strong quarter. Our brand, category and channel strategies are gaining momentum, which is a true testament to this talented team.

Thanks, Jen. Good morning, everyone. As Jay mentioned, third quarter results marked continued progress on our strategic priorities to grow our brands and set us up for improved profit flow-through. Strong brand momentum, combined with actions taken on our profit improvement initiatives, resulted in improved gross margins and operating income year-over-year. We entered the quarter with momentum that continued into the early holiday season, fueling a strong top line result. Consolidated revenue of $1.3 billion was up 5% from last year, and comparable sales also rose 5%. Operating income of $125 million reflected a 9.6% operating margin. Gross profit of $544 million increased $64 million, representing a gross margin of 41.8%, up 310 basis points from last year. As Jay noted, we achieved some of our highest merchandise margins on record, reflecting strong demand, lower costs and several benefits from our profit improvement initiatives. Inventory discipline resulted in lower markdowns as we maintained healthy promotions. With the change in our clearance model announced last quarter, we continue to sell through end-of-season merchandise at better margins. We also saw leverage on rent, reflecting our focus on strengthening fleet productivity at AE and the ramp-up of new Aerie stores as well as improved delivery, distribution and warehousing costs with efficiencies across several key metrics, including lower shipments per order and lower cost per shipment. SG&A expense of $362 million was up 16% from last year and in line with guidance. Consistent with strong business trends, roughly half of the increase was driven by incentive expenses after no accruals last year. As discussed last quarter, incentives are weighted to the back half of this year. Payroll also increased largely due to higher wages. Depreciation was up year-over-year and in line with guidance provided last quarter, primarily reflecting our investment in new stores. As noted previously, we have reset incentives to reflect improving business performance. With incentives now on our base and an ongoing focus on cost efficiencies, we're well positioned to leverage our expenses based on modest top line growth next year. EPS for the third quarter was $0.49 per share. Turning to our brands, Aerie revenue and comparable sales increased 12% in the third quarter, a positive noncomp lift from these stores was offset by lower third-party sales, reflecting greater inventory control and our shift to a more profitable clearance model. Aerie's operating margin of 19.3% hit an all-time high, expanding over 3 points from last year as the brand continued to scale, and we saw improved markups, lower markdowns and early benefits from the clearance shift. American Eagle revenue and comps increased 2% with the operating margin expanding 70 basis points to 21.5%. As we discussed on numerous occasions, our focus over the past several years has been strengthening the profitability of the AE brand. I'm extremely pleased with the progress we've made, expanding profit margin by 400 basis points since the third quarter of 2019. We're now turning our attention to growing the top line with a sharp eye on profit flow-through. Consolidated ending inventory cost was down 4% compared to last year with units down 3%. Inventory levels remain healthy and controlled as we maintain buying discipline and case demand. We ended the quarter with a balance sheet in strong position, including $241 million of cash and total liquidity of $875 million, including our revolver. Capital expenditures totaled $43 million, and we continue to expect full year CapEx to be in the range of $150 million to $175 million. Our plan for our consolidated store count in 2023 remains roughly flat to last year, reflecting approximately 25 new Aerie store openings offset by approximately 25 net closures for the AE brand. Before I move on to our outlook, I'd like to provide more color on our ongoing profit improvement work. Last quarter, we made an important change to our clearance model. This is tracking in line with plan to generate $25 million in savings in 2023 and $50 million in savings on an annualized basis. As we continue to lock down efficiencies that have supported our gross margin expansion, other significant work streams within SG&A have also been identified and are being actioned on. We are instilling an internal culture around continuous improvement and expense management, the results of which are incorporated into our plans for 2024. As a result, next year, we expect to drive continued gross margin expansion, leverage on SG&A and depreciation, operating rate expansion and healthy earnings growth, structuring the business to deliver this with low single-digit revenue growth. A more positive trend would drive incremental leverage and profit flow-through. We'll give further details in future months as we provide our specific expectations for 2024 and beyond in the spring. Quarter-to-date, we are seeing sustained momentum across our brands with revenue up in the mid-single digits. Additionally, we continue to make good progress in executing on profit improvement initiatives. With this background, we're raising our full year outlook for operating income to the high end of prior guidance. We now expect to be in the range of $340 million to $350 million. This reflects revenue up mid-single digits with comps up low to mid-single digits. For the fourth quarter, this implies operating income in the range of $105 million to $115 million, with revenue up in the high single digits, including a 4-point tailwind from the 53rd week. Comp sales are projected to be up in the mid-single digits. SG&A is expected to be up approximately 20%, including a 5-point impact from the 53rd week. As previously discussed, it also includes higher incentive accruals, which are skewed to the back half of this year. As Jen mentioned, we look forward to providing more color on our long-term strategic priorities and financial goals at our Spring Investor Meeting.

