American Eagle Outfitters, Inc. (AEO) Earnings Call Transcript & Summary

Good morning, and thank you for joining us for this next session of the Goldman Sachs Global Retailing Conference. My name is Brooke Roach, and I cover the apparel, accessories and brand sector here at Goldman Sachs. Our next fireside chat will be with American Eagle Outfitters. American Eagle is a leading global retailer of clothing, accessories and personal care products under its American Eagle and Aerie brands. Here to speak with us today are Mike Mathias, Executive Vice President and CFO; and Jen Foyle, President and Executive Creative Director of American Eagle and Aerie. Welcome, Mike. Welcome, Jen.

Thank you.

Mike, I'd love to kick it off with a question about the strategy. This year, you announced the launch of the Real Power. Real Growth plan. Can you briefly highlight the progress that you've seen on this plan so far and the key initiatives that investors should be focused on over the next 6 to 12 months?

Thanks, Brook. I think just start by recapping kind of the first half of this year. So we came out with that or communicated that our strategy play in last January. It's hard to believe it's 8 months ago already. But since then, we've had a record spring season, so a record first quarter results, record second quarter results, both in revenue and pretax or operating income that led us in the first quarter, so the operating profit goal we put out for ourselves for 2023 was $550 million in relation -- that was the relationship to $300 million plus in 2019. and our results in the first quarter and our outlook for the rest of this year had us guiding actually to that $550 million this year back on our first quarter call in May. Since then, we've had a record second quarter. So again, other revenue and op inc record in the second quarter, which then, as I'm sure everybody knows on our call last week, we guided to actually around $600 million of op inc this year, which basically says we're pathing to 10% above our goal that we had for ourselves in 2023. So we couldn't be more pleased with that. I couldn't be more excited about that, Jen as well. And really both brands are contributing, and it's really -- we're clicking on all the initiatives that we outlined in that Real Power. Real Growth plan to hit the brands quickly and really talked very much about gross margin expansion, inventory efficiencies, some things we were already working on heading into 2020 prior to the pandemic and then the pandemic just accelerated a lot of the work and that culminated in what we said in January. But for Aerie brand to start there, we've really redefined what success metrics are for the brand. We did a nice job prior to pandemic for a bunch of years growing revenue, but we didn't do a great job of actually flowing through that revenue growth to the bottom line and inventory and efficiency was the key reason why. We are expanding choices, expanding SKUs, really using inventory to drive revenue, and there's a lot of inefficiencies that come with that. There's a lot of tail to the inventory we were buying and trying to sell through. And when we really dug into that, we could see where the inefficiency was. It was a pretty significant tail in inventory, leading to markdowns, leading to higher cost per unit, operational costs, you name it. So that was a big thing we came into 2021 after last -- back half of last year cleaning up, and we've continued on that path. So these are structural changes to how we're running the business. They're not 2021-specific initiatives. And I'm sure we'll get into that more into the session. Aerie, pivoting to Aerie's just continues to see significant. Jen and team and what they've done with the brand and the CAGR and annual growth rate that we're on, maybe more importantly, the flow-through of that revenue, which we talked about last January. We're actually exceeding expectations there in terms of how much of the revenue growth that we're actually dropping to the bottom line. We basically -- we're on path to achieve the $2 billion revenue goal that we put out for ourselves in 2023, more quickly than that, probably sometime at the end of 2022, maybe into early '23 on a 12-month basis. So -- and again, the flow-through that we're seeing is significantly higher than what we put into those 2023 goals. That's all culminating in the back half that we're still excited about even though there's some different headwinds out there that I'm sure we'll get into here in a minute. But excited to come back out this coming January with new targets, obviously, that will be well ahead of what we said just 8 months ago.

That was a great introduction. Thank you so much for sharing those thoughts. Jen, I'd love to pivot to you. You've led a strategic transformation focused on energizing product and marketing. And at the same time, the company has been trimming SKU count by about 25%. Can you talk to the most important proof points that show that this strategy is working? And what new product innovation or assortment initiatives that investors should be focused on in the second half and into 2022?

