American Eagle Outfitters Inc
NYSE:AEO
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American Eagle Outfitters Inc
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Greetings, and welcome to the American Eagle Outfitters Second Quarter 2021 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ms. Judy Meehan. Thank you, ma'am. Please go ahead.
Good morning, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Executive Chairman and Chief Executive Officer; Jen Foyle, President, Executive Creative Director for AE and Aerie; Michael Rempell, Chief Operating Officer; and Mike Mathias, Chief Financial 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. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
Also, please note that during this call and in the accompanying press release, certain financial metrics are presented on both a GAAP and non-GAAP adjusted basis. Reconciliations of adjusted results to the GAAP results are available in the tables attached to the earnings release, which is posted on our corporate website at aeo-inc.com in the Investor Relations section. Here, you can also find the second quarter investor presentation. As a note, our second quarter fiscal 2021 results are primarily compared to the second quarter of fiscal 2020, with comparisons to second quarter fiscal 2019 included were applicable.
And now, I will turn the call over to Jay.
Thank you, Judy and good morning everyone. I am very proud to announce a record second quarter, fueled by strong customer demand for our products and brands. Financial results exceeded our expectations. Revenue increased 35% over last year. On a comparable basis, revenue increased 19% to 2019. Sales of $1.2 billion and profits of $168 million were the highest in our history.
With our renewed focus entering this year, we are running the business better than ever across the board. As I said in January, we have the best talent in the industry, and these results are clear evidence of that. So I'd like to start by thanking the entire AEO family for this significant accomplishment. Their passion, talent and commitment are taking our brand and company to new heights.
As I also said at our January Investor Meeting, we are on offence emerging from 2020 with strength and focus. Our Real Power Real Growth plan is our guiding light. I'm very pleased that we are making swift progress on our pillars, putting us ahead of schedule on our financial targets. Today the team will take you through the details of our performance, but I'd like to start with a few highlights.
Aerie just continues to deliver exceptional multiyear growth. As a brand new scaling, we are seeing significant profits flow through. This quarter was one more proof point of the excitement behind this brand. I couldn't be more optimistic about the potential ahead as we make our way to the next billion dollars in revenue.
American Eagle is simply proving to be a powerful brand we always knew it was. Its dominant market position, combined with a fresh focus on inventory management have resulted in the best margins and profits in years. Under Jen's leadership, the energized product and marketing are yielding results and the timing couldn't be better.
As a number one jeans brand, we are well-positioned to capitalize on strong demand fueled by emerging trends. Across channels, stores and digitals are firing on all cylinders and driving meaningful profitability. Our multiyear investment to improve our customer shopping experience and enhance our supply chain are delivering strong returns. We are gaining new customers and the relaunch of our loyalty program has been a success.
Across operations, we are creating efficiencies, increasing our speed and agility. The supply chain deliver great results even in the face of headwinds. While we made great progress, we're just hitting our stride. I see so much opportunity for us to generate incremental value moving forward.
Our focus on ROI is also evident in the second quarter. We drove incredible margin recovery and cash flow. Our balance sheet is healthy, and we're operating from a position of financial strength. I'm pleased that in June we raised our quarterly cash dividend by 31%, reflecting our confidence in the strength and sustainability of future cash flow.
Everything we do at AEO is done with purpose. We run our day-to-day business in keeping with our values to build a better world. To that end, we're making great progress on creating more sustainable products. This year, we have more than double the number of our most sustainable real good styles across all merchandise categories. Wider energy reduction and responsible sourcing remains top priorities.
I'm extremely pleased by recent recognition from step -- antisemitism.org for a dedication to combat racism by creating an inclusive and diverse corporate culture. This is something we strive for every day through innovative associate programs designed to build a collaborative environment. This spring we helped raise over $1.7 million for important causes including Bring Change to Mind and It Gets Better. Two organizations are making impact to Uplift use [indiscernible] and support mental health.
I am really proud of all the work we are doing to strengthen the launching within our company and our communities. AEO's top talent is a keystone of our great company. Last month, AEO was named the Fast Company's Best Places to Work for Innovators, a distinction that recognizes our deep commitment to encouraging innovation across the organization.
As the pandemic continues, our top priority is to keep our people safe. Our leading health and safety measures remain in place across all facilities. We’ve consistent communication support and education for our associates and strongly encourage vaccinations. Before I turn to Jen, I want to reiterate how pleased I am with our performance year-to-date and how excited I am for what's to come. We continue to execute well across all areas of the company.
Although the current operating environment is presenting challenges from the ongoing pandemic to supply chain disruption, there's a lot within our control, I am very pleased with current business trends. We continue to see strong demand for our brands, the macro backdrop is favorable, consumers are spending and new fashion trends are a positive.
We're focused on leveraging the agility we gained last year, and the strength of our capabilities deliver to our customers and post a strong second half. With all this in mind and confidence in our ability to achieve operating income of $600 million this year.
With that, I'll turn the call over to Jen.
Thank you, Jay, and good morning. Wow! what a great quarter. Aerie and AE are two of the biggest brands in the market and are delivering truly exceptional results. We are making incredible progress towards the goals we laid out in January, in fact, well ahead of my expectations. We are attracting new customers and they are spending more than ever. And I'm happy to see those trends carry into the third quarter.
Let me start with Aerie. Our leading brand platform combined with product that continues to delight and excite our customers is delivering strong consistent performance. Revenue in the second quarter rose 34% on top of 32% growth last year. I'm proud to say this marked our 27th consecutive quarter of double-digit growth.