Our first question comes from Matthew Boss with JPMorgan.

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

Sure, and happy Thanksgiving to everyone. I want to take a moment to celebrate our achievements in Q3. My team, including Jay's team and everyone at American Eagle, spent time in stores last week, visiting almost 20 locations in just 2.5 days. This commitment reflects our dedication to the long-term success of our strategy. I'm very proud of our results in Q3, particularly in Women's at AE, where we significantly outperformed Men's. We're excited about what we have planned for spring, focusing on relevant fashion trends. We've also been improving our merchandising categories for the past three years, and now we are ready to make a strong move at American Eagle, which I believe will pay off. Regarding Aerie, we’ve managed to maintain our market share in bras despite industry declines, and I see great potential for growth in this $80 billion market. Looking ahead to Q4, with many weeks still to go and the important Green Friday coming up, I'm confident in our readiness to compete. As Mike mentioned, we will share more about our long-term growth plans in the spring. I can see our progress, and I am optimistic about building a strong brand strategy moving forward.

Yes. And Jen, when you were in the stores, you would agree that our stores were the best-looking stores out there.

I think so. I think the way we operate. It's one thing to grow your business, it's another thing to deliver operational excellence. That's what I have to say.

Yes. In terms of profit improvement, the third quarter demonstrated our focus on reducing expenses and enhancing margins, leading to gross margin expansion. For three consecutive quarters, we've seen this growth in gross margin. We capitalized on expenses in this area, and we plan to continue this in the fourth quarter. This work is part of a multiyear journey, especially regarding SG&A, which will require more time as we examine labor models, services, and vendor contracts to negotiate reductions or consolidate vendors. We have a clear view into 2024 and understand the prospective benefits. We anticipate that gross margin expansion will persist next year, allowing us to leverage SG&A with low single-digit revenue growth, and anything better than that would yield even higher leverage compared to our historical model.

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

This is Kelly on for Paul. Could you just talk about how the clearance strategy change impacted the P&L this quarter? Was it a headwind to sales? And how much of a benefit was it to the gross margin in Q3? And how do we expect that to impact Q4 and FY '24 from both a sales and margin perspective? And then I have a follow-up.

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

Regarding the SG&A guidance for the fourth quarter, I believe the expectation was for SG&A to increase in the mid-teens. I'm trying to understand what is driving the larger growth in the fourth quarter compared to your earlier projections. Is this primarily due to the accrual of incentive compensation? Additionally, you've mentioned looking for cost savings for some time now, so I'm curious why we're seeing a greater offset.

Yes. I believe the 20% increase includes 5 percentage points from the additional week, bringing us back to mid-teen growth, similar to Q3. Half of this increase is linked to changes in the incentive accrual, while the other half relates to different expenses. As mentioned regarding SG&A, we anticipated a longer timeline for benefits. There are some advantages included, but not the level we expect for 2024, as we have clarity on several work streams currently in progress. The teams are integrating these insights into 2024. We've consistently noted that the benefits from SG&A would be more apparent next year and even extending into 2025. Some factors will continue beyond the upcoming year. Our primary focus on gross margin is evident in the second half of the year, and I'm very pleased with the positive evidence of our team's efforts for next year when SG&A and depreciation leverage begin to take effect.

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

As you think about the store remodels, and I was in the one downtown on Broadway on Sunday, and it was busy and it looked good with all the concepts together. How do you think of the remodels? What type of lift are you getting? And how much of CapEx would that play into it? And when you think about the digital and store channel performance by brand this quarter, biggest differences that you saw and how you're planning promotions for holiday in each channel?

