Greetings, welcome to the American Eagle Outfitters second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Ms. Judy Meehan. Thank you, ma'am. You may begin at this time your presentation.
Good afternoon, 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 www.aeo-inc.com in the Investor Relations section. Here, you can also find the second quarter investor presentation. Now, I will turn the call over to Jay.
Good afternoon. Thank you for joining us today. This is clearly an unprecedented time in retail. We are cycling extraordinary and uneven demand patterns brought on by stimulus and COVID over the last few years, and we are navigating through a highly volatile macro environment. Our second quarter results reflected these challenges as revenue came in below our plan and markdowns weighed on profit margins.
On the first quarter call, we highlighted the actions we were taking in response to changing demand and to reposition our business for an improved second half. This included a firm goal to rightsize our inventory and reset our expense base to be more aligned with demand in the second quarter. Significant progress was made across both these initiatives.
On the inventory side, we cleared all excess spring and summer goods and entered the third quarter with better inventory levels and fresh back-to-school and fall merchandise. We also actioned expense reductions across the organization. As Mike will review, we are taking further steps to drive improved profitability and cash generation.
This includes a hiring freeze, further reductions in non-critical expenses, and lower capital spending. We have also paused our quarterly cash dividend. We have returned $265 million in cash to shareholders through a combination of dividends and share repurchases, marking our highest level of returns since 2015. While we will take the rest of this year to strengthen our cash position, we are committed to continuing to return cash to shareholders as a fundamental principle.
On a separate note, we made strategic changes to our leadership structure to enhance focus on consumer experience and our growth initiatives. We combined store and digital operations to enable a more holistic and cohesive view of the customer. The new structure will create efficiencies and strengthen the brand experience as we execute seamlessly across channels. This includes more focus on our international business, where I see tremendous opportunity for our brands.
I'm pleased with the positive momentum we have been building over the past few years. This change will facilitate a more strategic approach as we further optimize key markets, including Canada and Mexico, while fueling our licensed partners for continued expansion over the long term. As we navigate through near-term macro challenges, we have not taken our eyes off the strong potential for future growth.
Aerie's incredible brand platform continues to see exceptional multi-year growth, with second quarter revenue reflecting industry-leading 25% three-year compound annual growth rate. I remain extremely bullish on the outlook for Aerie and OFFLINE and their future potential. American Eagle is a dominant jeans brand and the go-to destination for youth with very strong brand affinity and recognition. Innovation, new products, fueling new fashion trends, and further global expansion are key areas of focus to drive profitable growth.
We continue to invest in bringing our customers a seamless and engaging shopping experience across digital and stores. Our logistics business, Quiet Platforms, is providing significant benefit to our operations while also expanding its third-party revenue base by offering innovative and more cost-efficient logistics solutions. The growth in the business so far confirms our initial investment thesis on Quiet's value proposition and the differentiated fulfillment model.
I am encouraged by the business and excited about the long-term growth potential. I'm proud of the continued progress we are making on our ESG initiatives. We look forward to publishing our first ESG report next week, introducing standards, guides, reporting, and increased transparency. Our brands are healthy, and our business is resilient. Comparisons will eventually stabilize, and the supply chain landscape continue to improve, restoring agility in our operation.
In the meantime, we will stay conservative and focused on the core fundamentals that have brought us success in the past, creating great product, compelling marketing, building unique brands with strong customer connection, and chasing into demand. The actions we have taken to reset this year were a significant undertaking. I'm thankful to our teams for acting quickly and purposely.
Yet, we know there is more to do in these unprecedented times, and we are focused on driving continuous improvement across the business. With that, I'll turn the call over to Jen.
Thanks, Jay, and good afternoon, everyone. This was clearly a challenging quarter. As we managed through the current environment, we remained focused on adjusting our assortments and right-sizing inventory. I'm pleased to note that we entered the fall season with fresh and current assortments across brands. We have significantly pulled back on fall receipts and continue to adjust forward inventory to be more in line with shopping trends.
Clearly, lapping enormous demand from last year has also been a hurdle. Yet, I see no letup in the consumer affinity and love for casual, comfy, and active wear. It's a lifestyle, not a trend, and it's in demand. As we see comparisons to last year's ease, I'm confident momentum will come back to us. In fact, looking forward, there are great new trends emerging around silhouette, color, and fabrication that will create even more excitement around the lifestyle.
Now, let me provide some second quarter details by brand. Aerie revenue increased 11% compared to last year, driven by new store openings. Comparable sales were down 6%, following a 25 comp increase last year. Swimwear remained soft. While overall demand was below our plan, the majority of categories posted increases to last year. Undies, leggings, apparel, and accessories all posting positive growth. Additionally, OFFLINE continues to show incredible potential and demonstrates strong customer acceptance.
I'm also pleased to see that Aerie's multi-year growth trajectory remains intact. Since second quarter of 2019, revenues have nearly doubled, growing almost $170 million. Our customer file has expanded by almost 2 million shoppers. We continue to focus on delivering innovation and newness to our customers. SMOOTHEZ is our new collection of favorite first layers that we call anti-shapewear.
