Greetings, and welcome to the American Eagle Outfitters' First Quarter 2022 Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Judy Meehan. Please go ahead.

Good afternoon, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Executive Chairman and CEO, and Jen Foyle, President, Executive Creative Director for AE and Aerie; Michael Rempell, Chief Operating Officer; and Mike Mathias, Chief Financial Officer. Before we begin today's call, I need to remind you that we will make certain forward-looking statements. These statements are based upon information that represents the company's current expectations or beliefs. The results actually realized may differ materially based on risk factors included in our SEC filings. The company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as required by law. And now I'll turn the call over to Jay.

Thanks for joining the call today. This was a complex quarter with many macro variables to navigate through. Total revenue increased over last year but was well below our expectations. Lapping stimulus payments and pent-up demand, combined with rising inflation and higher gas prices weighed on our results. Adding to these pressures, the weather was unseasonably cold, dampening sales of spring goods. Higher freight and expenses deleveraged droves and operating profit results that was well below plan and what we are capable of delivering. In hindsight, our buys and overall plans were too optimistic for the current environment. We are taking swift measures to reset. We will clear through spring goods in the second quarter and be in better position for the second half of the year. We have adjusted our forward inventory plans reflect a more measured demand outlook. We're also looking after our expense base in a more meaningful way. Despite near-term challenges, I want to emphasize that our brands, operations and organization are on solid ground. Aerie revenue increased 8% in the quarter and has more than doubled since 2019. Operating profit is up over 5 full compared to 2019. Aerie continues to present incredible growth prospects for the future and highly desirable product categories. With a strong brand platform we see exciting potential as we reach more new customers. Brand expansion has been successful with a positive reception to new Aerie offline locations. Innovation is at the core of the creative team and we look forward to new product introductions this fall. American Eagle is a destination for you. It's loved by our customer base and consistently shows up as the top brand in our demographic. For well over a decade, AE has consistently ranked as a top favorite brand in the Piper Sandler Taking Stock…

Thanks, Jay, and good afternoon, everyone. In the first quarter across brands, we faced difficult comparisons as we lapped extremely strong demand last year. Shifting macro trends and the cold spring created additional challenges, making it tough to nail down a consistent trend. As March and April played out, our plans proved too optimistic, and demand fell short. Despite this, Aerie delivered good results, especially factoring in the outsized growth in 2021. First quarter revenue grew 8%, reflecting a strong 27% 3-year CAGR. Swimwear was weak, we believe, driven by weather. Excluding swim, Aerie revenue grew 15% with intimates, leggings, apparel and beauty and also accessories also posting growth versus last year. OFFLINE by Aerie grew in the strong double digits, lapping a triple-digit growth as it continued to scale its assortment and customer base. I'm also pleased to highlight that Aerie continued to grow its customer count. Aerie's rich platform and marketing investments are resonating. Our spring campaign promoting happiness was a huge success, making #AerieREAL the #2 trending hashtag on TikTok. Our Happy Spot event generated almost 8 billion views and 2 million videos. As the leader in women's inclusivity and empowerment, we continue to push the envelope on innovation, and we ensure our customers feel our passion for our great product and the best customer experience and a brand that they can be proud to shop. In the near term, as weather has improved, we've seen seasonal categories tick up. However, we expect the environment to remain a bit choppy. We also have excess spring merchandise and are focused on clearing through it during the second quarter. This will position us for an improved second half when buys will be better aligned with demand. For the fall season, we have exciting new product launches, and these are…

