American Eagle Outfitters, Inc. (AEO) Q3 2018 Earnings Conference Call Transcript

American Eagle Outfitters, Inc. (AEO -0.13%)
Q3 2018 Earnings Conference Call
December 11, 2018, 4:15 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the American Eagle Outfitters, Inc. third quarter 2018 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 *0 on your telephone keypad. As a reminder, this conference is being recorded.

I'd like to turn the conference over to your host, Judy Meehan, Vice President of Investor Relations. Thank you. You may begin.

Judy Meehan -- Vice President of Investor Relations 

Good afternoon, everyone. Joining me today for our prepared remarks are Jay Schottenstein, Chief Executive Officer, Chad Kessler, American Eagle Global Brand President, Jen Foyle, Aerie Global Brand President, and Bob Madore, 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 on 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 the company's new external website at www.aeo-inc.com in the investor relations section. Here, you can also find the third quarter investor presentation.

Consistent with the retail calendar and the 53rd week last year and the third quarter's financial report and discussion today reflect the quarter ended November 3rd, 2018 compared to the quarter ended October 28th, 2017. Comparable sales are shifted to reflect the comparable period of the quarter ended November 3rd, 2018 against November 4th, 2017. Thanks. Now, I will turn the call over to Jay.

Jay Schottenstein -- Executive Chairman and Chief Executive Officer

Okay. Thank you, Judy and good afternoon, everyone. Thanks for joining us today. I'm very pleased to report another outstanding quarter in which we delivered record third quarter sales. For the first time ever, we reached third quarter revenue over $1 billion. Additionally, this marked the 15th consecutive quarter of positive comp growth for AEO. This was quite an accomplishment and demonstrates the strength of our brands and meaningful progress over the past four years.

Consolidated comparable sales increased 8%. We achieved strong topline growth across brands and channels on lower promotional activity leading to higher gross profit. American Eagle and Aerie had extremely well-executed back to school and fall seasons. With a comp increase of 5%, American Eagle built on its number one overall brand position and leading jeans business. Aerie achieved an impressive comp increase of 32%, the 16th consecutive quarter of double-digit comp growth.

Store comparable sales rose 6%, continuing a positive trend for four quarters now. Once again, our online sales increased in the double-digits. The clear focus on our strategic priorities and execution against these priorities have delivered results and will guide us into the future. These strategic priorities include leveraging our leading brand position at American Eagle to expand our market share, accelerating the growth and expansion of Aerie, elevating the customer experience, and delivering financial returns.

American Eagle continues to dominate as a real youth-inspired brand with a team that consistently delivers outstanding quality, compelling new styles, and great fits. In addition to being a leading jeans and bottoms business, we are highly focused on fueling all categories to complement our bottoms business and build great outfitting. Expanding our reach and building on a great brand platform of inclusivity and youthful optimism will guide future growth.

Aerie is rapidly gaining share in the intimate apparel market as a leader in the body positivity movement. Market share gains have been impressive and results have been spectacular. Still in the early stages of growth, Aerie is a significant growth engine for AEO Inc. We are accelerating that growth with our sights on the next brand milestone of $1 billion.

I'd like to congratulate Jen and the entire Aerie team for being honored by Adweek with the prestigious Brand Genius Award for apparel. This honor places Jen and the team as one of the boldest and most imaginative brand leaders of the year. We put our customers at the center of everything we do. Strengthening our connection, engagement, and overall customer experience is a major strategy.

Our physical stores are important to our business. Over the past years, we've been raising the bar in the field organization to improve in-store service levels. It's absolutely critical to have the right associates engaging customers and driving a great shopping experience. The store team has been delivering and investments are paying off. We are seeing some of the highest store comps in years, driven by higher conversion, improved traffic, and transaction growth.

We're also focused on expanding our marketing reach and improving experiences with targeted emails, product recommendations, and digital marketing tactics. Our efforts in data analytics and customer insights will continue to put our brands in a leadership position. I'm so proud of our digital team where we've seen tremendous, consistent growth leading us to over $1 billion in online sales.

Record volumes posted this Thanksgiving in Cyber Week with our highest-volume days ever and were executed seamlessly. We made some omnichannel investments, including a new digital call center, distribution facility automation, and we are transitioning to an updated digital platform this year.

These advancements will provide customer experience upgrades and take us to $2 billion and beyond. Smart investments in our brands, channels, and our people will support further growth and long-term success for AEO. On the heels of a strong third quarter, we are pleased with our holiday sales results.