Sales metrics were very healthy. Strong demand led to significantly higher full price sales and we strategically removed promotions. We are also mixing into higher ticket with higher margin items. I'm pleased to report broad based strength across all product categories, which were all up in the double digits. Core intimate, Bralettes and apparel and swimwear saw strong demand.
We continue to gain meaningful market share in swimwear as Aerie is becoming a true destination in the category. In May, we launched our LOVE THE SWIM YOU'RE IN! TikTok campaign, highlighting all the ways to rock your Aerie swim. The content was extremely well received, driving incremental visits and strong conversion. Aerie's signature Bralettes and leggings are showing incredible growth, and also very pleased by the success of our OFFLINE activewear brand, which continues to gain traction.
Year to date, Aerie's customer file has expanded over 20%. Existing customers are transacting more frequently and spending more. On the marketing front, we continue to focus on giving our customers their own platform in new and innovative ways. We just launched our real voices campaign, amplifying the love of our brand and product through our customers own stories. The campaign has already generated a ton of buzz, generating close to 1 billion impressions in the first week, bringing the Aerie real movement to more people than ever before.
Market expansion is progressing with 16 new stores across the U.S and Mexico and our first store in Hong Kong. As Mike will review, we look forward to further growth as we better penetrate existing markets and expand into new ones. The profit unlocked from Aerie's growth has been explosive.
I am so proud of what this team has accomplished. Momentum has continued into the fall season as customers embrace our amazing brands and cosy comfy collection. I'm highly encouraged by our results and excited for our upcoming seasons. We remain focused on driving consistent double-digit growth and improving profit flow through.
Now, on to American Eagle. I’m absolutely thrilled with the progress we're making. Second quarter results clearly demonstrate the growth and value creation we are looking to unlock. Sales rose 35% compared to 2020 and demand was positive versus 2019. Brand and product updates, along with a laser focus on inventory optimization and promotional discipline drove strong AUR growth and significant merchandise margin expansion.
Operating profit more than tripled and was up over 30% to 2019. We are running the business with a clear agenda. The true up brand profitability excite our customers and seek further growth. While results to date have been tremendous, we are still early on this journey. AE's position as the denim destination could not be stronger. Our jeans collections continue to deliver great results across genders.
We believe the current trends and shifts and silhouette will be a tremendous win for the AE business. In the quarter, our women's business reached new highs, led by ongoing strength in bottoms across both fashion and comfort silhouette. Growth in the men's business was also strong. Our focus on great outfitting with updated bits [ph] and fabrics are certainly resonating.
Together, new imagery and messaging, AE remains the number one Jean brand within our demographic and the number one women's brand across all ages. It is clear that our customers are choosing a silhouettes transition with the new denim cycle. AE's new back-to-school campaigns featuring some of the biggest cultural influencers of the moment, including chase Stokes, and Madison Bailey of Netflix number one show, Outer Banks and TikTok creator Addison Rae has already become the most organically viewed video in the history of our brands.
We also launched our first digital clothing line on Bitmoji, which has generated a staggering 1 billion triumphs to date. Looking ahead, I am excited about our fall and holiday collections. Our team has had a lot of fun bringing this AE iconic heritage to light and I think our customers are really going to love what we're doing.
Earlier this year, we welcome Liz Brunnemer, AE's new head of design. She has hit the ground running. The team is energized, and I know we're in better position than ever to leverage our strong brand position. I want to thank the AE team for springing into action and driving such strong progress in such a short period of time. There is a renewed excitement around AE and I think we are at the very beginning of a great new chapter.
Thanks also to the Aerie team for being rock stars quarter in quarter out. We have a great slate of talent between these two teams, and I look forward to sharing the results of their amazing work with you in the quarters to come. Thanks.
And now I'll turn the call over to Michael.
Thanks, Jen, and good morning, everyone. Our record second quarter results clearly demonstrate the power of our brands and products as well as the strength and agility of our operations. Thanks to our outstanding team of associates and global partners, we were able to successfully navigate through a highly disrupted environment. I can say with confidence that we're running our business better than ever.
Investments we've made to strengthen our operations, technologies and overall capabilities are yielding material efficiencies, and contributed to our record profit performance. Importantly, I believe these benefits are sustainable and we're going to continue to build on them over time.
Beginning with our laser focus on the customer experience. This spring, it was great to see customers return to stores, fueling a 73% increase in store revenue with strong selling across brands. We saw strength across formats at both our factory outlets and mainline stores saw healthy growth. Our stores team did a terrific job welcoming our customers back and fueling record high conversion.
Digital demand also remained very strong, increasing 9% following a 48% increase last year. This channel continues to expand to new heights in both revenue and profitability as we leverage our multiyear investments. Consolidated second quarter digital revenues are up approximately $150 million compared to 2019 with both brands seeing solid expansion.
Digital represented 35% of total revenue, up from 25% pre-pandemic. Longer term, we continue to believe that digital is going to represent 50% of our sales. We are continually looking for new technologies to drive better engagement and connect customer shopping experiences across our channels. As consumers reestablish their shopping rhythm post-pandemic, our business models going to remain flexible in meeting them wherever and however they choose to shop. For example, our mobile sales more than doubled in the quarter as we continue to enhance the customer experience.
We're thrilled to see very strong customer data, especially as we head into our key back-to-school season. We have added over 1.5 million new customers across brands since this time last year, and over 2 million since 2019. The relaunch of our loyalty program last summer has been extremely successful. Customers in the loyalty program are spending more, they're staying longer and the average customer spend is up in the double digits.
