American Eagle Outfitters' (AEO) CEO Jay Schottenstein on Q4 2015 Results - Earnings Call Transcript

| About: American Eagle (AEO)

American Eagle Outfitters, Inc. (NYSE:AEO)

Q4 2015 Results Earnings Conference Call

March 2, 2016 04:15 PM ET


Judy Meehan - IR

Jay Schottenstein - CEO

Chad Kessler - Global Brand President, AE Brands

Jen Foyle - Global Brand President, Aerie

Mary Boland - Chief Financial and Administrative Officer

Michael Rempell - COO


Brian Tunick - Royal Bank of Canada

Courtney Willson - Cowen and Company

Lorraine Hutchinson - Bank of America

Jeff Van Sinderen - B. Riley & Company

Janet Kloppenburg - JJK Research

Paul Lejuez - Citi

Dorothy Lakner - Topeka Capital Markets

Neely Tamminga - Piper Jaffray

Lindsay Drucker Mann - Goldman Sachs

Betty Chen - Mizuho Securities

John Morris - BMO Capital

Adrienne Yih - Wolfe Research

Simeon Siegel - Nomura Research

Kimberly Greenberger - Morgan Stanley

Anna Andreeva - Oppenheimer


Greetings and welcome to the American Eagle Outfitters, Inc., Fourth Quarter 2015 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].

I would now like to turn the conference over to your host, Judy Meehan. Thank you. You may now 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 Mary Boland, Chief Financial and Administrative 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. Our comments today include non-GAAP adjustments, please refer to the tables attached to the press release. We also have posted a financial supplement with additional financial details on our website.

Now, I’ll turn the call over to Jay.

Jay Schottenstein

Okay, thanks and good afternoon everyone. I am extremely pleased with how the company delivered in 2015. In a tough retail environment we had consistent top line growth and significant margin expansion. Total sales growth 7%, fueling a 73% increase in EPS to $1.09. I am proud of how far we have come over the past few years. The strategic priorities put in place resulted in a strong year and enable us to manage well through a more challenging retail landscape in the fourth quarter.

As I reflect that, there were a number of highlights across the business in 2015. The American Eagle team made significant improvement to the merchandize with upgraded quality, compelling styles and innovation. AE continued to lead the market overall bottoms, including jeans. We took our iconic denim collection and made it even better. We also saw a good response across the number of categories. As a result we achieved higher average selling prices and stronger margins.

The Aerie brand really took off in 2015 exceeding our expectations, congratulations to the team for a record year and strong profitability. Aerie's well assorted collection and innovative Aerie Real campaign are distinguishing the brand in the market place. We continue to see traffic increases both online and in-stores as well as we have consistently gained new customers. Across brands the direct business increased over 20% driving more than $110 million of sales growth. Our investments in technology upgrades and omni tools are delivering.

Ship from store contributed about 20% of the digital business in the fourth quarter, much of which was incremental. The team's execution has been terrific. We seamlessly processed record volumes during peak shopping periods and shipped all orders from our distribution center within 24 hours. Approximately 90% of those orders were received by customers within three days. We will continue to maximize our digital business and improve the customer experience.

In 2015, we were thrilled to add Tailgate and Todd Snyder to our portfolio. The acquisition delivers long-term wins for AEO, including Todd's strong creative vision and talent as well as exciting new growth vehicles.

On the financial side we managed the business well. Operating costs and inventories were well controlled. We leveraged expense and delivered higher merchandize margins. We ended the year in excellent financial condition with $260 million in cash and no debt. We also invested $153 million of capital into the business and returned cash to the shareholders. In 2015 we repurchased 15.6 million shares for $227 million and paid out $97 million in dividends. Since 2010 we've returned over $1.6 billion to shareholders in the form of dividends and buybacks.

While Mary will go through the details of the fourth quarter, we achieved a solid performance in a challenging macro landscape. In the quarter we faced choppy mall traffic, unseasonably weather and a highly competitive retail climate. This prevented us from significantly reducing promotions late in the quarter. Yet we managed the business well achieving 4% growth -- comp growth and EPS of $0.42, up 17% to last year.

We are highly focused on moving our priorities forward in 2016. We're optimistic about the future and have many opportunities. Yet we continue to face macro challenges. Our near term priorities are aimed at addressing these issues head on.

Starting with products, in today's highly competitive market it's absolutely critical to offer our customer something special and new throughout the year. We are committed to maintaining a leadership position in product, continuously delivering compelling, innovative collections. Next, customer acquisition is a top priority in 2016. We must do a better job bringing new customers to our brands.