Today, I'd like to take a minuet to congratulate and thank the team for outstanding execution and performance. As we look ahead to 2019, in April we will celebrate 25 years as a public company. We are honored to be recognized as retailer of the year by American Apparel and Footwear Association.

Today, we're operating two of the most successful and recognizable lifestyle brands in the marketplace with much significant growth ahead. Thanks and happy holidays to all of you. Now, I'd like to turn it over to Chad.

Chad Kessler -- Global Brand President, AE

Thanks, Jay. Good afternoon, everyone. I'm excited to report a record third quarter for the American Eagle brand. We had best ever results in both sales and merchandise margin. Comparable sales increased 5%, building on a 1% comp increase last year. We saw momentum across our businesses, including a positive store performance for the fourth quarter in a row and continued robust online sales growth.

All geographies were also positive in the quarter. Within merchandising, we saw broad-based strength, with both genders posting positive comps. We continue to make progress in men and the women's business remains strong. AE Jeans continue to set record volumes and we delivered the 21st consecutive quarter of positive comps and best ever sales in both men's and women's bottoms.

As the destination for jeans and bottoms, we are capitalizing on emerging silhouettes and a new fashion cycle. As I've discussed on prior calls, reducing promotions and improving gross profit flow through have been major priorities. By leveraging our brand strength and strong customer demand, we pulled back on promotions and markdowns resulting in an improved gross margin.

The team is executing at a very high level. We are interpreting exciting new fashion trends and continue our speed sourcing strategy to fulfill demand and deliver more newness about the season. Our women's business is particularly strong across the board. Our focus on accessories is paying off, comps have turned positive and we see plenty of runway ahead.

Our AE X ME campaign has been very well-received. We are featuring real customers and highlighting individuality and diverse style. We are giving our kids a voice and letting them lead our brand. More and more young people today want to support brands they believe in. Our values of individuality, inclusion, and diversity align with the expectations of today's consumers. Our platform is improving brand perception and strengthening our customers emotional connection to American Eagle, which is driving more frequent shopping and a higher average spend.

Holiday is off to a very good start and I'm optimistic that we'll report another strong quarter. We achieved record volumes over Thanksgiving and Cyber Week shopping period while containing promotional activity. It was exciting to walk the malls on Black Friday and see both AE and Aerie with some of the highest traffic levels. Our investments in stores and customer service delivered. The stores looked great. We converted more traffic and offered our customers an improved experience that drove stronger sales results.

My congratulations to the entire team for the exceptional and consistent performance. We look forward to continued growth and success. Now, I'll hand it over to Jen.

Jennifer Foyle -- Global Brand President, Aerie

Thanks, Chad and good morning or afternoon, everyone. I'm absolutely thrilled with our third quarter performance. Aerie has posted comparable sales growth of 32%, building on positive 19% comp last year. This was one of our best comps ever. We hit a number of milestones, including our 16th consecutive quarter, four years of double-digit sales growth. We also delivered third quarter results on less promotional activity and higher margin flow through.

Our sales metrics were positive across the board. Traffic was particularly strong as we continued to gain brand awareness and grow our customer base. We also saw broad-based category strength with all major areas up to last year. The Aerie Real bra launch was a huge success as our customers embraced our proprietary fit technology, great style, comfort, and an expanded size range. We look forward to building on our real collection as we move forward.

Strength across apparel was another significant highlight of this quarter, which produced our strongest year-over-year increase. The team has done a nice job of adding newness, softness, and innovation in tops, which perfectly complements the bottom business and completes the Aerie lifestyle.

Another call out was strength of our stores business, which posted its highest comparable sales increase ever. We saw nice growth in both stand-alone and side by side formats. New markets are performing great and we look forward to accelerating store growth to 60 to 70 openings next year.

On the marketing front, I was so pleased with the enormously positive response to our most inclusive campaign yet, which featured a diverse cast of real women. We continue to build on our leadership position within the body positivity movement and give real women a positive inspiration.

We entered the holiday season with strong momentum and we are pleased with the early holiday results. Our focus is on surprising and delighting our customers with great gift-giving ideas, outstanding quality, and value throughout the season. Congratulations to this entire Aerie team. This team works with such passion and they inspire me every day. Thanks for being true ambassadors of Aerie Real.

Thank you. Now, I'll turn the call over to Bob.

Robert Madore -- Chief Financial Officer

Thanks, Jen and good afternoon, everyone. In the third quarter, we delivered consistency and positive performance across brands and selling channels reflecting the strength of our brands and investments to elevate the customer experience. Results were generated on less promotional activity and healthy quality of sale metrics. My comments will compare to the adjusted third quarter and year to date financials, which excluded certain items as detailed in the press release and the tables on pages six through eight of the investor presentation.

