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

Great. It's Matt Boss, retailing, department stores and specialty softlines here at J.P. Morgan. Happy to host the team from American Eagle. We have Chief Financial Officer, Mike Mathias; Chief Creative Officer, Jen Foyle; and Head of Investor Relations, Judy Meehan for a fireside chat as part of our 12th Annual U.S. All Stars Conference. On format, I've compiled a list of questions and topics from investors in advance. I'll run through that with the team. In addition, please feel free to e-mail me at [email protected] with any additional questions, and I'll try my best to incorporate. With that, I'll pass it back over to the team, if you wanted to kick off with anything. And otherwise, we could just start right in with questions.

I can say a few things, just coming off our second quarter earnings call. I mean, we are coming off our record spring season, both Q1 and Q2 revenue and income records. The Aerie OFFLINE trajectory and growth story continues through the second quarter results. We've seen great momentum in the AE brand as well, exceeding our expectations, both in terms of recovery of top line against the targets we put out last January and the profitability, which we're driving the business at that same similar revenue amount. So all the initiatives we had in place coming into this year are still maintaining focus. I think the results we're driving with those being the focus, have us believing that we're doing the right things. And then our guidance for the year of $600 million bottom line is almost 10% higher than what we put out last January as our target for 2023. So you can imagine then we're gearing up to update those targets this coming January. We plan on another Investor Day a few months from now. And you can imagine then both sort of top line and bottom line targets for the brands and the company will be well ahead of what we said last January. So we're excited about all those things. And we're looking forward to a good back half of the year. We know everybody out there knows what the headwinds are in the supply chain world and some excess costs we're incurring. And I would say what I said on the -- what we -- how we described that on the call a few weeks back, which is we're incurring those costs. We want to make sure the customer doesn't feel it. We want to be in the right inventory position to fulfill demand for holiday. And the guidance we gave, we believe, includes those costs or we would have guided something a little higher. So -- but we believe those are all short-term things that we're -- everyone in the industry is going to be navigating here through the holiday season, maybe a little bit in the spring. But for the long term, we're really focused on the long-term still in terms of how we're running the business and again, culminating in what we'll say this coming January.

Great. Maybe to start off with the momentum at Aerie, so I guess, is there anything you view as transitory or tied to the pandemic this year in terms of that momentum? Meaning, as we move forward, is there a way to rank the opportunity you see from Aerie from expansion into new categories versus growth from the current core? And again, tied back to that transitory this year, how best to think about growing off of this year's base? Is there anything you need to give back, I guess, is kind of my question.

Well, if I just think of the trends during the pandemic, like obviously, loungewear was a hot commodity, and we certainly answered the needs of the customer there. But as I always say, Aerie has been on this huge trajectory year-over-year, year-over-year, 26 plus quarters of double -- high double-digit comps. So I think we've proven that we can ride out the trends as they shift. We were right on it prior to the pandemic with fleece being just a hot category. We owned it and dominated it in it a few years back, and it continues to be a huge trend in Aerie. And look, bras and undies are the core of everything we do, right? That is our core competency business, and that will never go away. And of course, we have to have the right trends there. If high jeans -- high-rise genes are trending, we need high-rise undies, right? So that works for us. And the good news is, I have the view now to both brands, right? I see what's going on in AE, the shifts and trends there and the silhouettes of bottoms, so I can really manage that to Aerie and make sure that we have the right underpinnings for those garments, so to speak. So mom jean was trending in AE. It was one of our #1 fits. And lo and behold, we have the mom undie for back-to-school, and it blew out. It's great. So that's what I have to manage, the shift in trends and make sure that we're obviously dominating in our core competency business in each brand, denim and in Aerie, it's bras and undies, but then these new emerging categories; certainly OFFLINE is an exciting trend out there. You see the valuation of some of my competition and how great the legging business is, and that is here to stay. Leggings are never going away. And it's a huge piece of our OFFLINE business, and we see a lot of growth there. It's an exciting new business for us. We have some various footprints. We have a couple of shop-within-shops, side-by-side and some standalone stores. In those standalone stores, where we have an existing Aerie store, we're seeing nice growth for both boxes. So that's good news. And of course, we're just going to really continue to monitor the best footprint for OFFLINE. And we see Aerie in the future being $2 billion, and that includes the OFFLINE business. So we're just really excited about the growth, and we have our eye on the prize. Certainly, Mike acknowledged there are some headwinds, but I look at those as tailwinds in the future, and this is a long-term gain, right? We're here to continue to grow year-over-year, year-over-year. And that's my middle name. I like to comp. I like to comp items. I like to comp marketing. I like to comp everything I do. So -- and that's what we're certainly focused on.

