American Eagle Outfitters' (AEO) CEO Jay Schottenstein on Q1 2016 Results - Earnings Call Transcript

| About: American Eagle (AEO)

American Eagle Outfitters, Inc. (NYSE:AEO)

Q1 2016 Results Earnings Conference Call

May 18, 2016, 04:15 PM ET

Executives

Judy Meehan - Vice President of IR

Jay Schottenstein - CEO

Chad Kessler - Global Brand President, AE Brands

Jen Foyle - Global Brand President, Aerie

Scott Hurd - Interim Chief Financial Officer

Michael Rempell - COO

Analysts

Brian Tunick - Royal Bank of Canada

Lorraine Hutchinson - Bank of America/Merrill Lynch

John Morris - BMO Capital

Adrienne Yih - Wolfe Research

Simeon Siegel - Nomura Securities

Rick Patel - Stephens

Michael Binetti - UBS

Oliver Chen - Cowen & Company

Matthew Boss - JPMorgan

Lindsay Drucker Mann - Goldman Sachs

Susan Anderson - FBR

Richard Jaffe - Stifel

Dorothy Lakner - Topeka Capital Markets

Tiffany Kanaga - Deutsche Bank

Anna Andreeva - Oppenheimer

Jeff Van Sinderen - B. Riley & Company

Operator

Greetings and welcome to the American Eagle Outfitters, First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. And as a reminder, this conference is being recorded.

I would now turn the conference over to Miss Judy Meehan, Vice President of Investor Relations. Thank you, Miss Meehan. You may begin.

Judy Meehan

Good afternoon everyone. Joining me today for our prepared remarks are Jay Schottenstein, Chief Executive Officer; Chad Kessler, Global Brand President of the AE Brands; Jen Foyle, Global Brand President of Aerie; and Scott Hurd, Interim Chief Financial Officer. Also joining us for Q&A today is Michael Rempell, Chief Operations Officer.

Before we begin today’s call, I need to remind you that we will make certain forward-looking statements. These statements are based upon information that represents the company’s current expectations or beliefs. The results actually realized may differ materially based on risk factors included in our SEC filings. We also have posted a financial supplement with additional financial details on our website.

And now, I’d like to turn the call over to Jay.

Jay Schottenstein

Okay, good afternoon. The first quarter was strong for AEO. Within the context of a very tough retail environment, I am especially pleased with our results. We demonstrated momentum across our business, gaining market share with leading performance. In the quarter, comparable sales increased 6% and operating income rose 40%. EPS grew 47%, $0.22 above our expectations of $0.17 to $0.19. The quarter also represented a solid two year performance after significantly improved operating profit and a 7% comp sales increased last year.

We ended the quarter in solid financial condition with $239 million in cash and no debt. Our first quarter results would not be possible without great merchandize, strategic investments, and strong execution across the organization. Our teams can be extremely proud of their accomplishments. We saw a good performance across brands with sales and profit growth for both AE and Aerie. Aerie had another breakup quarter with comps rising over 30%.

E-commerce was exceptionally strong, as entries digital marketing efforts and site investment are delivering returns. We also posted positive store comps to both brands on outpaced mall traffic. Our progress over the past two years has made AEO a much stronger operator in a tough, macro environment. While weak mall traffic continues and other brands had struggled, we are taking share. We remain highly focused on leveraging our competitive advantages and positioning AEO for future success. Product leadership and customer acquisition remain top priorities in 2016.

We have a world class creative team who continues to raise the bar. They know how to consistently deliver compelling and differentiated fashion, build around our leading product lines such as denim. This fall American Eagle is unveiling a new marketing campaign that will alleviate and re-energize the brand. We will build on Aerie’s strength and momentum, selectively expanding and developing a strong customer following.

Technology in omni-investments have made us better, faster and more efficient. These investments have also been key to our recent success. In the first quarter, we drove nearly $30 million of revenue through ship-from-store and expect flexible fulfillment to generate ongoing benefits to our business.

We recently delivered our new MOGO responsive site with very good results. MOGO sales had run rapidly, contributing to the e-commerce growth. We continue to build our bench strength. Peter Horvath recently joined as chief global commercial and administrative officer bringing an extensive track record of success in the retail industry. I have the pleasure of working with Peter when he served as President of the BSW.

He is an effective and strategic retail executive. I am confident that you will have a meaningful impact at AEO. The day we announced that Kyle Andrew was appointed Chief Marketing Officer. He brings a wealth of creative and brand building experience to the team. Kyle has been highly engaged in creating our fall marketing campaign. We are thrilled to welcome her to AEO.

I believe our brightest moments are still ahead and we are just beginning to unlock the potential of our business. We know the AE branch is more broader and can successfully compete on the global stage. Aerie has a long runway ahead and I believe this is one of the most exciting and emerging brands in retail today.

We are also enthusiastic about the future prospects for Tailgate and Todd Snyder.