Total revenue increased $43 million or 5% as we achieved our first $1 billion third quarter in AEO's history. As noted on our last earnings call, total revenue this quarter excluded a higher volume back to school week, which shifted into the second quarter while we gained a lower volume week in early November. The impact of the shifted retail calendar reduced third quarter total revenue by approximately $40 million, which adversely affected operating income.

Comparable sales, which are shifted to reflect the like for like period, increased 8% following a 3% increase last year. Additional sales information could be found on page nine in the investor presentation. By brand, third quarter American Eagle comps were up 5%, building on a 1% increase last year.

Aerie comps increased 32% following a 19% increase last year, marking the 16th consecutive quarter of double-digit comp growth. In the third quarter, stores posted a 6% comp increase with positive results across both brands. Investments in talent and store payroll had delivered meaningful improvements in the stores sales trends, with positive comps and more consistent results for four straight quarters.

The online channel was also strong, posting double-digit sales growth for the 15th straight quarter, now contributing approximately 27% of total revenue. The quality of sales were healthy, with store conversion, average unit retail price, transaction value and the number of transactions all positive to last year.

Additionally, both brands outpaced mall traffic. Total gross profit rose 7% to $399 million from gross profit of $375 million last year. The gross margin rate increased 80 basis points to 39.8% of revenue due to lower markdowns in rent leverage, which was slightly offset by higher delivery cost due in part to increased digital transactions. Selling, general, and administrative expense of $248 million increased 14% from $217 million last year. As a rate to revenue, SG&A rose 220 basis points to a rate of 24.8% to sales.

The majority of the dollar increase was due to customer-facing store payroll, higher wages, increased incentive expense, and advertising. As Jay noted, we made key investments in our brands, customer experience, and people. These efforts are delivering improved comparable sales with stronger conversion, increased transactions, and average transaction size, in addition to increases in sales per hour.

Depreciation and amortization expense decreased 2% to $42 million, leveraging 30 basis points to 4.2%. Operating income decreased 5% to $109 million from adjusted operating income of $115 million last year. The operating margin declined 110 basis points to 10.8% as a rate to revenue.

To eliminate the noise of the shifted retail calendar, it's helpful to look at the year to date period presented on pages 7 and 8 of the investor presentation. Year to date, adjusted operating income is up 14% and operating margin increased 40 basis points compared to the same period last year.

Other income of $4 million is comprised of interest income and a vendor settlement, this compared to other expense of $13 million last year due to a discreet charge resulting from a reserve an against an account receivable. The effective tax rate decreased 24.3% compared to 35.1% last year, primarily due to the impact of the US tax cuts and Jobs Act. Earnings per share of $0.48 increased 30% from adjusted EPS of $0.37 last year, exceeding our guidance of $0.45 to $0.47.

Now, regarding inventory, which can be found on page 11 of the investor presentation -- we ended the quarter with inventory at cost of $592 million, up 11% from last year. The increase was primarily due to strong customer demand. Additionally, 3 points of the increase reflected earlier holiday receipts due to the shifted retail calendar and 2 points of the inventory increase supports 11 clearance stores, up from 5 stores last year.

Looking forward, we expect fourth quarter ending inventory to be up in the mid to high-single digits. Capital expenditures totaled $43 million in the third quarter and we continue to expect CapEx to be in the range of $180 million to $190 million for the year. Roughly half the spend relates to store remodeling projects and new openings and the balance to support the digital business, omnichannel tools, and general corporate maintenance.

In the quarter, we repurchased 1 million shares for approximately $25 million. 15.7 million shares remain authorized under our repurchase program. Including our cash dividends, the company returned a total of $50 million to shareholders in the quarter. Strong cashflow led to a 40% increase in cash in equivalence, ending the quarter with $360 million, up $102 million from last year.

Turning to our real estate portfolio, additional store information can be found on pages 14 through 16 in the investor presentation. We are on track to open roughly 40 Aerie stores this year and 5 AE stores net of closures. Next year, we're accelerating Aerie's growth with 60 to 70 new locations and 15 to 20 American Eagle stores.

We will also continue to focus on further global expansion with our licensed store strategy. Stores are very important to how we operate our business and engage with our customers. We have a highly profitable real estate portfolio and we will continue to invest in store remodelings to upgrade the fleet.

Now looking ahead, we expect fourth quarter earnings per share of $0.40 to $0.42 based on comparable sales in the positive mid-single-digits and revenue growth in the low single digits. This guidance reflects approximately $60 million of lost revenue and $0.07 of reduced earnings per share as a result of operating with one less week in the fourth quarter than last year.

