American Eagle Outfitters, Inc. (AEO) Long-Term Strategy and Q4 2023 Earnings Presentation (Transcript)

American Eagle Outfitters, Inc. (NYSE:AEO) Long-Term Strategy and Q4 2023 Earnings Presentation March 7, 2024 11:00 AM ET

Company Participants

Judy Meehan – SVP of Corporate Communications and IR

Jay Schottenstein – Executive Chairman & Chief Executive Officer

Jen Foyle – President, Executive Creative Director for AE & Aerie

Mike Mathias – Chief Financial Officer

Conference Call Participants

Matt Boss – JPMorgan

Jay Sole – UBS

Janet Kloppenburg – JJK Research

Kelly Crago – Citi

Adrienne Yih – Barclays

Dana Telsey – Telsey Advisory

Dan Stroller – BMO Capital Markets

Jonna Kim – TD Cowen

Chris Nardone – Bank of America

Corey Tarlowe – Jefferies

Alex Straton – Morgan Stanley

Marni Shapiro – The Retail Tracker

Judy Meehan

Good morning, everyone. Today, we are hosting an extended Earnings Call to discuss our Fourth Quarter and Fiscal 2023 Financial Results as well as our New Powering Profitable Growth Strategy and Three Year Financial Targets.

The call will include prepared remarks from Jay Schottenstein, Executive Chairman and Chief Executive Officer; Jen Foyle, President, Executive Creative Director for AE & Aerie; and Mike Mathias, Chief Financial Officer. This will be followed by a question-and-answer session. We expect to conclude the call at approximately 1 o’clock.

Before we begin, I would like to refer you to our safe harbor statement and additional disclosures around non-GAAP results posted on screen. 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 ww.aeo-inc.com in the Investor Relations section. Following today’s call, this is also where you will find a replay and our fourth quarter investor and powering profitable growth strategy presentations.

Now, I will turn the call over to Jay to kick it off with a quick review of key highlights of our fourth quarter and fiscal 2023 results. Jay?

Jay Schottenstein

Good morning. Thanks for joining us.

Earlier today, we unveiled our new long-term strategy and financial roadmap. Our focus is simple. Powering profitable growth. We are excited to share the details of our plan with you. But first, let me begin with a quick overview of last year.

I’ll start with a huge thanks to our teams for the perseverance and commitment throughout 2023. I am especially proud of the strength we delivered in the second half of the year as we began to implement actions from our profit improvement project. Building on momentum in the third quarter, we achieved record fourth quarter revenue and adjusted operating income reached the highest in over a decade.

With strong execution, we nicely exceeded expectations even after raising guidance in early January. While Mike will provide greater details, during the fourth quarter, we took a non-GAAP charge as we look to strengthen overall profitability. Our 2023 revenue reached a record $5.3 billion and we registered $375 million of adjusted operating income.

With the exception of 2021, this was our highest adjusted operating income result since 2012. We generated strong cash flow and we ended the year in a very healthy financial position. Cash and investments more than doubled from last year reaching $454 million at year end.

We exited 2023 with clean inventory, well positioned for our go forward plans. Reflecting improved financial performance and a healthy balance sheet, in December we announced a 25% increase in our quarterly cash dividend. And in February, we authorized 30 million shares for repurchase. This underscores our confidence in the strength of the business and our commitment to returning cash to shareholders. We enter 2024 well positioned with industry leading brands, a solid balance sheet and best-in-class operations.

Our profit improvement initiatives are taking hold and we expect to deliver nice revenue and profit growth in 2024, which Mike will detail shortly. We remain steadfast in operating the business with balance, staying agile and flexible to capitalize on demand opportunities while optimizing profitability for the foreseeable future.

With that, I will pass it over to Jen for some brief merchandise and marketing highlights of the Q4.

Jen Foyle

Thanks, Jay, and good morning, everyone. I’m very proud of our fourth quarter performance.

We saw sequential improvement across brands and channels and we achieved record revenue for both AE & Aerie. Merchandise margins were strong driven by inventory discipline and favorable product costs. We brought excitement with newness, including a fresh take on some tried and true classics. Collections were on trend, including an amazing array of gifting options that did very well over the holiday season.

As I will review in today’s strategy presentation, we saw early results from a number of new brand initiatives. Strong product, engaging marketing and an unparalleled shopping experience is delivering customer growth. In fact, at over $22 million our total customer count expanded across brands reaching an all-time high.

Now some brand highlights. American Eagle revenue grew 11% fueled by a 6% increase in comps. The extra week contributed approximately 4 points to brand revenue. Strength was broad based across jeans, pants, tops, sweaters, and outerwear. Women’s outperform men’s, yet both saw meaningful sequential improvement. The AE brand operating margin expanded 100 basis points to 17%.

As we have turned our attention to driving growth at AE, we are placing a renewed emphasis on top sellers and expanding availability across the store base. Our new store design is showing nice results, providing a positive lift to comps.

I’ll talk more about these initiatives later. However, we are incredibly pleased with the early results. They provide a strong proof point of our strategy to deliver profitable growth, which we are excited to share with you later today.

Now turning to Aerie, revenue grew 16% with comps increasing 13%, locking in yet another record fourth quarter. The extra week contributed approximately 4 points to brand revenue. Growth was led by soft apparel and our flourishing OFFLINE Activewear business, both of which posted double-digit growth.

Aerie operating margin of 16.2% hit an all-time fourth quarter high. This is a 400 basis point expansion to last year as the brand continued to scale. We also saw improved markup and lower markdowns. New stores are providing a tailwind to comp growth as they enter the comp base and are boosting margins as they ramp up through the maturity curve.

All-in-all, we had a very successful holiday season and fourth quarter across our brands. I’d like to thank our amazing teams for their hard work, talent and commitment. We made tremendous progress throughout the year and I look ahead, I’m very optimistic as we build on positive momentum. I look forward to sharing our go forward plans in a little bit.

And now, I’ll turn the call over to Mike to review the rest of our financial results.

Mike Mathias

Thanks, Jen, and good morning, everyone.

As noted in our press release and earlier in the call, fourth quarter 2023 results are presented for the 14 weeks ending February 3, 2024 compared to the 13 weeks ending January 28, 2023. Comparable sales metrics are presented for the 14 weeks ending February 3, 2024 compared to the 14 weeks ending February 4, 2023.

We’re very pleased with how we performed during the second half of the year when our profit improvement work began to take hold. We saw a sequential acceleration in revenue growth across brands with an exciting return to growth for American Eagle. This came hand in hand with a significant improvement in profit flow through where we saw a 320 basis point improvement in our second half adjusted gross margin over last year.

As we’ll discuss shortly, the early results from these initiatives gives us tremendous confidence in our go forward plans. Fourth quarter revenue of $1.7 billion marked a new company record, rising 12% to last year. The 53rd week contributed $57 million or approximately 4 points to growth. The adjusted operating margin increased 200 basis points to 8.4%.

Compared to last year, adjusted gross profit dollars increased 23% to $626 million and the gross margin rate expanded 340 basis points to 37.3%. Merchandise margins improved reflecting strong demand, lower costs, and a number of benefits from our profit improvement initiative. Inventory discipline drove lower markdowns and BOW expenses also leveraged. This was led by rent, delivery, distribution and warehousing costs, with a partial offset from higher incentives as we lapped zero accruals last year.

SG&A expense of $427 million was up 22% to last year. Consistent with strong business trends, roughly half of the increase was driven by incentive expense. Store payroll also increased driven by higher wages and additional hours associated with the 53rd week. As a rate to revenue, store payroll was flat to last year. Depreciation was down slightly year-over-year, leveraging 50 basis points. As we will discuss today, with incentives now in our base and an ongoing focus on cost efficiencies, we’re well positioned to leverage our expense base moving forward.

Adjusted EPS for the fourth quarter of $0.61 per share was up 65% to last year. Consolidated ending inventory cost was up 9% year-over-year with units up 11%. As Jay noted, inventory levels remain healthy and we ended the year with a strong balance sheet. CapEx totaled $39 million bringing full year spend to $174 million in line with our guidance. We have entered 2024 well positioned with a clear path to value creation from here.

As I will discuss throughout today, our profit improvement initiative remains a top priority. As part of this work, in the fourth quarter, we took a number of additional steps to streamline business priorities and strengthen the organization. This included restructuring the company’s distribution network, international operations, and associated corporate overhead.