To that end AE will launch a new marketing campaign designed to strengthen engagement, create a stronger emotional connection and build its global brand presence. As more and more of our tech driven customers fuel our online business we will prioritize site optimization and mobile capacities -- capabilities. We aim to create the absolute best shopping experience for our customers. For the American Eagle brand will focus on the store fleet, identifying opportunities to consolidate locations.

We will fuel growth for the Aerie brand. Our priority is just to continue to expand Aerie's digital business, open additional side-by-side locations and new freestanding stores. Lastly we will continue to strive for operational excellence across our organizations.

To conclude I'm extremely optimistic about the future. We have strong brands and outstanding talent. I look forward to another great year. Thanks, and now I'll turn the call over to Chad.

Chad Kessler

Thanks, Jay. The American Eagle brand had an excellent year posting a 7% increase in comparable sales and higher profitability. Our vision and priorities entering the year were on target. Greater quality and value combined with innovation in fabrics and styles infused across the collections struck a positive chord with the customers. Congratulations and thanks to the team for delivering an outstanding year. The fourth quarter marked our fifth consecutive quarter of year-over-year sales and earnings growth. We managed well through headwinds, including mall traffic and unseasonable weather.

Our collections were well received and we outpaced much of the specialty apparel market. We delivered a positive free comp with both genders up to last year. Women's continues to show solid growth led by denim, woven and knit tops, dresses and pants. Men's saw strength across denim, pants, knit tops and shirts. Merchandize margins increased over the last year, driven by improved product costs, more full priced sales and reductions in mark downs. During the quarter we were able to reduce all store promotions by a few days compared to last year. Our digital business was terrific with a strong increase in traffic and a higher basket size.

Looking ahead we're focused on fueling momentum and broadening AE's appeal. We aim to be the linen casual apparel destination. Specifically we will focus on the following. First, driving ongoing product innovation. We will raise the bar across more categories. Our results to-date have been highly affected with broad based strength across categories. So, as far as this brand we are seeing product momentum continue even as we lap improvements from last year. We see plenty of additional opportunities to add more to the merchandize, elevating style, offering great value while ensuring quality. With the product improvements and strong inventory controls, we expect to see AUR growth this year. We're also putting a greater emphasis on outfitting and looking for add on product expansion.

Second, from a position of product strength and leadership we look to broaden the appeal of our brand. We are reengineering our marketing to strengthen brand messaging and build a reputation for quality, style and innovation. Together with an external agency we are planning to launch a comprehensive campaign this fall. Third, as we broaden the scope of our customer base, international expansion is a priority. We have extraordinary potential to grow the AE brand over the next several years leading with digital. Fourth, we're excited to open a second Tailgate college store this spring which will also feature AE jeans. And hopefully you saw Todd's show stopping end to New York Fashion Week several weeks ago. We look forward to the incredible potential Todd and team bring to AEO.

Last, although it's still early in the quarter we've seen very good results in our spring business, with strength across a number of categories. We expect to deliver growth over a terrific first quarter last year and we'll continue to drive positive trends and build on our success.

Thanks. And now I'll turn it over to Jen.

Jen Foyle

Thanks, Chad and good afternoon, everyone. I am excited to be here to talk about another strong quarter as we complete a fantastic year for Aerie. In 2015, we delivered double digit comps in all four quarters and our results were robust as the year progressed. The team did a great job improving our collections in seasonal stores over the course of the year. Profitability expanded compared to last year and we continue to benefit from scaling up the business while increasing productivity.

During the quarter comparable sales rose 26% marking our seventh consecutive period for positive comps and earnings growth. We saw strong online traffic and consistent growth in our digital business with sales increasing over 40% in the fourth quarter. I am also extremely pleased to see positive store traffic which clearly outpaced the mall. We grew our active customer base by over 12% for the year as a result of great product, fresh marketing and broader digital and storage.

Our fourth quarter holiday collections were well received by our customers. We saw positive comps nearly in all categories. Our major businesses including bras, undies and apparel increased by over 30% and new offerings such as bralettes, swim and sleep drove incremental business. As we enter spring I feel really good about our assortment. Our spring trends line performed extremely well in January and that momentum has continued into first quarter.

Now looking at the year ahead, I'd like to talk through our key focuses. From a product perspective we will continue to drive innovation and enhance our quality and design to maintain momentum. We will further develop novelty businesses and expand offerings to include new categories as well as additional sizes and broader online assortments. Financially, we will aim to further strengthen our margins. We will take advantage of cotton and product cost opportunities, reduce markdowns and implement a more strategic approach to fabric and chase capabilities.

Next, digital and store growth are key to brand expansion and new customer acquisition. We see ongoing growth as we ramp our digital marketing and broaden online offering and more be proactive in our customer outreach. Selective store growth is also a key. The financials of the new store format are very, very compelling. Based on the success, we plan to open 10 standalones and 25 side by side in new and underpenetrated markets.