Sure. Let me just start with American Eagle. Aerie was a little ahead of the curve as far as really distorting our business, going after the big ideas and really owning key items. When I moved over to American Eagle about a year ago, this month, I really did see an opportunity for SKU improvement and productivity improvement, one being in the denim business. Denim is untouchable in American Eagle, that's not true. We found opportunities to even make it more productive and stronger. As you know, we lead in the denim business, #1 in women's and right up there in men's as far as our age demographic. So it's a strength for us and our customers come back for it. And -- what we really looked at is just really reducing our SKU count by roughly 15% to 20% and really focusing on the top 25 fits. And the results are really incredible. I can't share all of those with you because we really attacked back-to-school. So hopefully, I'll send the results at the end of this quarter. But I believe in the specialty sector. We are not fast fashion, right? So now I'm going to loop in American Eagle and Aerie. We want to create an environment where the customer comes in and she knows what we stand for. It's been a passion of mine -- my whole career. We did it in Aerie, and now we're really doing it in American Eagle. We want a well-edited assortment that our customers can easily shop and come into the store and understand what the big ideas are. And look, it's really -- we've been pruning away at American Eagle, particularly on the direct side, we were very over assorted on the direct business and trimming that up and refocusing that inventory into the big ideas has already proven to be a winning recipe for us in American Eagle. Look, I'm excited about the product. I'm excited about overseeing both American Eagle and Aerie because it allows me to ensure that we're dominating in our key businesses, our core businesses, denim in American Eagle, intimates in Aerie. Both businesses can survive trends year-over-year. They're fit intensive businesses. And once our customers get in them, they want to come back. We're seeing incredible retention in both businesses. And I think that's a win as well because, yes, we are a team-oriented business and our sort of sweet spot is in the higher side of the team business. But what we are seeing is customers are sticking with us a little longer. So one thing that you'll see in the future is we're going to really focus on product ideas in American Eagle, in particular, Aerie leans a little bit older in age that they can live with us. There's no reason why they couldn't come back to us for denim at the age of 30, there's no reason. And some of our new strategies are pointing to that. We're seeing that happen. We just went over some statistics yesterday in the Board meeting, and it's working. So I think that's a big win for us. Our customer file right now is at its peak it's ever been. So these strategies are working. So now we can take those ideas and move forward. So I'm pretty excited about that. Look, we're going into a big denim cycle. It's not going away. These kids want to go out. So that's another -- something to contemplate because has anyone been to the football games or watch them on TV. Kids are going out. So they want our denim and they're coming back for it. And same for Aerie, look, lots of conversation around lounge and what does that mean and everyone's staying at home. And Aerie,this product, we -- when kids were going out 3 years ago, Aerie was still winning. We're based in intimate apparel, that will always be at our core. But now with the launch of off-line, leggings are not going anywhere. Leggings are here to stay. And they're sort of ageless, so I like that category, and it's a winning category for us. So we're going to keep on reinventing our products. We're going to keep on exciting the customer. And more so coming up with marketing campaigns that really excite and delight our customers.

That was a great overview. And there are so many things inside of that, that I'd love to dig into. But maybe we can talk a little bit about denim and kids going back to the football games. Denim has been such a strong driver across the industry and supported by this key fashion shift in silhouette, how are you thinking about the longevity of this cycle? Do you expect the growth rates in denim to outpace overall apparel into next year?

I do. I think denim will continue into next year. We're only just scratching the surface on fashion fits. So good news there. We really penetrated that business for back-to-school, and we're still seeing upside there. And we're getting more and more excited about what the design team is showing up with. We just looked at back-to-school this week and the new fits look so exciting. And I love how we're thinking about testing and scaling these fits. We've sort of reinvented our testing cycle. They did used to do it a little bit differently. I sort of put some challenges on it to really understand what the new fit is. I don't want to -- I can't share my secret sauce, but it's really proving to be a winning new way of looking at the business, diagnosing it and getting the right fits here at the right time. So that's been working. And yes, the best thing about American Eagle is the denim looks authentic, but it's comfortable, right? We really led the way with comfort, not easy fits, comfortable fits, and I think we're winning with that. So yes, this cycle is -- will definitely last. And the other thing that's exciting for American Eagle is we still are underpenetrated in tops, right? So we own the denim business. So we just made a strategic hire. She's an amazing designer. She's really focusing on the outfitting and just I'm blown away with what I've seen so far. So I'm excited to really complete the outfits that they are going out again and getting to those foot buckets.

Fantastic One follow-up on denim here. Are there any incremental details that you can share with us on the new denim brand that you're looking to launch in select test stores this month?