I’m often missing about our future, yet fully aware of the many challenges that continue around us. We’ve built a strong model for success and we will continue to fund our business to maximize our investments and stay focused on delivering profitable growth.

Now I’ll turn the call over to Chad.

Chad Kessler

Thanks, Jay. American Eagle delivered another solid quarter, in fact we gained momentum from the fourth quarter of last year and amidst of macro challenges, including unseasonal weather and weak mall traffic. American Eagle brand comps increased 4%. Digital commerce drove meaningful sales gains and although mall traffic was soft, stores held up and delivered a positive comp.

Higher IMUs and lower product cost partially offset by modest rise and markdowns drove a strong merchandised margin. We benefitted from reduced cost and great work by our sourcing team to leverage our scale and achieve better pricing and improve inefficiency. We expect cost benefits throughout the year.

We saw higher, realized prices across the collection as we delivered compelling assortments and improved quality and contained price driven promotional events. We continue to evolve our customer base. Multi channel shoppers are our fastest growing customer segment and spend two to three times as much as those who shop at single channel. AE’s product leadership has resulted in a higher annual spend across all customer segments, with new customer spend up 17% and core customer spend up 6% from last year’s averages.

Throughout the quarter, inventories were well managed and we will maintain strong discipline going forward. Our move to an Omni channel organization has facilitated tighter inventories and a more cohesive brand experience across selling channels.

Our women’s business continue to be strong with first quarter comps up in the high single digits. We saw strength in most apparel categories, highlights includes denim, pants, shorts, dresses and knits and woven tops. But demand from men’s was not as strong and comps declined in the low single digit. We did see positive comps in men’s bottom. We also saw strength in men’s tees, woven shirts and underwear. We continue to see opportunity to drive product improvements in our men’s collections.

Now, as I look forward I am excited about our upcoming product lines. This back-to-school we will introduce the next generation of fabric technologies across AE jeans. The collection has been tested with a positive customer response. We will launch a holistic marketing campaign providing a fresh look to our AE denim collection, and I look forward to unveiling our new brand marketing campaign in September.

Last week, we opened our first new Tailgate store in Madison, Wisconsin. A few pictures can be found in the presentation on our website. The store celebrates the school spirit of the university of Wisconsin with the feel of a reinvented college bookstore. In addition to branded college gear, the store features AE jean, a coffee shop and a side by side boutique of our Don’t Ask Why fashion line. We look forward to growing our college presence with a few more campus stores this year.

I’d like to say congratulations to the teams across the company. We made great progress and look forward to building on our success. In this tough environment success will be built around our strong brand position, exclusive compelling merchandise, engaging customers in interesting ways and offering the very best shopping experience across all channels seamlessly. This is where we are focused upon everyday, thanks and now I will turn it over to Jen.

Jen Foyle

Thanks, Chad and good afternoon, everyone. I am pleased to report that Aerie’s strong momentum has continued and we delivered another fantastic quarter. Sales and profitability reached record high. Comparable sales increased 32% with strengths across all channels. The online business was particularly strong with digital representing over 30% of Aerie’s business. Strong collections and well received marketing campaigns are dragging more traffic and new customers to Aerie. By category, we posted positive double digit comp growth across major businesses including bras, undies, apparel and swim.

Our expanded swim short has been extremely well received and we look forward to building on the success and capturing new market share. We are also specially pleased to see stronger performance across apparel. Margins expanded as a result of favorable product cost and more targeted promotional events. We remain focused on fueling our digital business, maximizing store productivity and we will seek additional opportunities for Aerie within AEs existing store fleet.

Additionally, we are opening up new stores where we see market opportunity based on our digital sales and using AEs women’s selling data as a gauge. Pictures of our newest standalone store in the Mall of Georgia can be found in this presentation.

Lastly, we are really proud of how well the area real campaign has resonated with our customers. The feedback and interest remains high, everything and everything we do at Aerie’s is customer centric including our merchandised assortments, new product lines, strong social media and regular fun events, such as our recent love-the-swim you’re in campaign and our customer appreciation event just last weekend. Thanks to the team for a strong performance. I’m so thrilled with our execution and I look forward to the many opportunities ahead of us. And thank you , and now turn it over to Scott.

Scott Hurd

Thanks, Jen. Good afternoon everyone. In the first quarter, compelling product and improved customer experience drove sales and margin growth across brands. Favorable product loss resulted in merchandised margin expansion and expenses discipline enabled us to leverage operating expense and occupancy.

Now looking more closely at the details of the quarter. Total revenue increased 7% to $749 million from $700 million last year. Consolidated comparable sales increased 6% driving an incremental $40 million of revenue with positive comps both in stores and online. This fall was a 7% comparable sales increase in the first quarter of last year. Additional sales information to be found on page five of the presentation.

This quarter by brands AE comps were up 4% and Aerie comps increased 32%. Consolidated comps were driven by mid-single digit increase in the average transaction value due to a mid-single digit increase in the average unit retail price and higher units per transaction.

