American Eagle Outfitters' CEO Discusses Q4, 2013 Results - Earnings Call Transcript

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 |  About: American Eagle Outfitters, Inc. (AEO)
by: SA Transcripts

Operator

Greetings, and welcome to the American Eagle Fourth Quarter 2013 Earnings Conference Call. (Operator Instructions). As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Ms. Judy Meehan. Thank you. You may now begin.

Judy Meehan

Good morning, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Interim CEO; Roger Markfield, Executive Creative Director and Mary Boland, Chief Financial and Administrative Officer. Also joining us for the Q&A today are Jen Foyle, CMO of aerie brand and Michael Rempell, Chief Operating 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 from those expectations based on risk factors included in our SEC filings. Our comments today will focus on results from continuing operations and include non-GAAP adjustments. Please refer to the tables attached to the press release. We have also posted a financial supplement on our website.

And Now I'll turn the call over to Jay for opening remarks.

Jay L. Schottenstein

Thank you and good morning. I am glad that you joined our call today. I am very excited to be back as the Acting CEO of this great company. American Eagle has been in my family since 1981, when we had just a handful of stores. Over the years I have seen this company grow from a $150 million in sales to over $3 billion with strong profitability.

I served as CEO from 1992 to 2002, when we broke this brand in to what it is today. I hired Roger in 1993, then we public a year later. In 2002 I stepped out of the CEO role and remained on as Chairman of the Board. The company is very (indiscernible) our passionate and deeply committed to our brands associates and stockholders. I am also a large shareholder myself and I recently added to my holdings underscoring my confidence in the team and ability to reinvigorate our business.

The past year has been tough and we are very disappointed with the company’s financial results. Looking back our merchandise and overall customer experience fell short of expectations. We disappointed our customers and are working hard to get back on track. The search for a new CEO is underway, yet in the meantime we are not standing still. We have aggressive near-term plans and excessive urgency to deliver improvements.

My role is to ensure our teams are aligned and working together towards our common goals. The connection between merchandising, marketing, stores, e-commerce, production technology essentially all areas of our business have been strengthened. We have got great pants. I am confident that with Roger’s engagement and focus we will deliver better merchandise in line with the outstanding quality and value that our customers expect. We will energize the customer experience and bring fun back into our brand both in stores and online. The experience for our customer must be outstanding. This is at the heart of all great brands and the foundation of our past success.

Our long term strategic agenda remains in place, including continuing our factory store expansion plans. The investments to build omni-channel capabilities are clearly important to our future and global expansion is a very exciting opportunity.

Before I turn it over to Roger I like to reemphasize the confidence I have in the team to execute our goals. I am excited to be on the floor to deliberate on the many opportunities we have. Now over to you, Roger.

Roger S. Markfield

Thanks, Jay. Good morning to all of you. I wholeheartedly agree with Jay. As an organization we bring a long history, vast experience, deep knowledge and indelible brand, yet we have a lot to improve on and that’s our focus.

2013 and the fourth quarter were challenging. Overall the macro wasn’t easy especially the decline in mall traffic. We simply did not do enough to drive traffic to our stores. Our merchandise assortments were inconsistent and the overall customer experience lacked the excitement and fun our customers demand and deserve, as a result the need for markdowns and promotions hit record high levels. This adversely affected both our top line and merchandise margins. This is a big opportunity for us and something we are determined to fix in 2014.

Even with these challenges our brands remain incredibly strong. We are still our customer’s choice for denim; in fact we are thrilled with the popularity of the brand that can be seen on page 3 of the slide show. Recently Shakira wore AE Jeans for her spread in Women’s Health magazine. This is one great example of the popularity and broad reach of our denim line.

Though store traffic was difficult our online business was strong increasing in the low teens this year. Within aerie, we continue to right size the brand closing poor performing stores and positioning it appropriately alongside AE. Aerie delivered particular strength online and is getting great traction in global markets. Factory stores performed well in 2013 and we remain excited about this opportunity and the made for factory product assortment.

Now over the past several weeks we have taken steps to move in the right direction. We will align our marketing plans to better support our product and drive traffic. We have strong leadership in place across our brands and channels. Jen Foyle leading the AE brand and Chad Kessler has joined to head the AE brand bringing over 20 years of experience in our sector. To be effective we must embrace the youthful spirit of our customers and be passionate about our brand.

Some of the specific opportunities we are addressing for the near-term include strengthening our product assortments, including trend, value and quality. We must be innovative with distinct finishes, fabrics and washes will be set us apart capitalizing on the strength and popularity of our core programs such as AE jeans or bottoms, aerie undies and men’s underwear. We need to maximize what we are known for, with stronger marketing support. We will also drive legacy categories including accessories and outerwear which were deemphasized last year.