I can't share those secrets, but it's 9/17, I believe is, maybe 9/22, I think, is D-day, so lots of excitement will come out then. But I will share with you one thing. A year ago, we made the decision with our new Head of Marketing, he and I, and we were really looking at the business and thinking we own this business, we should really dominate in it, and we really pulled back on our promotional cadence, immediately. And particularly, we started out with the fashion denim. Our opinion was if they want fashion, they want it, right? They'll buy it. I remember when I was 14, I want my new pair of sasson jeans, got a couple of extra babysitting jobs to go out and get that pair of sasson jeans. So it was just a win for us. I mean think about it, like we had been typically running a bogo day in and day out promotional cadence, and we really did pull back on that. I mean, there's weeks, there's months that we're almost 100% reg price. So it's just amazing. And what we've seen inside of that is we have a jean, it's $98 in American Eagle. That is actually up there in the top 10. So it actually blew out. So I think that leads me to believe that: one, customers can live with us longer; two, they're willing to pay because they love our product; and three, we just have to keep on delivering more excitement to them.

That's so great. I'd love to pivot for a moment to Aerie and the path to building $2 billion in revenue. We've seen some increased focus on intimates, underwear and lounge as several other brands have entered the market. And some of those brands have started to gain a little bit of scale. How are you thinking about Aerie's competitive positioning and customer engagement strategy in this market? And can you talk to your confidence in a continued 30% CAGR in the brand as you look ahead?

Yes. Well, let me start with your last question. Our new stores are amazing. Like we just opened Garden State, and it's really just beating expectations. Greenwich, Connecticut. We just opened -- we're on a street location in Greenwich, Connecticut, great ZIP code and anyone who commutes from there, please get ready for 9/17 because you will see a takeover in the metro station. Aerie will be everywhere. So yes, I love what I'm seeing with the new stores. I think we're doing a great job with that. So when I think of the 30% growth, look, if we continue to deliver these new stores like we are, this is -- it should be there. As far as our product, look, like I said, Aerie has been able to ride 7 years of trend cycles, whether it is denim, whether it's stresses, whether it's whatever, I think she loves our foundation, right, our business that we're built on. Bralettes, let me just say, are still trending for us. They love our bralettes. They're actually wearing them out now. That's a whole other new trend that we're seeing, and it's been a huge business for us. We own that business. We were very aggressive in that business back in, I want to say, 2014, and we dominate there. And look, I have one of the best designers in intimates. She worked at key core competition. She actually patented bras and she is 100% innovating year-over-year, month-over-month, she does a great job. So I'm proud of that business, and it's a core part of our business. And as I mentioned earlier, leggings, they're here to stay. There's no way the legging business ever fade away. And I like what I see from valuations with some of our competition, they're up there tells me that there's lots of room for Aerie to go after that business. Like it was unheard of, did anyone think that Aerie could really shake up some of the competition out there, this little tiny brand? But look, we did it. We did it. And we did it because we're exciting. We have some of the best product. We have the best executed stores. Our stores are exciting. That is the -- that's the part that I think is just such a competitive advantage. The way we assort to our stores, but also just the way the stores are, the environments, they're fun. Our new offline store in Garden State, it's actually a side-by-side Aerie offline. It's spectacular. There's a pingpong table on the offline side. It's not just going into a sea of black leggings in the offline store. It's going into an environment that speaks to a girl that doesn't just do yoga. She has coffee after it as well in shops, in her leggings. That's how we think about offline. And then just the product, I just -- we keep on innovating. I'm in there working with the teams today on back-to-school for Aerie. And we came up with this high idea. And it was just there. We all just gathered around and just built it and we're excited about it. That's how we operate in Aerie. It comes from in these 4 walls, and that's what I think the customer feels. It's authentic, it's real and it permeates through these walls.

Just to add to that quickly, I think Jen hit it though. The leggings piece of the business and this offline sub-brands, if we go back to last January, we didn't talk a whole lot about it. We were excited about the launch that we just anniversaried recently. And it was sort of embedded in our thinking around our targets to $2 billion, but the acceleration of what we've seen from the sub-brand and what we're doing from a real estate perspective that will hit more in January in terms of -- it's incremental to what we thought last year. So we're talking about store performance. But the acceleration of the $2 billion target and then when that's going to happen and even beyond $2 billion, we'll probably be talking about the next $1 billion to $3 billion over time. This -- the growth of this category, the growth of offline within Aerie is different than where we were this time last year in terms of our thinking. So that's a bit -- so maintaining 30% CAGR, I guess to the point, there's a new -- those elements are a big reason why we think over -- on a consistent basis, we can do that. Offline is a bigger part of the story than what it used to be.