I like that on the middle name. So hopefully, it's -- maybe we continue to material comp or sustainable comp.

Sustainable, that's another great word too.

So you mentioned the $2 billion mark for Aerie. Well, I guess my question is, over time or multiyear, where do you think or what's the long-term aspiration for the brand? Is there a level that you think is the ceiling as we think about over and above the $2 billion mark? And I guess my kind of building up to whatever number it is, are you seeing expansion in the overall TAM in which Aerie sits? Or do you think the brand is taking market share? Or is it a combination of both?

I think it's a combination of both. And certainly, we still haven't expanded across the country yet. So even domestically, we are not -- I keep on saying we're not -- we haven't gone west fully, and we're starting to get into those markets, Texas being one of them. We see nice results there. So the great news is, as we continue to build Aerie into new markets, we're seeing that nice halo effect on the direct side of the business. We are definitely a higher penetration in the web business versus much of our competition, which I think is a competitive advantage, certainly during these times. Think about today, right? We were able to really play up that channel nicely during the time -- during this COVID period, but certainly be agile with our inventory when the stores open and would have it. But no, I think like just with our expansion, we haven't did a ceiling yet there as far as our store growth. We're looking at about 500-ish stores in Aerie, and we're playing with OFFLINE, whether they're going to have more standalone businesses or side-by-side or shop-within-shop. So -- and that certainly will allow for expansion. We definitely see $2 billion is not our ceiling. And internationally, that's -- we haven't even scratched the surface yet. We are opening up about 14 stores this year in Mexico, incredible business coming out of that country. So again, and we haven't even touched the international opportunity. Aerie, our DNA and what we stand for really is accepted culturally in many other parts of the world. And it's interesting to play on that DNA, and really, I think we could be really well received in some of these new markets, and that's certainly down the road past the $2 billion mark.

Yes. Matt, just, I mean, if -- just to tie back to Investor Day, too, and we'll probably be updating. I think if you go back to what we presented then, if you add intimate, soft, I think we labeled as soft apparel, swim and activewear, so call it OFFLINE now. It's like $65 billion U.S. market alone, were $1 billion as of 2020. So there's $64 billion out there and growing, we think, in the space. So yes, as Jen said, we'll be updating $2 billion, it's a no-brainer. We'll be updating the time line of when we think we'll get there. But I don't see any reason why the combination of Aerie OFFLINE and what denim is doing in those categories can't be $3 billion and beyond.

Yes. And I...

So, we'll probably start to tease that out a bit, too, in the January conversation.

Totally, Mike. And from a product standpoint, just thinking of OFFLINE, like we haven't even scratched the surface yet on innovation there. We're anting up on our innovation team to really ensure that we're going to have the newest, the best and the greatest. But certainly, our Real Me category in OFFLINE has been so well received. It's been a one-hit wonder, and we keep on chasing back into it. The demand there is incredible, and we have newness around that that's coming. I think the customer is really going to respond too. So again, I think that's how some of our competition really won in the business first. And I think that's what we really set out to do is find that legging that everyone's going to love. And now we have just expansion around new innovation and new product ideas in leggings.

Jen, it's a perfect segue. So for OFFLINE, what's different about it? What do you think the competitive advantage is here? How large do you think this business can be? I think you're around $200 million today? Or maybe a different way to think about it, I think you were able to triple Aerie revenues in 5 years. Do you think the opportunity is similar in OFFLINE?

I absolutely do. And look, our approach to OFFLINE is unique, right? It's using our Aerie DNA and just sort of expanding on that from an activewear approach, but it's just not taking it too seriously. And I think if you go into a store, if you see our store environment, it's fun. It's exciting. We have a ping pong table, it's very inviting. I mean, we literally have dogs as mannequins. It's hysterical. Like, we just want it to be a fun experience. We want exercise to be fun. We want it to be part of our lifestyle. We don't want that girl that's going into the yoga class feeling insecure because you can't find a place to put a map down. We want these girls to have fun with it and to feel comfortable in their bodies. And I think just leveraging our Aerie brand DNA will allow us to do so. But again, the store experiences is, in my mind, very exciting, it's colorful, it's inviting, there's print, there's pattern. And it's -- to me, a different take on much of our competition and we're going to continue to double down there. We're still finding our way like really how to push and drive what the DNA is in the brand. And then sometimes, that takes a little time, and we're getting there. We certainly have great creative ideas for the future. And there are so many categories we can expand on there, to be honest. We really are just -- our core business right now are broad top sports bras and leggings. But certainly, there's outerwear components, different sport components. We launched some tennis skirts this year. They blew out. They were incredible. So I really look forward to expanding just the product there. And certainly, we do see that type of growth that Aerie experienced.