This speaks to the quality of our engagement, our product, our marketing and the technology enhancements we've made and we still see opportunity for continual improvement and we are planning to experiment with new and interesting ways to better engage with our customers and to build a loyalty program going forward.
As I discussed back in January, transforming our supply chain is a major priority. And the past 6 months have truly underscored the importance of strong partnerships, as well as leading capabilities. We are continuing to prioritize investments in these areas.
During the second quarter, our product arrived without major delays, and we were able to chase into high demand items. From a logistic standpoint, our hub and spoke model with regional inventory positioning and regional fulfillment is working. It's part of what's fueling efficiencies, allowing us to drive substantially greater sales and margin on far less inventory.
We are delivering product to customers faster, and despite industry wide cost increases, our delivery expense is leveraged as a percent of sales. Needless to say, I believe our supply chain platform truly is a competitive advantage. The investments we've made to date are paying off. As global supply chains continue to be disrupted, this is creating opportunities for us to become even faster, more agile, and more efficient.
On that note, I'm excited to share that in the quarter we acquired AirTerra, an innovative logistics provider. With this acquisition, we are also excited to welcome an experienced leadership team with deep expertise in logistics and share passion for rethinking the status quo. We will run AirTerra independently as it supports AEO's business as well as provide services to other retailers.
On the product side, we feel good about our ability to maintain strong margins. Investments in our brands and product over the past several years are supporting our ability to successfully compete in higher ticket products. As we focused on innovation, quality and value, we have selectively raised prices with very little resistance from our customers. In conjunction with strong inventory management, we have confidence in our ability to sustain high margins and offset inflationary pressures.
There's no doubt that the global supply chain remains highly disrupted. Port shutdowns and factory closures are leading to longer delivery times and higher transportation costs across our industry. As Jay touched on, we're very focused on the things that are within our control. We're working closely with our partners and we're moving production wherever possible to minimize disruption. Of course, we also will leverage the significant structural improvements we've made over the past several years. And we believe that we're going to be well-positioned during the second half of the year.
In closing, I'm very pleased with our performance year-to-date. Our results are outstanding, and our teams are executing really well in all sorts of adversity. I am confident that the changes we are making to our supply chain, logistics and operations are also setting us up to succeed well into the future.
With that, I'm going to turn the call over to Mike.
Thanks, Michael. Good morning, everyone. I'm pleased to report another record quarter bringing our year-to-date financial results to an all-time high. Our brands continue to demonstrate incredible momentum, driving substantial profits to the bottom line. As we navigate through macro shifts related to COVID, our success has been fueled by the initiatives outlined in our Real Power Real Growth plan back in January.
Strong focus on our brands and product innovation, inventory and gross margin optimization and real estate and supply chain initiatives are all having a positive effect on our growth and profitability. Second quarter revenue of $1.2 billion, operating income of $168 million and adjusted EPS of $0.60 marked second quarter records for the company. The operating margin of 14.1% was our highest in 13 years. We also saw a nice growth across the business compared to the pre-pandemic 2019 period.
Consolidated second quarter net revenue increased 35% versus second quarter 2020 and on a comparable basis increased 19% to 2019. The reported revenue increase of 15% included a $40 million benefit to revenue in 2019 from a change in our Japan license agreement. Across brands sales metrics were favorable, or averaging in retail was up over 20% led by overall strong demand, higher full price sales and fewer promotions. This fueled a double-digit increase in our average transaction value.
As customers return to stores, we saw a material increase in traffic trends which drove at 73% increase in store revenue versus last year. Even with the meaningful shift, digital demand increased 9% hurdling last year's very strong online demand growth to 48%. Note, the second quarter reported digital revenue declined 5% as we lapped elevated sales due to a timing shift in shipments from the first quarter into the second quarter last year.
Our digital platform combined with our strong store footprint is a competitive advantage and the investments we've made continue to pay off. As Michael pointed out, logistics are a key differentiator and give us the ability to more effectively manage our business while generating meaningful efficiencies.
From a brand standpoint, Aerie's multiyear growth trajectory remains strong, with revenue rising 34% from second quarter 2020 and almost 80% from second quarter 2019 Aerie's operating profit rose 132% compared to second quarter 2020 and operating margin expanded to 21%.
As I've consistently highlighted, Aerie is now at an inflection point in its growth story with strong sales performance translating into significant operating leverage that is exceeding our expectations. Put some numbers around it, second quarter operating profit of $71 million, more than double the $30 million we realized in 2020 and was over 7x the level of operating profit in the second quarter of 2019.
Moving to the American Eagle brand performance, healthy demand, low promotions and inventory optimization drove another strong result across both revenue and profitability. We were pleased to see top line growth of 35% from 2020 and on a comparable basis an increase of 5% from 2019. AE brand reported flat revenue versus 2019 included the 2019 benefit from the change in our Japan license agreement.
AE's operating profit jumped 234% from second quarter 2020 with margins building to 23.5%, a proof point of the significant margin opportunity for AE we reviewed back in January. I'm proud of the transformation we have driven and how we are managing the business today.
We have redefined what success means for the AE brand with clear direction and focus on consistent profit and cash generation. This is driving improved sales trends as tighter inventory controls, enable higher full price sales and greater emphasis on the best selling SKUs where care continues and we see additional opportunities.