We recorded a $131 million impairment in restructuring charge in the fourth quarter, of which $119 million was non cash. This will result in approximately $20 million in annualized savings beginning in 2024. Now onto guidance. For the year, we are guiding operating income of $445 million to $465 million This reflects revenue growth in the range of 2% to 4%, including an approximately one point negative impact from one less selling week.

As we control expenses, we expect to drive SG&A leverage. Based on the current plan, full year SG&A dollars will be flat at the low end of our revenue outlook. As a result of restructuring actions taken in the fourth quarter, we expect D&A of approximately $220 million for the full year. Our tax rate assumption for the year is in the high 20s. And at this time, we are projecting a weighted average share count in the high one nineties.

Now, I want to provide a little more color on 2024, as a few important factors will impact the cadence of the year. With easier year-over-year comparisons, we’re guiding comp sales growth to be stronger in the first half at positive mid-single digits. For the second half, we are currently estimating comp growth in the low single digits. In addition, given the retail calendar shift and one less selling week in the fourth quarter, we expect total revenue and profit growth to be skewed to the first half of the year.

Now, specifically by quarter, in the first quarter we expect to pick up approximately $15 million in revenue as we capture a higher volume spring week. In the second quarter, we will gain approximately $55 million as we pick up a week of back to school, which are some of our busiest weeks of the year.

In the third quarter, we will see a net shift of about $45 million in revenue out of the quarter. And lastly, in the fourth quarter, we expect an $85 million impact as a result of one less selling week in addition to the calendar shift. These revenue shifts are important as you model out the year by quarter.

Now as we look at the first quarter, we are pleased to see business momentum continue. For the quarter, we’re expecting operating income to be in the range of $65 million to $70 million on revenue growth in the mid-single digits. We expect SG&A to grow in line with sales in the first quarter and begin leveraging in the second quarter as we continue to build on our profit improvement initiatives.

Now, I’ll turn the call back to Jay to kick off our strategy discussion.

Jay Schottenstein

Thanks, Mike.

Building on our strong 2023 performance, I’m pleased to now introduce our long range strategy and financial plan. This is our multiyear roadmap for powering consistent, profitable growth. Our plan is centered on three main pillars, amplify our brands, execute with financial discipline and optimize our operations. This strategy plan is a direct result of our profit improvement project started last year.

We reviewed every area of our business to set AEO up for profitable growth moving forward. The early stages of this project helped fuel a significant turnaround in revenue and profit during the second half of 2023. Yet, we are just getting started. I’ll start with a quick look back.

We have a strong history and heritage of building great brands. American Eagle is over $3 billion in revenue. Erie is closing in on $2 billion. We provide excellent customer service and have best-in-class operations. We’ve been successful over the past several years driving fairly steady revenue growth despite a lot of macro volatility. However, flow through to the bottom line has not been consistent. The plan we are presenting today is designed to address this head on.

Building on our strong results in 2023, our target is to generate annual profit growth in the mid to high teens on 3% to 5% top line. We are transforming how we operate to deliver steady profit growth. We have formalized this change with clear responsibility and accountability. And as Mike will discuss, we’ve instilled a culture of continuous improvement.

Before we get into the details, I’d like to begin with a refresh on who we are today and what I see as our unique competitive strength. This is what gives me confidence in our strategy and future potential. So let’s get started.

AEO has been on an incredible journey since its founding in 1977. My father, Jerome Schottenstein, set out to build a brand with heart and purpose. It was his priority to offer quality merchandise that was accessible to all. From the very beginning, we were open minded, optimistic and inclusive.

Over 45 years later, these remain the core tenets of our brands and the foundation of our company and culture. Our success has been underpinned by distinct and undeniable set of competitive advantages. These are strengths that have been fortified over decades. They set us apart and have enabled us to endure through both good and difficult times.

As we move on to the next chapter of our growth, we will lean into these strengths to drive further success. Our brands are the very heart and soul of AEO. American Eagle and Aerie have incredible brand equity, amplifying their strong foundation is at the center of our future growth plans. We are especially excited about the OFFLINE by Aerie Activewear sub brand. It’s expanding rapidly and we see a big growth opportunity here.

We also have two emerging brands in the luxury space. Todd Snyder, a premium menswear brand which we acquired in 2015 and Unsubscribe, a unique women’s brand offering consciously made clothing and accessories launched in 2021. Our commitment quality is a significant competitive advantage. We are not fast fashion. We sell merchandise that is built to last.

We ensure our finishes and fits are best-in-class and that our customers feel comfortable, confident and on trend. We believe that price is what you pay. Quality is what you remember. Innovation is woven within everything we do. We have a long history of creating superpower categories that reinforce brand loyalty and drive repeat purchases.

Our franchise categories are the cornerstone of our business and give us the authority and credibility with customers to build more. Today, you’ll hear more on this scene and the opportunities we see across brands to grow into adjacent categories, some new businesses and some that are being reignited.

We have invested in best-in-class operating capabilities. We have an extensive and diversified global supply chain network. Our strong partnerships ensure we can chase costs effectively and with speed. We have modernized our distribution network with edge fulfillment which has delivered significant benefits to our business over the past 2 years. We have a powerful and profitable store fleet and a significant $1.8 billion digital platform.

Together, this is a winning set of capabilities that enable us to operate with strength and agility. Top talent is a differentiator. This team is highly experienced in the retail industry with a broad range of expertise. The passion at AEO to build the best brands in retail and operational excellence is second to none.

We have two new members of our leadership team. Sarah and Valerie joined us in October, bringing strong backgrounds with years of retail experience. They have hit the ground running, introducing new ideas and ways of working.

We’re also supported by a deep bench of strong talent at all levels across the organization. With these competitive strength, we have a solid foundation. We are built to last and well positioned for success. As we embark on this next chapter, I cannot be more excited about our future.

With that, I’ll turn it over to Jen to walk you through our growth strategy for American Eagle and Aerie.

Jen Foyle

Thanks, Jay.

We have an amazing portfolio of brands and we’ve made great strides over the past several years. As I will share with you today, we continue to see incredible opportunities to amplify our potential and fuel the next chapter of growth. Let’s start with American Eagle.

As I said at the last investor meeting in 2021, when I first took responsibility for American Eagle, I love this brand. I love its strong platform and everything AE stands for, true today as it was then. Jay, his father Jerome, and Roger Markfield built something very special. A brand with heart that has always embraced individuality and diversity. It has truly stood the test of time.

American Eagle is the largest, most consistent youth brand, dressing generations of customers. And today, I’m going to tell you why I’m more excited than ever about our future. American Eagle is perfectly positioned for growth. But first, I’d like to show you a short video that captures the essence of AE and what we stand for.

[Audio-Video Presentation]

In addition to its strong brand positioning, American Eagle is also a financial powerhouse. In fact, it was the fuel that built Aerie with steady growth, strong margins and healthy cash flow enabling us to invest and grow. As we reviewed back in 2021, we saw potential for even better profit flow through. 3 years later, I could not be more proud of how far we’ve come.

AE’s operating margin has expanded nearly 300 basis points relative to 2019. With margins restored, we are excited to turn our sites to grow. Once again while maintaining a firm focused on profitability. So here we are, our pillars to power profitable growth at American Eagle. We will continue to lead in jeans. That’s what we’re known for, building brand loyalty and repeat purchases.

Next, we have a real opportunity to complete the outfit by offering a broader assortment of tops. Expanding into adjacencies where we know we have a right to play. Modernizing our store fleet with a beautiful new store design to elevate the customer experience. And lastly, enhancing how we allocate inventory to better support our best ideas.

So let’s get started with jeans. We are the number one denim brand for 15 to 25 year olds, the go to for women of all ages, and a preferred shopping destination. We love this for so many reasons. First, jeans are a huge driver of new customer acquisition. Almost half of new customers have jeans in their first basket.

Second, brand loyalty within jeans and bottoms overall is very sticky. In fact, it’s our best retention business across genders. We are upping our focus on test and scale, innovating in new fabrications, and ensuring that we’re offering the very latest and trends while balancing our tried and true. The acceleration we saw in the second half of the year is a great proof point.