We need to bring fun back to our brands with compelling events that engage our customers and are supported by clear and simple creative marketing messages. We are upgrading our styling and creative marketing to inspire our customers. Speed to market and fluid fashion flows remain our priority to drive the customer experience.

Our [short] dressing fashion line is an example of testing innovation. The full assortment is now Online and you can see some of the key looks on page four of the slide show will go online. More relevant marketing campaigns and deemphasized low margin [inaudible] promotions, AE' real people and aerie's recent real campaign were great examples of how we need to deliver and build brand momentum. And we will better balance our inventories through our sales plans.

As Jay said we have a sense of urgency to make improvements, stabilizing and strengthening our North American business is absolutely job number one. Over the years we've had our share of challenges and we've always recovered. It's clear that retail environment is changing and we are making the right adjustments to adapt our business.

Along those lines we continue to make progress connecting the dots between our stores and digital channels. We launched the pilot of ship from store and expect to expand it by the fall season. Our new distribution center opens this summer. This will enable a single pool of inventory which over time will bring greater efficiencies and inventory utilization. We are making ongoing improvements across digital to drive better customer engagement and brand experience for all channels and devices.

Having the best mobile and overall digital sites are absolutely critical to serve our customers. Additionally we will continue to expand internationally where we see strong demand. We'll do so profitably with the right mix of licensed stores and company owned markets. Our brands are highly relevant and resonate with customers from Asia to Latin America and we will build on that momentum.

We are excited to enter the London market this year. Before turning it over to Mary I would like to emphasize that I am thrilled the team is working and think across all creative areas we have strong leaders who are highly focused on developing the outstanding young talent across our organization.

I have great confidence in our future and I'll leave it at that. Mary?

Mary M. Boland

Thanks Roger. The fourth quarter and annual financial results largely reflected weak store traffic in North America and the high level of promotional activity which had a significant impact on margins and EPS. Total revenue for the 13-week period ended February 1, 2013 compared to the 14-week period ended February 2, 2013 decreased 7% to $1.04 billion. On comparable weeks and excluding the actual week in the fourth quarter of last year total revenue declined about 2%.

Consolidated comparable sales decreased 7% against a 4% increase last year. AE brand comp decreased 7%, aerie comp decreased 4% and the total online business grew 8% compared to last year. Lower transactions and transaction value drove the comp decline in the stores. Additional sales information can be found on page eight.

The consolidated gross margin fell 930 basis points to 31.9%. Increased markdowns drove 810 basis points of the decline which was partially offset by 60 basis points of cost improvement. Buying, occupancy and warehousing costs increased to 180 basis points as relate to revenue due to the deleveraging of our negative comps and increased delivery cost.

Selling, general and administrative expense decreased 15% and leverage 190 basis points as relates to revenue. The majority of the improvement was due to lower incentive costs and a planned reduction in advertising and stock.

Depreciation and amortization increased slightly and deleveraged 30 basis points. Store impairments and asset write offs offset the increase from new stores and IT investments. Operating income for the quarter was $85.8 million, down 52% to last year and adjusted EPS at $0.27 per share decreased 51%.

GAAP EPS of $0.05 per diluted share includes $0.22 of store impairments asset write-off and other corporate charges including severance and tax-related items. Asset write-offs include charges related to fabric and product viability and the discontinuation of the AE performance lines. For additional information please refer to page 17.

Now I would like to spend a few minutes talking about the year. Total annual revenue decreased 5% to $3.3 billion. AE brand comps decreased 7%, aerie comps decreased 2% and the online business grew 13%. Weak traffic lower transactions and transaction value drove the decline in store comps.

The gross margin contracted 540 basis points to 34.6% primarily due to 510 basis points of markdown and 150 basis points of BOW deleverage. The change was partially offset by a 120 basis points of product cost improvement.

Selling, general and administrative expense decreased 5% increasing 10 basis points as relates to revenue. The decline was also primarily from lower incentive cost, offset by higher store payroll and corporate salaries. Operating income decreased 47% to $234 million and adjusted EPS of $0.74 decreased 47%. GAAP EPS of $0.43 included the charges I outlined earlier. For additional information please refer to page 18.

Now turning to the balance sheet, starting with inventory which can be found on page nine of the presentation, we ended the quarter with inventory at cost per foot down 16% against an 8% decline last year. The year-over-year decline reflects the change in the timing of inventory ownership. Without his change inventory at cost per foot increased in the high single-digits.

Looking forward we expect first quarter-ending inventory at cost per foot to decrease in the mid-single-digit. Similarly without the change in ownerships we expect inventory to increase in the mid-single digit against the 6% decline last year. The increase is due to the investments in core categories including denim, pants and man's polo's, areas in which inventories were very light last year. We ended the fourth quarter with $429 million in cash and investments.