Total consolidated AEO gross profit dollars were up 89% compared to the second quarter of 2020 and gross margin came in at a very healthy 42.1%. Inventory optimization and refreshed product assortments are supporting promotional discipline and higher full price selling. This is driving healthy merchandise margin expansion.
Rent leveraged significantly as a result of negotiated savings store closures and benefits from impairments. As Michael discussed earlier, delivery also leveraged reflecting efficiencies enabled by our distribution and fulfillment nodes. As a result of strong sales, we saw SG&A leverage 70 basis points versus second quarter 2020. The dollar increase to $70 million was due primarily to the reopening of our stores. We also saw increased advertising as well as well as incentive costs due to strong profit growth.
Record operating income of $168 million reflected a 14.1% operating margin, our highest second quarter rate since 2008. Adjusted EPS was $0.60 per share in the quarter and marked the record second quarter outcome for us. Our diluted share count was 209 million and included 36 million shares of unrealized dilution associated with our convertible notes.
Ending Inventory was up 20% compared to a 21% decline last year. American Eagle inventory was up 10% and Aerie was up 16% compared to second quarter 2020 as we positioned inventory below current demand levels as part of our ongoing efforts to optimize inventory buys. As Michael mentioned, we feel confident in our ability to navigate ongoing supply chain challenges and secure product for our customers.
I'm very pleased with our liquidity and the health of our balance sheet. We ended the quarter with $824 million in cash and short-term investments. This compares to $899 million in second quarter 2020, which included $200 million from our revolving credit facility that we subsequently repaid in the third quarter of 2020.
Capital expenditures totaled $49 million in the quarter and $86 million year-to-date. For 2021, we now expect capital expenditures to be at the low end of our previously communicated $250 million to $275 million guidance range, reflecting cost savings on our planned projects.
With regards to our real estate strategy, as I mentioned last quarter with 450 leases either come to term or warranting action in some way this year, we have significant flexibility to manage our store fleet to support our revenue and profit agenda. We're making steady progress towards our long-term goal of right sizing AE store footprint.
For Aerie we are focused on markets with the greatest opportunity in our own track with our store opening schedule. Focused investments in our international business are also helping us gain traction in key markets where we see compelling long-term growth opportunity. Mexico is a good example of this where our omni-channel selling strategy is driving healthy growth and profitability in the market.
All in all, I couldn't be more pleased with our performance year-to-date. As we look ahead into the back half of the year, supply chain disruption is creating some challenges and uncertainties. We're putting our customers first and prioritizing product availability. While there will be incremental transportation costs, we believe we can offset a significant portion.
Demand for our brands is healthy. Our inventory optimization is enabling promotional discipline and our supply chain transformation is creating cost efficiencies. Based on our record first half results and the current strength in the business, we feel confident in our ability to achieve operating profit of $600 million this fiscal year. This is well ahead of our financial targets that we presented back in January.
We continue to execute on our Real Power Real Growth value creation plan with speed and confidence. Our results year-to-date are a clear proof point that we are focused on the right initiatives, positioning us well to drive continued strong financial results in returns to shareholders.
With that, I'll open it up for questions.
[Operator Instructions] Our first question is coming from Oliver Chen of Cowen. Please go ahead.
Hi, thank you. Good morning. Revenue growth is really solid, but it was below to somewhat elevated street expectations. What are your thoughts on inventory availability across both brands? And whether pockets where you may not have had enough? And how are you thinking about the ability to chase between back-to-school and holiday, depending on trends? Another follow-up on AirTerra. It sounds very innovative. Would love your rationale for purchasing that in terms of timing and how it may impact your financial algorithm longer term? Thank you.
Yes. Thanks, Oliver. It's Mike. I'll take the first part of that. I like your description of maybe somewhat elevated revenue. I think there's a couple of reasons for that. One, I know everyone is basing things on 2019. But there's a couple points there of back-to-school shift to July business and tax free events shifting out of July into August. I think that's us and others, I think [indiscernible] in July. Our business definitely accelerated into May and June and then in the back half of July is I guess you can attribute it to a back-to-school shift.
From an inventory perspective, we are really happy with where we're positioned right now in the third quarter. Pleased with what we saw in August with inventory being positioned well, and we think we're in a good position for the rest of the quarter and the rest of the year. And I'll probably turn that piece of over to Michael in terms of where we are for the rest of the season and in the AirTerra part of the question.
Right.
Hey, Oliver. Look, clearly there's a lot of challenges in supply chain. There's port slowdowns, we have some factories that are closed, transportation is less predictable. Our team has done a tremendous job. I mean, supply chain transformation has been a huge focus for us. And we're very focused on controlling everything that we can and there's a lot that's within our control. So we're moving freight faster than ever. We've added carriers, we've secured our capacity, we've moved production out of closed factories wherever possible. And we've diversified the ports we're coming into, and domestically, we've sped up our supply chain by almost a week and a half versus how it was previously and versus how a lot of our competition is. Our goods are coming in, they're going directly to markets and out to stores or to customers. So, our supply chain speed is better than ever.
As far as chase, we really booked a lot of holiday product early based on the insights that we had from spring, summer and the tests that we did for holiday. And we feel good about the assortment that's coming in. So there is volatility, but we're managing through it. We expect that we're going to get all the freight that we want. We're going to be -- have enough product to have a robust holiday season. And you know we are still chasing product. So we chase product as late as last week. And we expect that we're going to get it for holiday. So there is variability but we're managing through it and we feel like we're set up for a great season.