Total gross profit increased 12% to $293 million from $262 million last year. The gross margin rose 170 basis points to a rate of 39.2% of revenue. Buying, occupancy and warehousing leveraged 110 basis points due primarily to occupancy cost leverage. The remaining 60 basis points of gross margin improvement was the result of favorable product loss offset by a modest increase from markdowns. Our promotional activity was controlled with first quarter markdown rates within our targeted range, delivering healthy merchandised margins.

SG&A dollars increased 6% to $196 million due to investments in advertising, wearable selling expense and strategic initiatives. As a rate to revenue, SG&A declined 30 basis points to 26.2% from 26.5% last year. Depreciation and amortization increased to $39 million and de-leveraged 20 basis points to 5.2% as a rate of revenue.

Operating income rose 40% to $59 million from $42 million last year and the operating margin expanded by 180 basis points to 7.8% as a rate of revenue. Similar to last year, within other income we had $5 million of income related to currency gains on cash held in Canadian dollars. This compares to other income of $6 million last year.

As discussed last quarter, tax blending strategies are bringing our expected effective tax rate down to the range of 36% to 37% for the year. In the first quarter, the tax rate was 36.4%. Share buybacks led to a lower share count compared to last year. The benefits of the tax and buybacks were approximately $0.02 to EPS. EPS of $0.22 increased 47% from $0.15 last year.

Turning to the balance sheet, starting with inventories, which can be found on Page 6 of the presentation. We ended the quarter with inventory at cost of $334 million up slightly from last year ending units were down in the mid-single digits offset by mid-single digit increase in the average unit cost due to product mix. Like-for-like average unit cost were down to last year. The change from our guidance of down low single digits was due to the timing of new receipts. Looking ahead, we expect second quarter ending inventory cost to be approximately flat.

We ended the quarter with $239 million in cash compared to $327 million last year. Over the past year we spend $227 million of share buybacks, returned $95 million in dividends and invested $136 million in CapEx.

Capital expenditures totaled $24 million in the first quarter, and we continue to expect CapEx to be in the range of $160 million to $170 million for the year. During the quarter we opened three stores and closed four. Additionally, there were six international license store openings and we ended the quarter with 145 licensed stores across 22 countries. Additional store information can be found on pages 9 to 11 in the presentation.

As discussed on the last call, we are utilizing market data analytics to a much greater degree to identify geographies right for consolidation and we have a stronger digital consumer. Data is also helping us identify the best potential new markets as store locations as we selectively expand their reopenings.

Now looking ahead to the second quarter, based on a low single digit increase in comparable sales we expect second quarter EPS of $0.20 to $0.21. This compares to $0.17 last year and excludes potential impairment restructuring charges.

We expect continued gross margin expansion due primarily to favorable product loss and sourcing efficiencies. We will maintain tight inventories as strive to offer more strategic and targeted promotions.

SG&A dollars were expected to be up in the low single digit and we are targeting SG&A leverage. Across the company we remained intensely focused on building on our momentum, further improving our operations and delivering stronger profitability as we strengthen our leadership position in the marketplace.

Thanks. Now we'll take your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And with that, the first question is from Brian Tunick of Royal Bank of Canada. Please go ahead.

Brian Tunick

Thanks and congratulations, obviously very tough environment. Curious on sort of lot of conversations about what was going on in the mall during the quarter and I know you don't probably give us monthly trends, but just curious if you could maybe talk about performance by either mall type outdoor center, outlet, sort of what happen as the quarter progressed?

And then the second question really is on your AURs here, it sounds like there was more discounting this year versus last year, but can you maybe talk about what's happening whether its higher ticket or mix of product, what's the most opportunity in AUR as you move to the rest of the year? Thanks very much.

Scott Hurd

Hi, Brian, it's Scott. I'll take your questions. Looking at the mall types, our A stores were up 8%, Bs were up 6%, Cs were up 5%, our outlets which are primarily outdoor were up 3%, so certainly some weather impact there. But honestly for quarter itself we come positively and strong results in every month of the quarter. So [Audio Gap] sharp and as it relates to the markdowns, our Q1 markdowns, we're up, what I would say overall our margin is up, so when we look at the markdowns in Q1, what I point to is Q1 was our highest hurdle rate up against last year, so we had our best performance. And the Q1 markdown were actually near a company record, so we have opportunity as we continue to have targeted promotions that have been proven to drive our top line, will also drive bottom line as well.

Brian Tunick

So, that' very helpful.

Jen Foyle

Manny [ph], we'll take question.

Operator

Yes. The next question is from Lorraine Hutchinson of Bank of America/Merrill Lynch. Please go ahead.

Lorraine Hutchinson

Thank you. Good afternoon. Just wanted to follow-up on inventory exiting the quarter, it looks like your average cost is actually – if units are flat, it looks like your average cost is actually up and I just wanted to understand if that was mix shift or what you're there?