Capital expenditures totaled $278 million for the year. This was above our earlier guidance of $250 million, due in part to the timing of investments for our new distribution center and related systems to support omni-channel. In 2014 capital expenditures are expected to be approximately $230 million.

Similar to the 2013 nearly half of the capital spending plan is for new and upgraded systems, the completion of the distribution center and omni-channel projects while the rest relates to store upgrades as-well-as factory and international store expansion plans. As we have stated 2013 and 2014 are catch-up years in which we are making investments that are critical for our long-term success.

Total store square footage increased by 5% in 2013. We opened 64 stores including 39 new factory stores and 16 stores in Mexico in addition to taking ownership of our licensed stores in China and Hong Kong. We closed 42 stores including 29 aerie standalone locations. We added 23 international licensed stores in 2013 ending the year with 66 stores in 12 countries. In 2014 new store openings will be largely driven by additional factories and international stores including our launch in the UK. Store information can be found on pages 12 through 14.

Now regarding the outlook for the first quarter. Business trend to remain highly competitive and sales trends have been choppy so far this year. While we were encouraged by what we saw in the first few weeks of January, sales deteriorated and negative trends continued in the first quarter. This is partially due to severe winter weather which has resulted in nearly 900 full and partial day weather-related store closures in the month of February alone.

Based on a high single-digit decline in comparable sales we expect first quarter EPS to be approximately breakeven. Mark-downs are expected to increase albeit at a lesser rate than in the prior quarters. We also expect to deleverage fixed cost and expense our negative comps. Our guidance compares to adjusted EPS of $0.18 last year and excludes potential impairment and restructuring charges.

Across all areas of the business we are focused on expense reductions and efficiency gains. Based on the continuation of the negative sales trends we pulled back sales and inventory plans for the upcoming quarters. This should enable less reliance on broad sweeping promotional activity. Thanks for listening and now we will take your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will be conducting a question-and-answer session. (Operator Instructions). Our first question is coming from the line of Simeon Siegel with Nomura Securities. Please proceed with your question.

Simeon A. Siegel - Nomura Securities Co.

Thanks. Good morning guys. Hi, Jay. In light of the current promotional environment, can you just talk about your main focus as a CEO and then any color you can provide on the management search? And then Mary can you quantify your thoughts on SG&A for Q1 in the year implicit in the guidance and maybe just looking if you could add any color on that 23% goal? Thanks a lot.

Jay L. Schottenstein

Yeah, I would say my main focus number one is to make sure that all the key members are all in sync with each other, and to make sure that the experience with the customer whether it's on the e-tail side or the store side that's all the same experience. That's the -- business shouldn't be operated in silos, it should be operated as a group that everybody knows what everybody is knowing and we all have the same common goal to make experience better for the customer.

The biggest thing that we put our focuses on is to make sure that in the part of third quarter or fourth quarter that the merchandise in stores looked the way we expected to look, and not the way it looked last year and that's where a lot of our focus been put on to make sure that we put the emphasis on the product and make sure we build our product, not a good product but a great product and on personal basis I think there is big opportunities.

We travel around the world, we look at our competition and we go to various shows around the world, we see which is being done in trends and fashion we see where -- what should the assortment at different places, we see the embellishments that are being put on products and I believe that we are on the right track there, we have the right focus to do what we have to do.

As far as search of the CEO we formed a committee and we are in the process of looking but right now we are focused on doing what's right for the customer, what's right for the company.

Mary M. Boland

And then regarding your question on SG&A, for Q1 we expect SG&A to be up high single digit, driven by store growth and home office salaries, so expect SG&A to deleverage from last year. For the fiscal year at this point I would expect SG&A to be above our 23% long-term target, but of course we're obviously focused on expense reductions throughout the year.

Simeon A. Siegel - Nomura Securities Co.

Great. Thanks guys. Good luck for the year.

Operator

Thank you. Our next question is coming from the line of Adrienne Tennant with Janney Capital Markets. Please proceed with your question.

Adrienne Tennant - Janney Montgomery

Good morning, everybody.

Jay L. Schottenstein

Good morning.

Adrienne Tennant - Janney Montgomery

Jay or Roger I was just wondering if you can talk about the balance in inventory between core and however we want to describe it fashion last year. A number of competitors in the team space are moving to lower AURs more in this fashion, you are talking about being under inventory in some of the core categories. And then for Mary just a housekeeping, if you can talk about the difference between the high single-digit inventory after the change in term, I think you were looking for low single digits at the end of the quarter? And just trying to get a read on when we can see that inventory as the chains get in line with sales cadence? Thank you very much.

Jay L. Schottenstein

Adrienne on the power of the Eagle brand in terms of core there were situations that our bottoms business is such a strong part of our core business and when you own the bottoms business you have a long, long record of having the customer come back because there is nothing more important than fit and as you have seen now there was slide with Shakira wearing our denims, she can buy anybody's denims and choose ours. Our denim is an incredibly large part of our business and that business while it's been difficult because we haven't been in the denim cycle is starting to come back.