Thanks, Jen, and good afternoon, everyone. In the midst of current challenges, we continue to manage our operations well. We are focused on innovation to ensure we can deliver the best customer experience while also driving operational efficiencies and mitigating cost increases wherever we can. Channel performance this quarter reflected continued migration back to stores and solid digital results compared to outsized growth over the past few years. Store revenue increased 2%. Digital was down 6% against a 43% increase last year and 9% growth in the first quarter of 2020. Digital penetration grew in the quarter from -- to 37% from 30% in 2019. Our mobile app continues to show strong momentum, driving more than 1/3 of e-commerce sales and traffic in the quarter. As we've indicated in the past, mobile customers are our most engaged digital shoppers. We're also continuing to invest in new ways to drive better engagement and increase personalization. This quarter, we introduced Shop the Look, enabling customers to browse and shop head-to-toe looks, curated by our stylists. We're very encouraged to see strong conversion with this tool that is double that of other site visitors. Additionally, we also enhanced our search capabilities to return more relevant results and prioritize best sellers for our customers. Now moving to supply chain. Clearly, this environment remains challenging. Costs remain elevated worst history. And although lead times have improved slightly in the quarter, they are also still longer than any prior history. That being said, we do currently expect that freight costs for the fall and holiday seasons will benefit from lower ocean and air freight rates. And regarding product costs, we've been successful at keeping costs in check through a number of mitigation measures, including platforming fabrics, diversifying production facilities and leveraging our scale to find efficiencies.…

Thanks, Michael. Good afternoon, everyone. As the team has indicated, the topline was well below our expectations, while our plans baked in an impact of cycling stimulus and pent-up demand from last year, we underestimated the magnitude. A shifting macro environment created additional challenges with added pressure from unseasonably cold weather throughout the quarter. As a result of the topline miss, expenses deleveraged driving an operating profit result well under our plan. We also faced headwinds from freight inflation and the ramp-up of Quiet platforms as we discussed in the fourth quarter conference call. Based on our first quarter performance and the current macroeconomic environment, we have moved quickly to reset our plans for the rest of the year. This includes meaningful adjustments to both inventory and expenses, which I'll discuss throughout the call today. First, let me review the details of the first quarter. We posted consolidated revenue of $1.1 billion. The revenue increase of 2% included approximately 3 points of growth from our supply chain acquisitions. Brand revenue declined 1%, below our expectation of a mid- to high single-digit increase. Compared to pre-pandemic 2019, total revenue was up 19% and brand revenue was up 16% or $141 million. Consolidated gross profit dollars declined 11% compared to the first quarter of 2021. The gross margin rate of 36.8% contracted 540 basis points, primarily reflecting headwinds to merchandise margins from higher freight costs of approximately 340 basis points. As discussed last quarter, the integration of our supply chain acquisitions also adversely impacted the gross margin, driving 120 basis points of deleverage. Additionally, lower revenues drove fixed cost deleverage. Compared to first quarter 2019, merchandise margins continue to reflect markdown and promotional discipline. Additionally, rent dollars are down versus 2019, and leveraged as a percentage of sales, reflecting our measured approach…

[Operator Instructions] Your first question comes from Matthew Boss with JPMorgan.

So maybe, Jen, just to dig a little deeper on the magnitude of the 1Q topline miss relative to the initial plan. I guess, how would you break apart the topline underperformance at each of the concepts if we were thinking about the shift in category spending, weather, is it inflationary impact on your core consumer? Is there a change in competition? Just any help in terms of the magnitude of the first quarter miss.

Sure. We mentioned in Aerie as we think of the OFFLINE business, how exciting that business is. And it's still obviously in its infancy stage. So we're pretty excited about that category, Matt. And I think we're ready for some fierce competition there as we roll out stores and build on that business. And let me just take a step back and just say that in total, I think it was a little macro, right? Kids want experiences, weddings are happening again. So certainly, there's that occasion dressing. That I think you can see in some of our competition where dresses have trended really nicely. But going back to Aerie, I'm really pleased. It was fairly isolated in the swim business where we saw some miss. And if you think about that business, it's definitely more penetrated on the direct side where we do most of the business there and direct business was softer than stores. So again, fairly isolated, which I like because we're almost through the swim season, and we're pretty excited about some of the launches that are coming your way for Aerie. I just reviewed our back-to-school launch, and it is more than exciting. I don't know what to say. I just think like we're going to continue to forge ahead. This launch is very isolated in our go-to business. And like I mentioned, all of those businesses in Aerie, they're nice -- they did great. So hopefully, that points to a turnaround in Q3 and Q4, where we definitely left some certainly margin in Q4 on the table. So I'm excited about that. Thinking about AE, look, the denim business remains strong. We are up against our biggest year last year. But if you look back to prior years, it's still our second best volume season. So Q1 -- past Q1. So pretty excited because we know how important that business is for the Eagle, and certainly is a category that we look forward and we re-merchandise to for Q3 and Q4, like we had some learnings in Q1. And I think the team did a knockout job, re-penetrating the right fits and the right washes for Q3 and onwards. So excited about that. There were some softness in tops. And look, we're learning and we're moving ahead. So that's really the answer that I can say. I walked, I had the pleasure of walking Michael Rempell through our deliveries today, some of our future deliveries, our concepts for summer and some of the spring goods. And that's what we're doing. We're looking ahead. We can learn. There's always a learning in retail, and that's how we're thinking about the business. I love the new team in American Eagle. They're just getting going. So I think there's a lot to come down the pipe.