Scott Hurd

Hello, Lorraine, its Scott. I'll take that one. It is mix, so on a like-for-like basis our average unit costs are actually down due to certainly a favorable sourcing environment. So it really is driven solely by mix.

Lorraine Hutchinson

And what types of products are you mixing into?

Scott Hurd

Well. so, not sure I fully understand your question in terms of what we're mixing into, but what's driving the mix up or the investments in the product, we talked about the how compelling and well received the new products spend. So, there has been investments in the product but the mix that's driving the average unit cost up is really investments in denim and other categories.

Lorraine Hutchinson

Thank you.

Operator

Thank you. The next question is from John Morris of BMO Capital. Please go ahead.

John Morris

Thanks. My congratulations to everybody on really great performance, obviously pretty tough and you really stood out. Nice work. Quick question for Chad, maybe talked a little bit more. You pointed to it in the prepared remarks little bit more about the opportunity for men's and where you see that unfolding.

And then, Jen and within Aerie really impressive swim performance, you mentioned more opportunity there. I'm wondering if you started to see some of the opportunity from some of your – one of your key competitors looking to get out of that business. And then just finally, the marketing spend with new campaign in the back half would that be – would we expect that to be up or just shuffled around a little bit? Thanks.

Chad Kessler

Hi, John. Thanks. It's Chad. I think we definitely, we definitely believe we have opportunity in men's as I mentioned. In total I think first and foremost for both men's and women's we believe we still have a lot of runway in our bottoms business. We continue to distance ourselves from the competition both in terms of quality and innovation as well as market share. So we're excited about that and believe we definitely have opportunity there in both genders.

In terms of the rest of men's apparel, we really focused on driving innovation and fashion in men's Ts and woven and have actually pretty pleased with the performance through Q1 in those areas. Unfortunately, it wasn't enough to get the total men's apparel area positive. But with what we've learned in terms of what the customers responding to with innovation, with the product changes we've made in those two categories, we believe we've made adjustments starting as soon as June but carrying into the rest of Q2 and fall in the men's assortments and believe we definitely have opportunity and we're all fighting to get back to positive comps in men's apparel.

Jen Foyle

And for Aerie you know, we are just thrilled with the performance. We saw strength across all our businesses quite frankly. I think we were really strategic in the swim business looking at the spring break shift and really delivering on those shifts, for instance, we had a new delivery prior to Easter and it was strategic deliver and we thought really good about it, and we saw big wins pre and post Easter with the swim category. And we just – this team is doing great. I mean, we continue to stay in our lane, stay focused, look at product opportunities, swapping [ph] one of them, but certainly in our core competency businesses as well.

Chad Kessler

And John just your question on the back half investment, it really is a shuffle, so you know are target to leverage SG&A remains in place, so we'll fund it with the shuffling of the [Indiscernible]

John Morris

Great. Thanks very much.

Operator

Thank you. The next question is from Adrienne Yih of Wolfe Research. Please go ahead.

Adrienne Yih

Good afternoon, let me add my congratulations, stellar. That's all I can say, stellar. My first question is actually on the AUC, so if 60 bps of it was from AUC production also obviously by a little bit more promo, should we expect at least that in Q2. And then, should it not get larger – the opportunity get larger as you go into the second half because of the devaluation in August of last year. And then really quickly Jen on Aerie congrats I wanted to talk about bralette trends. How sustainable is it? Is it additive; does it take away from bras and do you think is unsustainable trends? Thanks.

Michael Rempell

Hey, Adrienne this is Michael Rempell. I'll take the first part of your question on AUC. Yes, so we actually thought little bit more than 60 basis points mark-up improvement in Q1, and we're expecting to see at least that in the balance of the year. So, it grows a little bit in Q2. Little too early to talk about the fall here, we haven't finalized that assortment, but I'm expecting to see at least that in the back half of the year as well.

Adrienne Yih

Okay, great.

Jen Foyle

And regarding bralette certain its accretive to the bralette business, it's definitely been a big portion of the business and we went after it. I'd like to say we were first and furious in that business and we really attracted it and we're really proud of what we deliver there.

With that said, the customers are evolving and we are in front of it. We platform fabrics and we are nimble and we can remain nimble. We have some great ideas coming up the curve and what we're going to re-launch and I think that is exciting, so we will continue to evolve the bra business, its important and there are some exciting things are going.

Adrienne Yih

Great. Best of luck.

Jen Foyle

Thank you.

Operator

Thank you. [Operator Instructions] And our next question is from Simeon Siegel of Nomura Securities. Please go ahead.

Simeon Siegel

Great. Thanks, guys and congrats. So, just on [Indiscernible], obviously fantastic results of Aerie. Have you just kind of step back, have you plotted out how large you think that business could become? And then what are the margin implications there as this business continues to grow? Thanks.