Marketing is also a major priority as we engage our customers in a unique way. The Aerie Real campaign is a point of differentiation and has created a strong connection with young women. With growing increased, and increased customer engagements, media impressions specifically on the Aerie Real campaign rose to 4 billion in 2015, up dramatically from last year. We put the real concept at the center of everything we do. We will continue to build on this message such as our current strong Beautiful Me campaign.

Now before, I hand it over to Mary, I'd like to once again congratulate and thank my team for delivering a fabulous year. I am thrilled with our execution and I'm excited about the many opportunities ahead of us. Thanks.

And now, I'll turn it over to Mary.

Mary Boland

Thanks, Jen, and good afternoon, everyone. In what proved to be a challenging holiday season, I am pleased that we were able to deliver a solid fourth quarter financial performance. Although we did not reduce our promotional activity as much as we had hoped to, markdowns still improved and we drove a stronger top line. The top line was fueled by the strength of our direct business and positive comps for both brands.

Now looking at the details of the quarter; total net revenues increased 3% to $1.1 billion. Consolidated comparable sales increased 4%. By brand, AE comps were up 3% and Aerie increased 26%. On a consolidated basis, traffic increased in the quarter. The average transaction value was up in the mid single digits driven by a low single digit increase in the average unit retail price and higher units per transaction. The strength in our AUR was driven by less markdowns and a favorable sales mix. Additional sales information can be found on Page 8 of the presentation.

Total gross profit increased 3% to $388 million. The gross margin remained flat to last year at a rate of 35.1%. A slight reduction in markdowns, favorable product costs and lower rent expenses were offset by higher incentive costs. Delivery expenses related to a strong direct business also increased. As a rate to revenue, SG&A leveraged 10 basis points to 21.1%. SG&A dollars increased 3% to $233 million and stock costs and planned investments in digital marketing were offset by a one-time gain on the sale of the previously closed Warrendale distribution center.

Depreciation and amortization increased to $39 million and we leveraged 10 basis points to 3.5% as a rate of revenue. Operating income rose 3% to $116 million from $112 million last year and the operating margin remained flat to last year at 10.5%. The tax rate was 27.9% in the quarter as a result of income tax settlements, higher federal tax credits and tax strategies. Fourth quarter EPS of $0.42 increased 17% from the $0.36 last year.

Now I'd like to spend a few minutes reviewing the year. Our performance in 2015 was exceptionally strong as we executed on our key priorities and ran a much healthier business. Revenue increased 7% to $3.5 billion, AE brand comps rose 7% and Aerie comps were up 20%. Gross profit increased 13% to $1.3 billion and the gross margin leveraged 180 basis points to 37%. This was primarily due to lower markdowns and rent leverage partially offset by higher incentive costs.

Selling, general and administrative expense increased 3% and leveraged 90 basis points to 23.7% as a rate to revenue. We managed expenses well throughout the year which offset higher incentive costs related to strong sales and margin performance. Operating income increased 55% to $320 million and the operating margin increased 280 basis points to 9.1%. EPS of a $1.09 increased 73% from EPS of $0.63 last year. For additional information please refer to Page 6.

Now turning to the balance sheet, starting with inventories, which can be found on Page 11 of the presentation. We ended the quarter with inventory at cost of 9% consistent with our expectations and guidance. The increase is primarily due to earlier receipts as we lapped the delays from last year's fourth quarter slowdown. Our inventories were well positioned with clearance units down in the high single digits.

For 2016 we remain committed to growing inventory at a slower rate than sales and expect to end the first quarter with inventory at cost, down in the low single digits. We ended the year with $250 million in cash and investments compared to $411 million last year. The decline was due to the $227 million investment in share repurchases. Of that 14.6 million shares were repurchased during the fourth quarter for a total cost of $212 million. Capital expenditures totaled $153 million for the year. For 2016 we expect CapEx to be in the range of $160 million to $170 million. This includes Aerie and international store growth, enhancements to our digital and omni tools, IT projects and investments in new concepts as we test and scale Tailgate and Todd Snyder.

2015 store openings were focused on new factory stores, Aerie and international location. We also prioritized international licensed stores ending the year with 141 locations across 22 countries. For the year we closed 21 AE and five O format Aerie standalone locations. Since the beginning of fiscal 2014 the company have closed 102 stores and we expect to meet our goal of closing 150 stores by the end of fiscal 2016. Supplementary store information can be found on Pages 14 through 16.