The launch has been extremely successful, driving incremental traffic to the brand and nearly 6 billion impressions to date. Our new Real Me Bra features revolutionary technology, reestablishing our authority and bringing newness back to the business. We will continue to build out our SMOOTHEZ collection in upcoming seasons. On the marketing front, we launched We Are Real campaign, amplifying inspirational messages from women within the Aerie community with a strong customer response.
Now, shifting to American Eagle. Revenue declined 8% to last year. Comparable sales were down 10%. This follows 39% comp growth in 2021. Category trends were challenged as we cycled exceptional growth last year in a tougher macro environment. Our best categories included menswear overall, women's dresses, shirts, fleece, and accessories. We have been highly focused on making adjustments to our buys to ensure we are better positioned for future seasons.
In addition to resetting overall inventory levels to be more in line with demand, we are making adjustments across all categories. As we make the transition into new denim silhouettes and fashion trends in bottoms, we see an opportunity to better allocate our investments. Additionally, we are beginning to see pockets of improvement in tops as our focus on outfitting yields results. Here, we are rebalancing our buys to emphasize the trends that are working very well.
We are also pleased to see the supply chain begin to normalize. This is creating better inventory flows, shorter lead times, and enables us to reestablish our best-in-class test and chase practice. AE remains number one in jeans and the number two favorite brand for females and number three for males in our core demographic. As a dominant player, AE is continuously bringing newness to the category.
This quarter, we launched our new Strigid collection. An industry first, Strigid jeans marry the latest in fashion trends with our unwavering commitment to comfort. AE continues to be a leader in social commerce and the new realms of the metaverse as we explore new ways to engage with our customers. In the second quarter, we partnered with Twitch on a gaming tournament, which drove strong traffic to our site.
Separately, our Roblox experience has become the second most popular experience on the platform. AE is second only to Gucci, with 35 million unique visitors to date and exceptional engagement metrics. As I said earlier, across brands, my confidence is stronger than ever. We are focused on delivering innovation and diving into new trends while maintaining a cautious near-term view.
We are ready for the upcoming holiday season, and spring is right around the corner with plenty of exciting trends to leverage. I wanna thank Aerie and the AE teams for their hard work in being quick to adapt in a very dynamic macro environment. Thank you, and now I'll turn the call over to Michael Rempell.
Thanks, Jen, and good afternoon, everyone. As we navigate a challenging retail environment, we are leaning into the strength of our operations. We've invested in our supply chain, which is yielding greater speed, efficiency, and cost benefit. We have amazing brands that our selling channels are very strong. We operate an industry-leading store fleet and a truly best-in-class digital capability. In the second quarter, channel performance reflected macro pressures across retail.
In stores, lower traffic and lower spend drove a 9% comp decline. Digital sales were down 6%. While down to last year, our digital business has seen significant growth over the past three years, with revenue up 60% to second quarter 2019. Digital penetration has also grown to 33% from 24%. Our mobile app had another strong quarter and is now our largest source of revenue in the direct channel.
This is a key positive as app customers are our most engaged and valuable omni-channel customers. We are continuing to invest in the latest new technologies to enhance the customer shopping experience. In the second quarter, we introduced a new mobile point-of-sale system across our North America store base, giving our customers the flexibility to check out or return items through a store associate anywhere in the store.
We expect this to improve transaction speed and minimize wait times, especially as we head into our peak fall and holiday selling seasons. As Jay mentioned, the organizational changes we have made will allow us to operate with a more integrated and channel-agnostic customer strategy, and it's going to create efficiencies and cost savings.
We are continuing to rationalize AE's store base and close seven more stores across the North America fleet in the quarter, bringing our regional store count to 858 stores. This is down from 931 at the end of fiscal 2019. We also added approximately 20 new Aerie and OFFLINE locations in the second quarter, bringing our total openings over the past twelve months to approximately 100 new stores.
Aerie's store expansion strategy has been very successful in building brand awareness. After significant investment over the past few years, we are slowing down the pace of openings as we focus on maximizing these investments. As we've noted in the past, new stores grow at an accelerated rate in years two and three before approaching the comp store average in year four.
As new stores ramp up, we expect to see very nice returns from our investments, including both the sales and profit generated within the four walls, as well as the digital halo created for our online channel. Our typical payback period on Aerie stores is less than three years, with returns that well exceed our cost of capital and reflect the company's highest ROIs. Moving on to supply chain. After a highly challenging year, I'm very pleased to see inbound supply chain improvements.
Shipping delays and bottlenecks are easing, transit times are shorter, and freight costs, although still elevated to pre-pandemic levels, have come off substantially from highs reached last year. As a result, our lead times have narrowed dramatically from their peak last November. Importantly, this is bringing back our ability to be more agile and responsive to changes in demand.
On the inbound freight side, we expect to see markup relief in the back half of the year as we anniversary $70 million in higher air freight related to factory disruptions in Vietnam last fall. This is going to begin to benefit the P&L in the third quarter and build significantly into the fourth quarter and into 2023 as we cycle peak usage. Cotton pricing has also moderated from peaks this past spring, and I expect we're gonna see product costs look favorable into next year. Now moving on to Quiet Platforms. Our localized fulfillment model now handles a third of our direct orders across the AE and Aerie brands and is continuing to drive efficiencies. We are fulfilling orders faster and with fewer shipments. Our costs of fulfilling orders are down to both last year and to 2019.