Women’s return to growth led by unique franchise fabrications like Strigid and Dreamy Drape. Men’s also saw improvement as we deepened our assortment of more relaxed fits. With 60% of our business in bottoms, we have an enormous opportunity to grow tops and other categories. The industry standard is a tops to bottoms ratio of 2:1, and we are below 1:1. Bridging this gap is not just a revenue opportunity, but also a margin opportunity.

Over the past year, our creative teams have been zeroing in on fueling our tops assortment, better fabrics, better fits, more on trend designs, and standing behind hero collections. And we are seeing these efforts begin to deliver results. Women’s tops return to growth in the second half. Men’s accelerated fueled by strength in graphic tees as well as new fabric innovation in core tees and flannels. Another smaller example is men’s underwear.

It’s over $100 million in annual revenue and a great basket builder for the men’s business. Starting the spring, you’ll see new innovation around fabric and function as we build out a more robust assortment. And as you can see here, a dedicated marketing campaign.

We are also excited about driving growth for AE by expanding into category adjacencies where we know we have a right to play. American Eagle edits to a 15 to 25-year old target customer, and we are the go to for everyday casual looks. Whether it’s going to school, going to the movies with friends, or running errands, American Eagle offers amazing comfort and quality in everyday staples. This is what we are known for, and we will continue to lead in this core occasion.

Additionally, as we are positioned for growth, we are expanded into three new areas, two new dressing occasions that complement our core, social casual and men’s active. And we are going to broaden our customer focus extending into the 25 to third-party, date night, or brunch with friends. Still comfortable, still casual, but just a little bit more fashionable.

Here’s a look at how we’re beginning to address this with our spring assortment in women’s offering skirts, dresses, and fashion and tops. And here’s a taste of it in men’s. Again, more style and greater outfitting. You’ll see this build as the year progresses.

Turning to men’s active, we see a huge opportunity here. It’s a $27 billion market. As casual dressing continues to evolve, men are increasingly adding activewear to their look both in and out of the gym. We see multiple ways to leverage AE strong brand equity to capture our fair share in this exciting opportunity. In 2023, we launched 24/7, a men’s activewear capsule. Early results are very encouraging. It’s already a $100 million business.

Looking ahead, we see continued potential growth as we leverage learnings and innovate deeper into performance offerings. Now here’s how we’re thinking about our customer base. Gen Z is our core. Yet the fact is we resonate strongly across a broader age range. Over the past few years, we’ve seen more 25 to 35-year olds in AE’s customer base, and we want to capitalize on this.

Here are some looks we’ve introduced into our spring assortment, more neutrals, interesting fabrications, and more elevated marketing, and we are seeing a strong customer response. Last year, we also relaunched AE77, a capsule collection offering more premium fabrics and looks at competitive price points.

A pair of jeans averages $130 compared to the $250 plus market for premium denim. With our four focus areas, everyday casual, social casual, men’s active, and a broader demo, we have a clear merchandising strategy moving forward and multiple avenues to drive growth.

Now a few words about our store fleet. We are updating stores, many of which are dated. Stores are the strongest customer acquisition channel, so it’s important that we invest and stay best in show. Last year, we launched a new lived in store design, bringing a fresh aesthetic to a handful of test stores. We’ve also explored relocations to stronger shopping centers. Results have been very exciting, which are showing a positive lift.

To give you a feel of our new store design, here’s a walkthrough of our Polaris store in Columbus. As you can see, it’s incredibly inviting with an exciting new look that showcases our product in a fresh and modern way. The design offers greater flexibility and merchandising options. The fitting room areas are a nice place to gather and feel very welcomed and comfortable. We have plans to remodel approximately 50 stores in 2024. We are just as proud and excited about our digital channel and Mike will cover the opportunities in a few minutes.

In our recent review of the business, product allocation was revealed as a significant opportunity. We have two priorities, to amplify our best sellers and improve localization. We see room to stand behind our biggest ideas and categories with greater conviction across our fleet. As we do this, we will also offer more fashion choices in key markets where we know there is demand. For example, urban stores.

As we look to amplify AE in all these ways, we will continue to leverage innovative marketing strategies, positioning AE as a center of culture. This past year, we had strong success with limited edition product collaborations. The summer I turned pretty, Outer Banks and Elf Cosmetics drove strong buzz creating urgency and excitement. And we have a robust influencer strategy to engage our customers on social media.

Looking ahead, we are excited to launch a new marketing platform for back to school in 2024 celebrating AE’s heritage of self-expression, acceptance, and optimism. Before I move to Aerie, a big thank you to the AE team for working so diligently to execute our transformation over the past few years. We’ve come so far together and our future is even brighter.

And now Aerie. Aerie has a powerful brand platform with an amazing community of customers. There’s so much love for our product and what we stand for and an incredible opportunity to amplify the magic from here. Before I get into that, here’s a short video highlighting what makes Aerie truly special.

[Audio-Video Presentation]

As we have welcomed more customers into the Aerie community, the brand has seen explosive growth, reaching almost $1.7 billion in revenue last year, and we are just getting started. Importantly, our growth has come with strong profit flow through.

As we have gained scale and introduced new higher margin categories, overall profit margins have expanded significantly. Intimates continues to be the foundation of the Aerie brand, yet two of our biggest categories today are soft apparel and activewear. We have seen standout performance in loungewear and cozy collections, benefiting revenue and margins.

Looking at the total addressable market for Aerie, we still have significant runway for growth. Our core product lines represent an over $70 billion market. Aerie today commands just over 2% of that pie, making the growth opportunity exponential. Here’s our strategy to go after that growth to amplify Aerie. We are focused on winning across the Aerie lifestyle. This includes fueling intimates and soft apparel and building on OFFLINE’s explosive growth in activewear.

We will also expand awareness of the Aerie brand as we target underpenetrated markets, new customer growth, and build the basket across more categories. So let’s dig in. Here’s a snapshot of Aerie’s brand positioning. Aerie’s chill. It’s effortless. We are famous for intimates, cozy dressing, sleep, and swim. In addition to being your favorite first layer, key customer occasions are chill out, girls night in, beach, and pool party.

Now starting with intimates. This continues to be a very powerful category for Aerie. It’s the number one driver of new customer acquisition. Great fit, quality, and comfort are key, and Aerie excels at all three. As trends evolve, we are constantly innovating. For example, in 2022, we launched smoothies, a differentiated second skin fabrication. Super soft, barely there and light as air. This is now our number one bra collection.

Last year, we expanded smoothies into body suits, an exciting new trend. This has been a tremendous success and we are bringing new cuts and colors to this fan favorite style in addition to other exciting smoothie launches later this year.

This past fall, we also introduced more matching sets, which were a great hit. Aerie’s soft apparel business has been our highest growth category, expanding double digits last year. It drives repurchases, and we see more upside from here. We recently expanded sleepwear where we are seeing great reads. It’s a natural adjacency to Aerie’s intimates and lounge offerings, and we are looking forward to building this collection over time.

Now, moving on to activewear, where we see significant growth ahead. This is a very attractive category. It’s large, it’s growing, it has great margins, and it’s ripe for disruption. We launched into activewear with OFFLINE in 2020.

And let me tell you, this business has been on a tear, and we expect to cross $600 million in 2024. It’s also highly incremental. In fact, our OFFLINE bottoms business was the number two driver of new customer acquisition across all OFFLINE and Aerie categories in 2023. OFFLINE brings a unique and fresh take to the activewear category, one that is fun, empowering, and body positive. And this is resonating.

We are now the number three legging brand, and we are right up there at number four in sports bras too. We are very excited about this new platform, a fresh take on the activewear category. OFFLINE is active, fashionable with the perfect blend of style, quality, and function. On the team, on the go, on and off the court.

We are bringing more performance activewear for the upcoming back to school season. As we invest in our assortments, we are also heavily focused on building our customer base in key markets. Customer penetration in our strongest markets is in the high teens compared to an average in the mid-single digits. Brand awareness at 55% compares to American Eagle and other more established brands at 80%.

As with AE, stores are the main source of customer acquisition for the Aerie brand and a key driver of revenue growth. We’ve had great success in driving expansion with different store formats. Houston, one of our focus markets has seen rapid growth. Ross Park is our best mall in our strongest state. We’ve moved Aerie to a bigger box and nearly doubled mall sales. In Green Hills Mall, we added an OFFLINE standalone store and a mall where we had an Aerie store.