Investments in our brands, customer experience, and our people will carry into the fourth quarter. We expect SG&A expense to increase in the low double-digits compared to last year. Additionally, the fourth quarter guidance assumes a tax rate of approximately 27% due to the impact of recently updated tax reform, transition tax legislation, and other discreet items.

Our fourth quarter guidance compares to adjusted EPS of $0.44 last year and excludes potential impairment and restructuring charges. In closing, congratulations and thanks to the entire AEO team for delivering a great quarter.

Thanks and now we'll open up the call to questions.

Questions and Answers:

Operator

Great. Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 if you would like to move your question from the queue. For participants using speaker equipment, it may be necessary to make up your handset before pressing the * key. One moment please while we pull for questions.

Our first question is from Brian Tunick from Royal Bank of Canada. Please go ahead.

Brian Tunick -- RBC Capital -- Analyst

Thanks for taking our question. In terms of the mid-single-digit fourth guide that would pose an acceleration on a two-year stack, I'm just wondering when you look at the comp drivers here in 4Q, what do you think has really switched on relative to 3Q? Then Bob, I heard the SG&A dollar guidance were low double-digits in here Q4, if you could help us think about a run rate into 2019 and any considerations we should take into light between the first half and the back half. Thank you.

Robert Madore -- Chief Financial Officer

Sure. Our comp performance has been very strong and it's really been supported by a number of things. Our product looks fantastic. The brand awareness and the strengths of the brands is spectacular. The investments that we've made in advertising have paid off in addition to the investments we've made in store payroll, just demonstrated through the strength of our comps in stores, the conversion rate going up and the number of other metrics I've highlighted before. It's a number of things, not one particular things or two particular things.

Related to your second question, run rate for 2009 on SG&A, we this year have invested significantly in advertising and store payroll in particular. You can think of next year as having that worked into the base and us having the ability to actually leverage SG&A expenses. We're in the middle of our budget process right now. It's not complete and we're going to give out guidance at the end of the fourth quarter, but you can definitely think about leverage next year.

Operator

Our next question is from Adrienne Yih from Wolfe Research. Please go ahead.

Adrienne Yih -- Wolfe Research -- Managing Director

Good afternoon. Let me add my congratulations. Bob, I was wondering if you could help us with some of the four-wall metrics for the Aerie concept. And then Chad, if you could talk about sort of the evolution of the fashion shift. We've heard it's very teen-specific. It seems like it's gaining traction in the back half of the year and the outlook for spring. Jen, congrats again. I wanted to know what you've done differently to get merch margin accretion or expansion after in the mid-year being somewhat impacted by some of the actions that Victoria's Secret was struggling through. Thank you very much and congrats, everybody.

Robert Madore -- Chief Financial Officer

Thank you for the question, Adrienne. We don't disclose four-wall metrics on a by brand or concept basis, but what I will say is with Aerie's phenomenal growth, demonstrated by the 32% comp on top of 19% and I think it's the highest comp they've experienced, that business is on fire. We've said that for a while.

I think we're demonstrated the profitability of that store through the acceleration of store openings, 60-70 next year, for sure. Aerie has been, continues to be a positive profit contributor to the company and is continuing to grow their operating margin by leveraging their overhead expenses on real strong topline growth.

Chad Kessler -- Global Brand President, AE

In terms of fashion trends, I think we're definitely benefiting from new silhouettes in the marketplace. The customer is really responding to the assortment, both in men's and in women's. I think we're seeing silhouette changes in bottoms impacting tops as well as accessories. We're seeing positive response to it. I don't want to talk about how we see that evolving through the rest of Q4 into the spring, but I will say I'm very excited for what's coming and happy to see the customer response.

Jennifer Foyle -- Global Brand President, Aerie

Adrienne, I think Bob articulated it well regarding the merch margin in Aerie. However, the most important thing I can ever say about Aerie is we continue to evolve what real means to our customer and I think competition is following us and what we keep on doing in Aerie is looking forward and ahead in how we're going to surprise and delight our customer with a powerful campaign and a strong -- we represent everybody and we believe in women and I think we're going to do some really surprising things coming your way when we hit spring. So, we're really excited about the future.

Operator

Our next question is from Simeon Siegel from Nomura Instinet.

Julie Kim -- Nomura Instinet -- Analyst

Hi, this is Julie Kim on for Simeon. Thank you for taking our question. Can you give color on comp progression through the quarter and separately any detail on different trends between your full-price stores, outlet, and e-comm?