Great. And then, Mike, maybe in terms of the looking ahead, what exactly is the composition of the excess inventory? What's the timeline to clear through the spring merchandise. And then on the EBIT outlook to be above 2019's $314 million base. Just any additional parameters you could provide, I think, would be helpful.

Yes. Sure, Matt. I mean I'll start with inventory. I mean I think we all know there are several factors to our ending inventory in the quarter. Freight costs are elevated, been talking about it for quite some time now. So that's in our cost inventory on the balance sheet, as we all know. Looking at the 24% increase in units, I'll say that -- a couple of things. One, we're coming off of last year's March-April hyper stimulus period. So from a unit perspective, we were down more than planned, selling through more units than expected. As we said a few times now coming into this year that we should expect that point in time balance sheet inventory at the end of each quarter to be almost a complete apples-to-oranges comparison this year. We're bringing in inventory sooner than typically planned with -- in the big seasonal change period just because of the supply chain length. It's planned that way. So to compare to last year's tough. But at the end of the day, we -- as we said in prepared remarks, we plan too high. So on that plus 24% units can gauge about 1/3 of that is just missing the plan and having to clear through spring and summer goods, as we talked about, that we will do here in Q2. The gross margin rate at 33% accounts for clearing through those goods. We're going to do it in a profitable way. We've seen that overpromoting is not paying for itself. So we are -- we think we have a good plan in terms of how to get to those units to be clear for back-to-school. And then I did forget one of the piece of that inventory, we do have quite a bit of new Aerie…

Our next question comes from Jay Sole with UBS.

My question is if you can just give us a little bit more information about how the quarter trended because February comps are pretty strong. If you can help us -- tell us what happened in March and April. And then give us a sense of May. Maybe give us a sense of how you're thinking about Q2? And then also back-to-school, assuming back-to-school is going to impact the July business. Given you're lapping the child tax credit from last year, and maybe some pent-up demand because there wasn't a lot of in-person school in 2020. How are you thinking about the July business as back-to-school begins.

Yes, I can start, Jay. So yes, February, the trend the last year was stronger. We planned it that way. We were up mid-teens. I think we said that on our fourth quarter call. But again, that was prior to lapping stimulus that really hit mid-March and through April in terms of the benefit from the stimulus last year. So we planned March down significantly. But then we planned April with the Easter timing being later. We had hoped or we believe that April would bounce back in somewhat positive way, even up against stimulus with some of that holiday shift timing. We know weather did not help us there. And quite honestly, I think we've learned now that the macro impact to the business from where we planned it, it's a little different. And we planned it higher, we planned wrong, and now we're going to reset our plans around that. The thing that's been consistent, very consistent through the first quarter and even now into May is our multiyear trend line and I think we all hate continue to do this. But we're still talking about 2019 because it is a grounding point, knowing the volatility of the last couple of years in '20 and '21. So Aerie has been very consistent on this doubling '19 trend, 25% CAGR over the 3 years. We're going to plan the business that way to drive profitability. AE down in mid-single digits has been consistent too. So again, that's why we're setting these plans up for the remainder of the year this way. We did see some pop as we got into May, and we did see some weather benefit finally in early May. So a little bit of a change in trend there, which is somewhat encouraging. But again, we're planning the business for the brands on this trend line that we've seen on this multiyear basis through the first 3.5 months. So the answer to your question -- you're July, I mean that is really essentially what we're doing for the remainder of this year with -- I hope that there's some potential upside to that, but it's -- again, it's the right place to position inventory.