I'll start, Mike, and then you can take over. The Gateway, we're calling it The Gateway, as a reminder, it's the first facade that you see as you enter Soho. And this incredibly talented team came up with and they did some research. And thus the name The Gateway. And what a place to highlight all of our brands and all the work we're up to. So I could not be more proud on that delivery, and there's more to come there. And there's learnings that I think we're going to leverage for the future. That said, as we think about the new store design, there's more out there. American Eagle has this incredible new lived in store design. And I mentioned it in my comments, those comps are exceeding, when I say exceeding the average sales comp in the brand. So many learnings there, and we're going to test and scale but we love this new design. It's so fun. And it's been a long time coming for the American Eagle brand to show up the way we deserve. So I love what I'm seeing there. As we fast forward, there's so much good in play here. The learnings that we've had over the past 3 years in American Eagle particular. We've definitely rationalized this brand. We've closed stores. We've done everything, and now it's time to forge forward and get what we deserve back. And I love what I'm seeing from the teams. I just looked at spring concept and our windows and the product that's coming in and like a good bottle of wine, it gets better with age. There's a lot to hurdle out there but I feel really proud of what this team is doing Aerie. That's a whole other story. It's about time. We have that halo effect on the comps with the new stores. And we did say that in prior calls. We acknowledge that, that it takes time to halo a new store opening and learning from that, and well, here we are. So we love what happened in Q3. And then on direct, well, so everyone talks omni but I think the best retailers look at each channel and drive what they are best at. And this is what the direct team is up to. You heard the comps are at 10%. But I want to say that this company is very modest in its ad spend and so we do it with a lot of return, and I love what this team is up to.

Just to provide some additional insights on remodels, as Jen mentioned, we have several locations that we are pleased with, along with four mall-based locations that we've remodeled. Early indications suggest that these locations are experiencing a significant and positive sales increase. We plan to share detailed plans for the AE brand growth strategy in the spring, which will include renovations that support other initiatives Jen and the team are pursuing to expand the brand. Currently, we are looking at approximately 50 more remodels for next year to help drive that growth strategy.

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

Jen, you mentioned you're excited about the spring product assortment. Just talk about the swim category a little bit, what you're seeing in that category, how do you think that is going to perform versus last year? And then maybe just, Mike, I believe the company has a business in the Middle East through some of its franchise partners. Can you just talk about how that business has trended since October and if that has an impact on the quarter or your guidance for the fourth quarter?

I apologize for the disconnection. Swim is indeed an interesting category with plenty of insights. It remains a strong, high-margin business for us. Our teams have been focusing on how to steer the business toward a more profitable growth path. I just returned from Brazil, where my teams gathered some valuable trends that we are actively incorporating. We are also expanding our testing and scaling efforts in that market. Furthermore, we are analyzing our brands, including American Eagle and Aerie, to explore how they can complement each other, particularly since both women’s business lines, Aerie OFFLINE and AE, are experiencing growth together. It's impressive what we can achieve when we approach the business collaboratively. As I consider swim and trends, I take into account all of our women's brands and how we can position ourselves for growth across all categories, which I believe gives us a competitive advantage. Regarding swim, that's our approach—balancing ambition with the understanding of our high-margin focus and ensuring we carefully test and scale. We also have opportunities across our brands that we can utilize. Spring looks promising, and I am hopeful we can keep delivering strong results.

I will address the question regarding the Middle East. Our international business in that region is strong. Initially, there was a slight slowdown, but recently, we've seen a solid rebound. Therefore, we're very optimistic about our prospects there. We're also hoping for a peaceful resolution in the future for that area.

Our next question comes from the line of Simeon Siegel with BMO Capital Markets.

I just want to express my gratitude for your support at the Times Square store; it truly meant a lot. Could you provide any insights regarding the gross margin drivers for next year? Additionally, congratulations on the strong growth in brand level EBIT dollars. Can you share any thoughts on the anticipated growth in corporate expense dollars that we should consider moving forward?