As far as AirTerra, we're extremely excited to acquire AirTerra and to welcome their terrific management team into the AE family. AirTerra, if you think about, it's really a relatively small purchase, that has huge potential for us. It's a company that's focused on middle mile and it's really focused on bringing economies of scale, and the benefits of speed and costing and diversity to shippers of all sizes. And previously, these benefits were only available to the largest shippers to the Amazon's or Target's or Walmart. And we looked at it as a company we wanted to use for the American Eagle business. And as we looked further, we thought it was a great acquisition opportunity. So it completely fits with our strategy of leveraging scale and innovation to help us manage costs and improve service. And they've shipped their first few packages for other customers and for us.
And quite honestly, we're blown away by the amount of interest we've had in this business. So they have a tremendous pipeline of brands and retailers, large and small, that all want to use AirTerra. The more people that get on, it helps to build the AirTerra business as well as support the American Eagle business, providing economies of scale and transportation benefits for us. And we think this is a big idea, something that we're going to be talking about in the coming weeks and quarters, and we expect that it's going to be incremental to the profitability of the company.
Thank you very much. Best regards.
Sure. Thanks.
Thank you. Our next question is coming from Paul Lejuez of Citi. Please go ahead.
Hi, this is Kelly Crago on for Paul. Thanks for taking our question. Thanks for the clarity on the shift with back-to-school. Just curious if you could provide a little bit more detail on what you're seeing quarter-to-date from the -- for back-to-school trying to [indiscernible] . And then just secondly on the $600 million in operating income, [indiscernible] its very impressive, but it does imply a step down in EBIT margin expansion in the back half of the year versus the first half. So just curious if that's coming from [indiscernible] or are you assuming a more promotional environment, any color there would be helpful. Thanks.
Hi, Kelly. It's Jen. And just let me know if everyone can hear me. Greetings from London, U.K. I'm over here. So I hope everyone can hear me well. Look, we're really pleased with the result. Certainly, if you look into the back-to-school season, it's a tale of two stories. Last year, AE really delivered their new goods for September, and Aerie had a new delivery, starting with the launch of OFFLINE in July.
Now keep in mind all the shifts that are happening, Aerie, for instance, has more of a Northeast and Eastern Coast penetration. So they were impacted more by some of these shifts into August and certainly the later Labor Day. AE really able to ride the storm. And from what I see in both brands, I see strength. Look, American Eagle, we dominate in denim. I've never seen a better assortment and certainly I haven't seen a better team executing to a strategy that I think is top notch.
Our denim looks phenomenal. I just got out of a testing meeting last week. Look forward into the future. This is a team that doesn't stop and we look ahead. We dominate in denim. We've certainly executed to the new trends. And these are all [indiscernible] we're currently driving new fashion silhouettes in both men's and women's. And look they're checking, and we're going to get more aggressive there as we look ahead. Just saw the holiday review for some of the new shoots in American Eagle and Aerie. It's very optimistic. It's addressing what these customers want.
And just moving on Aerie, what do I need to reiterate, 27 exact consecutive quarters of double-digit comps. I mean, do the math. It's almost 7 years. I don't see a lot of retailers delivering comps like that. I mean, this team is firing on all cylinders. And certainly we were prepared for the back-to-school shift. We have two deliveries this year versus one last year because we knew that it was going to happen later and we wanted to delight our customers even more as we face the headwinds into September. Lots of newness coming in to help us get through that month. It's a big month. AE too has a great strong delivery. But I think the strategy was really smart for the Aerie team and how we approached it and the goods are checking.
If I reflect back into Q2, all of our key categories gain market share in Aerie. The OFFLINE business continues to drive in a very competitive environment out there, I think we stand out. OFFLINE is a very unique approach to athletic apparel. Innovation there and certainly the store experience is winning, and all categories an area really checking for us as we speak, especially on the bralette and legging side of the business. And what we felt to get through Q3, we're always going to remain humble and hungry. We were aggressive getting goods here for holiday and more to come. We have few more months here to get through the balance of the year. But look, I like that $600 million number, it's far ahead of our -- what we told the street, and here we are to deliver it. So that's what we're going to do.
Yes, Kelly, just to expand on the $600 million, it's totally freight related, nothing to do with the slowdown in demand, nothing to do with anything else. We're executing in terms of gross margin expansion, our operating rate expansion, likely would have been higher, if not for the freight and transportation costs that we're embedding into the back half of the year here. Look, we're being aggressive. We're going to incur these costs to make sure that our customer doesn't feel any different storing holiday to their experience. We believe it's definitely short-term and we'll be coming out in January with our longer -- with what we think will be a significant increase to our longer term profit targets.
Thank you. Our next question is coming from Jay Sole of UBS. Please go ahead.
Great. Thank you so much. Maybe Jen, can you just talk a little bit about Aerie in terms of the different new category opportunities. You mentioned OFFLINE, but just can you give us a little elaborate a little bit more about where you're seeing the growth, whether it's obviously the core underwear or just beyond? Thank you.
Yes. As I mentioned -- can you hear me now? Sorry, I had a little technical difficulty. Hi, Jay. Yes, for sure. As I mentioned, all categories in Q2, we saw that -- we saw gains in every category, in fact, all categories delivering on double-digit constant growth. So, really pleased with those results. Certainly bralettes are key category for us. And the good news is they're not only wearing them in, they're wearing them out now. So we're definitely addressing that trend. As we look forward, Undies are trending nicely. We've continued to pull back on our promotional cadence in Undies and we're seeing strong results there. Pleased in sweat [ph], especially when you look at a matching set that's still trending for us. So we're going to continue to address that trend.