The OFFLINE store’s revenue is almost on par with the Aerie box. This is a very strong proof point of the power and the future opportunity for OFFLINE. We are also very focused on building the basket across Aries categories. Multi-category customers spend more and shop more frequently. Expanding these customers is a major priority. This year, we celebrate 10 years of Aerie Real, and we’re going to do it with a bang.

Look out for some great throwbacks to our biggest product hits and exciting content elevating the voice of our community, the faces of Aerie real. And we will continue to leverage various marketing platforms to drive awareness and build the Aerie community. We had great success last year with a 360 degree campaign in intimates targeted engagement in focused markets and of course, our incredible grassroots and paid influencer community. In 2024, we’re excited to launch a dedicated marketing platform for OFFLINE as we look to mirror this excitement in activewear.

Before I turn the call over to Mike to take you through our optimized pillar, I want to thank the incredible Aerie team for the passion and excitement they bring to our brand every day. This is a very talented team of seasoned leaders and together, we are ready to take on the next chapter.

And, Mike, now I’ll turn the call over to you.

Mike Mathias

Thanks, Jen.

As Jay and Jen described, we are energized by the work we’ve undertaken over the past year to set us on a path to greater profitability. The focus and drive across the organization is very exciting to see. As part of this project, we uncovered a number of opportunities to sharpen our operations and support profitable growth.

I’ll provide some key examples today, and then we’ll round out our presentation with our financial targets and capital allocation plans. Let’s get started.

As Jay noted, our operations are second to none. As we look ahead, we’re focused on elevating our capabilities even further to unlock incremental growth and create greater efficiencies. These are four focus areas, stores, digital, supply chain, and marketing. First, I’ll talk about our selling channels.

Let me start by saying we are channel agnostic. We operate as a single channel. Our customers shop across stores in digital and we’re well positioned to capture demand through both at comparable margins. Just to underscore, we’re similarly profitable across both digital and stores. We aim to maximize our profits per transaction regardless of the channel.

Now looking at the store portfolio, we have a very healthy and profitable fleet and are four well positive in over 90% of our comp stores. Our average lease term is approximately 2 years, providing good flexibility. We’ve been pleased to see customers return to in person shopping, underscoring the importance of having a strong physical footprint.

And given our strong portfolio of brands, we’ve been successful in achieving favorable rent terms. Our investment priorities moving forward start with Aerie and OFFLINE store expansion. This continues to be our highest return on investment with the majority of new stores paying back in under 3 years. We expect to add 100 area OFFLINE stores over the next 3 years. As we open stores, we see a digital halo as more and more customers get introduced to the brand.

We need to upgrade and modernize the American Eagle store fleet. Today, the average age of our AE stores is 12 years and we’ve not had a new store design in over 15 years. We’re targeting 300 remodels over the next 3 to 5 years using varying degrees of investment from full upgrades to simpler refreshes depending on the market opportunity.

As Jen noted, test stores have shown a nice positive sales lift, and we’re targeting a minimum ROI of 15%. As we make these changes, we’re also investing in new technologies to drive efficiencies in our store operations. Jen talked about product allocation to make sure best sellers are available across all stores, and this is already having a positive impact.

We’re using AI driven forecasting tools that are improving inventory allocation. This is providing more precise information by store, creating greater in stocks, and strengthening the customer experience. American planning RFID technology, which for the first time in our history will enable us to have a real time view of inventory counts in our stores. While still in early days, we’re very encouraged by what we’re seeing in our initial 100 stores and we’re targeting rollout to approximately 500 stores by the end of the year.

Together, these investments greatly improve our ability to read demand and keep fast turning items in stock. We also anticipate significant upstream benefits to how we manage inventory, ultimately allowing us to buy more accurately and fuel sales with less inventory.

Turning to digital, at $1.8 billion in annual revenue, we have a very powerful digital business. In the last 5 years alone, revenue has grown 61% with digital penetration expanding 6 points to 34% today. Last year, we appointed a new head of digital, David Zhang, to lead the business. He’s bringing a new level of analytical rigor to how we operate with particular success in improving online conversion.

To highlight one small example, we’re using tests as a means to roll out new engagement tactics. With 1 million visitors coming to our website every day, our scale is an incredible and competitive advantage when it comes to testing, allowing us to build real time insights very quickly.

As we’ve implemented learnings, we’ve seen small changes to how we engage with customers lead to very dramatic results. In aggregate, this work drove a strong acceleration in digital conversion and comms in the second half of last year. With work in very early stages, there are material benefits still to come as we continue to test and scale new insights.

Moving on to our supply chain. Let me address our fulfillment business and the restructuring taken in the fourth quarter. Due in large part to macro volatility, which has impacted demand for e-commerce fulfillment, third party business component of Quiet has not met our expectations. As a result, in the fourth quarter, we took charges to streamline the operation and focus on core capabilities that serve our brands and our best customers.

Now, as we talk about the edge fulfillment capabilities we acquired with this network, I want to underscore the significant benefits it has provided to AEO and our brands. Let me start by looking at how we used to operate prior to the acquisition. Like the traditional model in retail, we had a small number of large distribution centers. Ours were located in Pennsylvania, Kansas, and Mississauga, Ontario. This was simple but not terribly efficient.

And as our brands were growing, we were running out of capacity. The decision back in 2020 was to buy or build. In anticipation of our future needs and many of the changes we’re seeing unfold in the industry today, including demand for faster shipping and rousing costs, we made the decision to buy a regionalized fulfillment network.

Here’s how we operate today. We’re customer focused, built for efficiency, speed, and agility. Inventory is closer to customers aligning with population density and big metro areas. Inventory is also closer to stores enabling faster delivery times and lower costs.

In the last 2 years, we’ve lowered our cost per order by 8% relative to 2021, even if some of the industry’s largest shipping companies have taken double-digit rate increases. We’ve done this while speeding up our delivery times with over 80% of orders now delivered in 3 business days or less. This network has also given us the needed capacity to fuel long-term growth.

Separately, in terms of logistics business, as discussed earlier, we’re refocusing on core capabilities. This will greatly simplify our operations and result in cost efficiencies, which will drive structure ongoing benefit beginning this year. And lastly, I’ll talk about marketing, which typically averages 3% to 4% of sales annually. It’s an important driver of the business.

We’ll continue to spend and support our brands, yet we see opportunity to make our marketing dollars work harder for us. We are enhancing our capabilities here, leveraging advanced marketing analytics. This has been a game changer in improving our return on media spend.

We’ve reallocated how and when we’re spending to be more efficient and effective. We saw excellent results from this over the holiday season and expect continued benefits as we implement new learnings. Now a few minutes on our international opportunity. We are the partner of choice in licensed international markets across the globe. We have a successful capital light model, and we continue to pursue opportunities for expansion with existing and new franchise partners.

The largest part of our business outside of the U.S. is our company owned operations in Mexico and Canada. Mexico, in particular, has been especially successful more than doubling since 2019. We continue to expand this market where we have strong brand recognition and customer loyalty. This includes introducing and further expanding Aerie and OFFLINE in key markets across the country. And now, the final pillar of our strategy, executing with financial discipline.

Last year we keep our project breakthrough. Our profit improvement initiative. As Jay said, we left no stone unturned. Keep in mind, this is a growing business and there are variable expenses associated with fueling that. However, through this project, we’ve identified efficiencies and savings that will enable us to keep operating expenses across BOW and SG&A flat this year. And repeating the structure is our intent for the next several years.

Importantly, this work is ongoing. It’s been formalized into an office of continuous improvement to identify incremental efficiencies and drive accountability and results. As Jay shared with you a little earlier, here’s another look at our financial algorithm. We are driving to $5.7 billion to $6 billion in revenue and an operating margin rate of approximately 10% by 2026.

On the revenue front, we have multiple levers we can flex to achieve our 3% to 5% growth target. We’re very encouraged by the American Eagle brand as we position for category growth and expansion into new adjacencies. As Jen said, our plans here are strategic and thoughtful. We will test and scale, fueling areas with clear proof points.

Our expectation for AE is low single digit revenue growth with potential for upside as we continue to understand the benefits from new initiatives. Aerie and OFFLINE present very exciting growth potential.

We’re encouraged by the level of customer excitement around activewear and soft apparel. Our plans here are modest as well. Growth expectations are mid to high single with the ability to chase into stronger demand. Our 10% operating margin goal embeds a gross margin outlook of 39% to 40%. We closed out 2023 above 38%, reflecting the start of our profit improvement work.