Jen Foyle

So, we're not going to stop, I mean we finally have done a platform that we believe in. The AerieREAL campaign has resonated really with this customer base. We've seen nice increases in our new to file, and actually really solid increases on the 12 months trailing file there and we are just the customer is really you know spearheading this for us which is what you love and that I think has a big part in the Aerie play and for the American Eagle portfolio.

Like I said, we're growing this business. We're opening up new stores. We're going to take advantage of the AE profile in the women's business and leveraging that every day. The direct business continues to be a big win in here delivering almost 30% of the revs or 30% of the revs in Q1 so that was huge. And like I said, we're just going to continue to look at opportunities and see how high it high.

Michael Rempell

Simeon just to our question on margins, as Aerie continues to improve their margins we'll see improvement in our overall margins rates as well as it scale.

Simeon Siegel

Okay, great. Thanks a lot guys. Best of luck for the rest of the year.

Operator

Thank you. The next question is from Rick Patel of Stephens. Please go ahead.

Rick Patel

Good afternoon, everyone, congrats as well. Can you update us on your ability to test every act? Where exactly are you in terms of the percentage of products or categories that this can be used for? And second as you introduce new fabric for back-to-school, do you expect to see like-for-like increases in average selling prices or is this more gaining market share?

Chad Kessler

So, on the AE brand, really it's our goal to try to test almost everything that we do, and do it in different ways. We have online focused groups. We have pre-season tests of most of the collection. And we also to style test. So, it's really our goal to try to get customer feedback, real customer feedback in advance of each collection and we definitely use that information to influence the buyers.

We also have a Don’t Ask Why collection, which for us it's been great testing vehicle in women's apparel and I think we continue to learn from that move forward. In terms of reactablity and reaction, my team is partnering very closely with Michael's team in terms of speed sourcing and the supply chain trying to get goods every season faster than we're able to get them the season before and even to the point now of reacting within season from selling to making new commitments and getting new goods within a season. So it's really been beneficial to us to close correcting the assortments and trying to maximize profitable sell-through.

As for the denim innovation for fall, I think if you look at denim, like we look at the whole assortment, we continue to see improved AURs in the business. We're driving that AUR really in three ways. We're driving it through innovation and innovation that provides value for the customer. I do believe that the new fabrics for back-to-school, we are going to see an increase. We're planning an increase in AUR and Jeans across back-to-school, but I think that the customer were confident based on both test and also experiencing the product ourselves the customer will pay us for that innovation.

The other way we're seeing that AUR grow, its about innovation, its sell-through, as we're reacting faster, as we have better information about the product, as we're getting more right in the business, we're getting better sell-throughs. And then the third thing, just being the mix and denim will definitely play into that mix driving up AUR at fall.

Michael Rempell

And it's Mike. I would just add on to that, that we're talking about AUC before and the market improvements that we're expecting through the year. We are delivering in the sourcing team and our vendor partners are doing a terrific job delivering those mark-up improvements while still improving the value we're offering the customers, so, while simultaneously putting more innovation into fabrics, [Indiscernible] et cetera, so we're excited about what we're going to deliver this year.

Rick Patel

Thanks very much.

Operator

Thank you. The next question is from Michael Binetti of UBS. Please go ahead.

Michael Binetti

Hey, guys. Congrats on a nice quarter. Good afternoon. As you guys – as we think about your men's business, couple of housekeeping questions, could you give us a size of the men's versus women's business a sense of the dimensions those two within the Aerie stores -- I'm sorry, within American Eagle stores. How should we think about the cadence of how quickly you think you can touch the product there and when you think we'll see whatever I guess you would consider significant change to the product in the men's category?

Scott Hurd

Sure. So men's represents about 40% of the business and that fluctuates throughout the year depending on the season, but in total it's around that number. As I said, the team has been focused on the men's and we did see good improvements, pretty significant improvements in the T and woven shirt business and it was offset by the other categories, so Fleece, Poulos, some of the other apparel categories.

Also even that we had a positive comp and bottoms, with some of the weather headwinds shorts were not as strong as we would have liked in Q1. But I think we've really as I said, I think I said earlier, we're starting to believe that there are some increased improvements in men's that we should start seeing in back half of Q2 and in to Q3.

And then, we're in the process right now of finalizing an assortment for holiday. And the whole team is focused on trying to make sure men's can be as strong as it can be. And we really believe it's going to be through driving innovation and pushing for more trends and similar fashion in the men's business. That's what we are seeing.

Michael Binetti

Okay. And then if we look at the numbers obviously impressive, I can tell you happy, but how would you speak to concerns out there on – that we heard on impactful categories for you like bralettes which have become very popular very quickly. Whether those, do you think those are more of a fashion trend that you're keeping eye in the near term versus your long term change in customer preference? Thanks.

Jen Foyle

I think overall there is just – I think there is an evolution happening in bras for sure and certainly bralettes are part of it. But I alluded to earlier, there is other categories within bras that we haven't maximize yet and we're going to do that.