The resulting savings are helping us to contain delivery costs even as rates remain elevated across the industry. Faster delivery times are contributing to a much better online shopping experience for our customers, with approximately 75% of online orders reaching customers within three days of checkout in the second quarter. We even see room for this rate to move higher as Quiet Platforms expands its footprint to service additional markets next year, which should enable nationwide next-day services. Over the past eight months, we have made significant progress in scaling Quiet Platforms. Since closing the acquisition last December, we've added significant amounts of new customers and entered new markets. We expect the momentum's going to continue in the second half.
As new customers are entering the platform, they're realizing efficiencies in their operations, resulting in greater engagement and additional business. While Mike is going to highlight the impact of the business on our consolidated financials, I wanna note that it performed in line with our plan with improved results from the first quarter. I remain very encouraged by all the interest we have received in this business as it continues to expand. As we look ahead, our focus remains on capturing even greater share of the market opportunity. With that, I'll turn the call over to Mike.
Thanks, Michael. Good afternoon, everyone. As Jay mentioned, we're taking numerous steps to improve profitability and cash flow, which I'll discuss throughout my remarks today. Let me start with a review of the quarter. Consolidated revenue for the second quarter was $1.2 billion. This was flat to last year, including 2 points of growth from our supply chain acquisitions. Brand revenue declined 2% following record revenue supported by an exceptionally healthy consumer environment last year. Consistent with what others have said, we saw a slowdown in demand this summer. For the quarter, Aerie revenue was up 11% and American Eagle declined 8%. Compared to pre-pandemic 2019, total revenue increased 15% and brand revenue was up 12% or $130 million. Gross profit dollars declined 26% compared to last year.
The gross margin rate of 30.9% contracted 1,120 basis points. Higher markdowns drove 750 basis points of the decline. I want to emphasize that as we cleared through inventory in the second quarter, our priority was to maintain the pricing integrity and brand equity built over the past few years. Our AUR in the second quarter was the second highest achieved in the history of the company, down only 4% to last year. We leaned on end-of-season sell-offs to fully clear out all excess spring and summer goods, which was roughly one-third of the markdown pressure in the quarter and had a $30 million impact to profitability. Higher freight costs were a 200 basis points headwind to the gross margin rate, and the integration of our supply chain acquisitions drove 60 basis points of incremental deleverage.
Turning to expenses, SG&A deleveraged 110 basis points compared to the second quarter of 2021. The mid-single digit dollar increase was in line with guidance provided the last quarter, led by higher wages for store associates, new store opening expense, as well as increased corporate compensation, advertising, and professional services. This was partially offset by lower incentive accruals and expense actions announced last quarter. We remain laser-focused on resetting our expense base. Since our last update, we have expanded the scope of our expense reductions as we continue to target store and corporate compensation, professional services, travel, and advertising. We've implemented a hiring freeze and paused non-critical spending. With these actions, we now expect $100 million in annualized expense reductions from our original plan ahead of the $60 million discussed last quarter.
This translates to SG&A dollars approximately flat to last year in the second half compared to prior guidance for low- to mid-single-digit growth. Second quarter operating profit of $14 million reflected a 1% operating margin. This included a $30 million impact from incremental end of season inventory sell-offs mentioned earlier and a $25 million headwind from higher freight costs. It also included a $9 million loss from acquired platforms, reflecting a sequential improvement from the first quarter as planned and previously communicated. Margin pressure was felt across brands due to their miss to plan. Aerie's margins were more impacted as a result of several factors. Aerie saw a larger variance to plan, which was based on outsized growth over the past few years.
This resulted in a larger impact from sell loss to clear inventory and in-season promotions, felt most acutely in the second quarter due to the timing of Aerie's seasonal clearance activity. Additionally, we saw some pressure on margins due to higher number of new store openings, which are still in their ramp-up period. As inventory resets and newer stores continue to build, we expect Aerie's margins to show a meaningful recovery back to double digits in the second half. Adjusted EPS was $0.04 per share and included a $1 million interest add back to net income. Our adjusted diluted share count was 207 million. During the second quarter, we took steps to strengthen our capital structure. We exchanged $342 million or approximately 80% of the principal associated with our convertible notes and upsized and extended our ABL facility.
This provides additional liquidity under more favorable terms. We also completed a $200 million accelerated repurchase program. In the second quarter, we repurchased 17 million shares as part of the program. With the full benefit of these actions, we expect a third quarter weighted average diluted share count of 198 million. Consolidated ending inventory cost was up 36% compared to last year, reflecting a 10-point improvement from first quarter levels. From a brand standpoint, Aerie and AE each represented half the increase with approximately 20% of the increase driven by black leggings, a core item that sees strong year-round demand. Total inventory units were up 22%. This reflected higher in-stocks as we lapped supply chain disruption last year. Earlier receipts of back-to-school and fall goods reflecting improved lead times and higher units to support new Aerie and OFFLINE store openings.
Quarter end inventory is current and fresh for the fall season. Clearance levels are in line with last year, and we do not have packaways. Given ongoing macro challenges, we've taken further action to reduce inventories for the second half of the year. As we make additional progress, we expect to end the third quarter with inventory up in the mid-single digits% and fourth quarter ending inventory down to last year. We anticipate promotional intensity to remain high across retail in the back half of the year. Although we will not be immune to this, with inventory plans more aligned with demand, we're better positioned to navigate through it. We ended the quarter with $98 million in cash and total liquidity of $453 million. Capital expenditures total $69 million in the quarter.