On gross margin expansion, we have clarity on our purchases for the first half of the year. We anticipate positive factors improving our initial markup and thus benefiting our margins. There is also an ongoing realization of many benefits we previously observed in expenses and gross margin. We have visibility on our shipments per order and cost per shipment for the first half and expect to continue seeing advantages in our expense categories. We still observe benefits in areas such as rent, delivery, distribution, and warehousing, which will have a long-term positive impact as we progress into next year. Additionally, we have at least half of the year's expansion and markup included in our current plans.

Yes. And Mike, like we also see like an opportunity like the international part of the business still growing. We see that as a great growth vehicle, too, international part too.

Great. And then just the corporate expense dollars?

Yes. It's again, just tied to everything else we talked about from a profit improvement perspective. There's pieces being embedded into our plans as we speak for next year, really across all areas of the P&L, just expanded on the gross margin opportunity that still exists, and then corporate expenses that really straddle both gross margin and SG&A, making changes to labor models in the next year, services line items, maintenance line items, those tender being embedded, all the benefits we're seeing from the work happening as we speak being embedded in next year's plan.

Yes. Additionally, I believe Mike is indicating that he does not expect SG&A to increase next year.

Yes.

Yes. Great. And then just a quick one, it's a follow-up. How should we think about the right total sales to comp spread for Aerie at this point?

It's only a few points now. I think as we anniversary all that store growth in '21 and '22, that comp spread definitely less than digital comp. We're only opening 25 stores this year. So really, as we get past this year, you only have those 25 in a noncomp base. So it's maybe a point or 2. It's probably low single-digit spread.

Our next question comes from the line of Christopher Nardone with Bank of America.

Two questions. First, could you clarify how comps are trending quarter-to-date for each brand, specifically? And then as we think about next year, how much do you think operating margins can expand? And is this low single-digit sales growth you mentioned, is that your base case for next year? Or is it more of a point that you can still leverage costs on that level of sales growth?

I'll address the second part first. We are not providing specific revenue guidance at this time. However, we believe that we can increase our operating rate and leverage expenses even with a modest sales growth next year, considering our current plans. So far this quarter, our comparisons are similar, and we are maintaining guidance consistent with the 5% growth we achieved in Q3. We are just a few weeks into the quarter and have around 20% of our revenue in, with the peak weeks about to begin, but we remain within our guidance, expecting similar performance for our brands. Regarding operating leverage, we anticipate expanding our operating rate by 100 to 150 basis points for the year with the low to mid-single-digit sales growth we have projected. As we move into early next year, we will provide more detailed guidance for 2024 in March, including our expectations for leverage based on different revenue outcomes. The initial point is that we see a chance to leverage costs and increase gross margin, as well as to enhance operating rates by managing expenses across the entire P&L, rather than just in gross margin as we have done in the latter part of this year. This is an early indication of our outlook for 2024, and we will share more specifics in March.

Our next question comes from the line of Kathryn Hallberg with TD Cowen.

This is Katy on for Jonna. I just wanted to dig in a little bit to the intimates category and how you're thinking about Aerie's brand positioning there as well as the performance within intimates. I know you mentioned market share was pretty consistent across bras, I believe. And then just briefly, I'm sorry if I missed this, but can you talk a little bit about traffic trends through the quarter?

Great question. We're maintaining our position in the intimates category, which represents an $80 billion opportunity, and we're only beginning to explore this market. When we introduce new products, like our smoothies, which have become a key part of our business, we achieve success because customers trust us in this area. They appreciate the comfort and how it embodies our brand values. There's more to come. We now have a solid foundation to compete effectively. This aligns perfectly with Aerie's daily mission to empower women, and smoothies contribute to that goal. The bra market has evolved, and I can assure you that our design and merchandising teams are continuously innovating to engage our customers. We have a lot planned for the future, and I believe we will effectively compete on our terms, aligning with our brand platform and product offerings. While I can’t reveal everything just yet, there's significant potential in this market, which has been overlooked, and we are committed to meeting our customers' needs.