Michael Rempell

I just like to jump in, not to tell about bralettes but just to talk about a little bit of how we operate. There is conversation for example, lightly lined bras or bralettes or AE brand, are they're flare jeans or leggings or we looking at shorter tops, longer tops. There is a lot to be said, I think in terms of the product leadership that the teams are brining today, but we also have a very rigorous process to learn what's working, what's coming to test, react, to understand where the customer is moving and to respond and get the inventories in that position.

So, hopefully we'll continue to see positive momentum in the denim business for me and positive momentum in bras and bralettes [Indiscernible] but the way we operate this business is to find everyday to be searching for what's next and to try to get ahead of the customer.

Operator

Thank you. The next question is from Oliver Chen of Cowen & Company. Please go ahead.

Courtney Wilson

Hi. This is Courtney Wilson on for Oliver today. Thanks for taking our question. Congrats on the results. We were hoping you could talk a little bit about your online business. How you feel about your current platform and sort of what's next from a catalyst perspective online and how you're using mobile strategy? Thanks.

Jay Schottenstein

Yes. So, as I think we said in the prepared remarks, we've seen a lot of strength in our online business. We're very pleased with the team with performance for the quarter. We've seen an acceleration in that business from third quarter to fourth quarter in the comp for that business from third quarter into fourth quarter now fourth quarter into first quarter. And when you look at it, it is the investments that we've made in addition to the great product and brand strength for Aerie that have set us apart, so a few of those things would be flexible fulfilment which I said it earlier, make our inventory more available.

We drew $30 million of sales in the quarter. We continue to expand our capabilities there and continue to learn from those capabilities to make sure that we capture any fails and we're getting our inventory in the right place at the right time letting customer shop whatever they want. International has been big focus for us in ecommerce. We're continuing to look for ways to expand the ecommerce business internationally.

In Q1 we had some new shipping options that made it both cheaper and earlier for customers to shop with us internationally. Those results were very promising. We lost our U.K. platform last year. We're expanding that to Europe in the back of the year, so we'll be servicing Europe from our distribution center in the Netherlands and we're lag T mall and we're going to extend our ecommerce business in China to additional marketplace in the back half of the year.

Our sales with International Canada is actually our largest international market and throughout the year we're going to be expanding our omni capabilities to the Canadian customer and we're excited to see those results. Okay, sorry, you asked about mobile too. I'll should – I'd be [Indiscernible] without talking about mobile. We feel like we saw the move to mobile and over the last two years considerably distorted our investments there. When you think about mobile it's really those investments are in two places, one is the app, where we're seeing tremendous results, in fact our iPhone app had over a 100 comp within the quarter, so really impressive result there. [Indiscernible] it has are largest average order size et cetera.

And the second area we launched our mobile first website are responsive site as Jay mentioned earlier. In Q1 we saw a 20% lift in conversion after launching that site, so tremendous results. We still think we had tons of opportunities to improve it and we're going to be doing that throughout the course of the year.

Courtney Wilson

Great. Thank you.

Operator

Thank you. And the next question is from Matthew Boss of JPMorgan. Please go ahead.

Christina Bradley

Hi. Its Christina Bradley on for Matt. Thanks for taking the questions. Let's larger picture, lot of seem of apparel capacity online proposition and Amazon, can you just talk about [Indiscernible] and how you maintain brand perception and market share. Are there any changes that has been made or need to be made to better compete going forward?

Michael Rempell

I think the best things for us is it really is about having a strong brand and exclusive compelling merchandize and is really build around our leading denim. I think a lot of the brands, if you are retailer, my belief is if you're retailer who is selling product you can get multiple channels than good luck, Amazon is going to eat you alive. But if you have a strong brand and you have good product than you have an opportunity to sell through your vertical channels. You can engage with your customer in compelling ways and get paid for the value you're delivering there. And that's really I said in the prepared remarks, that's really what we're focused on.

And I think the key going forward was such a huge competitor out there is to make sure that we have exclusive product and that we have a compelling brand and that we continue to engage the customer.

Christina Bradley

Great. Thanks.

Operator

Thank you. The next question is from Lindsay Drucker Mann of Goldman Sachs. Please go ahead.

Lindsay Drucker Mann

Thanks. Good evening guys. I wanted to follow-up on just a question about the promo strategy and the markdowns. I think this is the first quarter in a while where you actually had markdown higher year-over-year. And I think Scott you talked about how we're able to balance it and actually drive healthy bottom line expansion. And so I just wanted to clarify your remark about whether you saw it as we think about balance of year the promo cadence will be up or the markdown activity would be up year-over-year or as you look forward 1Q is kind of anomaly, I guess I'm just trying to understand if there was a shift in strategy, because what we heard pretty consistently was that the focus was to be less promotional and drive lower markdowns. I know it's really tough out there, so I want it if you were sort of shifting focus and how we should be expecting this for the balance of the year? Thanks.