As mentioned earlier, we have paused all uncommitted CapEx spend for the balance of the year as we absorb and grow into our investments. For the full year, we now expect capital expenditures of approximately $250 million. This is down from our prior guidance of $275 million, with work being done to reassess investment needs for 2023 as well. Now on to our outlook.
Demand remains challenging, especially as we cycle an incredibly strong and record back-to-school season last year, with brand revenue down in the high single digits percentage quarter to date. Assuming current trends continue, we expect third quarter gross margin to be in the mid-30s% and fourth quarter in the low-30s%. This reflects higher markdowns as a result of the current demand environment and our seasonal clearance cadence, which is more weighted to the fourth quarter.
We are also anticipating freight relief as we lapse significant use of air freight linked to the Vietnam factory closures last year, especially in the fourth quarter. As I noted earlier, SG&A dollars are expected to be relatively flat in the back half. Our tax rate assumption in the high 20s and weighted average share count at approximately 198 million. 2022 is clearly shaping up very differently from what we'd originally anticipated. As Jay noted, we're prioritizing liquidity and financial flexibility in the near term and pausing our quarterly cash dividend of $0.18 per share. American Eagle Outfitters has a long history of returning cash to shareholders through dividends and share repurchase. We remain committed to maintaining this precedent in the long run.
In the midst of the challenges we're facing this year, we're also working hard to position 2023 for improved profitability, solidifying work across expenses, CapEx, and inventory. As Jay noted, our brands and operations remain strong, and I'm confident this will come through in our results next year. With that, I'll open it up for questions.
At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the star keys. In the interest of time, please limit yourself to one question. One moment while we pull for questions. Our first question comes from the line of Jay Sole with UBS. You may proceed with your question.
Great. Thank you so much. I wanna ask about Aerie. If you could just talk about, you know, where in the quarter maybe the projection differed from what played out. Was it that, you know, your view on the macro was optimistic? Was it, you know, some of the styles didn't resonate? Was it some of the categories maybe that you thought would trend didn't versus other categories? If you can just sort of dive in a little bit and talk about where the differences were, in that business versus your expectations, that would be great. Thank you.
I can start, Jen. I'll just hit some of the trend progression. You can hit the product side of Jay's question. Thanks, Jay, by the way. If you go back to the first quarter call, May 24, we talked about the consistency of the sales trend that we were seeing through the first quarter. You know, mid-teens to high teens to 2019 is what we were talking about then. We saw that very consistently February through April. Actually, in May up into the call, we actually saw May accelerate to that trend a bit, which made us confident in kind of grounding ourselves in that. What happened really mid to late June, just as others have talked about, we did see a deceleration to trend as we got into summer. That's really continued.
That continued through July, continued into sorta early mid-August through back-to-school peaks. We've definitely seen some improvement in recent weeks here as we've kind of got into September and this past Labor Day weekend. We're still guiding conservatively, and we're assuming that high single digit trend continues that we've seen quarter to date so far. The guidance we're providing is assuming that negative high single digit trend continues that we've seen quarter to date so far. That's what really changed. It was really that mid-June to late June timeframe. Feels like across the industry, it's been consistent in terms of a bit of a slowdown that occurred at that point. Jen, you wanna hit the category for it?
Yeah. Thanks, Mike, and you said it well. Really it was isolated in the swim category, to be honest, Jay. We saw really incredible results in all of our other categories. You know, you heard from Mike how that really impacted from a seasonality standpoint. What I like what I'm seeing, like, look, we look forward, we look ahead. We just had one of our best launches ever, the SMOOTHEZ launch, which is highly rooted in intimate apparel, which is seasonless, so I love that category. Leggings are off to a great start. Again, you know, we don't take a lot of markdowns on leggings. They're highly isolated in black. They do the majority of the business.
You know, early on and, you know, it's early to say, but we're very pleased with the results so far for back to school. Like I said, going back to Q1 and Q2, very isolated in swim, but other categories saw nice results.
Yeah. Jay, maybe the last point to that too. In the end for Aerie specifically, we still saw almost doubling the 2019 results by the time we got to the end of the quarter. From a go-forward perspective, now we feel like inventory is reset very appropriately. You know, we've got these new stores that are still in their ramp-up period. Michael described kind of where we think those are headed. We got now over 100 stores that are sort of non-comp or new going into the back half with inventory reset. Very bullish on Aerie for the back half or in terms of where we're going from here, knowing the macro environment's still uncertain.
As we go forward rest of this year and into 2023, there's a lot of optimism in terms of Aerie's bottom line, top line growth and bottom line results that we're focused on.
Got it. Okay. Thank you so much.
Our next question comes from the line of Matthew Boss with JPMorgan. You may proceed with your question.
Great. Thanks. Jen, could you speak to demand shifts that you're seeing across categories? What changes are you making across the assortment at Aerie and American Eagle in the third quarter? Is there a way to think about the timeline needed in your view for inventory completely across the board to be fully reset at this point?