Totally. And don't forget, AerieReal. It's what we launched back in 2014. We were so -- like if the stars were so aligned with how we approach, how we are going to go into the fashion world. And we did it so differently, not hypersexed, not super models, real girls, not air brushing our models. What a concept. I mean they're models for a living, why would we air brush our models. I don't understand that. So it was simple thinking that led us to really compete with the -- we really get out there and compete as a brand. And Look, we mean business there. And when we enter new markets, we reiterate what we stand for. And it's so important because I see a lot of people following that, which is great. I'm very proud of that because it should have happened a long time ago. So we were like frontier men out there, paving the way for a new way to approach fashion, and we did that. And that's a proud moment for me and this team, and we live by that. We live by AerieReal every day.

Excellent. I'd love to follow up a little bit with the size of that offline business and how fast that's growing? Can you talk to how big active is for the company today? And the growth expectations that you have for that category within the Aerie brand going forward?

So I can say that the legging business is a big piece. Let me just say a big percentage of the whole Aerie Inc. business, and it's growing at a very rapid rate, very rapid. I don't know if I really can share all the details on that, but let me just say the comps are -- exceeding our comps that we're posting as a total inc. for Aerie. So that's the news that I have there. And we're just so pleased with the results and the innovation there, our qualities, I mean we're in the best factories. We're in the best factories at really compelling prices. So that recipe is a winning recipe. And we are going to go after market share here. We mean business. So we think about every day on how we're going to please this customer. I had an experience going to the gym the other day and changing afterwards. We have this whole haha about that. I have the teams working on that right now. So this is real -- as real as Aerie was, and we mean real business.

Mike, I'd love to follow up on the Aerie's growth strategy with a question about margins. You've talked to Aerie being at an inflection point in its product trajectory now. Can you talk to the leverage point of this business, the outlook for margins at this brand and the key levers to drive that further momentum?

Sure. If you go back to our targets, we implied as we hit $1 billion in 2020, we're looking for this next $1 billion, happening sooner than we thought. The targets we put out for ourselves implied about 20% flow-through on that revenue. And I think we got some questions about whether we thought that was conservative. The answer to that at the time was yes. And if you look at what we've done in the first half of the year and even just this recent quarter, we actually flowed through 40% plus of Aerie's volume to the bottom line to the brand op Inc. Now I'm not sure when we -- coming to this January, whether we'll like we'll count on that continuing 40%, but definitely something north of 20%, maybe 30% plus range will be something we talk about. But again, we'll talk about that more in January. The things that are -- the initial comment around inflection point was leveraging fixed costs, total revenue being at $1 billion and growing from here. That was the point of hitting that $1 billion mark where that fixed cost leverage becomes a bigger part. But what's happened is as much as a lot of the inventory initiatives, promotional discipline, the things we've executed where there was more opportunity in the AE Brand. There were some opportunities in Aerie. And we've seen that come through some of the sort of the combined promotions with the AE Brand in some ways digitally that we're seeing flow through to Aerie in a big way. The other parts of it are the other pieces of what we're trying to optimize, which is our rent structure, negotiations with landlords, they're all portfolio negotiations. So even as we're closing AE stores or renewing for favorable terms, we're getting good terms on Aerie in offline renewals -- Aerie renewals and Aerie offline new stores, better terms than we've seen in my history here. So those have been benefits through the rent line for are as well. Then all the supply chain initiatives that we've talked about, Michael Rempell has talked about on calls from delivery, digital delivery optimization the node network that we have in place, the AirTerra acquisition, all these things that we're doing within our supply chain are a bigger benefit to Aerie as well. So that's what's driving this more healthy flow-through than we talked about last 8 months ago. So I think those are all sort of sustainable pieces of the flow-through story for Aerie and AE and the company as a whole. So that has me comfortable with it's going to be a much -- a bigger target in terms of the operating income benefit that Aerie is going to have to the bottom line for the company, and we'll talk about it more, but it is big drivers of the 20% plus operating -- or brand operating rates that we've reported the last couple of quarters, both AE and Aerie in the low to mid-20s, driving this 13%, 14% operating income rate for the company. And I think it's all those reasons are why we believe that kind of this low to mid-teens that we're in will be a new target versus the 10% that we put out for ourselves. And again, we'll talk about that more in January. But it's an inflection point, both from a fixed cost leverage perspective and then all the initiatives we have that are focused on gross margin optimization as a whole, Aerie is benefiting from all those just like AE is. So it's a bigger part of the flow-through story than we even thought, not too long ago. So you can imagine on the next $1 billion, it implies $300-plus million of flow-through, and we'll probably be talking about beyond $2 billion this coming January at that same rate.