Mike, I think you outlined 500 to 600 Aerie store target back at the Analyst Day. But as we think -- and I think that includes OFFLINE. As we think about the momentum in both of the brands from a store productivity trend and how quickly they've recovered, what's the best way to think about that target? Is it still the same? Has it changed at all?

I think it will be changing. Jen is hitting some things here that -- especially the OFFLINE portion of that target, when we put the 500 to 600 out there, as you said, it was -- OFFLINE was included. It was only a few months after launch, we've learned a lot in the last 12 months around what was said. We have a few stores out there now, a bunch more opening here between today and holiday. So we'll get to get a read on those, both mix of standalone and OFFLINE locations with side-by-side Aerie. So we'll be evaluating those from a format perspective. So I think total door count, I'll say, because it does include a mix of side-by-side locations with Aerie, will be something higher than the 500 to 600 just based on what we've learned to date, and I think we'll continue to learn more as we go forward in terms of just how many stores we think we want. So I think you'll be hearing an update on, I think, a higher number in January.

So I guess my follow-up would be, when you put this together as we think about Aerie, I think you've spoken to 30% multiyear CAGR at the Aerie brand. I think at the Analyst Day, it was kind of mid-20s. So you're already kind of citing a higher run rate. What gives you confidence in that multiyear outlook? And is there anything -- I guess, is there anything impeding that being the outlook starting next year and beyond? Meaning, is it a 30%-plus growth rate next year and going forward? Is that the best way to think about it? And how confident are you in that?

I think the one of the key variable ties to your earlier question, which is just how fast we move a store growth and how many stores? So I think the 25% we talked about last year was organic or natural comp growth; maturity curve, we think, is there; plus the assumptions we had around stores. So if we continue to pace and maybe go a little -- at that same rate we were in pending last year, 25% total growth rate makes sense if we accelerate a bit, maybe tie to the OFFLINE story and we evaluate these stores that are getting out through the back half of this year. I think higher end of that range being at 30% is possible. So a lot of it's going to tie to how many stores we get out there and at what pace the digital halo associated with those as we know that occurs and is a big piece of the strategy, and that's probably the difference in that 5 point gap. The 25%, we think, is more than achievable, a little higher depending on pace of store growth.

Got it. And then as we think about flow-through at Aerie, I think your recent flow through at Aerie has well exceeded Analyst Day expectation, which I think you set at around 20%. Help us to think about the flow-through going forward on Aerie? Have you seen structural improvement relative to that 20% mark that you had initially outlined?

Yes. I think all the company initiatives tied to that, too, right? So I think -- I mean, you even asked a question back in our Investor Day, somebody did around the 20% and if we think it was conservative. And the answer then was, yes, we likely think that's conservative. Recent quarters here, second quarter specifically, we were 40% plus, whether you compare it to last year or '19. I think there's a lot under those covers in terms of whether that's sustainable or not, but definitely exceeding 20%, something else we'll update in January. Even if it was another 5 points to 25% on next $1 billion or $2 billion of growth and probably $250 million to $500 million of pretax income growth associated with it. So I think it will be higher than 20%. We'll update that as well. The learnings we have from recent results are going to have us be very confident in that. And everything we're doing -- we'll probably get to these questions later, I'm sure some conversation around gross margin, gross margin optimization, the rate we're seeing today, Aerie, a lot of those initiatives had more upside in AE based on the way we're running the business, but at the same time, whether it's supply chain network, delivery optimization, rent, leverage, the things that are benefiting gross margin that we intended to see happen across the board for the company this year are definitely benefiting Aerie as well and probably not necessarily embedded in that 20% flow-through that we talked about in January, and we're seeing the results in Aerie just like we're seeing in the results in AE. So I think the -- we'll get to an operating margin conversation, but definitely a higher flow-through on this Aerie growth and definitely a higher target for the company from an operating perspective, all tied together.

Perfect. I'll go right to the operating margin question right now at Aerie. So basically, last 12-month EBIT margin at Aerie, I think, was 18% and front half of the year was low-20s. You laid out a 15.5% operating margin target at the Analyst Day. So as we take together, what you've seen to date, should we expect at least high teens moving forward on that mid-20s to 30% top line? Or how best to think about with the -- in your opinion, what the rightful Aerie operating margin is?