Sure, Matt. Mike mentioned it. We certainly get in a great position as we move into Q4, and then as we're looking out to 2023, as far as inventory is concerned. I mean, the teams have worked tirelessly to make sure that we are in good position, but also making sure that we distort in the right categories. Look, I love what's happening out there right now. We just actually chased something within 19 days. We have deliveries here. Michael Rempell said it. We're like starting to get best in show again. I would like to say we, you know, the testing and the chase that we're capable of doing in this company is remarkable.
I mean, I learned it 12 years ago when I joined the company, and it's nice to be in a position where, you know, logistics are freeing up for us and we're able to sort of move a little bit more seamlessly. There are some category shifts happening, but I just, you know, it's funny, the team we were talking today, how we are just so dominant in bottoms, and now that's happening in Aerie as well, from leggings to denim to other bottoms. We are seeing some new shifts in silhouettes and denim. The teams, like I said, we're moving fast and getting into some new categories there from the bottoms perspective. In Aerie, certainly OFFLINE being a new business for us, we're seeing great results in that business.
I think that holds a very promising outlook for the company as far as a growth vehicle. Certainly, you know, as we've been able to shift the categories in American Eagle, I like what I'm seeing in outfitting. It's taken a little time, a little longer than I thought. Early on, for back to school, some of the women's trends that we're seeing, we're able to chase. I mentioned that 19-day chase ability. I mean, that's pretty impressive and we're gonna continue to test and scale. Mostly, I would like to say that this team has responded fast. We've worked tirelessly. We're not quitting from the marketing to production to the product categories to the innovation that I'm seeing from this team. You know, we're not quitting here, Matt.
I'm really proud of the team.
Great. Mike, could you just speak to the magnitude of the recent EBIT margin contraction that we've seen at Aerie? Maybe if you could just elaborate on some of the drivers of double-digit margins in the back half. Has anything changed on your multi-year view of profitability for Aerie? How do we maybe break down the structural versus transitory elements of the profitability of Aerie today relative to previous plans?
Sure. Thanks, Matthew. I mean, to Q2 specifically, really first half, I mean, Aerie's had some challenges, obviously, go back to the supply chain disruptions last fall, the air freight that we experienced mostly in Q4, some of that carried into Q1. Elevated freight costs in general hitting the brand in Q1 and Q2 on, you know, beyond the air freight. You know, we talked about that being a 200 basis point impact to the quarter. Aerie was, you know, about half of that, I think. So $20 million to 20-some million in total. You could take $10 million-$15 million, that being an Aerie impact. If you think about the, you know, resetting inventory in Q2 and the $30 million charge I described, Aerie was over half of that.
The combination of those two factors, plus the, you know, Michael Rempell talked about the 20 stores we opened in the quarter and the ramp up of the new stores we've opened in general. Those three factors, you could take Aerie's operating rate from 3% to double digit in the second quarter alone. As we get into the back half now, inventory is reset. We don't expect any impact from inventory or us over-planning the business like we did in the first half. Freight actually normalizes. We'll anniversary elevated ocean freight from last year. As we've described, we think there's actually some light at the end of that tunnel in terms of freight costs and freight and transportation coming back in line or maybe even some benefit versus last year.
Now we'll have these new stores carrying into the back half and not much impact from new store opening costs. Those three main factors really go away for the back half. We think inventory is reset, and we're focused on, you know, the profitability of, you know, all these new stores and the business in general. We're very confident in being double-digit in the back half, and we're looking forward to 2023 already, benefiting from all this growth, 30%+ square footage growth from these 100 locations and focusing on a, you know, at least a mid-teen operating rate, if not better. This is how we're setting up our plans for next year.
Helpful call. Best of luck.
Thank you.
Our next question comes from the line of Paul Lejuez with Citi. You may proceed with your question.
Hi, this is Kelly Crago along with Paul. Thanks for taking our question. I was just curious, with the brand sales running down high single digits versus last year's quarter-to-date versus the down 2% you saw in 2Q. I was just wondering if you could help us think about that deceleration by brand. I'm just curious, given the inventory position has improved so much, is this kind of a function of having, you know, less clearance sales available that might have, you know, drove some of the sales in 2Q and you're just not expecting that? Just any thoughts there would be great. Thanks.
Let me hit the last part of that question first. The, you know, the $30 million impact to the second quarter profitability to get ourselves right to that inventory, devalue that inventory, it's really down to, you know, bringing summer goods into August at a historical clearance level. We still have. I'll just leave it at that description. We're in line, and we think we're in a good place in terms of typical historical clearance levels coming into August and the sales related to those units.
As far as AE's trend, if I think that was the first part of your question, yeah, I think we expected coming into Q3, you know, on top of a very hyper back-to-school season last year with, you know, really not having a 2020 back-to-school stimulus checks out there again starting in July last year, just that pent-up demand and the, you know, amount of money that came to us during back-to-school in the brand because we are such a back-to-school destination. We knew AE lapping that period was going to be tough, so we actually planned for Q3 a bit of a deceleration versus the plan for the first half already, you know, that was part of the plan initially.
Not necessarily surprised by that, based on the macro conditions out there and knowing what kind of back-to-school we were lapping last year. I think we're, you know, maybe Jen can take on the product side, what we're seeing so far during fall and what we're expecting go forward. We're expecting that to normalize a bit knowing, you know, we come out of that hyper back-to-school period here after Labor Day.