Now, our first quarter outlook; based on mid single digit increase in comparable sales, we expect first quarter EPS of $0.17 to $0.19. Guidance compares to EPS of $0.15 last year and excludes potential impairments and restructuring charges. Regarding the year we expect comparable sales to increase at least in the low single digits as a result of our merchandizing and brand initiatives discussed today. Our average unit retails are expected to increase primarily due to mix and improved product innovations and we will of course continue to work on reducing markdown. We expect our investments in digital to drive further growth in the online channel.

In 2016 we will optimize our omni tools to extract further benefits to the business. We expect lower product costs throughout the year reflecting a favorable external environment and internal sourcing initiative. As Jay indicated, we will look for opportunities to close additional stores through market consolidation and as always we will focus on inventory efficiency and look for further expense savings.

In sum, although we continue to operate in a challenging sector we are confident we will be able to comp strong results from last year. Thanks, and now we'll take your questions.

Question-and-Answer Session


Thank you. At this time we'll be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from Brian Tunick from Royal Bank of Canada.

Brian Tunick

I guess the question for you Mary on the components of gross margin versus your original expectations, can you maybe just breakout for us what was going on there? How much was compensation? How much was from the digital exceeding your plan? And then maybe Chad can talk about what are one or two specific categories that he thinks he can bring some of the flex or some of the AUR opportunities to in the near term? And then finally just a follow-up on the tax rate maybe can Mary give some color there, what happened versus your plan and how should we think about the tax rate for 2016?

Mary Boland

Okay. In terms of the components of gross margin, they were a multitude of puts and takes across pretty much the whole lines of the P&L throughout the fourth quarter. As I said earlier, our gross margin rate was flat to last year. We did see higher markdowns especially in the month of January as the fourth quarter was very choppy and that was one of the big differences from where we start or where we thought we would be when we start the quarter. We also saw some nice -- some improvement in our IMU and some leverage on our rent as well too, but the higher incentive costs clearly impacted the overall gross margin for the quarter.

Chad Kessler

Brian, it's Chad. In terms of your question on flex and driving innovation, I think that we've already seen some examples where we've already expanded flex. We have flex technology now in some of our managed fleet as well as in our men's underwear and we're one of the leading underwear providers in the sector. But I think when we talked about AUR improvement, innovations like flex I think is one way that we can do that, but really it comes down to innovation in creating value for the customers. So it we can be -- we found success in growing AUR whether it's through flex or Denim X but also in other fabrics where we lead like Soft & Sexy, or [Enhanceio] or generally overall quality and on-trend appearance to the garment. So as I look across the categories, I really believe we have an opportunity to add greater value to the product and therefore grow AUR across most of the categories within the assortment.

Mary Boland

And then Brian to answer your question on the tax rate, the Q4 was impacted by some tax settlements as well as work we've been doing internally on some tax strategies. But as we look -- more importantly as we look forward to 2016, we expect to be back to a more normalized tax rate in that 36% to 37%.


Thank you. Our next question comes from Oliver Chen from Cowen and Company.

Courtney Willson

Hi, guys it's Courtney in for Oliver today, thanks for taking our question. We're just wondering how we should think about any share buyback cadence throughout 2016?

Mary Boland

We did buy back our stock here in the fourth quarter of the year. We saw an opportunity that made sense for us to do that. We'll ask for new authorization from our Board here coming up shortly and we'll evaluate share repurchases as the year goes on. Again our first priority is to absolutely invest in the business and make sure we're positioning ourselves for growth and we'll look at buy back opportunistically throughout the year.


Thank you. Our next question comes from Lorraine Hutchinson from Bank of America.

Lorraine Hutchinson

I just wanted to get your thoughts on how we should be thinking about gross margin going forward. With the fourth quarter results below your plan because of these January markdowns and then what kind of opportunities do you see from here?

Mary Boland

Yes. Definitely the fourth quarter was impacted by the higher markdowns but as I look forward into 2016 -- into Q1 of 2016, we expect to see a growth in our gross margin rate somewhere in that 100 to 150 basis points of improvement. So we'll get back to kind of where we were the first part -- the first there quarters of last year seeing some nice growth quarter-after-quarter, year-on-year. So we expect to see some growth here in Q1.

Lorraine Hutchinson

And you think that 100 to 150 can continue throughout the rest of the year?

Mary Boland

We're not giving guidance but for the rest of the year, but that's our goal here to continue to drive gross margin improvement.


Thank you. Our next question comes from Jeff Van Sinderen from B. Riley & Company.

Jeff Van Sinderen

Actually was just -- maybe you can speak a little bit about Roger Markfield's recent transition to a consulting role. Just wondering, if there are any shifting of responsibilities there and then maybe just touch on -- I know Roger built a strong team, but is there anything different this time I guess in his sort of diminishing role? And then also maybe you can just touch on, remind us of the potential of Aerie to rollout more units and speak more about the strategy and plans to grow that segment for 2016? Thanks.