Yes. I think when you look at the brand operating rates, we've provided in that mid-teens range that tied to a 10% target for the company back in January. Now we're talking about not only just based on current results, but what we're learning in terms of the gross margin components first, that we've been focused on. And SG&A will come later with revenue growth in terms of leverage, operating rates for the brands being in the high-teens range, most likely, Aerie being a little higher than AE just based on being able to leverage the revenue in Aerie more. But the operating rates for the brands on a combined or mix basis being in high-teens with the operating rate target for the company, then coming up from 10% to something in the low to mid-teens, right? So I think that relationship stays the same. But that's definitely how we see it going forward as operating rates for the brand is higher than what we set, more in the high-teens that you're describing.

Perfect. Maybe to switch gears to the American Eagle brand, maybe for -- back to Jen. What do you think in terms of long-term growth drivers for the core American Eagle? What gives you confidence in the multiyear outlook, which I think now you're talking about low to mid-single-digit revenue versus flat that we talked about before? I guess, what's giving you the increased confidence? What have you seen to bolster your view at the core American Eagle?

Sure. Just starting with denim, it's everything we do in American Eagle. It's our foundation, and we do it incredibly well. I mean our washes, our fits and our finishes and our price points are just so well received from our customers, and we still see opportunity in denim to remix that product to continue to drive the fashion side of the business and do it with a lot of intelligence. So it's not a markdown business. There's lots of ways to do that. I have a lot of history in denim. I ran denim at the Gap in its hey days. So I really understand that to manage that business. So lots of opportunity there. Our customers are demanding more there from even sizes and fashion. So I see some long-term growth there. We own and dominate in that business. It's our -- the #1 in women's for all ages and #2 in men's. And again, we -- that would lead to some more opportunity, too. And I see denim as a long-term growth plan, too, because we're starting to see some of our customers. So we're seeing lots of retention, which was also like definitely an initiative of ours to keep these customers. And I think it's through some of these new washes and more like, I would say, adult washes that they can grow up with us a little bit. So we're seeing some nice wins there, and I see that a long-term strategy, too. So retention, not only just getting new customers in, but retaining those will provide us lots of continued growth in denim, and again, making sure that we're right on the fit and fashion, and that is something I think we really have a well-oiled machine on. Our existing and go-to-market strategy is truly unbelievable, like I've never seen in the business, so denim alone. And then, certainly, we have dominated in this category. I still see lots of opportunity in tops and fashion and other categories. We're seeing a lot of nice wins in men's. We started that earlier. They needed a lot of repair in that business. We need to get back to our roots, and we're seeing such nice results there. And we're doing the same in women's. But I think long term, we can really ensure that we're trying to meet some of the tops to bottom ratios and looking like we're a little bit more balanced in the stores, and we're working hard on that. And like I said, or like Mike said, we're going to have conservative plans, but we're going to set those plans up where we can chase and hopefully beat the plans, but we're going to do it with the level of intelligence so that we're not over inventoried, and we're really positioning our inventory strategically, but also just answering some of these new demands for the customer. I think through our marketing lately, we -- I started a year ago, we brought on a new head of marketing, and we're just seeing such nice results. We used to be so focused on denim. And now, when we're really showing up with the tops, and we're just seeing really nice wins there. So there's lots of opportunity in the other categories as we continue to grow the AE business as well.

Jen, I know you've cited the potential for a multiyear denim cycle. I guess, do you see us still in early innings of this? Anything at all that you've seen that changes your view on that? Or are you just as confident that we have a long runway ahead with the denim category?

I think we're in early innings. When these legs shift like this, this much, it was jegging, jegging, jegging for so long. And I actually like the shift because, as I mentioned, leggings are never going to go away. They're never going to go away. They're just not. So that will help me really dominate on that side of the business with OFFLINE. And then as these fashion fits shift, you do see a year-over-year cycle. There's some real fashion silhouettes out there right now that it takes a little longer to introduce the mainstream. And then when they buy into it, you do see a life cycle change, and it can last for a few years. So I feel good about that. And like I said, there's still lots of opportunity. We have a new team in place, a new head merchant, a new designer who's -- they're very highly engaged and excited about just really mixing this denim into and really showing up in a unique way for our customer.

And I mean, maybe more near term, but how best to characterize overall back-to-school? Are you happy with what you've seen? What categories, I guess, maybe are you seeing the customer choose American Eagle first? Where do you think you're taking share? Are there any areas you wish you would have done better as we think about back-to-school?