And look, leggings are core in the OFFLINE business. And keep in mind, we still sell that product within Aerie. As we grow OFFLINE, we will start to sort of separate the results. But right now, OFFLINE leggings are sold underneath the Aerie umbrella, and they're definitely our number one category, or up there after Intimate. So we're -- we could not be more thrilled with that business, and we're going to continue to dominate there and innovate there. We have some really great ideas for the future and the team continues to strategize around the OFFLINE business. And how again, we can differentiate because that will be key to really be top of mind for our customers in the future. So the trends are looking solid.
And again, for business, I have saying this -- we continually drive comp 7 years, almost double-digit year-after-year. We have to ride with the change, right? So I know everyone is very curious about an outside trend that's happening and people going out again, and look, we've managed to ride those storms as well in Aerie where we dominate on some of our other categories, swim for sure is a go-to destination for Aerie and I've seen the assortments for spring and summer. They are strong. And that's the go-to, that's almost like what our girls wearing out in the spring and summer season. So, again, we're going to continue to navigate and drive what's working in our business for the future and remain nimble.
Got it. Thank you so much.
Thank you. Our next question is coming from Marni Shapiro of Retail Tracker. Please go ahead.
Hey, guys. Congrats on the -- sounds like great denim start to back-to-school. Jay, we talk a little bit about denim. You guys are now, you are -- just depending on the category, the number one or number two denim player. I guess, how do you think about growing that business further from where it is, with this AirTerra, you're working with third parties, would you consider wholesaler white label of your denim business to support a third-party? Would you consider a premium line or premium brand under the AEO, Inc. banner? I'm just curious what your thought is because you’re clearly a very powerful player in denim. So strategy wise, how do you take that to the next level beyond just American Eagle?
We always said, again, it is [indiscernible] show it. We're the number one brand between the 15 to 25 year old. We are the number one brand for ladies denim in the country. If you look at our lineup, you'll see that we keep introducing new and new [indiscernible], new and new finishes, and new and new higher price point goods to a better quality. It's a little premature, but we'll have a probably announcement in a few weeks about a new denim brand. Because you asked a question, we are working on a new denim concept that will be introduced in the next 3 weeks.
That's very exciting. It seems like the right thing given the denim platform.
That’s right. This is something that we've been working on for the last 12 months. We're about to open our first test stores in the next 30 days.
Great, congratulations. Looking forward to seeing that.
Yes. And the good news about our denim is we have plenty done in the sale. We don't see any problems for the fall for getting all the denim. All the factories produced our denim are running. We're getting shipments on a regular basis. We have plenty of air capacity. One thing we've done, it is in the last 2 years the internal model of this company has been logistics, logistics, logistics. We've invested in our logistics system, as Mike was talking about. We have other investments that -- they’ve been made, that are also being made as we're talking. We think we put together a world class, not a good class. Michael didn't go into business backgrounds. We think we have some of the best logistics people in the United States clearly.
And what we've accomplished, what's the most amazing thing is, is our cost of getting the goods to our stores in the last several months has been less than it was a year ago, 2 years ago. I don't know another retailer who can make that statement that their cost of getting the goods to their stores has less than it was before with all the current costs today. And all the costs increase to be able to bring it for West Coast is an amazing accomplishment, and our logistics team is world class have done that. So we're very proud of that.
We've done things that other retailers haven't done because we know the future of this business is going to be not just the marketing and the merchandising and running great stores, it's going to be how you operate the whole flow. And if you don't do it efficiently, you'll get beat. The pandemic has just speeded up everything. A lot of these things that we put in, we're in work before the pandemic started, but it speeded it up. And at the end of the day, if you don't win in the handling of your merchandise and your cost, you get beat by everybody. And we realize that we have to be able to control as much as we can and we have to be the best of it.
And one thing I'm very proud is that we put together great teams, whether it be marketing, whether it be merchandise team, whether it be our design team, whether the store operations, and definitely our logistics team, we're very proud of. Another thing we're very proud of, is we're able to attract great talent to the company. Fast Company just rated as one of the 25 best companies that could work like innovation. So we're able to track great people between our human resource area and the whole company we have great strides being made everywhere and really a great culture and great morale. Everybody in this company is focused. And one thing we've done is we've been following our strategic plan. We don't get off track. We stay focused focus, focus, and I'm very proud of that.
That's fantastic. And maybe just a follow-up on that conversation about your logistics with the AirTerra acquisition. Does that allow you guys to step up your Buy Online Pick Up in Store and that element of the business so you could even further integrate your online business with your in-stores business, is that part of the strategy here and take that more efficient?
Yes, it is. This past year, we talked about our nodes. A couple years ago, they came with the concept, they showed me what they thought the future should look like. And all of a sudden the pandemic started within 4 weeks, we had five or more reestablished. It's amazing job they did a year-ago. This would give us the ability in many markets be able to get same day delivery to the stores, same day delivery to the customers, being able to respond right the way. We are testing technology that we're working out right now that in our stores we could follow every item. If something is missing, we'll know immediately and be able to fill it the same day. So it's always being 100% in-stock level.
Your next question is coming from Matthew Boss of JPMorgan. Please go ahead.
Great, thanks. So maybe on gross margin, so both first and second quarter, more than 500 basis points above 2019. Is there anything structurally preventing similar performance in the third quarter? And Mike, do you view this as a baseline for gross margin for which to build on as we think about this year? Or are there any areas of give back for us to consider as we think about gross margin beyond this year?