Adrienne Tennant - Janney Montgomery

Okay.

Jay L. Schottenstein

And the season has just started that you were to go and take a look at our new set that went into the place where we had a bit more emphasis on the short part of the business, the shorts seem to be strong and the underwear business continues to be a pretty strong difference for us. We do need to get the tops part of the business better than where it’s been and we are working on that but we are going to have relevant marketing with our core bottoms business, we own that business and we got a lot of customers in [bottoms].

Adrienne Tennant - Janney Montgomery

Right.

Mary M. Boland

And then in terms of you asked about AUR, I mean we are planning the year for AUR to be basically flat to last year. So we are not planning any significant movement in AUR in total for the year. In terms of inventory we are, as I projected in Q1 up in the high single digit excluding the ownership term and if you remember last year in Q1 we were light on denim, pants and men’s polo inventory and saw that we needed to make some further investments in that product, since we have done here in Q1.

I think we’ll be in balance, in line with sales, to your other question probably at the end of Q2, early Q3 but we have taken a fair amount of inventory actions here already to bring the inventory more in line with the continuing negative trend that we are seeing in our business.

Adrienne Tennant - Janney Montgomery

Okay, thank you.

Operator

Thank you. Our next question is coming from the line of Stephanie Wissink with Piper Jaffray. Please proceed with your question.

Stephanie Wissink – Piper Jaffray

Hi, good morning everyone. My question really focuses the cover station around merchandising I think an expansion, which was mentioned several times in the prepaid remarks. Just curious if there’s any internal discussions around the [advent of] expansion which should be contraction in some of the capacity in the U.S.?

Mary M. Boland

Yeah, I think you know as we look at our overall merchandise margin, it’s obviously it’s been impacted this year by the high level of markdowns and we are planning to balance our inventory to our sales trend which would help alleviate the kind of backstop promotion that we encountered last year. There is obviously opportunity here from a store perspective as we look at our store fleet and we will continue to drive the work that we are doing at our store fleet in terms of some further rationalization as there is a fair amount of capacity.

All our stores at the end of the day are cash positive and we have only a handful of stores that are actually in a loss position. So we need to balance that with a long term view of the capacity and the overall Tee market but we are sitting in a position where as I said our stores are all cash positive.

Jay L. Schottenstein

And we’re very well positioned at this point in view of you talk about the competition, in terms of what we are, where our vision is and what the DNA of the Eagle brand is. We have 1,066 stores out there, they are all cash flow positive. We are in a very strong position going forward, especially in view of what the treasure hunt stores are doing and what some of the people in our lifestyle area are doing. I really feel good about how we are positioned now.

Roger S. Markfield

I remember when Chris got involved with the company in ’92 I couldn’t say it was all cash positive.

Judy Meehan

Stephanie, we’ll take the next question.

Operator

Thank you. Our next question is coming from the line of Susan Anderson with FBR Capital Markets. Please proceed with your question.

Susan Anderson – FBR Capital Markets

Good morning everyone. Thanks for taking my question and I was wondering if you could talk about the store trends in the warmer regions versus the colder and then when you talk about the guidance, the minus high single-digits for the quarter is that currently where sales are trending right now?

Mary M. Boland

Yes so in terms of warmer versus cold stores we are seeing a better run rate in the warmer stores than what we have seen in the colder stores, especially over the last couple of weeks when weather actually warmed up a bit more across the country. The guidance for Q1 of negative high single digit I would say that’s been the trend. We have had better days when the weather was warmer but at this point it’s still a trend and that’s what our guidance is based on for Q1.

Susan Anderson – FBR Capital Markets

Okay, thanks. That’s really helpful. Thanks.

Operator

Thank you. The next question is coming from the line of Dorothy Lakner with Topeka Capital Markets. Please proceed with your question.

Dorothy Lakner – Topeka Capital Markets

Thanks, good morning everyone and welcome back Jay.

Jay L. Schottenstein

Yeah, thanks Dorothy.

Roger S. Markfield

Hello Dorothy.

Dorothy Lakner – Topeka Capital Markets

Thank you, Roger. Good to have you on Board as well.

Roger S. Markfield

Thank you.

Dorothy Lakner – Topeka Capital Markets

Just a question about opportunity that you might have this year on average unit cost and then also Roger if you could just talk about where you are on market and how much faster you think you can get and then just a little detail on getting back into more the accessories business which has been real distinctive factor for American Eagle?

Roger S. Markfield

Mary will take the first part and I'll take the second part.