Robert Madore -- Chief Financial Officer

Yeah. Comp performance in the quarter was pretty steady and pretty consistent in the high single-digits. I will say it strengthened a little bit toward the end, but we were very happy with the consistent comp performance demonstrated through the entire third quarter.

Julie Kim -- Nomura Instinet -- Analyst

And if you had any color on the different trends between your full-price stores, your outlet, and your e-comm channel?

Robert Madore -- Chief Financial Officer

All performing very strong. E-comm, as we pointed out, was up double-digits. Stores had a six comp, pretty consistent across the board.

Operator

Our next question is from Janet Kloppenburg from JJK Research. Please go ahead.

Janet Kloppenburg -- JJK Research -- Analyst

Thank you and good afternoon. Bob, just a couple of quick questions -- it looks like the two-year stack on SG&A is accelerating. It's going to be higher in the fourth quarter than it's been all year. Maybe you can talk a little bit about that. Also, I think I missed your fourth quarter gross margin guidance. Do you expect markdown trends to continue to moderate?

Just quickly for Chad and Jen, Chad, the variation in leg openings that we're seeing in bottoms, how well does that transfer to denim, which accounts for the majority of your bottoms assortment? Jen, congratulations on that great comp. I'm just wondering what impact a higher penetration of apparel at Aerie may have on the overall product margins. Thanks.

Robert Madore -- Chief Financial Officer

Thanks, Janet for the questions. On the first one, SG&A, you have to go back -- there's a lot of noise, as I pointed out, with the 53rd week shift into Q2, out of Q3. We've been very clear that we are operating this business for the long-term. We're making very purposeful investments in advertising, stores payroll, capital to support our omnichannel initiatives and when you look at year to date SG&A, we've only deleveraged 80 basis points. When we look at year to date operating income, it's actually up 14% and has improved 40 basis points year over year.

So, the 53rd week really creates a ton of noise between Q2, Q3, and Q4, as a matter of fact. It's approximately $60 million of sales and represents $0.07 of EPS. So, when you're stripping out revenue of that capacity, that volume, you're going to see a little bit of deleverage.

Our level of investment in Q4 is expected to be the same level of increase that we saw in Q3, less deleverage than we experienced in Q3, but same dollar amount. Really, a good chunk of that increase is really comp-related, large, large chunk related just to incentives and a lesser amount related to continued store payroll investment. We're increasing our investment in advertising by $10 million in the fourth quarter. So, a number of conscious investments that we believe and we know are actually fueling the business and driving some really strong quality metrics.

As it relates to gross margin in Q4, I didn't give guidance on that, but I'm happy to. You should expect to see gross margin either flat or slightly improved from last years.

Chad Kessler -- Global Brand President, AE

Janet, as I said to Adrienne, we are excited about what we're seeing in the silhouette shifts. We're seeing silhouette shifts both in men's and women's bottoms. The wider leg openings have been more prevalent in softer woven categories, but we are not just a jeans destination. We are a total bottoms destination. So, we've been taking lots of advantage throughout the year. I think going forward into spring, without sharing too much, we have opportunities to leverage that across all of our fabrications. It's really exciting.

One of the things I love about working in the youth market is that the customer is always excited to try something new. When there's a new silhouette, new fashion, it's a great opportunity for her to update her wardrobe. I think we're taking advantage of that and I think we're going to continue to do that for all the quarters to come.

Jennifer Foyle -- Global Brand President, Aerie

Janet, I think Bob said it well as far as profitability in Aerie. It's not just apparel that's helping the product margins. Really, if you look at Q3, all businesses were highly successful and led to great flow through in Aerie. So, we're pretty pleased with all the categories that we're running right now.

What I love about Aerie is we are a lifestyle brand. So, we can throttle different businesses when they're trending and we're not just solely dependent on intimates, although that's what we stand for in Aerie. So, again, as we scale this business, we're going to see really nice flow through as we hit $1 billion. We're excite for that $1 billion mark.

Operator

Our next question is from Tiffany Kanaga from Deutsche Bank. Please go ahead.

Tiffany Kanaga -- Deutsche Bank -- Analyst

Thanks for taking our questions. I know you touched on it, but would you specifically recap how merchandise margin came in for the quarter? Given the slight AUR expansion in the quarter after a large stretch of larger increases, can you help work us through how you're working to drive further progress ahead, especially by category?

Robert Madore -- Chief Financial Officer

Yeah. Sure. So, as we pointed out, total gross margin came in at 80 basis points better. Our merch margin improved greater than that through markdowns being significantly lower than they were in the third quarter of last year. But merch margin was up over 100 basis points.