As we move forward, we expect to maintain inventory discipline and continue to optimize promotions and markdowns. We’re also seeing favorability in product costs and pursuing other opportunities across sourcing and the overall [indiscernible]. Delivery and transportation are also areas where efficiencies and cost savings will continue as we leverage our edge fulfillment model and benefit from the recent restructuring activity. And we expect rent to continue to be controlled as we focus on maintaining a favorable cost structure across the fleet.

Moving to SG&A, we expect to be in the range of 25% to 26%. We closed out 2023 a little over 27%. Over the long-term, we’re structuring the business to keep SG&A dollar growth below revenue growth. We have work streams that will continually address 85% of our expense base with focus areas being store and corporate compensation, professional fees and services, and optimization of marketing spend. So all that said, here’s a view of the major building blocks that take us to approximately 10% over the next 3 years. Our outlook is balanced, anticipating both puts and takes.

As I reviewed, we have a number of initiatives to control expenses and drive efficiencies across the business. As we grow American Eagle and scale Aerie OFFLINE, we also expect to see leverage from a higher revenue base. These initiatives will allow us to comfortably absorb pressure from wage inflation, new store openings, and investments we’re making to incubate emerging brands like Todd Snyder and Unsubscribed. As we build profitability, we expect to generate even stronger cash flow. We’re focused on providing healthy returns to shareholders and have a long history of doing so.

In fact, over the past decade, these returns totaled nearly $2 billion. We recently announced a 25% increase in our quarterly cash dividend, and we also have a new $30 million share repurchase authorization in place to offset dilution and fuel opportunistic repurchase. So here it is, our model for driving shareholder value. Starting with our financial algorithm to drive mid to high-teens operating income growth, we believe we are set up to deliver double-digit total shareholder returns over the next 3 years.

We are extremely confident in the roadmap we shared with you today. The levers at our disposal to drive growth and profit provide multiple paths for us to deliver on our 3-year plan with potential for upside. Our priorities are clear and the teams are focused.

And now back to Jay.

Jay Schottenstein

Thanks, Mike.

As I hope he conveyed clearly to you today, this is an incredible company with powerful brands, capabilities and talent. And we have significant opportunity to scale further. We are at an inflection point in our journey. Having undergone a huge cultural transformation over the past year to align our strategy and priorities towards delivering consistent, profitable growth. From here, we are focused on execution and we know we are set up for success.

With that, I will open it up for questions. Judy, over to you.

Judy Meehan

Thanks, Jay. Before we start our question-and-answer session, we’ll take a quick three minute break.

[Break]

Question-and-Answer Session

A – Judy Meehan

Okay. Thanks, everyone, for joining us for the question-and-answer portion of our meeting today. We’re back from our break, and we want to get right to your questions. So, first up is Matt Boss from JPMorgan.

Matt Boss

Maybe to start off, Jen, could you speak to the total addressable market and customer file opportunity just as we think about the market share opportunity for the AE brand? Or more specifically, how are you positioning the assortment across key destination categories and price points to drive that consistent profitable growth that Jay cited?

Jen Foyle

Yes. Sure. The total addressable market is $70 billion, which is incredible. And, there’s huge white space here that we can go after. You know, what AE owns is the social casual. I love this new term. It’s our new term that we’re using to describe our core assortments, which are going to be strong across all of our fleet. That’s what we’re up to.

Getting all of our fleet robust, certainly managing the inventory and obviously doing it with prudent disciplines. But we’ve really been up to just going back, really rationalizing the fleet, rationalizing our SKU count. So we really built a baseline now that we can sort of leap off and introduce all these new expanded categories. Men’s active, $27 billion market that we’ve only just begun. You heard that number, a $100 million. We’re only just getting at this.

Keep in mind when we launched OFFLINE, that’s where it started, a $100 million. And now look where it is. It’s almost over $600 million this year. So think about that. So we have huge expansion there. And we’re already seeing results in the 25 to 35 age group there. Let our denim category is a rite of passage. We love denim, and getting denim on all ages is really what we’re up to.

But if you notice in the slides, wow, we have such opportunity to round up the assortments, and we’re so excited about that. Yes. And we didn’t even mention the premier denim collection we launched last year. We love the early reads. So we have, categories now that we can expand on. We have a great baseline, and we’re looking forward to building on this.

Matt Boss

And then maybe just a follow-up for Mike. With SG&A expected to leverage roughly 200 basis points, I think, relative to 2023. Maybe just could you elaborate on the expense buckets where you found savings and efficiencies to support the plan while at the same time funding brand marketing reinvestments?

Mike Mathias

Sure. I think, I mean, just to highlight again, I mean, I think a proof point around this initiative this past year was definitely the expenses up on gross margin. That’s where we started. We’ve articulated that for a few quarters now. Every quarter this past year, not only do we extend product margins, but we leverage expenses within gross margin every quarter even in the first half of the year when revenue was a little tougher.

We’ve expanded that to SG&A now. So we’ve talked about, the big buckets in SG&A, 85% of the total expense is within store compensation, corporate compensation, related incentives and taxes, marketing dollars and services. So the big areas that we have gone after, reflected in this 24 plan and the guidance we’re providing and within this continuous improvement office, program office as we call it, underneath project breakthrough. That work is going to continue and not stop.

So those are the buckets. Store labor, we found efficiency offsets to what has been wage growth and wage inflation pressures in the industry. We’re looking at flat rate of revenue for store dollars. So stores and marketing are place where we places we will continue to invest to fuel growth, but we want to maintain at the rate. The savings or reduction areas or the leverage areas or other compensation, corporate compensation, incentives, taxes, and services is the other bucket that we are going after to actually more aggressively reduce.

So that’s where your puts and takes are. We’ll continue invest in store compensation and advertising to fuel growth, but we’ll not be looking to deleverage, which maintain right there. Other compensation areas along with services, then some other areas, smaller areas like supplies and repairs and maintenance. We’re looking is where the leverage would be continuously providing leverage in those in those areas.

Judy Meehan

Next question comes from Jay Sole from UBS.

Jay Sole

I want to ask about some of the newer topics that came up in the presentation. One is about Todd Snyder, you mentioned you’ve been going this since 2015, it’s grown nicely. Just wanted to talk about what’s implied in the guidance from Todd Snyder and what gives you confidence that Todd Snyder can become a bigger business? And also international, how does the international opportunity play into the three year outlook and maybe beyond, like, what’s the ultimate aspiration for the international business for the company?

Jay Schottenstein

We know, Jay, if we bought Todd Snyder around 2015, that time, Todd was only going to $2 million and here in the last set of years, we’ve run a couple $100 million plus business. We see a big opportunity with it even this year, I think we’re set up with 6, 7 additional stores. We think what’s all done, it could be a $5 million to $7 million brand in the next couple of years.

Mike Mathias

I can expand upon that. It’s reaching the point of profitability. So nice growth this past year, right around that breakeven mark, and our plans for ’24, and this three year plan is for Todd to contribute profit to the company. So that’s a great milestone. Double-digit top-line growth is the continued expectation and profit increases from here. For the international opportunity, I think the one thing we want to highlight, we hit Canada and Mexico from own markets and our biggest contributors from a revenue perspective.

Mexico specifically has been a source of growth, especially it’s really 90% plus AE Brand. The size of the business in Mexico actually contributes, the trajectory is on contributes one point to total AE Brand revenue growth at this point. So if we talk about AE Brand, expectations being in the low single digits, Mexico alone with its growth is providing about a point.

Jay Sole

Also like, part of the international goes, like, my government involvement company back in 2014 that we were losing $20 million to $30 million on the international business today, it’s going to bring a profit center and we haven’t witnessed on the tip of the iceberg. We’re not in Europe yet, there’s no opportunity there. We’re like really a couple countries like the South America, major opportunity. So we see a major opportunity with our national business and it’s being very what we see.

Mike Mathias

Very strong partnerships with our franchisees and we’re looking to expand, with them and with new franchisees. That’s the model from here.

Jay Sole

But the next business and Canada business is our own business.

Mike Mathias

Yes. So we are in North America. There is plans for expansion in Latin America, past that, which is a natural progression from the success in Mexico. So there’s Jay said, there’s runway here. We’re not banking on a ton of growth, within this next three years, but there’s continual runway for multiple years from here.