Scott Hurd

You know, it's too early to talk a lot about the fall season for sure but focusing in on the second quarter. So, we did a bit more target promotion, again driving top-line margin is up, I mean I think that's the strongest message that I had you walk away with, but there is no meaningful shift in how we're thinking about our markdowns and how we were thinking about our promotions. Again we were up against the most difficult compare in the first quarter. And I see as those compares get easier you'll see the results in line with that.

Michael Rempell

We do not – we are not at this time we are not changing our strategy to be more promotional. So…

Lindsay Drucker Mann

Great.

Michael Rempell

Scott, to the number but it is not shift in strategy.

Lindsay Drucker Mann

Okay. Thanks.

Operator

Thank you. The next question is from Susan Anderson of FBR. Please go ahead.

Susan Anderson

Good evening, congrats on a great quarter. I was wondering if you could give a little bit more color on the international business and the performance in the first quarter also if you're seeing kind of that inflation and possibility as expected and then expectations for the rest of the year.

And then just really quick on the traffic, obviously you are outperforming your peers. How do you expect to continue to drive that if we kind of go throughout the rest of the year? Thanks.

Scott Hurd

Hi. It's Scott. I'll take the international question and our international business is nicely profitable. We've build a strong foundation and what has become a fantastic franchise business. We have a very strong and profitable Mexico business that we continue to invest behind. And when I look at our developing markets where in the U.K. and in China we're proceeding with cautions there making great progress, not satisfied but continuing to push, learn and scale and Michael spoke to the digital initiatives that we have been really – that really have driven that international business. So, we have a lot of opportunity left in international, but we have great profitability, expectations both in the second quarter as well for the balance of the year.

Michael Rempell

I think, and just to tag on there, another nice thing about international business, they love our jeans. So as we grow the denim leadership we have in the United States, we are fully anticipates having our kind of leadership worldwide. More traffic is tough out there. We were able to based on our counters, we were able to have better traffic than what the total malls are in Aerie brand and Aerie even outperform that.

We believe we're taking share in the mall. We believe we're doing that through product leadership and engaging our customer with better product and with more compelling marketing. But knowing this is an ongoing -- most likely an ongoing headwind, its part of the reason we keep talking about and are still focus on the brand, marketing campaign we're going to launch for fall. We really are looking to engage our customers in a more emotional way with broader appeal for the brand to continue to take share and to continue to get at least our share of mall traffic if not grow that mall, but grow our traffic within a tough mall environment.

I think the other thing we need to remember is that the real goal for us as an omni organization to grow the total traffic and total transactions for the brand as we’re able to shift our traditional store customer to be a multi-channel customer as we talked about earlier in the call. That's actually huge win for us. The customers are engaged in both channel spend significantly money than the customers involve a store only customer. So we'll do everything we can to get the customers in the mall, but if we can get them engage in both channels that's even a better thing.

Susan Anderson

Great. Good luck next quarter.

Michael Rempell

Thanks.

Operator

Thank you. The next question is from Richard Jaffe of Stifel. Please go ahead.

Richard Jaffe

Thanks very much guys, and really an exciting quarter. Wondering just about the SG&A, the investment we saw in – I guess in marketing and advertising and in brand building, could you address the increase in operating expenses and how we see that going forward in the year and how you anticipate spending it, or how you spend it and why work so well? Thank you.

Scott Hurd

This is Scott. I'll take that one. So, again our target in SG&A is leverage. And making the strategic investments that we'll get paid for not just in the quarter itself but over the long term and what you're seeing in the strategic investments that we're making, we talked a little bit about the marketing campaign that will talk more about and you'll see in September. So it's about driving the business over the long term, not about the current quarter.

But again our target is to consistently look into our operating structure or operating infrastructure to find ways to either to reduce costs but we're going to continue to invest in those that will drive the business year in and year out.

Richard Jaffe

Broadly speaking can you give us a sense of what those things might be?

Scott Hurd

Yes. Certainly like digital traffic was up over 20%. Direct result of our increased investments in digital market would be an example.

Richard Jaffe

Any others.

Scott Hurd

More strategic, nothing that we'd want to share too much on the call.

Richard Jaffe

Okay. Thank you very much.

Scott Hurd

Marketing I think is the other biggest piece outside of this strategic just to give you some examples of some of the things that were coming up against, obviously fair amount of discussion went on wage rates and so forth, so we're seeing the same thing that the rest of the retailers are seeing impacting us about 1 million to 2 million each quarter on minimum wage and just cost of living adjustments some of that type of stuff.

Richard Jaffe

Okay. Thank you very much.

Scott Hurd

You're welcome.

Operator

Thank you. The next question is from Dorothy Lakner of Topeka Capital Markets. Please go ahead.

Dorothy Lakner

Thanks and good afternoon everyone. Congrats, just a great quarter. I wanted to go back to Aerie for a second and just I think Jen mentioned getting more into more Aerie into some American Eagle stores. And I just wondered kind of where you are on that? How much opportunity there is? And then just if you could provide a little bit more color on the store's performance you started opening more stores, any thought behind where that expansion might go?