That's incredibly helpful color. You talked a little bit about the supply chain investments that the company is making. And supply chain and logistics are top of mind among investors. Can you talk to the investments that you're making in hub and spoke, the speed in the margin quantification that you're getting from this? And then what does AirTerra bring to the table?

Yes. So I think if you go back to this time last year is when we really expanded our distribution network outside of our own facilities in East Northeastern PA in Kansas to what we're calling our node network, which is our third-party piece of the hub and spoke model. So we're up to 5 locations now in that network, 7 total domestically plus our facility in Toronto. And that entire strategy was about getting inventory closer to our customers. Delivery efficiencies that has not only to direct to consumer, but also being able to pull a lot of inventory out of stores in terms of 4 weeks of coverage and replenishing that inventory more often and closer to our stores. That has allowed us just one, that's a big part of the efficiency piece of it, where we're buying less inventory to drive the demand. and the cost of which carrying that inventory, delivering and transportation cost of that inventory. And again, the digital delivery piece, where we're leveraging digital delivery as a company that not a lot of other specialty retailers can say that is because we were shipping a lot from stores through BOSS initiatives, split shipments were high. So we're getting the product to the customer, but it came at a higher delivery cost. We're now -- we pulled back on that significantly, and we're shipping more full orders from this hub and spoke model and from this network directly to customers. So it's allowed us to do more with less inventory and then delivery efficiencies getting closer to the to our customers. AirTerra then is sort of the middle mile part of that. So I just described sort of the last mile of delivery to customers, replenishment of stores. AirTerra is going back upstream to inventory comes to a port, consolidating inventory with other customers, quite frankly, that we're going to have running this business, getting scale cost efficiencies of actually that in delivery speed from whether it's L.A. or New York or coast-to-coast efficiency of getting our inventory faster from port to that network to that hub-and-spoke network. So it's cost efficiencies there and speed efficiencies there. And that's what AirTerra is meant to provide as part of the network.

That's great. Sticking with supply chain. The pressure that we're seeing on the supply chain is certainly an industry-wide trend. And you recently provided some color on this on your latest call. Can you further clarify here? Is this a cost issue? Or is this also a risk to top line sales momentum?

I think we think we've mitigated to just a cost issue. I think others are worried about other retailers at some of our competitors are actually worried about getting their inventory for holiday. We feel like we're in a great place right now where our mentality around this has been it's short term, sort of Vietnam being in locked down for quite a bit of time is the main culprit for us and others. But the air costs we've been able to secure, we feel really good about getting our product here for holiday and the goal being that the customer does not feel a difference from us, whether they're shopping in our stores or shopping digitally and they don't care if it cost us more to get it here. And that's -- I think that's where -- that's the situation we're in now. It's going to be a short-term cost headwind for us. It's not going to be a demand disruptor in any significant way. Just to size it, I mean we, call it, 20% plus of our inventory comes from Vietnam, which has been the biggest challenge. It's just certain factories that have been the challenge. So you're somewhere probably between 10% to 15% of total inventory. And then we think we've been able to mitigate the timing issues with securing -- especially air transportation once we're expecting both this week and next week, the factories that have been a challenge or expected to be open. So again, it's not a demand disruptor for us. We don't believe it's a cost headwind, and that's embedded in our $600 million guidance that we provided for this year.

Got it. You talked about sequential step-down in margin expansion embedded in your second half outlook, as you just mentioned, as largely a function of that freight and transport. Can you help us understand the magnitude of those cost headwinds you're seeing now and the levers that you have at your disposal to mitigate those. When do you think that will normalize?