Jay Sole

As it own brands?

Mike Mathias

What we’ll do is, it’s I think we mentioned in the presentation, it’s asset light outside of North America. We like that model, franchise revenue drops straight to the bottom line. We have a few joint ventures that are really just in early stages. So we will be, we’ll be ROI oriented with that expansion, and not over invest to go after it.

Judy Meehan

Next up, we have Janet Kloppenburg, JJK Research.

Janet Kloppenburg

Hi, everybody. Thanks for a great presentation. For Jen, I like the adjacencies I’m seeing in the AE stores. I’m just wondering, about maybe a risk of building SKUs. And also as you move a bit older, do you worry at all about, losing that young, that older teen customer that’s always had a strong loyalty to your brand.

And in the intimates category, which I think you’ve done a great job on with the SMOOTHEZ line. Do you see that category growing or hearing from others that the intimate sector is, is experiencing a downturn in the range of mid-single digit revenues? And for Michael, when you talk about SG&A going from 27% to 25% to 26%, that’s a 3 year period. Do you see more of that coming in the in the in the later year, or should it be linear as we move along?

Jen Foyle

Yes. Look, everything we do is with discipline. American Eagle, we went back to our heritage. We completely over the past three years and by the way, may I add, we rationalize profitably. It’s really hard to do that when you’re getting rid of thousands of SKUs, and we did.

We got rid of thousands of SKUs to focus on the core assortments, this new social casual that we’re talking about. We are not going to comp with just buying our comp, which means we’re not going to just add SKUs randomly. We’re going to do it with integrity. There’s always trends that ebb and flow. And as we do so, we’re going to make sure that, we’re leaning into the categories that are trending, without over sorting.

I cannot stand over assortment. We are the most disciplined teams around that. I think you can see it in see it in our stores. They look incredible, and, I think we’re out to be better than ever. So certainly not. We’re going to do this with integrity and pride, and that’s what we’re up to. As far as intimates is concerned, look, there has been a slowdown, but we held our market position, Number 1. Number 2, we leaned into new categories that are behaving like intimates.

So you saw the SMOOTHEZ. I mean, I hope you love the pictures. The SMOOTHEZ collection is just amazing. We love it. Not only is it around bras, and by the way, that’s our number one bra within that collection, but other collections outside of just bras, for the bodysuits, the crop tops are all doing incredible. So, there’s a little bit of a wear out trend that’s been happening, and it began last year, and we were on it.

Bra tops were completely trending, and we still see that business working. However, intimates, that business is a huge unpack category. And may I remind you, it’s just incredible the way Aerie tapped into that business. We were disruptive, and we did it. I mean, looking at that business now, the Aerie business is $1.7 billion. This growth has been exceptional, and it’s still a huge market that’s right for the taking.

So, we’re highly focused on new bra launches. Undies, we haven’t even spoken about undies. There’s new categories in undies. So we’re going to keep on innovating there and delivering newness, and continue to dominate the way I think we have, leveraging our platform.

Mike Mathias

Then SG&A, yes. I think, first, I want to make sure to stop this score, just the results that, we’re providing our guidance for ’24. Flat operating expense dollars across the entire P&L is a milestone for us and flat SG&A dollars also within that is a milestone for us. We’ve provided that guidance of dollar growth being in line with revenue in the first quarter, but we’re expecting to leverage SG&A every quarter thereafter even with some of the revenue shifts that, we outlined for the day that’s today based on the calendar shift.

The work is continuous. It’s not a one and done. So I think and then it’s very much correlated to revenue. So the guidance we’re providing down to that 25 to 26 range is more about sort of probably the low to mid of that 3% to 5%, revenue guide.

If we achieve the higher end of that guide, we expect to get to 25% faster. So one assume linear for now, you’d be assuming sort of plus basically, us achieving the mid-range of the revenue guide. I ended up revenue guide even further, we would be sooner and the expectations continue to leverage there or leverage from there in our years beyond this figure plan.

Janet Kloppenburg

And, Jen, I just wanted you to know we all think the stores look the assortments look amazing. So good luck.

Jen Foyle

Thank you. The teams have been really working hard. I’m really proud of them. Love to see AE back on the growth trajectory, and Aerie certainly has growth that we can talk about when we’re we get questions.

Janet Kloppenburg

We can see how hard you worked.

Judy Meehan

Up next we have Kelly Crago from Citi.

Kelly Crago

One on the long-term and one on the near-term. First to Jen, just wondering if you could elaborate on the opportunity to broaden the demo at a what percent of your business currently is in that 25 to 34-year old demo and where can that go over time? And just curious what tools you’re using to market to that customer differently than the core Gen Z consumer.

And then secondly to Mike, just, on the near-term, congrats on the great results. You made a comment that the momentum is continuing 1Q quarter-to-date. Wondering if you could elaborate on that comment, just given, some of the other retailers calling out weakness in February.

Jen Foyle

Sure. As we, as the business, grew in 2023 in American Eagle, quarter-over-quarter, we actually saw this happening. Roughly about 20% to 30% of our share is in this 25% to 35%, and I think it’s because our genes are so sticky. Like I mentioned, genes are a rite of passage for us and once you get into our genes, they grow with us. So we’ve seen our retention rates continue to accelerate, something that wasn’t happening in the past.

And I believe the biggest reason, what we know, is because of jeans. Now as we round up the tops business, like I said, I think it’s going to really just add on and win new customers. So, look, we’re leaning up a little bit, but it’s not to say we’re going to ever walk away. Our core is our core. It’s our tried and true.

But if we still extend new ideas, which 24/7 or 77, some of these new offshoots, I think we’re going to gain these new customers and win them over time. It’s something we’re highly focused on. We were losing customers after, you know, roughly the age between the age of 18 and 25. So we’ve been focused on this, and certainly doing it through most tactics. Right?

We have new brand collabs that we worked on. You saw them on the screen. The summer I turned pretty, the number one hit last summer and we’re going to continue to work on these collabs. There’s so many exciting ones coming your way. Influencers are, influencers are certainly a big win for us, leveraging them.

But, again, we’re always going to protect our core, and now we’re going to expand into this, age demo. And we’re excited about it. And like I said, we already saw the results. It’s happening as we speak, so now we’re just going to lean in a little bit more.

Mike Mathias

Then on the first quarter guide, we’re pleased with the momentum that we’re see that we saw in February. It’s coming off of Q4. As always, at this point, our guide has some caution in it. February is the smallest month of the quarter. We’ve got our peak spring break and, Easter holiday periods coming up in March and April, and then March and April are obviously bigger months than February. So, again, pleased with the momentum and, guide, reflects that with some caution.

Judy Meehan

Next we have Adrienne Yih from Barclays.

Adrienne Yih

Jen, just let me add the tops look phenomenal. The denim always looks great. So it’s really nice to see the entire kind of top to bottom looking fantastic. So I just want to shout out to your merch team. Thank you.

On that, there’s a fashion bottom thing that’s been happening. It’s sort of percolating, simmering, and now it’s really happening. Right? So you walk the mall and everywhere, it’s kind of the wider bottom finally here.

Can you just remind us sort of the denim penetration at AE? I think it’s like north of 30%, mid 30%. And then just remind us like the skinny legs emerged in 2011 and then it really peaked in the next 2 years and it’s been there for a decade. So, this could be potentially something that continues to help kind of drive that piece of the business?

And then for Mike on the can you give us just the markdown rates relative to mean like average kind of over the past, where are you in that continuum? And then remind us, AIR is probably up, 20% relative to 2019 and how much are AIR is contributing to the LRP? Thank you.

Jen Foyle

Yes. In dead or man bottoms, we’re seeing wide rates trend, and honestly, it started for us last year. We were, ahead of the cargo trend, I would say, first, bikini on the beach there, and, the teams did a great job, testing and scaling and wider legs. And the beauty of our denim business and how we approach it is we have such a incredible testing model and we are now on testing so many new silhouettes, not just wide legs.

So we’re on the we’re ahead of the curve as new fashion silhouettes trend. So I can’t tell you just what this team does as we build on new assortments towards the future and learn. And we’re just so agile to do it and balance out our assortments.

When I started, jetties dominated our business and women’s in particular, huge percentage of the business, over 80%. Now we’re seeing fashion emerge and other silhouettes where we can really lean in to what’s trending, and that’s what we’re all that’s what we’re up to. Honestly, it’s about as simple as that and the team is executing with style.