Jay Schottenstein

Okay. First of all Roger is like two years older than last time. What we did was a year ago, we knew Roger was going to retire actually, that his contract was written and at that time we had Chad and Jen assume their President roles. So, this time the big difference is when Roger retires, Jen and Chad have already had a year in that position as a President. Meanwhile they've been here for like -- as far as Jen has been here for what eight, nine, 10 years, Jen.

Jen Foyle

Five years. Eight is this what you think guys?

Jay Schottenstein

It feels longer. But they've already stepped into their roles. That when in the past when Roger would retire some of us stepping up to that position will be brand new. They've had the experience for last 12 months being in that position. Second, Roger is on a consulting agreement with us. He's under contract and he's available for Jen and Chad at any time and for myself too.

Jen Foyle

And for the Aerie growth yes, I think the core of what's happening here in Aerie is really this marketing campaign that's really starting to take hold, the Aerie Real campaign is still authentic and it's really resonating with this young women today. So starting from there and then we've tested four smaller store formats that are highly successful. We're really pleased with the productivity we're seeing and we're comping in smaller square footages in [some] malls. And the productivity is up roughly 50% in those formats. So, we're excited to grow a smaller footprint and of course growing the side-by-side we've seen really nice results as we attach ourselves to the AE Box as well leveraging the operations and their customer base, so that's been fabulous. And then the digital growth, that has been really something that's really unlocked the growth for this brand right now. Speaking to the customer with the Aerie Real campaign, touching all the social points and engaging with her is driving traffic to the site and we've seen really nice results with that. And certainly as AE grows internationally we will jump on the bandwagon, where we can and open up in-stores primarily in the AE Box.


Thank you. Our next question comes from Janet Kloppenburg from JJK Research.

Janet Kloppenburg

I was wondering, if Chad you could contrast the guidance for gross margins for the year to what happened in the fourth quarter? Was it just weather and regular holiday heightened promotion or was there some merchandizing misstep that took place that you've corrected quickly? I think that would be interesting for us all to understand. And I was also wondering, if you could give us some highlights on the fashion direction that is motivating the strong comps here in the first quarter? And Jen just if you could highlight new product categories that you are introducing in Aerie that could help your comp momentum to be sustained? Thanks.

Chad Kessler

Janet it's Chad. I think when we look to Q4, we have been doing a lot of hindsight around what happened. I think that there were a lot of macro headwinds that impacted us we said, I think weather was a big factor. I think the highly promotional environment during the quarter I think is really -- has become a challenge. And the way we're doing that -- so I think that there were some categories that were impacted by the weather, but I wouldn’t say that broadly we had merchandizing issues that were -- that caused a little bit less momentum in the quarter than we've seen in the rest of the year. We're really feeling that Q4 was an anomaly. We've seen -- we're really happy with the results in Q1 so far, it's still early days. But back to Q4 I think we've been doing a lot of hindsight and we've plans for next year to try to make sure that we can -- expecting another challenging promotional environment, we want to make sure we can maximize the quarter, Q4 of 2016 and we're already taking steps to make sure that will happen.

Janet Kloppenburg

So, you think that you'll be able to be less promotional in the first quarter, Chad than you were in the fourth quarter and perhaps versus last year?

Chad Kessler

I think as we begin to lap year-over-year our field promotions, I think the decrease in promotions will seem less dramatic than it's been. But we do continue to plan -- continue to plan to be less promotional and to spend fewer markdowns than prior year, as part of that would be through we continuously focus on inventory control, part of that'll be I think we're continuing to see more on target merchandize. We -- as always we're leading with our world class bottoms assortment and receptivity to that so far in the quarter has been very strong. So, I think it is our goal to reduce markdowns and promotional activity, but I don't think you'll see the same sort of rate decrease that we saw last year.

Jen Foyle

And for Aerie, we launched a new [fit] category in January and saw really nice results, so we'll continue to scale that. Particularly online, we loved what we saw there in January, was a great launch and novelty bralettes, that's been a huge category for us. It's been incremental. But we think that there is expansion in all categories in bras because its incremental which we love. So we will continue to look for technology similar to what AE does. I just got out of the spring kick off meeting where we have a lot of great ideas in the hopper that we are really excited about and I look forward to next year already, because we have to continually comp year-over-year. Beauty is another idea that we are getting behind. We are dabbling in it only right now but we made some strategic hires to start to really think about that category and how aerie would address it. And we also are looking for new opportunities. Lounge has been extremely well too, our soft dressing categories and we will continue to expand that.