Mary M. Boland

Yeah, our average unit cost, I mean we're looking for to be excluding mix relatively flat for the year. I think the team, the sourcing team has done a really nice job of offsetting any economic pressure with other sourcing savings but basically looking for it to be about flat for the year.

Roger S. Markfield

And on an apples-to-apples basis it should be should be somewhat flat, obviously you heard Jay's comment, you heard some of my comments we sort want to please our customer, we have one voice and that's the customer. So we've got to give end products that incredibly compelling and it's got to be what I call it -- we do 10 Broadway shows a year, that's pretty fast fashion. Everyone talks about the fast fashion guys I remember the old fast fashion guys, the 579s, the [Chess Kings, the Foxmores] I don't see them around anymore.

But the lifestyle brand is an indelible brand and you can read all the reports, your own analysis of who's is the -- what Randy did was a terrific report and it's not us saying it, American Eagle is the number one relevant brand. The beauty of this brand we sell in excess of 200 million units a year, is really and I don't want to over simplify because I got to get it right and I have a great team to get it right with and I have a great partner in Jay to make this happen.

We have to do in those units is get an extra half a buck or buck a unit because the customer wants to buy it and that's the difference between making 7% operating profit and making 15% operating profit. So we've always done it, we've always gotten it back and I got a big mission ahead of me but I have a great partner and a great team to accomplish it.

Operator

Thank you. Our next question is coming from the line of Kimberly Greenberger with Morgan Stanley. Please proceed with your question.

Kimberly C. Greenberger - Morgan Stanley

Great, thanks so much, good morning. Mary, I am wondering if -- you've belt tightened pretty aggressively here in 2014 what's the minimum kind of level that we might able to see SG&A dollars grow, do you think you could keep it to a 5% to 6% dollar growth rate for the year? And then secondarily on the cash balance I noticed the cash fell $200 million year-over-year. I am wondering what sort of initiatives do you have here in 2014 to stabilize that cash balance? Thanks.

Mary M. Boland

Yeah, so I would say for SG&A we are looking probably at this point at a low kind of single-digit increase over the course of the year. Obviously we are hard at work at looking at all our expense areas, there is a multitude of things we've done already, as Roger mentioned we have more aligned our inventory with our negative sales trend, which should help us reduce our markdowns significantly as we don't have to go after the backstop promotion.

We are hard at work on our store fleet in terms of stores that have rental relief for very short lease terms like about one year lease term. And then of course on the expense side we're really reviewing and deep diving into the expenses related to our U.S. mainline stores which is driving the negative trend.

So two ways to call the year, Kimberly at SG&A which is we're maniacally focused on it. And then in terms of cash I mean obviously the pressure here that we got on the team here is to drive our margins up with some great innovative products and the work Roger and his team are doing which is really critical here to drive our operating cash flow.

Jay L. Schottenstein

Also about cash, I like cash if you look at my history I've always like to build cash. The good thing about our company is we have no debt on our balance sheet. It's a clean balance sheet and my goal is always to build cash.

Mary M. Boland

And the other thing I would add too Kimberly is that we said we were -- had two years of investment, 2013 and 2014 and to Jay's point because we have no debt on our balance sheet we don't -- we need to continue to focus on investments to drive growth and then as we get into 2015 that level of CapEx spend will certainly decline from 2013 and 2014.

Kimberly C. Greenberger - Morgan Stanley

Thanks.

Operator

Thank you. Our next question is coming from the line of Matt McClintock with Barclays. Please proceed with your questions.

Matt McClintock – Barclays

Yeah. Hi good morning everyone. So Jay you talked earlier about the customer experience improving that, and you also talked about bringing back the fun into the stores and clearly merchandise plays a large role in that. But I was wondering if you could share any other strategies or if you are thinking about anything else maybe from a more physical remodel or some other perspective that will help you achieve that? Thanks.

Jay L. Schottenstein

Well. One thing is it's -- on a personal level I did not like the way our stores looked the way the merchandise was all stacked up there, the way we had certain racks in the store, it wasn't the image of the past. So we will be focused to make an easier shopping experience for the customer. At the same time in the merchandise speaks for itself. And you want to have the right looks, it's very important to have the right looks, the right feel, the right ways at the right time.

And I'll will tell you this that when I got involved in the last couple of months the first thing Roger and I sat down, I said Roger we got to focus, got to get this merchandise right, we got to get the team all speaking to each other, we have to have the designers, the merchandizers, everybody on the same page. And unfortunately this past year we weren't on the same page. Our biggest job the last two months is to make sure that everybody is speaking in the same way, everyone is on the right page and that we have the merchants touched and involved.

We got away from having the merchants touched on the price and in the store level too and experience and the way the marketing was being presented to the customer and the whole package. And I will tell you this we are focused now, I've seen some of the future floor sets and that looks good.