Chad Kessler -- Global Brand President, AE

AOE expansion, as we continue to grow the AE business, as we continue to grow the bottoms business gives us a lot of opportunity as the jeans and overall bottoms carry a higher ticket price. We're also seeing expansion as the brand gains more emotional connection and we have better value and better fashion and pullback markdowns. We're seeing high full-price sell through and better sell through in categories like sweaters and woven, which also carry a higher ticket.

Jennifer Foyle -- Global Brand President, Aerie

In Aerie, we're seeing nice increases in AUR, again, having the ability to throttle different trending businesses, including apparel, which is really doing great for us. That does obviously warrant a higher AUR. We are seeing nice improvements in Aerie.

Operator

Our next question is from Marni Shapiro from The Retail Tracker. Please go ahead.

Marni Shapiro -- The Retail Tracker -- Managing Partner

Hey, guys. Congrats on an outstanding quarter. Jay, I actually want to pick on you for a moment and ask a big picture question. You've been in retail a while. You've seen a lot of ups at downs even at American Eagle. Can you talk about how you feel about the brand health right now and how you vision it long-term? It feels to me almost like American Eagle is the new and improved GAP or Levi's and you are exporting the American dream to the world. I don't mean to raise the flag here and everything. It's an important brand name.

Jay Schottenstein -- Executive Chairman and Chief Executive Officer

We work very hard on the brand. We work very hard -- we take the merchandising very seriously. We put together a great merchant team. We're very proud of our bottoms business. Like I said earlier, we are going to be the denim destination. It's our goal to be the number one denim brand in the United States. We made a big investment in our team. We invest in our technologies for denim. We invest in the fit, the stretch, and we have to be the leader. We can't be a follower. We have to be the leader for that category and the authority for that category.

At the same time, we are committed to make our stores more exciting. We are opening a flagship store next week in Las Vegas, which will be a meg tourist attraction. We're looking for some other flagships. We're working technologies within the store to make an exciting experience for the customers that we'll be able to introduce in the next six to eight months.

We want to sell a whole experience. We believe there will be other categories in the future to expand on in the accessories area, beauty area. We see tremendous opportunity. With the tax savings we got, we wanted to reinvest by giving better service in our stores. We're very proud when you walk in the malls and you look at the shape of the condition of the stores and look at the merchandise display, I think we're the number one looking store in the malls today.

The malls that I walk in, our merchandise is set up right. We pride ourselves on the service level. We're one of the few retailers that didn't cut back on service. We've improved our service and are making that investment on services. At the end of the day, the customer today expects everything. They expect a great online experience as well as in-store experience. That doesn't happen by itself.

We believe we have to have good looking stores. We have to be able to offer certain excitement to the customer. We have to offer more services to the customer. We have the ability in our stores -- we are true omnichannel. We have the ability to ship from the store level, ship from the warehouse level, do reservations for the customer and we're adding more and more services at the store level too.

To be able to go four quarters and get comp store increases in today's world at the store level, I don't know many retailers that have done that. It doesn't happen by itself. We're investing more money in technology, doing more research, working with a lot of different companies to see what the latest stuff out there is.

We know this is nonstop. You can't sit on your laurels. We challenge ourselves as well as being able to offer beautiful-looking garments at a great price. One thing we pride ourselves on is we make affordable fashion for everybody. We believe we can offer better denim that fits lots of people and makes people proud to wear it.

Marni Shapiro -- The Retail Tracker -- Managing Partner

I think you've hit a nerve out there in a good way. Best of luck for the holiday season.

Operator

Our next question is from Oliver Chen from Cowen and Company. Please go ahead.

Oliver Chen -- Cowen and Company -- Managing Director

Thank you. Our question is about the omnichannel tools ahead -- what do you see as big opportunities in terms of making sure the experience is seamless and your mobile experience is where you want it to be. I would love any thoughts on AEO Connected and how that program is going.

Chad, I would love your thoughts on breadth versus depth of denim and how you're feeling about how that assortment is evolving in terms of how you're inventorying it as well as what the customer is wanting there. Then Jen, I would love your thoughts on any surprises from the very successful bra launch in terms of learnings there. Thank you very much.

Chad Kessler -- Global Brand President, AE

Sure, Oliver. Thanks. We're excited about all the omnichannel, what we're doing for digital investments going forward. One thing we do not yet have is buy online, pick up in stores. We have reserve in store, but we will be adding buy online, pick up in store, which from other retailers will be a good opportunity for us.