Mike Mathias

And how on markdown rates, we’ve been really since ‘21, been very we’ve been managing the markdown rate very consistently, and we found a sweet spot. We maintain our AUR that we gained, post-pandemic, a couple fiscal years ago. And in some of our few years prior, even 2019 I’d say, we were running markdown rates in the mid-50s. We’re now in the mid-40s and been able to do that consistently for a few years. So we know an end of giving any of that back.

Think on initial retails, we have seen markup benefits, and I think the mix of our categories is just outlined in the entire Amplify section of today’s presentation. The mix of categories will continue to be beneficial there with, tops being a driver, Aerie apparel being a driver, OFFLINE within Aerie. All those growth drivers have mixed benefits to initial tickets and to margin rate in general.

I will say in these 3-year targets, we actually are not assuming much product margin improvement. Most of this 3-year target, Keller today is based on expense leverage. Expense leverage within the gross margin line and expense leverage in SG&A depreciation. Jen outlined a lot of initiatives and a lot of opportunity within categories for that product margin to expand. That would be beneficial to these targets.

So I think that’s something that we should all understand is that when we push about product margins over the last 3 years up 300 basis points. We’re in a very healthy place. We’re not assuming much improvement in these targets, but there is opportunity there on top of the expense leverage that we’re seeing.

Judy Meehan

Next up is Dana Telsey from Telsey Advisory.

Dana Telsey

I could tell the thought and the hard work that went into it. One of the areas that you touched on is modernizing the fleet. As you think about the fleet and modernizing the existing stores, opening new stores, what’s the cost model and the return model that you’re thinking of for each?

And how do you see the role of malls versus open air in your network?

And lastly, Jen, with the enhancements to the product offering that you’re doing and the category adjustments, what is the impact on margin that you see? Is there a higher merch margin potential from new categories versus existing?

Mike Mathias

I can start with the fleet remodel. I think we outlined it very well. I think, the average agent fee fleet is 12 years. Definitely paused on some plans to update the fleet during the pandemic, for obvious reasons. Jen and team come up with amazing designs that well accepted in the test stores that we rolled out in 2023. So nice sales list that we as we outlined. But sales doesn’t always translate to income and cash, so we have an ROI focus for that investment as well. I think we said, 15% is a good target for our remodel.

So we are managing inventory, managing store labor, managing investments, beyond underneath the capital investment to generate that kind of type of return, to drive income and cash flow generation incremental to what the store was doing prior to the remodel.

Then for Aerie, we outlined produce store growth, whether it’s Aerie stores, repositions at American Eagle stores, Scott Snyder, three year payback is our part, and we get no better return on investment than these than these store openings. But we have very refined process around those decisions, and we’ve done, again, that three year payback is consistent and no reason to believe that, we won’t continue to see that kind of payback.

Jen Foyle

Yes. As we build into these assortments, we like what we already saw in Q4. The margins were great. So we’re going to be really careful. We’re not going to over skew. I already mentioned that. These businesses typically are higher margin businesses. Tops, T-shirts, wear out tops typically are, like I said, higher margin businesses. So the one thing we have to be careful of is not over sort, okay, and turn those items fast. That’s what that business is all about, and that’s what we’re going to be focused on.

Judy Meehan

Next, we have Dan Stroller at BMO Capital Markets.

Dan Stroller

Let’s see if there’s any color for the next several years on how the general corporate expense line should trend or if there’s a percent of sales target. So anyway, if that’s a tailwind to margin or any way to think about that?

Mike Mathias

Yes. I think, this past year, the growth in corporate debt and corporate expense bucket definitely correlated with incentives against no accruals in 2022. We’ll see that dollar amount come down in 2024 within our plans. And as we talked about addressing 85% of our expense phase, there are definitely expense lines within the corporate segment there that we are looking to continue to optimize, either all the dollar is flat to then leverage that rate down or, like I said, like, I’ve outlined places where we would be looking to reduce dollars.

So I know we’ve been, historically, around that’s 7%, 8%. It’s a little higher this past year for all the reasons we just said. As we look to leverage that line item within this 3% to 5% revenue target, we’d see that rate come down on the higher end of revenue result faster, but, sequential leverage from here is the intent for that expense line as well.

Judy Meehan

Next, we have Jonna Kim from TD Cowen.

Jonna Kim

Just curious, a little bit more details on around promotional strategy. You’ve mentioned how it changed over time, but if you can provide any more colors around that and what the new promotional discipline will look like going forward? And also if you can just talk to your current lead time now and how much you plan to leave open for buy across both banners going forward? And then just a near-term, any color around gross margin cadence will be helpful. Thank you so much.

Mike Mathias

Sure. I think as yes. Just to underscore again and reiterate that our markdown rates used to run-in the fifties pre-pandemic. And really for the last three years, we’ve been articulating, talking about inventory optimization, reduction in choice in skews, which, that tail of inventory had a lot of markdowns attached to it. So now and that’s it’s largely an American Eagle brand initiative. Jen outlined the fact that that’s been the case.

We are now reset for profitability. That inventory work is never done, but that that tranche of work is completed. So now we’re looking to actually expand and grow the brand. We have, but we’ll do that prudently, and choice counts and SKU counts, but we’ll represent what’s needed there to do that. So there’s sort of the end of season impact or that’s tail of inventory markdown, kind of pre-pandemic phenomena that that will no longer be part of our operating model.

And from there, we’ve learned over these last three years how to pace promotions. So we used to BOGO Jeans almost every day. Jen and team are not doing that anymore. That we don’t intend to ever go back to that type of promotional strategy. That was a big markdown driver, a big rate driver as well.

But then even within key periods, key holidays, key weekends, we have, we might run our 40% off or whatever the deal, but we do we’re doing it less with less days, pulsing in a way that customers react to more positively. Those strategies are intact. They’ve been proven for 3 years now. So at this mid-40% is we think we settled in a sweet spot in terms of the balance of value to the customer and driving traffic and conversion, and not having to over promote to do that. I think open to buy, we are back to chase mode.

So I think that’s the only thing you should do with everybody should understand that supply chain disruptions of software few years and unite us, some minor issues out there all know around things happening in the least but we have very little exposure to that that won’t change our timelines drastically.

Any product coming from that region, we but we have adjusted timelines for the remainder of the years. We don’t see that being a big impact. But chase mode is the mantra. We’re putting a 3% to 5% revenue growth number out there. We’ve achieved the high end of that historically for the last 10 years, setting ourselves up structurally to leverage on that, but then chase a higher revenue amount is the formal win, and that’s what we’ll continue to do.

Like I said earlier, we’re not really looking for product margin expansion in these three year plans. So when you ask about the gross margin outlook and puts and takes, the gross margin of 39 to 40 that we’re outlining for the next 3 years is more about expense leverage than it is about product margin expansion. But I know Jen and he will be disappointed we don’t see that. There are ton of initiatives that she just outlined earlier that could benefit product margin beyond what we’re expecting right now.

So gross margin leverage to that 39 or expansion, that 39% is all about expenses at the moment. And we would get there faster on the high end of the revenue guide at 5% than we would read, but expecting to expand within that range in total.

Judy Meehan

Next question comes from Chris Nardone of Bank of America.

Chris Nardone

Within your area growth expectations over the three years of mid to high-single-digits, Can you clarify what you’re assuming for comp growth? And then how we should think about growth by category? And then one follow-up on this gross margin topic we’ve been discussing. Can you remind us how long you have visibility into both freight and cotton costs, given the recent price moves in both of those inputs?

Mike Mathias

As we’re only opening 30 stores a year now, that kind of gap between total growth and comp growth closes. We’re at 1 to 2 points now. So for guiding mid to high-single-digit expectations, which is modest, we believe that’s modest. They’re more up to than that. You can assume about a one point differential, so you’re, call it mid-single-digit comp then, on a mid to high-single-digit total growth.

Jen Foyle

Yes. And I think, if you just think about it, this brand platform you saw the video, it’s incredible. This community that we’re building, and guess what? We only have 55% brand awareness out there. There’s still tons of expansion that we can do to introduce the current categories to our customer. So we’re pretty excited about just getting the brand out there in more markets.

And, secondly, this is another, like, incredible stat. 65% of our customer base only purchased 1 category. So the marketing team is really up to introducing all the other categories that we’re in, and ensuring that the customers can see it. Like, right now, if we could get them to buy 2 of our categories, their expansion right there.