Our next question comes from Paul Lejuez from Citigroup.

Paul Lejuez

You mentioned the aerie customer base I think was up 12%, do you have the same metrics for the American Eagle brand? And then just curious about how we should think about AUR growth throughout the year as you try take AURs up a little bit. Is that more of a second half opportunity versus the first half, and if you could maybe just discuss the progression there? Thanks.

Mary Boland

Yes. I will start with the AUR. I think the work that Chad and Jan have done on innovation and finding the right value and proposition with our customer will continue to help us see some growth in AUR, probably kind of low single digits in that kind of range. As Chad mentioned, our opportunity for a reduction of markdowns becomes less and less, although I still think there is some efficiency to be had in markdowns. But we do see an opportunity to improve AUR as we pace through 2016.

Chad Kessler

In terms of the customer file for AE, we actually saw a decline in the customer file in the single digits to the year prior. I think part of that is we're seeing that the business is still growing, part of that is customers who are finding -- most customers are responding to the value we're putting in the product and I think some customers are leaving the file as the AUR has increased slightly. However that said, part of our real focus on having this marketing campaign and working with external agency is a determination to get that file back to growth. So I think we have an opportunity to add new to file, also to retain customers in the file as we go forward.

Paul Lejuez

Did you say it was low single digits or single digits?

Chad Kessler

Single digits.

Paul Lejuez

So down more than now or can you give us any more specific there?

Chad Kessler

No. We are not going to be more specific.


Thank you. Our next question comes from Dorothy Lakner from Topeka Capital Markets.

Dorothy Lakner

Congratulations on a nice finish to a great year. I wondered if you could talk a little bit more about just where you think you see opportunities in product both for the AE brand and the Aerie brand? Just where do you think the most opportunity is this year? And also just on the men's side talk a little bit about how Todd Snyder is helping you raise the bar in the men's side of the business? Thanks.

Chad Kessler

Well I think in there for products, believe it or not I still believe we have a ton of opportunity in bottom. We're best-in-class, I think bester than beyond class in what we do in bottoms and I think as people continue to gain that message, we continue to see growth and momentum there. I think we still have opportunities, big opportunity across the fashion categories of women's tops and dresses. We've seen strong reception there over the last year and into this first quarter. And I think in men's we have gotten -- we're transitioning the assortments there. I think we've had good success as we said in knits and woven. I think what Todd brings is a fresh perspective and clearly the greater vision of a world class men's designer. He is helping the men's assortment in terms of from a conceptual point of view and really helping to provide some creative vision for the brand and I think that will expand us as we go through the year. And he is also helping to work on some of the marketing campaigns, just how we're looking at the brand in total. So it's been fantastic to have him as a partner and on the team and I look forward to what he'll contribute.

Jen Foyle

And I think for Aerie just slightly repeating what I said before, we really just want to increase our AUR. We want to grow our business and innovate the product along with that. So as we continue to innovate we believe that we have new opportunities in all of our product categories and that’s really our approach.


Our next question comes from Neely Tamminga from Piper Jaffray.

Neely Tamminga

Just wondering if you guys could help us about a little bit more on the mobile initiatives, some more details maybe timing of deployment? Are the friction points that you guys are solving this year more around consumer navigation and conversion or is it really kind of deploying some of that omni-channel apps more in-house to improve the flow of inventory? And just a housekeeping question, what are you expecting for D&A given all of this investment in IT for 2016? Thanks.

Michael Rempell

Neely, it's Michael Rempell, I'll take your question on mobile. We had very nice growth last year in mobile. Like many other retailers, we're starting to see more than half our traffic come through mobile and our sales increased last year almost a 100% on mobile. What I'm really excited about though is we're in the process of launching our new mobile responsive site, which is the website designed for mobile devices first and it's still early, it's going to be done by the end of this quarter. But we're seeing very nice results including a nice increase in conversion for customers who're coming to us through mobile devices. So, I imagine we will have more to say on the second quarter call, but we've lots of good momentum there. The other thing we did last year was really enhanced our native mobile apps, those AE and Aerie apps that run on Apple devices and Android devices and saw incredible growth. So, these -- the apps have been very well received by customers, they're highly rated, they're winning awards, and the team has done a great job enhancing them.

Mary Boland

And then in terms of depreciation for the year, we will probably take sort of around $40 million a quarter, for the year.


Our next question comes from Lindsay Drucker Mann from Goldman Sachs.