Yes, sure. There's always a hindsight, right? Like this business isn't 100%, like we always have something, which I love. I love a good hindsight because then I just can tackle it for the future year and future growth, right? So that's always -- there will always be a hindsight. But certainly, August, we were very pleased with what we saw in denim, and I think we were right on top of the fit in the silhouette shifts. It's really the categories I was speaking about. In Aerie, we dominate in bralettes. It's been a win-win category for us. We own it like no other. We have the best designer in town, and she continues to innovate on that business and certainly, lagging are competency business for us. So I don't think it's a surprise if you see where we distort in the stores as well, what we went after. And honestly, fleece and some of those other categories have been great for us. So it's been a solid August, I would say. But look, we have a few weeks ahead of us. We have to get through. We have some new receipt sitting that we're excited about. And so we'll get more read on what the future looks like with those receipts, but I'm pleased with the results. And certainly, we're going to -- we have a few more weeks left in this quarter.

And as we think about that and maybe move forward, any learnings or takeaways that you think are relevant as we think about the fourth quarter holiday? I know you were bullish on overall back-to-school opportunity. Are you just as positive on the upcoming holiday and the assortments? And what you think your brands will bring to the table?

Yes. I mean I saw holiday yesterday, I went to Pittsburgh. I mean, a, like -- I asked them to pull up last year. That's what I always do. I have to see what the floor set looked last year. And I would say, like I'm really pleased with how the floor set looks, TYLY. We were not in the sweater business last year. I think it's going to be a nice sweater season as we shift the weather, and we are in the sweater business. So I feel good about that. We definitely left some business on the plate last year in AE in men's and some of the items, and I felt they really dominated there. So yes, I feel really pleased. The color looks great. I think AE had a lot of opportunity and color and I love color, so I felt good about that. And Aerie, we're still in the process of working the floor actually. So I didn't see the full final. But what I saw, I love some of the new items. We have a great gifting. Aerie looks like a gift destination to me, and I think that's going to be really important this holiday. So I want to get those gifts out early, so people can buy them early. I think that will be a win-win for Aerie.

Mike, I know a big point that you were trying to make on the last call was, as we look at year-over -- as we look at [ 2 LLY ] results to look at it more from a profitability perspective at the core AE, just given the change in promotional activity and the amount of inventory that you operate with on hand, so maybe could you just elaborate on kind of the profitability focus, what it might mean as we look and compare 2019 to upcoming back half of the year results, just kind of how to think about top line gross margin or maybe gross profit dollars?

Yes. I mean, thanks, Matt. I think trying to provide that point of view to everyone in terms of using history. We all use it, right? [ Denim is ] using history from a product perspective to look at comp opportunities. You're modeling the results of the company off of history, we're doing the same thing. The difference in what I'm trying to get across, though, is that we're not really proud, obviously, of that history a bit, especially when you look at '19. 5 years prior to the pandemic, we were going be -- grew revenue by $700 million to $800 million, but we could -- we were stuck in like a $300 million operating number, somewhere between $300 million, $350 million in those years, in 2019 actually was the worst of the year -- of all those years, I think, even though we had record revenue numbers. So there's definitely the unhealthy aspects of how we're managing the business, which we keep talking about inventory being the first and -- the first item. So there's structural differences to how we're managing the business that are here to stay. Inventory disciplines, talking about store closings and rent, all the initiatives we have around controlling delivery costs, so there's a lot that's happening differently in the business. But the inventory pieces it and how we were driving some revenue in an unhealthy way with inventory is the structural change. The thing that's phenomenal in my mind is that we're actually in AE branding, the bigger opportunity there and probably the focus of that point. We're at or exceeding '19 revenue, running the businesses' way with drastically less choices, drastically less SKUs, a lot less inventory in stores than we need to drive the business. No network is now in place that are going to keep putting inventory closer to customers to fulfill demand both in stores and digitally. So all those structural, operational changes to the business are here to stay. And the focus on revenue then gets -- can be a little frustrating because if you go back 2 years ago when all that was happening, we were being labeled as a market share grab company who didn't know how to make more money. Now we're focused on both. Revenue is always important. Comp is always going to be important to focus for all of us and Jen's hitting some -- the way she looks, thinks about comp, but the focus on the bottom line profitability and not being sustainable is really where I'm more focused. Aerie and the OFFLINE growth is going to come, sort of getting to 2019 AE brand revenue or exceeding that already and the profitability of that with the structural changes, I couldn't be more excited about, and our targets go forward are obviously going to be higher for both brands, both on a revenue and income basis based on these structural changes. So when you go back to the second quarter results and the headline being we missed a revenue number is actually a record revenue number still and a record income number for the company that we are going to grow from here. It's going to be record revenue and record income from here despite it's all of our intent. So just a bit better balance of just focusing on whether there's something unsustainable in the top line. And I know there's a lot of uncertainty out there right now to what is sustainable in terms of our operating model and the way we're running the business to the bottom line impact. And that's what I'm more excited about is that consistency that we're bringing to the table now in terms of how we want to run things.