Traffic was healthy throughout the quarter. We saw positive traffic across brands and channels, so both in stores and in digital. And this is sort of kudos to the team. Within our profit improvement work, we're not looking at reducing marketing expense, but we've done a ton of work to optimize how we're spending media to drive healthier and more qualified traffic. And then we're actually seeing significant benefits to digital conversion, especially really conversion in both channels but the work that David and team are doing on the digital side to convert that traffic and make A/B testing, making continual changes to our customer journey and how we're messaging the customers we're seeing the digital benefits. So we've got a lot of work happening on driving healthy traffic and then a lot of work happening on converting that traffic, and we're seeing those benefits to the back half and believe that's going to continue into next year as well.

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

Great. Jen, you talked about your growing customer file, your file, excuse me, I believe it's now over $10 million. Could you maybe provide a little bit more color as to what you think the major drivers of that are perhaps contextualize the growth that you've seen in this customer file and how that's benefiting the overall enterprise?

Sure. Let me just reiterate that both brands have customer file growth. So really exciting to see AE take a position on growth as far as not even just their comps but their file and Aerie grew nicely. Both brands are just really dominating on a 360 approach to marketing. So not only are we spending on performance. In fact, when we spend on performance marketing, we ensure that it delivers a return on investment because it's an easy game to go out there and overspend on performance and dominate. It's not that easy to have a 360 approach to marketing, right? So that means when we think about what we did actually, coincidentally but not so, when we had installations in the Meatpacking District in Aerie, and in AE, we took over that district in New York City. Well, how many eyeballs are on our brands, right? Between that, between our influencers, between our store influencers, don't forget about that, our stores represent our customer, right? So when we go to a store, we see our customers, they're our employees. And by the way, they spread the good news of our brands, and they see all the work that we're up to, right, delivering better product, delivering innovation, delivering new store concepts. We haven't stopped. As a reminder, The Gateway, I find this just as a testament to the team. In July, we came up with this idea to put all of our brands together in SoHo and to see what it means to our company, AEO, Inc. And well, in July, we came up with a concept and lo and behold, we have a whole new store design, brand new ideas, innovation at its max. So again, it's not just one thing when it comes to delivering sustainable long-term growth and brand power. This is what we're up to. We believe we are next in show to the #1 brand out there, I'm not going to say, but trust me, it's a big brand. And top of mind is AEO, Inc. And so when we think about our brands that way, we think about the long-term growth, long-term strategies and how we're going to be one of the most powerful brands in retail. So again, it's not about just one tactic in marketing, it's about thinking about the future and how we're going to be the best in town.

I'd like to mention that with the 25 stores we're opening this year, since 2021, we would have opened around 100 to 150 locations. This aligns with our strategy for customer file growth and acquisition. These stores are still in the early stages of development, and we'll be opening more locations next year. Everything you're discussing from a marketing standpoint, along with this brick-and-mortar expansion for the brand, shows that we still have opportunities to increase our store base and enhance our customer file. We operate within a sizable addressable market where we currently hold only a small share.

Got it. And then just to follow up on that, Mike, on the topic of store openings. Could you provide any color as to how to think about the AE store fleet as we look ahead? And then just did you also talk about how AUR trended in the quarter? I know you talked about traffic but could we get color on AUR trends and then how you think about that throughout the remainder of the year?

I hit AUR first. AUR was up in the quarter. We talked about kind of holding on to that AUR position that we've been able to grow to over the course of the pandemic, the brand equity we've built, we're not giving back up. It's part of the gross margin expansion story for sure. Your question on AE store count, we're still talking about a net 25 closures this year. But we're coming to the point where that, that number will be similar to maybe down. We're actually continuing to explore repositions in market versus net closures, and we're seeing healthy results from some of those strategic moves. So again, as part of an AE brand growth strategy, we'll articulate where we think the fleet is going when we provide more color in spring but square footage reduction won't be as significant as it's been in the last several years as we've reset the profitability of the brand.

Our next question comes from the line of Alex Straton with Morgan Stanley.

Perfect. Maybe taking a step back, what part of the profit improvement plan has been the most impactful in your eyes so far? And then how should we think about the next leg? And then secondly, I feel like we haven't heard your latest thoughts on the Quiet Logistics business in some time. So perhaps if you could provide an update there, that would be great.