Yes. Thanks, Matt. I'll answer the second part first. Yes, I think you're describing it accurately This is a new baseline to start from. So I think you get back to our target for 10% operating margin, we talked about gross margin being in the high 30s, right. And I think we're exceeding those expectations. So I think, yes, as we talk about our targets, again in January, and are probably what our new operating rate target will be, which will definitely be higher than 10%. Probably more like the mid to -- low to mid-teens operating rate. I think the new gross margin baseline is this 40% on an annual basis. So, yes, we've exceeded that the first couple quarters. We don't see any structural reasons why this is our one quarter or two quarter and done phenomenon is going to be something that is the new baseline go forward.
Great. And then maybe just a follow-up on the top line. As we think about back-to-school timing and the shifts that you mentioned, just to be clear and relative maybe to the second quarter which was up mid teens relative to 2019, is it fair to say that August has accelerated. It seems like that's what you're speaking to. And then maybe just any color on the third quarter? Meaning sales growth, maybe relative to mid-teens growth that you saw in the second quarter. Anyway to help on August and third quarter.
I mean, it will hit the first half of the year again. So I think we were up 17% in Q1 to 2019, if you normalize for that [indiscernible] payment. If you're comparing to '19 for the second quarter, we're actually up 19%. So we actually did pick up a few points from Q1 to Q2. The bigger point I'll make though, is that if you go back in history, and the revenue -- our revenue number in 2019 was a record for the company. But I think at that point, we weren't happy with the profit we were generating from that revenue, and that all goes back to unhealthy inventory levels, too many SKUs, too many choices, we bought revenue. So we are as much as we're looking at the same compared to 2019 you are, we're not focused on that because I think we are creating a new revenue baseline as well. And we are focused fully on profit generation, cash flow generation on the revenue we're seeing. We're focused on flowing through these phenomenal area growth. That'll be a continuation, that'll be baked into our targets we come back out with in January. So I guess the answer to the August question, it's a little bit apples to oranges. We're very -- we are happy with what we saw in August, it's on path to what we're expecting is built into our guidance. And like I said earlier, the guidance would have been higher without this incremental freight and transportation costs. So we're focused on profit, we're focused on operating rate. Revenue is obviously part of that, but these maniacal compares to a -- to history that probably doesn't matter as much anymore is something we're not focused on as much.
Thank you. Our next question is coming from Dana Telsey of Telsey Advisory Group. Please go ahead.
Good morning, everyone. Jay, you mentioned logistics and the strength of logistics. Do you see other acquisitions coming into the fold going forward that would continue to enhance your logistics abilities, and potentially even drive the operating margin higher? And then just lastly, as you think about the holiday season, with the extension of back-to-school, how do you see the timing and planning for the cadence of holiday this year? Thank you.
Okay. To your first question, yes. About the acquisitions, yes.
And what kind of framework would you want there? What other qualities would be beneficial?
It's -- we are working on something I can't go into details. But there'll be announcement probably next couple of months.
Got it. And then just on …
I mean, Dana, we're looking for -- everything we're doing is focused on providing scale and speed and cost benefit and customer service benefit for the American Eagle business. But clearly, there's a lot of opportunity with what's happening in supply chain today, there's a lot of disruption. But with that disruption creates a lot of opportunity. And like Jay was saying, it used to be that just if you had great brands, and you had great products, you won. In today's world, that's not the case. There's a bifurcation happening in retail, where you -- it's not just great brands, it's not just great products, but you need incredibly efficient, agile, fast operations.
So AirTerra fits that mould. It's going to serve as the American Eagle business well, it's going to service other retailers well, it's going to be a very successful profitable company on its own. And we are looking for other opportunities of companies that fit that mould.
Got it. And then the cadence of holiday, how you're thinking about it?
I can answer that if you want. Look, I think we keep on leaning on logistics here, because I think it's mission critical. I'm getting the goods where the customers demand is in today's world. We're looking at countries, thinking about shutting down again, we could go into lockdown again, who knows, God forbid. So again, the demand could change versus direct or in-stores and that's what we're prepared to address, as a team, where our customers that we're going to provide the product for them. Certainly, with a little bit of leadership back-to-school, I think we're in the field a little bit of that, as we move along once a month. And then I would say, though, I do think, gifting could happen early again, with all this in mind, similar to last year. So I think the team is ready to address that.
Yes, Jen, and I also -- I will also add some key data. We believe that this will be an earlier Christmas shopping, holiday shopping. What we believe is that from our standpoint, we'll have plenty of merchandise, we'll have a lot of great new merchandise to choose from. But we believe that there are going to be problems out there for other retailers. We see there could be shortages of goods out there for all, not just for apparel, but you go out today, anything you want to buy cars, you have a shortage of cars, right now. You want to buy furniture, there is shortage of furniture out there. So anything you want to buy out there, there's shortages. You want to go build a house, it takes longer to build a house, and it costs you a lot more money.
So for those people, those retailers who are able to get their merchandise on a timely basis, it's going to be a big opportunity. And we feel we're in great position, we're going to have great selection in our store, and it's going to be exciting place to shop, it's going to be a great online experience where these thing would be first introduced in the United States, why retailing on our app is being introduced right now. So, we're very optimistic and we feel in a position as far as inventory is going to be. But it's going to be -- it's going to differentiate us from everybody, and it's going to be a big opportunity and we're going to get more money for our goods because it's going to sell or --is that could be as promotional, which is good. I think we [indiscernible] sell merchandise and get paid for your effort and give good value to the customer and give them great product. It's a win for everybody. And we will have goods and that's the key. Having the right merchandise and having goods, we will have goods. When Michael was talking about logistics, we already have reserved airplanes that we bought up. So if there is excess air freight, we'll be selling it.