Mary M. Boland

And then the one other point that I would add from a store perspective as we've mentioned we highlighted by online ship from stores. So there is a multitude of omni-channel initiative that we are beginning to implement in our store fleets, as our customers use alternatives choosing to shop. So in addition to Jay's comments I would say a fair amount of work from the technology perspective and from an omni-point of view.

Operator

Thank you. Our next question is coming from the line of Brian Tunick with JPMorgan. Please proceed with your questions.

Unidentified Analyst

Yeah, hi this is Tina on for Brian. Thanks for taking my questions. Just with more [topic] on the decline and the consumer increasingly accustomed to these back stop promotions. How do you wean off of these store events particularly he's only in the mall on a handful of days? Thanks.

Jay L. Schottenstein

I really think that the customer will tell you for a product that they want, I can see examples of it, I've been in this business for a long time. And by being a lifestyle brand you are not a treasure hunt, you are not putting a thousand racks on a floor. If we put our stores together in a compelling way with the right marketing around it and the online experience that drives them into the stores and it's all the touch points talking to the same thing and it's an exciting experience, you watch what happens in a lifestyle store, the big big box stores that are just racks to treasure hunt stores are not capable of doing that.

Unidentified Analyst

Okay, great. And then just one quick follow-up. Inventory is expected down mid-single-digit per square foot in the -- at the end of the first quarter I believe, is that how we should think about comps as we move into the second quarter?

Mary M. Boland

Well we gave guidance for comps for Q1 of negative high single-digit decline and at this point we are not giving any guidance for Q2 but the current trend is high single-digit negative. And remember that inventory decline was driven by ownership change the minus 16%.

Operator

Thank you. Our next question is coming from the line of Randy Konik with Jefferies. Please proceed with your questions.

Randal Konik – Jefferies & Co.

Great. Thanks a lot. I guess a couple of questions. First for Jay, Jay is there a type of CEO that you kind of want in the business as you look forward to the long-term future of the company? Is it more product type person or an operational type person? I guess for Mary is there any kind of perspective you can give us on how much CapEx can come down in 2015 I don't really need an actual pinpoint number but maybe give us perspective of what a normalized CapEx run rate number is for the business.

And I guess lastly for Roger what specifically do you think you and Chad need to kind of change regarding the product out there in American Eagle stores to kind of drive more traffic? Is it more product change or price point change or what do you see that needs to be done to kind of reengage or reenergize the consumer? Thanks.

Jay L. Schottenstein

I think it is a person we need, who one, understands the operations, understands the balance sheet, but at the same time has understanding of merchandize itself. It doesn't have to be a merchant himself but has to have the proper respect of the merchandising team to be able to give the proper support to the merchandise.

Mary M. Boland

And then in terms of 2015 CapEx, we're at this point targeting somewhere around $150 million to roughly a $170 million. So as we said ' 13 and ' 14 were big investment years and expect us to be down somewhere $75 million to $100 million from those two peak years.

Roger S. Markfield

Randy, by the way thanks for that report on [inaudible], you made American Eagle sound pretty good even in the tough environment. Clearly as you've heard me over the years when I have been directing the business, when you have a 6,000 foot box on average, there are advantages and disadvantages. But one of the advantages, you really most people don't have an address themselves and really what they are looking for is what they should look like and what the outfit should look like.

When you have a 6,000 foot box you'll have that opportunity when we do the filing right and we hit the trends right and we [inaudible] and we are absolutely doing it right now and you want to really go online and take a look at this [made in the China] on the project which on a choice basis is twice is faster than anything else that we have on average in the store and there is lots of things that they are going to come from that as an advantage for us, we will offer a great compelling product and a great value by the way. When I say we are going to add these things it's going to be great value for the customer.

Apples-to-apples of course will not go up, it might go down. But where we are at in I am expecting to get a higher return rate in terms of return on invested capital in that item, and not -- it will be the stores we have and the markdown factor should be less. I think that after we get through the first quarter, my hope is that the markdown rates start to come down.

Operator

Thank you. (Operator Instructions). Our next question is coming from the line of Anna Andreeva with Oppenheimer. Please proceed with your question.

Anna Andreeva - Oppenheimer & Co. Inc.

Great. Thanks so much. Good morning guys. Just a follow-up on SG&A dollars being up high singles in 1Q versus I think you said annual guidance for up low singles, what's driving that. Are there any timing shifts that we should be aware of? And then quickly just on inventories, if I heard that right to be in-line with sales coming out of 2Q. I guess why not take a more conservative approach there given the comp run rates especially as obviously some of your competitors are reining inventories in? Thanks so much.

Mary M. Boland

Yeah. So on SG&A the increase is there is really no timing shift, it's really driven by store salaries as well as opening additional stores and anniversaring some of the stores that we opened in 2013 as well as home office expense. We don't really start to lap the in-centers until the back half of the year.