Lindsay Drucker Mann

I had two questions, first of all you talked about international as an important initiative for 2016, I was wondering if you could give any more detail on store strategy, your franchising strategy, new e-commerce platforms, that's how you're looking to drive that business and some other strategic investments you're making? And then secondly, Michael maybe you could give a bit more detail on the AUC outlook for this year as it compares to fourth quarter of '15? Thanks.

Jen Foyle

I'll take the store and e-commerce question. So we look to continue to grow in a three pronged approach, owned and operated stores, probably primarily focused in Mexico with a handful of stores elsewhere around the world. We are also focusing on our digital channel as well to -- we launched our U.K. site here, the fall of last year. We expect to move that outside the U.K. as later in the year and continue to look at opportunities to launch the site in other European countries here as well. And of course we have continued to look at our franchise opportunities around the world. I think the team has done an amazing job of building that business here over quite a few years and we'll continue to look for those opportunities.

Michael Rempell

And on the sourcing side Lindsay the team has done a great job, taking advantage of what's happening in the marketplace today. So, weak demand, the strong currency that we have and relatively inexpensive raw materials have helped us pretty significantly improve our costs. Mary alluded to the IMU increases that we're seeing but we expect that it'll be a 100 to a 150 basis points in the first half of the year and it's a little early to tell but I would imagine it's something like a 100 basis points of IMU improvements in the back half of the year. And that -- all that being said, our number one priority is investing into the product, so driving the innovation, the quality, the, the [washes], et cetera that Chad was talking about before. So, we feel like we're getting the best of both worlds. We're getting better costing and we're significantly upgrading product as we go.


Our next question comes from Betty Chen from Mizuho Securities.

Betty Chen

I was wondering if you can talk a little bit, Mary about, it looks like for the first quarter the implied SG&A is for some decent leverage there. Can you talk about some of the puts and takes in SG&A for first quarter for interpreting that correctly and how that may continue for the balance of the year? And then housekeeping, given the share buyback activity in Q4 what's the proper share count that we should be using? Thanks.

Mary Boland

In terms of SG&A for Q1, from a dollar perspective we expect it to be up a bit from Q1 of last year, but we certainly are targeting to leverage SG&A. And I would say that's our philosophy for the balance of the year is to continue to leverage SG&A. Work hard on expense reductions to help offset any growth in our fixed expense and manage through the variable piece of that. In terms of outstanding shares for the year it's about 184 million shares.


Our next question comes from John Morris from BMO Capital.

John Morris

Mary, a quick follow-up on that. I was just thinking about that, I mean on the SG&A question, the marketing spend for -- the marketing spends, maybe give us a little bit of color for how that's going to compare for next year versus last year? Whether or not we should be taking into account any kind of cadence given I guess the launch of this campaign in the fall, is there a particular quarter where we might see a little bit more of an impact? And maybe talk a bit about I guess where that marketing --what kind of mediums or media will we be looking at, is it really primarily social marketing, I guess this is probably in-store and social marketing primarily, what's kind of the execution there look like?

Jen Foyle

Yes. In terms of marketing spend, it will up versus last year and there is really truly two components of that. One is what we call our performance marketing in the digital space that is driving a nice return to our business and you'll see that increase pretty much over every quarter of the year. We saw good results of that last year so we're continuing to fuel that fire with dollar investments. In term of the campaign, it is definitely the back half of the year to really to provide much detail on that as the team is still working through it.

John Morris

And just a follow-up, when we're talking, you're talking about testing and scaling Tailgate and Todd Snyder over the course of the year, can you give us a little bit more color to elaborate on what we mean by scaling, what should we expect to see?

Jen Foyle

For 2016, I mean the impact of both brands is really not material. As Chad mentioned, we opened up a second Tailgate store here recently. We will look to do perhaps a handful of stores this year depending on the real estate availability. But I think what's most important here is that we do test and scale and we learned a lot from the first handful of stores that we opened. And we'll make any adjustments or corrections based on what we learned and it still means that we see really good results which we're confident we will. We'll put fuel on that fire as we go into next year.


Our next question comes from Adrienne Yih from Wolfe Research.

Adrienne Yih

Congrats on the momentum heading into the first quarter. I was wondering if could talk about Chad, if you could talk about the reception to the spring transition flows which sounds positive? And then for Mary, can just give us any color on what your plans are for any minimum wage increase, any pressure that you're feeling there? And of the 100 to 150 basis point expansion, how much of that should we expect to come from lower AUC versus higher AUR? Thank you very much.

Chad Kessler

So I don't want to go into too many specifics on Q1 other than just to say as I said a little earlier, it really feels like Q4 is a bit of an anomaly. It feels like we're back with momentum we had through most of 2015 in terms of the product and the reception. We continue to see that bottoms are just dominant within the market place and nice momentum there. And I think we're seeing growth in men's and women's and nice sales right across tops and other fashion categories. So far it's been a broader base acceptance to the assortment, is what I would say and we're pretty excited about how the business is going. Easter is a couple of weeks away but we're pretty excited so far.