Your next question comes from Janet Kloppenburg with JJK Research Associates.

Just a couple of questions on the repositioning of the assortment. Was there enough time to get the back-to-school and holiday assortments better positioned, perhaps the weakness that you're seeing in the tops business? Or do you anticipate that there will be further margin pressure as we go through that period. It seems like you do, given the EBIT guidance. But I'd love you to talk through where you were able to make changes and if we should see greater progress at Aerie or at American Eagle. And then, Jen, if you could address for me something that's confusing me is, I love the assortments at Aerie, but they seem to be overlapping a lot with a lot of the women's assortment at Eagle. And I'm wondering if you're contemplating any cannibalization there and how we should think about that?

Yes. Janet, again, I need to hear you, I'm sorry, Janet. I'm thinking about something else so as you speak. I feel really great about how we reassorted back-to-school. And our famous 4 categories like I mentioned in my first response are set up to go and -- so for instance, using denim as an example, not only did we look at our wash and our fit and making sure that we have the right qualities for both men's and women's and distorting there. We also really like how our price positioning is. So we definitely make sure that we have the good, better, best pricing assortments. And I feel really strongly that the team's really well-balanced that whole denim assortment. Tops get stronger, Janet. I mean, Janet, we don't have an issue actually in men's. Men's has been very strong. And women's, like I said, this is the most important thing. We're just getting going. We have a brand-new designer, a brand-new lead merchant and new head of marketing essentially. And I think what I'm seeing for the future, we're going to get really psyched around these assortments. I feel really good, Janet. I really do.

Can you identify what went wrong in women's tops at Eagle because I thought they had been okay through last year. And then there's been some shift.

Okay. It's more just about the balance of the inventory really. It's just about how we planned it. I think Mike set that up well. We were just too aggressive on the plan, that's all. And we reset them and we reset our inventory levels that I think we're going to really reap the benefit there. Look, I like the profit margins in American Eagle. I mean our gross margins are still fine and we're not knee-jerking during this time. We made the decision not to overly promote, which I think was a very smart, strategic, long-term decision. Our markdown rates are at all-time lows. And we're going to ride this way. This is what happens during these times. It's our job to get through it in the most profitable way, and I like where our inventories are positioned. I mentioned in Aerie are that our great businesses get stronger in the back half. OFFLINE, which we've seen great results. Those assortments get bigger and stronger with new launches. So it's really -- swim. Mike mentioned the number. We've been up 15% without that category. So as that seasonality takes hold, I think I feel really good about where we're headed in Aerie. [indiscernible] Yes, I get that question a lot, Jan. And you know what I love, I love that I can actually see all the assortments now. And when I mention that, that was another thing that we put in place. We used to see the American Eagle line at a very different time frame than I saw Aerie. So not only do we have a new team in place, but we have a whole new process where we actually -- I can see the various lines during similar weeks, which I think is a huge advantage. That said, I will say when there's a trend, there's a trend, there's a trend. I look at that as our opportunity to gain market share. And we see it all the time since lease. The fleet is trending. It sells both in American Eagle women and in Aerie. Now my job is to make sure that they're differentiated enough so that we can still see incrementality. So that's what we're working towards. But American Eagle really is about, Janet, slow and steady wins the race. Not getting too aggressive, making sure that we're protecting the margins, rebuilding assortment and setting up the plans to beat. That's really how I'm thinking about the business. And of course, you've heard the Aerie members. I still feel very passionate that there's growth there, particularly with OFFLINE.

[Operator Instructions] Your next question comes from Marni Shapiro with Retail Tracker.

Jan, I actually thought the top was really nice. So they were a great improvement over last year. But Jay, I actually have a question for you.

Thank you, Marni. Thank you. We're working hard.