In terms of inventory, we did as I said needed to take a stronger position on denim, pants and polos which we were too low on inventory in Q1 as we transitioned out a lot of our denim product too early last year. So I think we're trying to balance obviously versus the sales trend. Denims are very important business for us so are polos so are pants, so critical that we are in stock at the store in those product. So I think we're getting this relatively balanced, obviously the sales trend will have a pretty big impact on this, but we're planning for a continuation of the next sales.

Jay L. Schottenstein

Yeah. And I would like to add one thing on the core products we owe it to our customer to be able to service them and we are the dominant supplier of denim in the country today for this 15 to 25 year old customers and as you can see on Shakira, even at the high age and the beauty of denim is really is ageless. On fashion we will churn faster, on fashion we will churn faster and the inventory level would be less than the sales, but on the core product we are not going to dissatisfy our customers.

Roger S. Markfield

It's very important to always be in stock on the right size, you can't be out of stock, you can't be out of balance.

Jay L. Schottenstein

And that you know the bottoms business is a SKU intensive business. When we were putting in -- I will let Michael Rempell tell this, someone's going to ask him a question, talk a little bit about the pool of inventory and what that will do in terms of the efficiency of being able to replenish an SKU, why don't you talk a little bit about that Michael?

Michael R. Rempell

Yeah. You know Mary mentioned earlier our shipment store project and I will tell you that one of many projects that we have, that we are pretty excited about in terms of the potential to drive top line, improve margin and make more efficient use of our inventory so we were an early adapter at shipping inventory being -- and allowing the customer to be in our store and order through our distribution center. We plan to improve that capability going forward.

We are in pilot in 20 stores now with shipment store capability and we think given our record stores, the ability to service the customer and the challenge with staying in stock we think it’s a massive opportunity for us in the back half of the year. And Mary also mentioned earlier that we are building a new distribution center that’s going to service e-commerce in 2014 and ultimately e-commerce and retail from a single pool of inventory in 2015, that’s how we plan to run our operations in the U.S. and that is actually how we are setting up our operations globally.

Judy Meehan

Okay, next question please.

Operator

Thank you. Our next question is coming from the line of Lindsay Drucker Mann with Goldman Sachs. Please proceed with your question.

Lindsay Drucker Mann - Goldman Sachs

Thanks, good morning everyone. Mary I was hoping that you could just expand on the asset write-off what the fabric and product liability charges were and whether we should think of those as inventory write-downs that would have flown through cost of goods in the first quarter some detail around that. And then just secondly how Jay maybe if you could talk about when we should expect new product to hit the floors and have impact?

Mary M. Boland

Yeah so Lindsay on the fabric and product liabilities we took the decision before that product was completed to write that off, so it’s fabric and work in process, so liabilities to better balance eventually kind of what we were looking at here in Q2. So within finished goods we are looking to try and get that balance before we ever took that product into [inventories] here, and then the other piece was discontinuation of our performance line that we put in place last year and discontinued here in Q4.

Jay L. Schottenstein

Okay and I would say like in fourth quarter you’ll start seeing new products coming in.

Operator

Thank you. Our next question is coming from the line of Oliver Chen with Citigroup. Please proceed with your question.

Oliver Chen – Citigroup

Hi, thanks a lot. Regarding the opportunity going forward and as you look beyond the next quarter which comp levers are the most likely to get better in an improving scenario and also on your enthusiasm on the denim cycle could you just highlight where you are seeing that and what we should expect and that we have had a good year, a good prior year with covered denim and skinny denim being a strong secular trends I am just curious about whether we should get excited for denim as well. Thank you.

Roger S. Markfield

I won’t talk too much because I know my competitors are on the phone call but we’ve been in a rough cycle of denim and Jay and I travelled the world, we go to all the important shows, we look at what the kids are wearing on the street and we can read our own numbers. There is definitely something taking place in denim as well as obviously the active bottoms pot of the business, that combination in total is a plus for the bottoms business and I will leave it with that.

Mary M. Boland

I think in terms of comp levers you know our conversion throughout 2013 and projected for ’14 has actually been pretty good. So once we get the customer in the store we have been able to convert to sale. It’s really been a traffic issue and to Roger’s earlier comment it’s all about products and the marketing in communication with our customers to drive them into the store as there’s been a bit of a traffic issue.

Oliver Chen – Citigroup

Okay.

Jay L. Schottenstein

And I would just add to that we can't underscore enough the importance of e-commerce and omni-channel retailing as we move forward and we built out a very strong team and capability last year. We saw a decent amount of improvement in terms of our online conversion rates and we have a number of initiatives this year. That again is exactly what Jay and Roger were describing, which is we think we have a very good store experience and potential for store experience as we move forward.