I think you said it well, Mike, just really after coming off of the swim, a little bit of a hangover with the swim business and Aerie and summer. Honestly, you know, obviously both brands had incredible tailwinds last year. AE's just getting going. You know, this is a fairly new team, and we did have, you know, a little bit of that benefit last year with the stimulus and lapping the tailwinds that a lot of retailers benefited from. I like what I'm seeing on the AE team. We're very conservative. We're sticking with our strategy. Like I said, we're testing and scaling new product categories. We have some excitement coming up for spring 2023.
I can't tell you my secrets, but some new launches in the AE brand and, you know, we're not gonna stop there. I, like I said, it's a fairly new team, and I like what they're doing. They're turning into a very well-oiled machine. The Aerie team, again, we have so many new ideas, so many new categories. I mean, I mentioned it. We just launched that SMOOTHEZ category. Let me just say in one day, we thought we saw 30% increase in traffic to the direct site that one day when we launched that campaign.
Again, you know, we have to keep on, you know, challenging ourselves to comp year-over-year, whether it's marketing, product, production, but that's where we're into right now, and that's what we're thinking about 2023 and beyond.
Thanks. Just to clarify, the American Eagle brand is kind of driving the deceleration in brand sales quarter to date relative to 2Q more than Aerie?
Do you mind repeating that? Sorry. You faded out a little bit during your question.
Sure. Just, it seems like the American Eagle brand is driving the deceleration in brand sales quarter to date relative to what you saw in the second quarter. It's more coming from the American Eagle brand versus Aerie.
I think it's just based on their likes if you're looking at last year. Aerie, you know, has year-over-year, quarter-over-quarter likes that are, you know, high double digits. AE saw nice benefits last year, as I mentioned, from the stimulus. I think if you just are looking at last year, that might be what you're comparing. Like I said, we're looking at the business going forward. You know, it's really interesting, and I'm gonna pivot here for one second, but there are a lot of conversations out there, what's happening in retail, whether it's getting all, you know, dressed up, and certainly the luxury sector seeing some, you know, benefits of weddings and what have you.
I have to tell you, casual lifestyle apparel is not going away with our sector. I watch my daughter every day going to school in sweats and a hoodie, and it's here to stay. I think American Eagle and Aerie does it best as far as comfort, casual lifestyle, you know, wear, and that's what we're up to, and that's what we're focused on in the future.
Thank you.
Our next question comes from the line of Marni Shapiro with The Retail Tracker. You may proceed with your question.
Hey, guys. I'd actually like to take a little bit of a step back. Jay, I want to address this to you because we've been through and certainly you've been through periods of time where the customer has, you know, pulled back for a moment in time. It sounds like there's a lot of, you know, confidence still here at the company. You cleared out the inventory. You're positioning for the back half. I guess, broadly speaking, knowing what you know, knowing what you've been through, what gives you the confidence for the back half and next year? Is it the brand strength? I guess, you know, how do you think about holiday and further into 2023?
Let me ask you, was that question to Jen or is that question to me? I, you know, I didn't hear what you asked.
That's to you. I mean, you've been doing this as long as I've been doing this, so
Look, I've been around, like, a few go-rounds here. We have a great team at American Eagle. The people we have, the merchants we have are top-notch. They, you know, they didn't go bad one day. You know, they, you know, they are top-notch. You know, Jen said that, you know, in American Eagle, you know, like, we put some new designers in, it takes time for people, you know, to get, like, acclimated with, you know, with the brand. But the stuff that I see and the stuff that I see that Jen and the team's working on for the holiday season and for the spring of 2023 looks very exciting.
also introducing new concepts into the brand, not just introducing more denim but introducing some additional fresh product and some new type of product too, which would be very exciting. You know, we emphasize that this past quarter we opened, you know, it was our biggest opening of, like, Aerie stores, which we should get the benefit of the future.
You know, today, I don't want to get too excited because you know, say something and all of a sudden something else pops up somewhere else, you know, as far as, like, the rest of the world. I feel very good about the company. I see, you know, the freight rates are going the right way. Our timing's coming back on. You know, this past two years, everything got out of sync.
You know, we had countries close up on us.
Yeah.
We had to put stuff on containers, and containers all of a sudden got backed up in ports. It was, you know, it's been a strange year. Like Jen said, she was smiling because she was able to chase a product and get it in 19 days.
We haven't had that happen to us since the beginning of 2020. That's a very good sign for us to get, you know, to get back in sync.
That's great. That's a lot to follow.
I think the company is, you know, gonna be in great shape. To see the way that, you know, investors carry on, I can't control that. The only thing I can control is what we do, and we have a great company, and we have great vision. You know, we're very innovative, whether we're innovative in merchandise, whether we're innovative in our technology. I think if you walk into the malls, we're the best looking store in the malls. You know, we're figuring out more efficient ways of getting the merchandise to the customer and to the stores. I think we're doing a lot of stuff right. I think, you know, we got caught up in, you know, this past year, you know, going against last year's figures.
For the future, I think, you know, I think we'll be one of the big winners out there.
That's great. Thank you.