I think we have been discussing this for about nine months now, focusing specifically on gross margin. This includes aspects like margin and markdown, as well as inventory management. In the third quarter, we achieved 60 basis points of leverage from gross margin expenses. We've managed to leverage these expenses every quarter this year, and we anticipate continuing this trend moving forward. The results from this year demonstrate that leverage and validate the efforts we're making. Since this has been our main focus and we're seeing results, I feel very confident about what we're planning for 2024 regarding SG&A and depreciation to maintain this momentum.

Yes. Yes. And Mike, on the Quiet part of the question, Quiet has provided us enormous benefits to our brands and we're starting to see a flow-through on the gross margins. We're starting to use it more in our sister company, Todd Snyder will go onto the Quiet platform this year. And we're also seeing an opportunity to still strengthen our third-party business too.

Melissa, we have time for one more question.

Our final question today comes from the line of Janet Kloppenburg with JJK Research Associates.

A couple of questions. First, Mike, could you provide the breakdown of the gross margin improvement? I'm just wondering about how much came from freight and how much came from markdown improvement and what we should look forward to going forward? Also on SG&A, I know you said you'd leverage next year, which is terrific. But when I look at the SG&A increases in the first half of this year, they were mid-single digits. So should we expect first half next year to have higher bonus accrual? I'm not sure there. And Jen, if you could help on AE men's, was it positive for the quarter? And what's your outlook book there? And maybe you just talk a little bit about the legging business because I know that's a very high-margin business for you at Aerie.

On the gross margin components, we observed benefits in all areas, including product margin improvements, effective markdown rate management, and lower markdowns, as well as expense leverage through gross margin. This encompassed all three components. Regarding SG&A for next year, I believe the growth in the first half will be in the mid-single digits. Our plans for 2024 include allocating 80% of our SG&A budget to compensation, advertising services, and certain maintenance areas. We are implementing changes that were not part of this year's plans, and these will affect all components in our 2024 strategy. You are correct that we might experience a different flow regarding incentive compensation compared to the current second half of the year, but we can provide more detailed information about how the quarters will shape up once we issue specific guidance in March.

Men's has been weaker compared to women's, which we anticipated as we moved into Q3. We focused significantly on the women's segment of the American Eagle business, and the results reflect that: the comparable sales were much stronger in women's than in men's. However, this doesn't imply that we lack opportunities in men's. In fact, we view it as low-hanging fruit as we progress through the latter part of this year, specifically Q4, and into Q1 and Q2 of next year. We've been putting in substantial effort, and I definitely see men's as an area where we can be more efficient. Historically, we may have offered too many options in that category, and we can certainly streamline our SKUs while continuing to enhance the women's business. As for leggings, I consider that a key part of our offering; this category is here to stay. We have strong innovation in this area. If you haven't tried our leggings, particularly the Aerie Real leggings, you absolutely should—they are fantastic. The Real Me leggings are among our top-selling items due to their excellent design and comfort. Everything ties back to our brand identity, and Real Me embodies what Aerie represents. There's a lot of positive momentum happening in OFFLINE as well. We had an inspiring discussion this week about the significance of OFFLINE to the Aerie brand on its own. It's impressive to see both OFFLINE and Aerie performing well in the same mall; customers are responding positively. Additionally, there are some overlapping products available in both stores. This suggests that as we explore growth for Aerie, we have further opportunities for both brands ahead. To reiterate, leggings are a staple that isn’t going away. I’m also excited about the women's denim business, which is showing promising early results. Essentially, we can offer both: she can wear leggings to a gym class and then switch to our denim for going out, and that's the direction we're headed.

Thank you. That concludes our question-and-answer session. I'll turn the floor back to Mr. Schottenstein for any final comments.

Okay. Thank you, operator, and thank you for all joining the call this morning. I hope this is clear in our third quarter results, we are seeing momentum building across our growth and profit improvement initiatives. This is a strong testament that our strategies are working. Like Jen was saying, we're here to build enduring brands, whether it be AE, Aerie, OFFLINE and Todd Snyder. We are focused also on driving consistent profit growth and return to our shareholders. Thank you for your interest and investment in the company, and we look forward to updating you in the coming year. Thank you.

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