Perfect. 2 follow-ups to that. First, maybe, Jen. As we think about the AE brand, and as Mike just laid out, reducing redundancy in the assortment overall inventory, I think at one point, you might have cited you've taken about 40% of the inventory off the floor. Don't quote me on that number. You can correct me on that number.

30% to 40%, less inventory than '20. If we're rising in '19 again, which is what we keep -- continue to do, we're running stores with 30% to 40% less inventory than we had.

Perfect. So question is, is that sustainable? And from here, do you still see further opportunity for enhancement that could drive margins at the American Eagle brand?

Well, the good news is, I still see SKU improvement. We had some nice results for back-to-school in their denim categories. And I think there's still opportunity there to really go after our top, say, to 25 styles and really just make sure we dominate there and own our sizes and have that size integrity. So I actually think there's still opportunity there, and that might be losing some of the lower productive SKUs and moving them into the higher. But again, as we strategically grow our other businesses, we're going to do it, like I said, at a pace that we can grow year-over-year. Look, I think we're in a position to win, and we didn't really talk about this. With some of these cost headwinds and what have you, I'm here to make our quality better year-over-year, right? I want to have great quality with not only intrinsic details, but details that are built to last and that can warrant the prices. And look, we're not going to go crazy. We're going to still have that nice price balance equation. But I wonder with some of our competitors as they're so value oriented, how much can you sustain some of these higher costs and just pumping out units? That's a question I ask. So the message to my team is quality, quality, quality. Let's get paid for the product. Let's not over assort, and let's not -- just -- I want to make sure that this is a quality built company and both brands, Aerie and AE, and that we're really thinking about that for the future because I think that's sustainable. I think that's a long-term strategy. And I think it always wins. Like these fast fashion retailers come in and they go and brands that are built around your brand and your DNA and like we think about our AUR growth year-over-year slightly maybe with some strategic pricing underneath the covers. I think it's a winning recipe.

And just from the supply chain side, Matt, that's sustainable and structural. So a lot of the store and there's a SKU count, choice count. We've learned what we don't need from what we used to call presentation inventory just to make the floor look pretty. And then 4 weeks of coverage then was based on the fact that, in some cases, it would take 5 to 7 days to replenish stores, so you want to cover demand for a longer period. We can replenish in 1 to 2 days now with the network we have. Combination of our NDCs and nodes, and we're not -- that's not going away. We're actually looking at evolving and improving upon that, not something that's kind of 1 year or 2 benefit. So those are -- that level of inventory in stores will not go back to those pre-pandemic levels.

Great. And then my follow-up on the second one that I said was just from a structural perspective, as we think about the brick-and-mortar side, maybe could you talk about progress that you've made renegotiating leases, how best to think about rent going forward, maybe if we were thinking about pre-pandemic 2019?

Yes. And I'll start with just continued flexibility. We've got this 450, what we call, lease actions between expirations or renewals, et cetera, kick outs. So that short-term flexibility with anything we don't close or anything we renew, we're renewing on a short-term basis as well. So there's benefits not only from that, but then the mix of -- I think the way we've explained it is rent dollars not really being that significantly different than even 2019 as we're talking about the next $1 billion of revenue growth for the company coming. And that's, again, a little bit of variability depending on how quickly or what -- how we may change the pace at which we open there in OFFLINE stores, but it's really carrying OFFLINE, like AE closings being offset by Aerie and OFFLINE openings. And at the end of the day, we're getting very good terms from a renegotiation perspective at a portfolio level because where a retailer come to the table with some significant growth coming from these 2 brands while renegotiating AE deals. That's not only helping us on the renegotiation side of renewals, it's also creating some of the best most favorable terms I've seen on these new stores in my history and being involved in the real estate decisions. So I think we're still in the same place of rent dollars, not really being that significantly different from 2019 as we look out a few years from now. And again, the only variable there being do we increase the pace at which we're opening stores, but that has revenue growth tied to it beyond what we said last January. So I think the leverage point of rent is still a significant part of the gross margin story for us from here.