Our next question comes from the line of Adrienne Yih with Barclays. You may proceed with your question.
Great. Thank you very much. Actually, Jay, this might still be for you, but anybody who wants to comment on it. Can you talk about the changing competitive landscape? I know that we have always talked about kind of fast fashion, then there's faster fashion with boohoo and ASOS, and now there's hyper fast fashion with competitors such as Shein. I'm just wondering how often do you, kind of in your research, how often do you compete against them, and what does that do to the overall kind of pricing pressure? For Mike, when you talk about a pause in the dividend, would that imply a pause in repurchase activity as well, or are those two distinct events? Thank you very much.
Hey, I can take that if you want. As far as,
Yes
You know, fast fashion and competition. Look, there's always competition. I mean, that's what our job is, right? To compete and to try to do it better than anyone else out there. You know, certainly we're humble, and we certainly pay attention to the new up-and-comers, Shein being one of them. Look, we look at building our brand. You know, we're brand builders. We protect our brands, both American Eagle. I mean, certainly American Eagle is something to be proud of, and Aerie, the new up-and-comer. You know, that's what we're up to. You know, we are up to building our brands, protecting our brands, not turning on a dime. I think slow and steady wins the race, in brand building and how we think about our business.
We think long term, right? You know, obviously the retail sector's been hit a little bit, you know, more recently. You know, we're in this for the long haul, and I like what I'm seeing in the future. Jay already said it. He said, you know, there's innovation out there that's up and coming. We have new ideas every day. We have some really new exciting concepts that we're gonna launch. We stay focused. We stay in our lane. Something I tell our teams every day is just stay in your lane, stick with our brands, and look ahead, and make sure that we're innovating and competing on our terms.
That's very helpful.
Yeah, you know, and Jen, you talk about concepts, you know, we have Todd Snyder, which is a on fire brand.
Yeah.
Mike, you want to talk about that a little bit, Mike, over in PAL?
Yeah, sure. I mean, look, we're, you know, we're not just working on American Eagle and Aerie, and obviously doing some great innovative things there. We're also incubating new brands and new businesses. You know, one of the things we're proud of as a company is we're not resting on our laurels. We're not solely dependent on one business to drive the company, but we're looking for ways to grow it into the future. We have Todd Snyder, which is up well over 50% this year. We're expanding its footprint, opening more stores. It's still an 80% digital business. It's going to be profitable, growing nicely.
We're incubating on Unsubscribed, which is an exciting new concept that Jen and team launched quietly last year that has about five stores open and is doing very nicely. Of course, we're investing in Quiet, which is a business that not only is it providing benefits to American Eagle, but we're very excited about where that's headed and the potential in that business.
That's very helpful.
Thank you.
I can handle the yeah Adrienne your question on the dividend. I think. Look, our priorities are the same. We investing back into the business first, which we've done pretty aggressively in the last two years, and are continuing this year. We've talked about the 100+ Aerie and OFFLINE locations, and we continue to invest in our digital and supply chain capabilities this year with other projects. On top of that, we've already returned $265 million back year to date to shareholders between $65 million in dividend and then the $200 million ASR that was strategically tied to that early convert settlement to offset the dilution of the shares we issued there. That $265 million is the highest we returned to shareholders in a year since 2015.
I think Jay and I both said that in our prepared remarks. At this point now we're looking at, you know, improving profitability in the back half, generating positive free cash flow in the back half into next year. I'm confident we'll get back to some level of appropriate dividend and investing back in the business first where appropriate, some level of appropriate dividend and then, you know, opportunistic share repurchase is the way we've approached it. We will definitely. We've had the history of returning cash to shareholders, and we will definitely get back to that once we build our cash position a bit here.
Fantastic. All very helpful. Best of luck.
Thank you.
Our next question comes from the line of Kimberly Greenberger. You may proceed with Morgan Stanley.
Great. Thank you so much. I wanted to just check on inventory. If you could talk about how much you expect inventory to be down at the end of the year, that would be great. I'm just cognizant that at the end of fourth quarter last year, inventory was up around 24% compared to 2019. Looking at, you know, the revenue run rate here in the second quarter, revenue, total revenue is up only looks like about 15%, compared to the second quarter of 2019. I'm just wondering if, you know, how much you think you could cut, inventory by the end of the fourth quarter, and what would your preliminary plan be for, how much, you would expect inventory to be down next year? Thank you.
Thanks, Kimberly. I think the fourth quarter right now, I mean, a lot of volume to go, a lot of business to be had. Our projections as we sit here today, we would be down in the double-digit range. Something probably low double to maybe mid-teen. That's again a preliminary projection. We'll refine that as we go. For next year, we are gonna plan conservatively. This is still an uncertain environment. I think the great thing we're excited about is that we're back to, from a timeline perspective, as Michael talked about it, being able to chase again. We're not committing to inventory, you know, three to six months earlier like we had to in the past 12 months.
That's part of our issue in the spring season is how early we committed to those plans and didn't have much flexibility. We're looking at spring as we speak. We've had some initial conversations, some initial POs have been placed, but we're keeping a lot open and keeping ourselves flexible now that, you know, timelines are back to, you know, some of the historical flexibility that we're used to.