So in our -- just from a kind of P&L taxonomy perspective, it's embedded in our landed costs. So it's [indiscernible] kind of in a markup headwind. We're still quantifying it. And then because it's embedded in that line item, we actually don't incur the cost until we sell the specific goods that were impacted. So it's a bit of a moving target. We think we've got our arms around exactly kind of when we'd incur the cost. It's more -- it's definitely fourth quarter weighted, maybe a little in October. So it's not as much as a Q3 impact as it is a Q4 impact. Basis point-wise, I don't want to quantify it just yet because it is a bit of a moving target in terms of how it's accounted for. But again, it is -- but the mitigation side of this is that we still have quite a bit of promotion built into our fourth quarter plans, around Thanksgiving, Black Friday, Green Weekend, Cyber Week. We think actually scarcity of inventory and even -- we believe we actually -- before any of this started, we had some room potentially in that promotional stance. But now we also think there's scarcity of inventory that may allow us to be even less promotional that's what's planned on paper right now that could be an offset to this markup impact. So through gross margin, we think there are offsets here that we could -- we can execute to. And again, we think the $600 million accounts for what we think now, but there could be upside to that, which we did imply in our call. We definitely said we would have guided something higher than the $600 million, if not for this uncertainty around some of the transportation costs, which are short term. We think it could carry in because, again -- because of how we account for it, it could carry into Q1. We do sell some of these goods into the first quarter within our clearance bucket. And there still probably could be some backup, not only from country of origin there with Vietnam, but even the port congestion could continue, we think into holiday and maybe a little bit post holiday to impact a little -- impact Q1 to some degree, but we don't think it's significant past that initial spring season timeframe. So short term, probably the next 6 months or so is where we think, 6 to 8 months could still be a bit of a headwind, but definitely mostly fourth quarter this year is where the impact is going to be.

Great. You mentioned promotions and the overall apparel industry has had one of the best overall promotional environments for some time, and you've seen very strong AUR gains on lower promos. You briefly mentioned your outlook for promos a little bit there. But can you talk a little bit more about your outlook for promos in the second half? And then into next year, how are you thinking about bringing back promos? Will you focus on full price sales? What will your approach to promotions be? And how much of this is a function of American Eagle strategies versus the overall consumer environment?

Michael, do you want me to take that?

Yes. Jen, you start, I'll chime in if needed.

I mean in general, we're going to continue to pull back. Our goal is -- we're not a fast fashion retailer, right? So I think we have a lot of opportunity to continue to build on our quality, our fashion styling and continuing to -- I mentioned some of the success we're having in the higher price point at denim. And all that comes with some scale to it, too. We're a big company. So even if we grow and build our quality and better our product, we do have scalability, too. So that's how we're thinking about it, but we are going to continue to make sure that we're pulling back on our promotions and getting paid for where we're building our quality. So for holiday, it will be the same. And we're focused on continual pullbacks in both brands, and we see that continuing into the spring. The product that I'm seeing with American Eagle warrants higher retails. And it's just -- in my mind, it's that more exciting than where we've been. And we constantly talk about comping business year-over-year and how do we do it. So it will be with, I would say, similar promotional cadence, but with better product offering and more exciting offers. So same for Aerie too.

The only thing I'd add is that I think there seems to be a bit of perception, like higher price selling mix, all those things or more full price selling, I should say, next are all benefits. And there's this perception, there's no discounting, and that's actually not the case. We're actually not even close to our historical test markdown rates. So even if we just -- what I would -- how I would describe it is, we're at a healthy level of promotion versus what we were doing pre-pandemic for years, where we were driving markdown rates in the mid-50s. I mean our best years when things are more of a one channel, just stores, digital was not as much of an impact. Some of our best years, we were in the mid- to high 20s, from a markdown rate perspective. We're implying through our gross margin results now, our guidance for the year, and we're in sort of the mid- to high 30s from a markdown rate, which is -- I just -- it's a good healthy range for us. So even if we're able to maintain where we are. And then Jen, as she just described ticket opportunities, product cost opportunities longer term, mix of selling to Aerie and offline where higher ticket and higher margin items. Those are all just merch margin and gross margin benefits that have nothing to do with promotions. So even if we just maintain the same promotional level, which I think is just a healthy level, it's not a no discount level, we still have gross margin and merch margin opportunities.

Great. And just to round out the state of the overall consumer, I'd love to hear your insights on the state of the consumer. What are you seeing in back-to-school so far? Has this business seen any impact from the Delta variant? And as you think about trends into holiday, how are you thinking about the potential impact as the consumer moves farther away from the stimulus benefit?