Maybe to switch gears. You announced this morning the launch of the AE77 more premium denim brand. Sounds like for men and women. AUR is definitely higher. Can you speak to the rationale, maybe strategic goals with this launch? Do you believe this will be a new customer? Have you tested it? Just kind of anything you could provide us on that?

I can weigh in here. No, I was in some of the initial conversations with the opportunity here. We do see opportunity for a better jeans business. I know, Jay, my boss is very excited about this opportunity. It's all sustainable. But just so you know, it's really interesting, I don't know if we talk about this enough. In American Eagle, over 80% of our denim has some form or fashion of a sustainable characteristic. So I think that's pretty amazing. I think we're going to continue to work on both brands, AE and Aerie on getting greener by the day. I'd like to say in our swim business is over 65% sustainable, our fabric there. So we have just so much great things to talk about. But this is -- the denim is all sustainable, and it has a story around that. Look, I haven't seen the store yet, so I could really fill you in more. I go to tomorrow with Jay to see the store. But I think the concept is interesting, and I think it will allow us to really understand pushing some of the fashion and understanding that. We can certainly leverage those learnings for American Eagle. Those customers that are highly fashioned forward that are willing to pay can signal to us some ideas that maybe we'd like to test, but that's really not what the concept is built on. It's really a pop-up right now, and we'll see how it does and see what it can do in the future. And I like the idea of sort of this premium brand concept for us. And Aerie, we kind of did the same thing. It's not tied to Aerie, but we have this unsubscribed brand. That's about this big, and it's built on the same sustainable concept. We have a few stores now. And it's doing really nicely. It's chugging away, and we get a lot of learnings there as far as new fashion silhouettes and what's happening there. So again, both of these are just teeny tiny. We certainly spend our time on the beast of the business, Aerie and American Eagle, and that's what we're focused on. And I think we've set up the teams strategically so that we don't get distracted.

Perfect. On the gross margin front, Mike, so as we think about gross margin from here, I think you -- I think this was actually my question on the conference call. So maybe I know the answer, but I just wanted to circle back. Should we think about gross margin from here exiting this year as a baseline and then further growth from there? Meaning, is there any give back? Is there anything that happened this year that you think you over-earned on the gross margin line? Or does this create a new baseline for gross margin expansion going forward?

Yes. I think -- I think I described -- it's good to hear the answer again, even if it was asked on the call. That 40%, I think, is a new benchmark for us, and we'll kind of refine that for what we think will happen in the out years here. But there's pieces -- I mean, if you pull it apart, and I think everyone's focused on promotional activity and how sustainable that is. So I'm going to start with the other pieces there first, which I think we believe we're going to get other benefits through gross margin, everything we're already focused on from under our -- what we call our gross margin optimization list of efforts. #1, Aerie and OFFLINE growth, there's a mix benefit go forward, we think, to initial markups. And not only just the brand mix there, but even some of the momentum or opportunity tends describing in tops as a mix benefit as well over time. So you have that from an initial market perspective. I think ticket changes. We haven't done much there, but I think where Jen and team have pushed the envelope a little bit, we haven't seen price resistance in terms of actually increasing tickets and the value equation for the product that's being developed. So I think there's places we can pick our spots there, that will be a benefit. We've talked about just inventory management in general, and the amount of business we're doing with less inventory, all being structural. I won't repeat all that, how I described that earlier, but that's here to stay rent levers. You just asked a minute ago, a big component of the gross margin story. We're already leveraging digital delivery and investing in even more ways to control that cost and knock it down as a rate of sale. So that's the list of everything going on, then I'll get to promotions, which the perception that there's no discounting going on isn't really accurate. We're at what I'm -- what I describe as a healthy level of discounting. Nowhere near being historical best markdown rates, not really counting on getting to historical best because historical best is really store channel, digital business didn't really exist in a big way. But there's structural things there we're doing, too, where we're getting away from full box, full BOGO, like full category BOGOs like BOGO jeans, being more select in that messaging and targeted in those markdowns, so the things that have to move faster and not marking down things that don't, which means we're just getting more value per unit for the things that we -- that don't -- that are working well versus those getting wrapped up in big promotional full store or full category promotions. And it's really the way we used to run the business kind of pre-recession actually, which is just a healthy rate. And I think just to add to that then, maybe the last point is that this healthy level is something that is sustainable as well. So even if things do get a little more promotional out there in environment, we think the way we're managing is not -- we're definitely seeing more full price sales, but the way we're managing is a healthy level and we can pulse that as needed. So I don't -- I think it's actually a mentality in the industry it's going to stick. It's not a 1 year thing. It's not just a pandemic behavioral thing that's happening across the industry. I've described it as -- I think the recession kind of kept us into this level after about 10 years of running the business the way we are today. I think the pandemic could be another longer-term cycle in terms of just some discipline in the industry around inventory and promotional level. And then the other thing, just the structural change as well that I don't think we talk about enough is our loyalty program. So there's a definitely what I'll describe as a healthier level of promotions and discounts built into the program now where we're seeing more frequency from loyalty shoppers with a less markdown or a reward that is a better markdown equation for us. And the things that we were doing also that were sort of self-inflicted, we were giving away free genes, giving away free bras, and that was not driving behavioral changes. They were just costly markdowns for us. So there's a lot -- it's a lot to say about gross margin, but there's a lot of moving pieces and components. It's not just one thing. It's not just discounting. And I think all those things -- most of those things are sustainable and structural changes for us that we don't plan on. There's no reason to revert back to old ways of managing the business.