That's really great color. Thank you for that. On the $70 million in freight relief in the back half, I'm wondering if you can help us understand how that portions out between Q3 and Q4. You also alluded to some savings you anticipate in the first half of the year next year. Any numbers you can help us with on that would be great. Thanks.
I think it was $10 million in Q3 and $60 million in Q4 was the air freight.
That's right, Mike. Yeah.
Yes.
Yeah. It was $10 million in Q3, Kimberly, and $60 million in Q4 for the air freight.
Some of that air freight carried over into Q1 a bit with goods that we sold. That's when we incurred that expense, and we actually sell the unit. So, some of that impacted Q1 as well, and we see some benefit there, we believe, too.
Okay. That's great color. Thanks so much.
Our next question comes from the line of Janet Joseph Kloppenburg with JJK Research Associates. You may proceed with your question.
Hi, everyone. Good evening. I was wondering, Jen, if you could talk a little bit about the shift in denim. We're hearing a lot of mixed reads on denim right now, and maybe some disappointment in back-to-school performance. If you could talk about that and if there's a shift towards, you know, something dressier or maybe pants and how American Eagle might be positioned for that. As we look to the future and you talk about introducing new concepts, I'm just wondering if some of this dress up trend that we're seeing prevalent today is something that American Eagle can participate in. Perhaps if some of your new concepts are built around that or if you think the dress up trend is just a temporary moment. Thank you.
You know, how are you, Janet, by the way? Yeah, I'm really.
Good. How are you?
Doing well. You know, like I said, I think the casual trend is here to stay. Certainly our generation and the generations to come love casual, comfortable sportswear, which I'd like to say we do best. When it comes to denim, there's definitely some shifts, Janet, and we're certainly reacting to it. We've been working on the inventory. That was a big piece of the inventory rationalization that we need to do from an AE standpoint, and we've been working on that. Inside of denim, there are some great hotspots that we're seeing that we're able to now, you know, go in and double down on some of these, you know, baggier fits that you're definitely seeing out there, flare. We always have our staple in jeggings.
There is a shift for sure into some other bottoms that we're starting to see, and certainly, we're testing all of the silhouettes as we speak. Again, we've actually like, we've initiated a whole new test and scale, not even just based on, you know, the timelines that we're getting now based on, you know.
Just the logistics freeing up, we're actually trying new testing scenarios that are gonna make us even more smart or smarter, I should say, for the future. Those are in play right now. We're gonna get results very soon, and we're gonna be able to, as Mike and Michael said, we're gonna be able to implement those tests for spring and on the go forward. There are some new exciting trends happening in bottoms, so we're excited about that. When it comes to our new idea, I can't tell you, but it's very exciting. It will be launched for spring 2023. It's a new concept for us and I'm pretty excited about. We've already had some early reads on some of the product categories and very well received.
Very well received. More to come there. I can tell you one secret. It's in the American Eagle brand. Very exciting.
Great. Okay, Laura, I think we have time for one more question.
Okay. Our last question comes to the line of Dana Telsey with Telsey Advisory Group. You may proceed with your question.
Good afternoon, everyone. As you think about the Aerie business and the rate of growth, can you talk a little bit about store openings? Obviously, you've opened a lot of stores over the past few years. How do you think of current store metrics, and how do you think of the growth of existing stores and what you're doing and adding on the product front? Thank you.
We know Jay should answer part of it.
Yeah.
The part of it also is, you know, like, we're very excited about Aerie and OFFLINE. OFFLINE is a new concept for us. It's being very well received. We think it's a big opportunity there too. Now, Mike, what do you wanna add?
Yeah, I can just say, I think it's a good question, Dana. It's very. It's something we're very focused on, not just for the back half, but we're really. I think it's a major opportunity for us next year in terms of improved profitability, obviously for the brand, but then, you know, impact of the company as well. We, you know, we know that when we open these many stores, we do have a short-term comp impact because, as markets absorb these new locations and, you know, digital shoppers in those markets kinda go to the new stores. We see a ramp-up of customers and what we call our digital halo effect, you know, six to 12 months later.
If you think about these 100 stores we just opened, we'll carry these into the back half, you know, get our plans right set around them, focus on that into 2023, and that digital piece of it kinda kicks in. You can do some of your own math on just the implied revenue growth from these stores. If we believe, you know, inventory being positioned conservatively but appropriately to drive the right margin rates, expense focus, we can be mid- to high-teens operating rate, and that will be our goal for the brand. Off of this year's kinda guided profitability, it means significant impact to next year in our minds, and that's where we're already focused on that.
Thank you.
For next year, as we talked about, look, we wanna grow into these investments. We've $250 million in capital last year, $250 million capital this year. A lot of it tied to these Aerie and OFFLINE stores. You know, from a cash flow perspective and, you know, the sort of philosophy that we wanna generate positive free cash flow and focus on the profitability of the investments that we've made, we're probably gonna look at a, you know, relatively smaller new store count for next year just so we can focus on that. We still believe there's runway in terms of store growth over the next three years.
I think there's just a lot of benefit to focusing on the profitability of what we've already invested in over the next four to six quarters.
Thank you.
Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn this call back over to Mr. Jay Schottenstein for closing remarks.
Okay. Thank you for joining us today and hopefully next earnings calls, that we'll, you know, like, we'll have more positive news.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your day.