Mary Boland

On the minimum wage increase, obviously we're seeing pressure like everybody else on that front. What I would say though, the teams are doing a pretty nice job of trying to find productivity opportunities to mitigate some of that increase. So at this point it doesn't appear to be horribly material this year but we'll keep you posted as the year moves on. And then in terms of gross margin without getting into the detail, it's probably more AUC driven than AUR driven. We do see opportunity in AUR, as I mentioned earlier, but I think the clear opportunity for 2016 is around AUC.


Thank you. Our next question comes from Simeon Siegel from Nomura Securities.

Simeon Siegel

Can you talk about the factory channel, the comp declines have leveled off there so how is the profitability and the productivity versus the full price at this point? And then just Mary, kind of giving the moving pieces, any color on just what the merch margin expectation should be for the year? And then just lastly a quick clarification, the Q4 onetime gain from the Warrendale DC sale, just how much that was? Thanks.

Mary Boland

Okay in terms of the factory channel, we're seeing a nice improvement there in the comps of the factory channel. Profitability is still good in the factory channel and productivity and it is above the mainline channel productivity and profitability, so still seeing a nice spread between the two. I think the 2016 merch margin question, I'll just answer that from a gross margin perspective. We expect to see continued improvement in gross margin as the year progresses, Q1, 100 to 150 basis points improvement and we expect to see improvement as the year goes on. The onetime gain from the Warrendale DC sale was about $9 million. What I would say though that if you look at the year in total, 2015, with all the transition costs between the old DCs, the new DCs, depreciation, et cetera, et cetera, the net impact for the year, is something more like $3 million. So, lots of transition that happened last year between the two DCs.


Our next question comes from Kimberly Greenberger from Morgan Stanley.

Kimberly Greenberger

I just wanted to ask two questions if I could. I'm not quite getting the comp metrics to add up to the total comp, I think you said traffic was positive, maybe perhaps conversion was negative, but if you could just reconcile how to get to the four comps with the different comp metrics, that'd be super helpful? And then I wanted to just ask about the gross margin, I know that at the beginning of Q4 the 150 basis points increase for Q4 looked very much within reason. it ended up not working out like that and so I'm wondering, what is it about the first quarter or the rest of 2016 gives you confidence that you can hit that 100 to 150 basis points, targeted increase? Thank you so much.

Mary Boland

So, for Q4, I think the story here is we did see an improvement in conversion but obviously traffic, traffic was a bit challenged here in Q4. So I think that might be the piece of reconcilement for you. In terms of gross margins and the confidence around gross margin here in Q1 versus Q4, as Chad said earlier, it really does feel like Q4 was a bit of an anomaly with the external factors that happened and the later shopping and our flow through here in January. As I look at Q1, the guidance of gross margin up 100 to 150 basis points, we do see AUR improvement. We do more importantly see improvement in our IMU, we are really starting to see that flow through and we'll see that as the year progresses as well too. So it gives us confidence that we should to be able to post a nice improvement in gross margin here quarter-after-quarter.

Judy Meehan

We have time for one more question, please.


Thank you. Our last question comes from Anna Andreeva from Oppenheimer.

Anna Andreeva

I guess I was hoping we could talk about some of the ticket increases that you're seeing in the spring product thus far versus last year and what kind of elasticity have you seen in terms of price? And a follow-up just on the gross margin guidance, for 1Q as well, just curious what kind of a promotional environment you guys are embedding either in near term or as we go through the year and any changes you're seeing in the competitive steps? Thanks.

Chad Kessler

I think in terms of ticket pricing and AUR increases that we're seeing in Q1, I don't think we're seeing any resistance at this point. It's really -- it's all driven primarily by either innovation that, flex shorts and men's continue the rollout of flex in denim and far expanded assortment of Denim X and women's shorts. Other categories like dresses we have better fabric, better fashion. The customer is recognizing all of this as a good value for her, for him and I don't think we're seeing -- I don't think it's a headwind or a challenging -- the reception to the product. In terms of promotional cadence, as I said earlier it is our goal to be less promotional in Q1 than a year previously and that's how our plans fit today and that's how the momentum we're seeing in the business is consistent with that so far. So, I think that we'll be able to do that. It does seem like from the mall environment, it does seem like some others are starting to be or attempting to be a little less promotional as well, which I think it can only be a win for us. So, I feel optimistic that with the product that we have, with the reception we're seeing so far and with the already less promotional stance we've taken that it looks good.

Judy Meehan

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


Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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