I mean, compared to 2019 also, unbelievable. But, Jay, I actually have a big picture question for you because you've been through periods like this before. But I feel like as a company, American Eagle has just done so much work operationally and technology that you're coming into this tough period a very different company than you were in the past. And at the same time, you have a fashion trend in denim that's playing to your company's strength. So I guess, am I seeing this right? Or is there something else going on? Because it feels like compared to past times when we've had these moments with the consumer or inflation or anything else, the company is much better positioned. You're starting from a stronger point to fix what is going wrong.

Is this question like address me or is it addressing Jen?

Yes. No, just to you because you've been through a number of these ups and downs in business.

Yes. Look, I've been through these ups and downs since being involved with the company since early '90s. And look, one thing is we consistently make money no matter what the story is. We got a little surprised this first quarter. The team has made a lot of adjustments. We feel very good about the third and the fourth quarter. And we think we're in good shape. I think, like you said, we put a lot of money in our technology. We're making investments in our supply chain. We're making investments in the stores and making it easier for the customer to shop, making the experience online better. I think we're in great shape. There might be a hiccup this quarter but the company is in great shape. We have a great team. I think we have the best -- like the best team out there, period. I'm not worried about it.

And you feel good...

I feel very strong about the company. And look, we're opportunistic and there'll be a lot of opportunities for us out there also.

Your next question comes from Dan Stroller with BMO Capital Markets.

I just wanted to ask about the omnichannel capabilities and channel profitability. I think traditionally, you've mentioned that store and e-com profitability has been relatively in line with one another. So I was just curious if that diverged at all? And if so, how you get more focused orders to drive in-store transactions?

Yes, Dan, I can start with that question. I think the way I've described this before, is -- I mean, obviously, we look at the channels in terms of productivity, both in topline trend and then the profitability flow-through coming through both channels. At the end of the day, though, I don't like to talk about channel profitability all that much because we are looking at delivery efficiencies. We're looking at store labor efficiencies. We're looking at really the cost of a transaction. We've reduced rent cost. So it's really about efficiencies through the P&L because as we know, our customers don't really shop channels. They just shop us. A lot of times they're shopping on their app as they're walking into the store. We're fulfilling orders from the store directly to customers' homes. So channel profitability in general is not that different, and we're working through the expense line items that attach to each transaction to find optimal -- to find ways to optimize. I think it's the best way to answer that question without getting into a lot of accounting because a lot of our accounting around channel profitability is allocations, which we don't like to get into. So it is just finding efficiencies related to every transaction and the cost of every transaction is a way we like to think about it.

Your next question comes from Corey Tarlowe with Jefferies.

Firstly, just a point of clarification on the inventory. Is the expectation that it will be completely worked through by the end of the second quarter? And then if so, how should we expect the remainder of the gross margin to cadence throughout the rest of this fiscal year?

Yes. Yes, I think from a spring and summer perspective in terms of how we play in the business, we expect to be clean going into back-to-school. And when I say clean, we have reset our plans multiple times now for the back half to so that our average inventory is in line with these trend expectations and the trends we've been seeing for almost 4 months now. So on average, for those seasons, we're really happy with the way inventory is positioned against our current trend line. At the end of each quarter on the balance sheet, again, you're going to see some apples and oranges comparisons in terms of just timing of inventory. So we feel really good about that. From a gross margin perspective, we provided the 33% for the second quarter, which is where we think we'll be to get through the goods we own right now. When we look to the back half, we do expect to see improvement in Q3. I think we gave previous guidance to be in the low 40s. We do expect to be at a very healthy gross margin. I'm not sure we'll be exactly at that rate with just the top line trend change. But I would think targeting 40 is the right place to be for us in that third quarter time frame. Q4, we typically -- again, we get a little more promotional, just the nature of the holiday period. And we -- in January is when we think you cleared through all of our fall and winter and holiday goods. So gross margin is typically a little lower, but we do expect to see significant improvement to last year's rate because of that $60 million impact from airfreight. And I think Michael hit in his prepared remarks, we do not expect to incur much air freight at all in the fourth quarter compared to that $60 million number.