Jen Foyle

Sure. First and foremost we're looking to make every format within Aerie as most productive is possible. You still have to remember we're a fairly small brand here, so we're seeing opportunity in our current existing state, but as you look forward we are opening up new side by side this year, its reflective I believe in the release. And there are still some 80 stores that we are not within right now. They're not a lot left quite frankly we're in those formats within the AE store format, but again we're looking to maximize that and ensure that we're the most productive as possible.

And then, regarding the standalone, those stores are between 40% and 60% more productive, so we love what our productivity results are there, they are smaller. And again we're going to ensure that we're evaluating that, the Mall of Georgia which just opened, I mentioned in my script. It’s a little bit larger, it's about 3,000 square feet and it has some expansion businesses in that.

So again we're still learning and scaling. But we are opening up new stores and we will continue to evaluate the market, not the markets that we go into. Scott team has done an amazing job looking at the brand from sort of a market scope versus just opening up new stores. And I think that is really important when you look at our relationship in the direct business to the store business.

Scott Hurd

Hi, it's Scott. The Aerie stores perform and they had an 8% comp here in the quarter and to Jen's point on the future rollout we're really being very selective in using the data analytics to identify not only where we can service the customer through the cash interop [ph] but where we can continue to fuel what has been an absolutely amazing digital business for the Aerie brand.

Dorothy Lakner

Great. Thanks. It's very helpful.

Operator

Thank you. The next question is from Tiffany Kanaga of Deutsche Bank. Please go ahead.

Tiffany Kanaga

Hi, congratulations on a great quarter and thank for taking my question. Can you talk about the game plan for beauty at Aerie? How does the category do in the first quarter and how are you thinking about competing and differentiating yourselves in a pretty crowded field?

Jen Foyle

Yes. Right now, we're really highly focused on our core competency businesses as I said, we have a lot of opportunity within bras, undies, swim and apparel for store. And we did assimilate a team to venture into the beauty business, but we are going to walk before we run. We're going to approach it very strategically and do it with some thought and integrity beyond it.

Tiffany Kanaga

Thanks so much.

Operator

Thank you. The next question is from Anna Andreeva of Oppenheimer. Please go ahead.

Anna Andreeva

Great. Thanks so much and congrats guys. I was hoping if you could address what kind of trends are you seeing quarter to-date here in May. Are you running in line with that guidance for low single digit comp on top of a difficult 11% from last year, obviously lots of concerns about the consumer that we're hearing nowadays? And then secondly on the margin expectations for the year, should we still expect the markdowns to be down versus last year? Thanks so much.

Scott Hurd

Hi, Anna, it’s Scott. I'll take that one. In terms of trends of the business we don't really talk about that you know within the quarters [Indiscernible] , but obviously the first two and a half weeks here are in the bank and we’ve set our low single digit guidance and we are confident that we’ll be able to achieve that. You know as it relates to margin markdowns, you know our margin will be up and you know a lot of it coming on the back of favorable sourcing and great INU expansion and as it relates to markdown certainly in the back half we are still baking our plans and accessing the competitive environment, but again I think the center point for you is we expect margins to be up.

Judy Meehan

Okay, Manny we have time for one more question.

Operator

Thank you. Our final question is from Jeff Van Sinderen of B. Riley & Company. Please go ahead.

Jeff Van Sinderen

Let me add my congratulations, amazing quarter. Let me ask you, as far as the e-commerce business at this point, I’m not sure how much you’ve shared about where that stands as far as penetration. Any color you could give us there would be helpful. And then on Aerie, did you say that it was 30% of the overall women’s business in Q1 and then maybe you could also just touch on apparel at Aerie?

Jen Foyle

Yeah for Aerie, I will clarify, it was 30% of the total Aerie business.

Jeff Van Sinderen

Okay.

Jen Foyle

And then what did you ask regarding women’s?

Jeff Van Sinderen

Was just -- was trying to get a better sense of the Aerie apparel business kind of what you are seeing there. I know you talked a lot about bralettes, but we’re was just wondering more about the apparel part of that.

Jen Foyle

The apparel had some record highs in some of its businesses. It’s really -- you know we look at the apparel business as a compliment to our core competency businesses and that’s how we are really approaching it. So for instance -- and we’ll cover up and we’ll continue to approach it down there.

Jay Schottenstein

And the e-commerce business is roughly 20% penetration to total, you know obviously growing nicely but like Chad said earlier, you really can’t look at what we are doing it is just one channel versus the other. Our investments there, we are investing in digital not only drives e-commerce sales but ultimately to drive customer loyalty and sales across our brands.

Jeff Van Sinderen

Thanks.

Jen Foyle

Great. So thanks everyone. That concludes our call today. We appreciate your participation and continued interest in American Eagle Outfitters.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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