Thank you. Our next question is coming from Adrienne Yih of Barclays. Please go ahead.
Yes, good morning. My question is, this is such a different company today versus 2 years ago and I know you've gone through all the reasons why. But as we look at that, sort of the early look toward the low to mid-teen, we haven't seen those types of margins for pre-2008. And I'm just wondering last two quarters, you've come in sort of in line with the street expectation. But I'm wondering if the street from our perspective needs to appreciate on a 2-year basis, 14% over '19, at 7% for each year, how should we think about the algorithm of top line growth? Should it be mid to high single-digits with low double-digit EPS growth -- leverage growth to the bottom line? Because it really sounds like you’re driving this business for quality sales at higher and higher profits. And then, Mike, my second follow-up question is can you quantify on basis points the [indiscernible] impact to 2Q? What's embedded for the second half, and how much have you been able to offset that with AIR increases? Thank you very much.
Thanks, Adrienne. I think you just told the story for me a bit. But yes, so I think the -- this is a different company, a different focus. We're not chasing revenue targets. We're very focused on I guess [indiscernible] I could say is, you think about the two brands, we're looking at area that 30% plus CAGR continuously AE's modest growth. We saw a plus 5% increase in 2019. In the second quarter, again, normalizing for that payment.
But Mike, you saw tremendous growth in margin dollars at the American Eagle side.
That's where I'm headed. So I think when I talked about 2019 baseline and the fact we drove a lot of unhealthy sales, it was the AE brand, it wasn’t Aerie. So we are -- we've changed the business model, we're operating differently. Inventory is healthy top line node. So to be honest with you to hit a 5% over '19, for the AE brand that is a new record again, because 2019 was a record. I'm actually ecstatic about the fact that we're driving similar to higher revenue with this income flow through that we're seeing. I mean it's an amazing baseline that we're creating here. So for the go-forward, I think we're looking at probably modest top line growth in AE, 30% plus CAGR in Aerie continuing and the focus is the flow through on both the revenue from both brands.
So when you think about operating margin go-forward, I think we'll be coming out in January talking about and this is just round numbers, 40% gross margin, low to mid 20 SG&A, 3 to 4 points of D&A, and a new target that's in the low to mid teens we're operating, right. And maybe exceeding that as we continue to optimize how we're flowing through especially Aerie revenue growth. And we have some other growth stories, we'll probably be telling too. We hit on Mexico a bit. And in our prepared remarks, we think there's some other international opportunity that we can flow through at a very healthy rate as well.
On the freight costs, Adrienne, that's a moving target every day. We think we have in our guidance accounted for everything we know to date. It could get better. So we're going to see how that comes to fruition. But as we all -- we've all been saying, our intent is we're going to be aggressive on getting our product here and making sure the customer does not feel any different from us in holiday and I think that can be a competitive advantage, we all do. But it's a bit of a moving target. So it's hard for me to give you the exact basis point. So I'll just say it's embedded in our $600 million for now and again, could get better.
Great. Thank you very much and best of luck for back-to-school and holiday.
Thank you.
Thank you. At this time, I would like to turn the floor back over to Mr. Schottenstein for closing comments.
Okay. Thank you. First of all, I want to say I'm very proud of the great team that we've been able to assemble. Whether it's in the marketing, whether it's in the merchandising, design, store operations, logistics side, we have world class players that we were able to attract and still attract that type of caliber. So we're very excited about that. As we said early, we worked hard to make better product, get better selection to the customers and we could see it in the improvement of the performance, whether it be American Eagle, and as Jen emphasized 27 straight double-digit comp quarter increases for Aerie. I don't know another retailer, if you go back 7.5 years, almost 8 years you could say, every quarter, a double-digit comp growth and still going double-digit comp growth.
So -- and have a new exciting brand like OFFLINE introduced now to and to have that potential to grow like Aerie. We are very excited about that. We're very excited about the other brands that we'll talk later about whether it be Todd Snyder, whether it be Unsubscribed, whether it be the new [indiscernible] concept, we see a lot of opportunities for us. The other thing is that we had our Investor Day last January, we gave a 3-year strategy. And a little bit we realized when we gave that 3-year profit strategy, that in the same year, we'd already be breaking the 3-year strategy. It puts us on the 3 years ahead, and we'll have another Investor Day probably next January where we will reset the goal for the next 3 years, and we're very optimistic.
And as we said, we're very well-positioned for back-to-school. We like the way [indiscernible] started. We like the way September starting and we're very excited for the second half of the year, and we think that with the systems that we have in place, and what we have going on for us, they differentiate us from everybody else. At the end of the day, we have to be different than everybody else. We have product that customer loves. We have great brands with great loyalty. We didn't talk about it. Really they drive this back, but the -- but our strategy in marketing [indiscernible] we launch our loyalty program, we have the largest enrollment of loyalty members that this company has ever seen in the last few months. So we're very optimistic about the second half.
So we want to thank everyone for their support. And I could just tell you, this team is laser focused. And like Jen says, we're humble. And we just know we got to keep driving and keep the innovation, the technologies and be able to put it all together and we push ourselves. This is a great team we have. So thank you for all your support.
Ladies and gentlemen, thank you for your interest in American Eagle Outfitters. You may disconnect your lines at this time and enjoy the rest of your day.