Got it. And then in an environment where freight costs continue to increase, can you highlight some key takes as it relates to your -- how your supply chain businesses performed in the quarter? And then maybe what to expect going forward?

Sure. So yes, our supply chain business, actually, I think what Mike said in the prepared remarks was performed a little bit better than expected in Q1. We're clearly in a very disruptive supply chain environment. And to me, that only makes the impetus for people needing this kind of service greater. Clearly, positioning inventory closer to customers, being able to get supply chain efficiencies, being able to have fast and efficient delivery, it is the future. It is the way that retailers are going to want to operate. I said earlier, to me, it's the same as when retailers all decided to go omnichannel or most decide to go omnichannel a few years ago, we're going to look back at this moment. And we're going to look back at the changes that Quiet leading in the industry. And we're going to say positioning inventory on the edge, using shared capacity to do that, is as transformative to the retail landscape as omnichannel changes were years ago. So we're pleased with how the supply chain business has performed. It acquired significant new customers. Jay mentioned Saks and Fanatics. We're excited to have them join. And for me, what I'm excited about is when we talk to new customers, they get it. They want to operate this way. They see this as the way in the future. And I'm very optimistic for where that business is headed.

Final question today comes from Rebecca Duval with BlueFin Research Partners.

I am -- just a quick 2 questions. The first is, you guys seem to be pretty disciplined in terms of your SKU count on markdowns, particularly in comparison to 2019 levels. And so I just want to -- understand how you're thinking about, obviously, you have some inventory you're going to move through here in Q2. But then should we think that your goal is obviously to get to that SKU count reduction again in terms of markdowns. And then the second question is on raw material inflation. Obviously, denims are a huge part of the business. and we've also started paying attention to where cotton is going. And I just wanted to know where you guys stand on that and if you're able to hedge that.

Regarding SKU count, we continue to look at our CC counts. We definitely have reduced a tremendous amount in American Eagle since they started really rationalizing denim. We were way over skewed. And like I said, you heard the numbers, I'm very pleased with the results, looking at 2019 and the volume that we were able to drive in bottom just way more productive. And I think that's going to bode well for the future for our margins as well. Look, we're in the business of having edited, well-defined assortments. That's one thing that I really I think is what we do best in both American Eagle and Aerie. So again, we're going to continue to optimize. There's some more opportunity in denim as we move into Q3. Aerie, we've pretty much always been really disciplined there, some learnings in OFFLINE as we've expanded that assortment and that was really from back in Q3 last year. That's really where we saw some opportunity, and we worked on that as a team, and I'm feeling like we're in a really good place there.

It's Michael Rempell. On raw material inflation, we had platform fabric, I mentioned last year very aggressively all the way through back-to-school this year. So we had cost -- product cost locked in through back-to-school. I expect markups. Our receipt markup is up in Q3 and really at pre-pandemic levels. And Q4, we do start to feel cotton price increases, but it's more than offset by the transportation benefits that we're going to get. And actually, when you look at the receipt IMU in Q4, it's really very close to what pre-pandemic levels were also.

And Rebecca, just one more point quickly. Just to be clear, because the current inventory levels have nothing to do with SKU count and choice counts. We're still down well over 20% to the 2019 levels. This is just we just bought to a higher level of sales demand. That's really what we're cleaning up. It's not anything in terms of choice or SKU counts, elevating again and becoming undisciplined. That's not -- I think Jen said, I just want to make sure that's clear.

Yes. I was thinking more like a SKU count on a markdown basis, like it's still pretty clean compared to 2019 levels. And maybe that's a reflection of the fact that you do have less SKUs, period. And so we could expect that to stay the same amount.

Yes.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Mr. Jay Shantenstein, CEO, for closing remarks. Please go ahead.

Okay. Thank you, operator. Challenges unveil opportunity. We have a very strong business with leading brands. We're using learning from this quarter to right set our plans to deliver improved performance in the back half of the year. Thank you for your time and investment. I look forward to updating you on our progress on the next quarter call. Thank you.

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