But we continue to invest in the platform. We're actually replatforming the site this next year, which will make it more easy for us to run the site globally and make more updates. We're also using our data tools to offer more personalization and segmentation across the site and in our communications with the customer, which we've just started to do and we're seeing a positive return there and think there's a ton of opportunity to speak in a more targeted way to our customers.

I think there's a lot we can do. Our mobile experience so far has been pretty great. We're driving the majority from our digital revenue from the combined mobile site and the app and we continue to see the customer shift more there.

We are thinking even further into the future about new experiences on the website and how to make the customer experience seamless, as you say, but how to make the customer experience seamless across all the channels. The customer, as you know, isn't really, I think, focused on whether they're shopping online or shopping in stores. They're really focused on the brand and on the product.

They want us as a brand to know them and anticipate their needs wherever they come to us. That is really our goal with the customer data we have and the site and the store experiences that we're building. I think you'll see that roll out over the next few years but starting with the site being replatformed this spring.

In terms of denim, part of our leadership in jeans is that we offer a jean for everybody. We have a jean for everyone. We have expanded sizing in stores and on the website. We'd love to continue to do that. We have, I think, the broadest range of silhouettes. We see productivity across all of those. It does require an inventory investment to run such a size intensive business, but we continue to see a positive return and great productivity across the breadth of the assortment we have. We love to make sure we can satisfy our customer with whatever he or she is looking for.

Jennifer Foyle -- Global Brand President, Aerie

The bra launch was amazing. As a reminder, we redesigned every bra frame in Aerie, which was a group effort. The whole team really rallied around that. That's a big undertaking. We knew we wanted to do something big. Anyone can launch a bra and we really wanted to do something that was going to be a little bit more remarkable to our customer.

We reached out to our customer base and they were the cast of this launch. It was so well-received just because it was really understandable and authentic. I think that's really the most important part of the campaign. Everything we do really is authentic. I think it has to come from inside the four walls for it to permeate out of the building. It was an amazing campaign.

I will tell you we left some money on the table, which I love. We added some extended sizes, smaller and larger and we saw them sell out. So, there's really good news there, which means we still have opportunity in bras to really grow that business and ultimately grow market share.

Operator

Our next question is from Jay Sole from UBS. Please go ahead.

Jay Sole -- UBS -- Analyst

Thank you. Bob, as the mix continues to shift to online, how did that impact margins in the quarter and how does your store margin compare to online margin at this point? Maybe one other question is as you add store payroll and store hours, how is that leverageable next year? Do you have to add more payroll and more hours next year to continue to grow the comp at a strong rate?

Robert Madore -- Chief Financial Officer

Our margins are actually very comparable between our digital business and our stores businesses. I know that's not the case in a lot of other circumstances, but it very much is ours. As it relates to store payroll and being able to leverage that, as I said, it will be in the base. Every incremental dollar sale doesn't necessarily drive incremental payroll. Our payroll model is tied more to traffic. I don't anticipate there to be a significant incremental investment required to drive decent comps next year at all.

Jay Sole -- UBS -- Analyst

Got it. If you talk about compensation for the quarter, is that a one-time thing or is that something amortized across all the quarters and as the performance of the company gets better, that increases for every quarter? Thanks.

Robert Madore -- Chief Financial Officer

It ramped up starting Q2 into Q3 and Q4. A lot of it was upgrades of talent in the field. Some of it was wage pressure related to increases in minimum wage or us increasing our wage brands to not only be competitive, but actually one of the leaders out in the industry. That's the main areas where we're seeing comp pressure. We may feel a little of it next year, but I think the bulk of it we're experiencing now and it's behind us.

Operator

Our next question is from Susan Anderson from B. Riley FBR. Please go ahead.

Susan Anderson -- B. Riley FBR -- Managing Director

Hi, thanks for taking my question and nice job on the quarter. I was curious what you're seeing so far for this holiday season around the promotional environment. Obviously, third quarter ended very well for you. Are continuing to see the environment fairly rational out there. Then also, I think I heard gross margin expectation for fourth quarter but not sure if I heard merch margin. So, just curious around your expectations around that. Thanks.

Chad Kessler -- Global Brand President, AE

I think we were very pleased with how we were able to contain promotions throughout Q3. I was especially pleased to see through the Thanksgiving week, which was obviously critical. We were slightly less promotional in the AE brand than we were last year. We exceeded everything, all of our metrics, all of our KPIs across that week. It was really nice to see that we were able to drive great traffic conversion in sales with a pullback promotion over that week.

I am seeing the holiday season is pretty promotional out there. It seems like a lot of retailers have maintained their Thanksgiving-week promotions through the month so far. This is a quarter that tends to be highly promotional and we anticipate that every year and we are prepared to compete in the promotional environment in Q4 and through the rest of December. We've got two weeks left. So, here we go.