Mike, a question that I had come through, as you were speaking, was just as online penetration continues to grow. Where do you stand in terms of the economics of an online sale from a margin perspective relative to an in-store purchase? Are you agnostic? Any big differences between Aerie and American Eagle as we think about online relative to brick-and-mortar from a margin perspective?

Yes. We still -- I mean, look, we -- every month, we still get brand ramping us, of course, but we still look at channel P&L. As much as I'm trying to not do it as often as maybe we've done historically, it's still something we look at. But promotional level between channels is not drastically different. Actually, the promotions we're running, for the most part, are similar. There are some obviously some things that go a little deeper online. And you do have affiliates of other impacts to kind of your customers are shopping digitally. So from a merch margin perspective, they're pretty consistent, a little less on the digital side. But then the flip side is the SG&A rate on -- in digital is a lot less than stores because of the fixed elements of store to labor and other things that hit the stores channel. So the balance of it is digital channel actually has been more profitable for us in recent quarters. In general, both are very healthy operating rates. But the net-net of that is digital is just as healthy if not healthier. So as we see that channel shift happening, we actually think it's a favorable thing for us from an operating rate perspective over time as well.

Great. And then from an expense perspective, so I think you outlined low to mid-20s SG&A rate target over time. So is it best to think SG&A dollar growth slightly below revenue growth? Or how best to think about expenses relative to revenues?

Yes. I mean, we were -- I think if you go back historically, pre last year, we were 24%, give or take, x amount of basis points. So I think as we -- that's -- you just outlined it well that go forward on, especially Aerie and OFFLINE growth, some modest revenue growth in AE that SG&A in total will -- dollar growth will be less than revenue growth. And I think as you look at the out years and maybe past this next couple of years and as we kind of look at that, not only the next $1 billion in AE -- in Aerie and OFFLINE, but maybe the next $1 billion after that, you'll start to see even more SG&A leverage as we look out a few more years. So when I say like that low to mid -- that low-20% range, something lower than the 24% we've been over time, that's, I guess, the model of how to get there.

And then maybe just last question. As just we think about the cash flow and the balance sheet, what's the best way to rank priorities for cash flow, general plans to return cash to shareholders on a multiyear basis?

Yes. Investing back in the business first and foremost. You can imagine on everything we're talking about here in terms of increasing our targets this coming January and accelerating some investments in the business. That's the first thing we're looking at is how to invest for growth, drive ROIC in different ways, too. I mean, historically, here, it's been investing in stores, investing in digital channel. We're actually -- the AirTerra acquisition is something that's maybe a bit of an insight into just how else we're thinking about it, which is how do we -- the volatility of which things are out there in our industry around costs, just about transportation costs, delivery costs, you name it, where can we invest in the business to not -- to control that more, reduce the volatility, make sure we can leverage those expenses. So those are things we're looking at, too, in terms of cash deployment. So back into the business, first and foremost, we raised the dividend back in June. So I think just dividend ratio there in terms of relation to net income, it's something we'll continue to evaluate and probably continuously maintain a healthy ratio there. And then share repurchases would be the next thing in line, which will be part of the equation, but those other pieces first, especially making sure we're evaluating the use of cash to invest back into the business first before contemplating share repurchases, but those 3 components in that order.

Perfect. I think that's a great place to leave it. Thank you so much for the time and the transparency and best of luck continuing the momentum.

Thank you so much.

Thanks, Matt. Appreciate it as always.

Really appreciate it. Take care.