Yes. I definitely think holiday is going to happen a little bit earlier, similar to last year. I think -- so we're definitely planning on that and thinking about that. We're pleased with our back-to-school results. Yes, there has been some headwinds, Michael alluded to them. We're sort of getting some of our deliveries in Aerie in particular, a little bit back loaded, but I think we've been able to nicely mitigate it. And to maintain this business that we're so pleased with. And then thinking about American Eagle, look, same thing. We have a customer, I mean, both in Aerie and American Eagle. We have a customer base that wants to shop if there's 1 base that will continue -- parents will continue to spend their money on their children. They continue to want to look good. I have a 14-year-old, trust me, she shopped during the pandemic. She shopped when can -- they shop, right? So it's our job to have the right goods at the right time. That's how we're thinking about it. We're pleased with back-to-school. We win in denim, and we really laid out a great plan in American Eagle to own it and to continue to be in that business and win in that business. So we're very pleased with the early results. There's still some weeks to come and -- but we're just counting on getting these deliveries here and showing up. That's what we're focused on.

Great. And Mike, to round out the discussion, we've talked a little bit about the strategic initiatives and the great things happening at both AE and Aerie. We've also talked a little bit about some of these cost headwinds. Can you give a little bit more color on how you're thinking about profitability moving forward across each of these line items? Can you provide a little bit of color on how you're thinking about those operating margin targets in the low to mid-teens long term?

Yes, I think we had some of this earlier, but aside from some short-term headwinds that we're talking about in supply chain and road transportation costs, again, probably carrying into Q1. Everything we're going to talk about again in January is sort of reissuing or providing more color on what our new targets for 2023 are. So I think it's beyond any short-term headwinds, hopefully, for all of our sakes beyond COVID and variant impacts that we're seeing and Jen's hit it right, we're not really seeing a disruption to our customer behavior or demand even from the Delta area now, no issues in stores, no capacity constraints, no traffic disruption, et cetera. I don't think we're going to see anything significant like we were still dealing with last year. And I think within our 2023 targets, we're going to assume that that is the case as well. But the flow through -- the #1 story was 2 pieces of it, right? Aerie and offline growth. So we'll talk about when $2 billion is in our sights. And because of the impact that we're seeing from offline and really the real estate and market expansion growth we see for both Aerie and offline as a sub-brand, we'll probably be talking about $3 billion as an opportunity for us beyond 2023. So the flow-through on that, again, at 30% plus, I think is what we'll probably be talking about as a target from the $1 billion we saw in '20, you're implying $600 million that we think is a longer-term opportunity, and we're a company that just prepandemic for a bunch of years only made $300 million to $350 million. So that's just the Aerie portion of what we think could be incremental over time. The AE part of that story is we've got -- we've corrected some inefficiencies or just things that were not being managed from a control perspective or even just from a profitability view for the -- within the brand. Inventory was by far #1. Again, we'll talk about this more in January, but we still have work to do. I think the the SKU rationalization, choice rationalization, the cost embedded with all that excess inventory and excess choices, not only just the margin, like merchandise margin impacts from markdowns and selloffs, write-downs of inventory, but the costs of transportation of distribution of store labor. We're seeing all those things come through. And those are structural changes in the brand. So even on modest revenue growth for the AE Brand, we see the profitability picture being very different than it was a few years ago. So the contribution from an operating income perspective for both brands has us excited in total. So I think when you translate that to operating margin, Aerie is at an inflection point of leveraging fixed cost, plus all the other variable cost benefits I described earlier. AE was already a big business, generating a bunch of a ton of profit and cash. The combination has us really excited about the future. And when you kind of add all that together, the idea that we can be at a low to mid-teen operating rate you might start to question me whether that's conservative still. But more to come on that in January. We don't think we're single digit annually, again, I mean, from my seat, I don't ever want to be in a single-digit operating rate, again, as a company, we shouldn't be based on everything I'm describing. It's just a matter of how high the targets should be, which will refine again in a few months.

Thank you so much for sharing those thoughts. And with that, we are at the end of our time here. So I'll say thank you to Mike. Thank you, Jen. Thank you, Judy and Shirley for also joining us today. We're hoping that everyone who's joined us online can join us for the next session. Have a great day.

Thank you.

Thanks, Brooke.