I mean, we see the area business getting to well above $2 billion in the near, couple years. And with that, we’re going to definitely introduce our current categories. But again, it’s our job to introduce innovation in those categories, excite the customers in those categories, and make sure we’re expanding in trends in those categories. So, but those are the two really important facts that I would love you to hear because it just proves that it proves that we have just so much more opportunity.

Judy Meehan

Next is Corey Tarlowe at Jefferies.

Corey Tarlowe

I was wondering if you could talk a little bit about how you intend to leverage AI within your long-term plan to enhance the customer experience, drive better sales and enhance profitability. And then second question is within your long range plan, what’s your outlook for wages over the multiyear time horizon, and how do you expect that to trend as we get move ahead?

Mike Mathias

Yes. I can address the AI question. I think, some of what we’ve already seen benefits from this past year is we continue to expand upon our machine learning forecasting capabilities within our inventory allocation work. And the more data we gather there, the more we see the optimization of that. We’re seeing better in stocks and stores, better fulfillment rates and that we expect those things that continue conversion benefits both in stores and digitally.

Jay Schottenstein

And also Mike, could I add that from the customer standpoint in the next couple of years, we’ll be introducing new concepts on our online in the store with AI to make a better shopping experience for the best.

Mike Mathias

A combination of those capability with our RFID rollout, we’ll be able to expand the customer experience, not just the inventory optimization or inventory benefits that we see with those efforts.

Jay Schottenstein

We see a big opportunity, tremendous opportunity.

Mike Mathias

On wage growth, there’s two components we’ve always we’ve talked about historically. One would be in our distribution centers, and part of our supply chain, which with the expansion and, to this edge fulfillment network and the client nodes, that’s mitigated some of our peak needs during, like, back to school and holiday peak hiring, which is where some of that wage pressure is coming to play. So there’s some mitigation efforts there or some mitigation impact there, expand the supply chain that we have.

On the storefront, yes, since the pandemic wage growth has been a hurdle. That subsided in this last year, year and a half, kind of come back to the mean in terms of annual expectations for around just typical annual increases, minimum wage increases by markets, and that is a massive major focus for us within the profit prove proven work to offset that wage growth with efficiencies in our stores, especially in the area of, kind of non-selling task hours somewhere else where AI can come into the to the next stage points, not only just on the customer experience within stores, but efficiency from both RFID and AI, keeping buildings in store to mitigate some sort of non-selling tasks, wage, faucet some of that wage challenge that will that we had out in stores.

Judy Meehan

Next is Alex Straton from Morgan Stanley.

Alex Straton

I just have two for you. The first is on the American Eagle banner. Can you just break down that businesses? It looks like 300 basis points of improvement versus pre-COVID, just big picture, what’s happened there? And then also explain kind of what your 10% target over time assumes American Eagle can get to?

I’m looking at that low-20s that it did, I think, in the pandemic. I’m wondering if that’s within the realm, and I just have a quick follow-up.

Mike Mathias

The 300 basis points improvement over the last several years has been very much tied to product margin and gross margin benefits. Both product margin and then the leverage of expenses within gross margin benefiting both brands. And that’s been, that’s we’re stagnant flat to even revenue being down slightly. So we’ve reset the ramp for profitability through all of that inventory work and optimization of gross margin.

Now as we’re turning our attention to growth, even with modest growth, we can leverage other areas to the P&L and other areas within the brand to drive bottom-line operating rate. So as we pass to this year’s guidance is implying another 100, 150 basis points of operating rate of improvement to the mid-8s.

We would expect, really, that the brands to get to that high-teen rate and start to start to tap towards 20%, while we’re all also optimizing or leveraging that corporate overhead bucket. So now 80 brand growth revenue growth, we part of the leverage story or part of the operating rate improvement that we expect to see over the next several years.

Alex Straton

Maybe same question on Aerie in terms of and it might be the same story in terms of that profitability improvement versus pre-COVID. And then also what you’re assuming in terms of what that business gets to within the 10% target as well?

Mike Mathias

So it’s very similar. Aerie product margins have reached some new milestones this past year as they’ve closed the gap where Aerie has gotten to. And that’s, again, from here, I think with even on the modest mid to high-single-digit revenue, we expect that to continue, both leveraging again expenses and gross margin, SG&A expenses.

But even beyond that, where the growth is coming from in soft apparel and OFFLINE, there’s even product mix benefits on top of that that product margins should also expand. So I think both brands have their path to this high-teens, 20%, brand operating rates, over the next several years.

Judy Meehan

Now we have Marni Shapiro from the Retail Tracker.

Marni Shapiro

Congrats on a great quarter and thank you for doing this. It’s very helpful. Mike, just a couple of housekeeping questions. I just want to make sure, did you just say mid-8s operating margin for 24% and did you put a dollar value to that? You gave out a bunch of numbers and my hands couldn’t write as fast as you were speaking.

Mike Mathias

The math on, 3% to 5% or 2% to 4% revenue growth, none as a point of impact from the 53rd week. So we’re basically getting 3% to 5% consistently, but then this year is a one point impact. The 445 to 465 on that growth would put you, in the low to mid-8% operating rates range. Different ways to get that income and just off of that guidance, you get to a low to mid-8% operating rate for 2024.

Marni Shapiro

And then did you guys give any guidance about store openings and closings for ’24? I know you talked about some renovations, but did you talk about store openings and closings for the year?

Mike Mathias

It was about 30 Aerie OFFLINE that we’re expecting. 5 sider stores, we’re looking to add about 5. And then for the Aerie brand, still a net closure amount, but we are, as the brand is seeing growth now, that’s becoming the net number will be less. We closed about a 130 stores over the last 3 years.

Another 25 to 30 this past year wouldn’t be more than that, and we’re actually seeing opportunities in the repositions in some of these markets. So that number, we expect to continue to come down. So net, net for the year, 30 openings very OFFLINE, net closures for AEs still being maybe around that 20 mark, but that’s being refined. Then a handful of other stores for Todd and not subscribe.

Jay Schottenstein

And plus the results and the remodels, we like what that’s doing. So hopefully, that can close the gap to continue to do this low single-digit growth for AE.

Marni Shapiro

And then, Jen, I did have a couple of quick questions for you on the product side. The first is just you made two comments, one about skewing a little bit older in spots, but then also about the urban stores. Would where you want to add a little bit more product, a little more variety, would this slightly older skewed product just belong in those urban stores? Is that how you’re thinking about it? I’ve seen it in some of the other stores as well, but I’m just curious.

And then could we talk about the tops business, because Eagles tops, you started spring off with a bang. Congrats. I’m curious. Do you have this ratio issue in Aerie as well? Because I feel like you have a very solid tops business in Aerie. And as you grow back or grow the Eagle Tops business, how do you make sure that you can keep Aerie’s Tops business also very strong?

Jen Foyle

Yes. Thank you for the compliments, by the way. We’re really proud of, what we’re delivering. Love what happened in Q4. What we’re seeing as we head into Q1. Look, it’s not even just about urban. We’re going to put the best assortments where they belong. We’ve done a deep dive on how we approach our assortments by store. Once we used the tiers, so we had Tier 1, Tier 2. It doesn’t really mean anything to you.

Now we’re calling them clusters, where it’s about a market cluster where we can put the best assortments, in the best markets. It’s essentially that. So it’s not just necessarily urban. So that’s where we’re up to there.

Tops to bottoms, yes. You’re right. AE’s tons of, you know, opportunity here to round this out in the assortments. I love what I’m seeing. If you even saw our denim watch, more recently, as you noticed, it was head to toe. Really fun to do this because, basically, we’re leaning into, our key cap category in American Eagle and doing it differently. I love how we showed up with our initial spring campaign, we call it denim on denim.

Looking at Aerie, yes, you are right. We’re definitely more, balanced on the head to toe assortments. Leggings are very strong as you know, and it’s a very strong pillar for the OFFLINE business. So if you think of OFFLINE, they’ll always lean in heavier on the legging side of business and the bottom side of the business. But the area we will always be definitely more balanced, and keep in mind, we still have intimates in other categories to think about.

Judy Meehan

Alright. Well, that wraps up our question-and-answer session today. Thanks, and, we look forward to speaking to you soon. Have a great day.