Robert Madore -- Chief Financial Officer

As I pointed out, gross margin is planned to be flat or up slightly versus last year and merch margin should improve at a rate slightly below our third quarter improvement.

Operator

Our next question is from Jen Redding from Wedbush Securities. Please go ahead.

Jen Redding -- Wedbush Securities -- Analyst

Thanks. Hey, guys. Thanks for taking my question. It's a really high-level question. A lot of investors I speak with are focused mostly on the economic cycle. We're in a peak now, so they're looking at what comes next. Everyone's rightfully cautious from what we remember from 2008. I felt like last year, retailers in general were pretty positive on the consumer and I know there can be a long leg between -- I still think we have room to run. How do you guys feel about the consumer right now? Any change in how you were feeling about the consumer?

Jay Schottenstein -- Executive Chairman and Chief Executive Officer

The customer is out there buying. People have jobs. There's great demand for associates. So, there's no reason why it should be different than it's been the last few months.

Jen Redding -- Wedbush Securities -- Analyst

That's helpful. Thank you.

Operator

Our next question is from Janine Stichter from Jefferies. Please go ahead.

Janine Stichter -- Jefferies -- Analyst

Good afternoon. I wanted to ask a little bit more on Aerie. As you think about accelerating the new store openings next year from 60 to 70, how should we think about that splitting out between stand-alone and side by side? Any differences you're seeing in productivity between the two formats? Then kind of along those lines, any update you can give us on how many American Eagle shoppers current shop Aerie and where you see the opportunity going.

Robert Madore -- Chief Financial Officer

Related to Aerie's accelerated openings next year, it will be a pretty even mix between side by sides and stand-alones, probably, with slightly more stand-alone locations, then the side by sides because there are more available for a singular store than waiting for adjacent space next to an existing American Eagle store to open it up. I will say that out of the 15 to 20 American Eagle stores we plan on opening next year, I know we've already committed to more than half of those having side by sides.

So, it really depends on availability, but it will be a pretty equal mix if we're able to manage it accordingly.

Jennifer Foyle -- Global Brand President, Aerie

And it's about 50% of the American Eagle women's customer base. But the nice thing is as we open stores, we get about basically 80% of those customers online. So, that's what we're seeing. Now, the 65% number that we spoke earlier was the actual percentage of the business, but 80% of the shoppers when we open the store will give us their email. That's really good news as we move forward.

Operator

Our next question is from Laura Champine from Loop Capital. Please go ahead.

Laura Champine -- Loop Capital -- Managing Director

Thanks for sneaking me in. My question is about conversion. It's a pretty high-class problem, but it looks like your comp store traffic is growing faster than your transactions. What can you do to drive improved conversion in Q4 and beyond?

Robert Madore -- Chief Financial Officer

We had a 50-basis point conversion improvement in our stores business in the third quarter. Transaction growth is outpacing traffic. One of the KPIs that tells us that our investment in store payroll is paying off is we're actually able to drive transaction volumes in addition to higher AURs by servicing the customer better, getting people to try on bottoms. It's fueling our bottoms and denim businesses to record highs in addition to solid comps, nine, nine, eight, and guiding to mid-single-digits in Q4, as Jay said, we're really proud of that. So, I think the team is doing a fantastic job and I'd ask them to keep doing what they're doing.

Judy Meehan -- Vice President of Investor Relations 

Great. Thanks, everyone. Thanks for your participation today. Everyone have a great holiday.

Operator

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

Duration: 55 minutes

Call participants:

Judy Meehan -- Vice President of Investor Relations 

Jay Schottenstein -- Executive Chairman and Chief Executive Officer

Robert Madore -- Chief Financial Officer

Chad Kessler -- Global Brand President, AE

Jennifer Foyle -- Global Brand President, Aerie

Brian Tunick -- RBC Capital -- Analyst

Adrienne Yih -- Wolfe Research -- Managing Director

Julie Kim -- Nomura Instinet -- Analyst

Janet Kloppenburg -- JJK Research -- Analyst

Tiffany Kanaga -- Deutsche Bank -- Analyst

Marni Shapiro -- The Retail Tracker -- Managing Partner

Oliver Chen -- Cowen and Company -- Managing Director

Jay Sole -- UBS -- Analyst

Susan Anderson -- B. Riley FBR -- Managing Director

Jen Redding -- Wedbush Securities -- Analyst

Janine Stichter -- Jefferies -- Analyst

Laura Champine -- Loop Capital -- Managing Director

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