We need to make sure that the online digital experience is as good if not better than that store experience. So we're going to be focused on product details engagement, how quickly we -- how we communicate with our customers, how quick -- how easy it is to navigate our site, building out our mobile capability and really making the digital channel a real strength in the company.

Operator

Thank you. Our next question is coming from the line of Jeff Van Sinderen with B. Riley. Please proceed with your questions.

Jeff Van Sinderen - B. Riley & Company

Hi, Just a follow-up on the bottoms business that you mentioned that just wondering when you discontinue the aerie performance segment was that really due to poor execution or just your customer not really wanting that type of product from you. And then also just kind of just wondering how you are thinking more broadly about the overall store count given the shift to digital online. And I guess do you think that you need as many brick and mortar stores given the shift that's going on? Thanks.

Chad Kessler

Okay. On the [HITS] program I say well it's the combination of many different factors but it was poor execution. The plus side every time you launch something new, you learn something from it even if it's lousy execution. So there is some core items within that collection that we obviously are putting as part of our sportswear but in the 6,000 feet box it's very difficult for us to do that business that sets aside from the rest of the assortment, which now gives us the opportunity to get back into the accessory business which is a huge margin gain and also a big units per transaction gain and should help the transactional value and make the store that much more exciting, it's through accessories that should finish all the outfits.

Mary M. Boland

And then in terms of overall store count as we look forward to 2014 we are looking at roughly about 60 opening. But they are very much driven by factory and our international expansion and very few U.S mainline brick-and-mortar. As we look at our brick-and-mortar fleet which was the second part of your question as Jay mentioned earlier we are cash positive in our stores but having said that given the growth in the direct business and continued pressure on our mainline fleet we are actively reviewing our store -- our U.S mainline store fleet.

As I mentioned earlier we have probably about 10% of our store fleet either in some kind of rent reduction or rent release scenario on a very short-term lease like a one year lease renewal and we are continuing to build that. That will give us the flexibility we need as we look out and as the direct business continues to grow at this pace and we need to further rationalize our store fleet it will be easier for us to do at especially with the number of stores on one year lease.

Operator

Thank you. Our next question is coming from the line of Janet Kloppenberg with JJK Research. Please proceed with your questions.

Janet Kloppenberg - JJK Research

Good morning everyone and welcome back Jay, and Roger I didn't think you had left, so I am glad you are here. Okay, just a couple of questions Roger I am confused about how you will effect the assortments going forward. Simplify it for me, please, too much core, not enough core, too much fashion, wrong fashion. And how does the soft dressing business work with the increase in the core inventory.

So I thought that the soft pants would perhaps cannibalize the denim business this year it sounds like you think they can work hand in hand. Maybe you could give us a little bit more understanding there. And just a question for Mary we are all confused about the SG&A rate being up high single-digits in the first quarter Mary and up low single for the year given the fact that SG&A was down dramatically in the back half of fiscal '13? Thanks so much.

Roger S. Markfield

Janet I am not sure exactly what you are confused about but we are going to offer a compelling assortment, the core part of the business will probably represent upward of 60% of the business, it’s a huge business for us and it’s something we are going to have ownership of and remain destination and true merchandising and marketing, grow that audience even larger. As relates to soft dressing and denim they work very well together, one is the fashion element which will be in and out fast and done on a weekly basis and denim is done on a longest cycle.

Mary M. Boland

And then in terms of SG&A as we look forward in the year probably up low single digit. So a lot of that again will be driven by some assumption around incentive comps but what I would say as we sit here today there is a tremendous amount of work going on. It was in the company around expense and expense reduction. We’ll be able to talk more about that on our next call but rest assured we are focused on it and hope to drive a better performance on that.

Judy Meehan

Stephanie we have time for one more question.

Operator

Thank you. Our final question of the day is coming from the line of Howard Tubin with RBC. Please proceed with your question.

Howard Tubin – RBC Capital Markets

Thanks guys, maybe quickly can you just remind us where you stand on some of your sourcing initiatives and strategies in terms of reducing lead time and increasing your speed?

Jay L. Schottenstein

Sure. Well what I will tell you is when you look at the process that frankly we always had at the company and I have been here almost 15 years we always had an ability to test and read and react. What we have done over the last couple of years is really build out the capabilities a lot more, so whether it's things like platform and fabric, building systems to support it, making sure that we book capacity and keep that capacity with our vendors and having a responsive supply chain that allows us to ship product to stores either from factories, from the coast or from our DCs.

We have really worked on refining those processes over the last 12 months. I can’t tell you that we have exercised it as much as we would like to over the last year but that’s exactly the game that Roger is referring to that we want to get back to leaner inventories, faster turns on fashion and really exercising all of the capabilities we have in our extended supply chain.

Judy Meehan

Okay, everyone. That concludes our call today. Thanks for your participation and continued interest in American Eagle Outfitters.

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