American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: The supplied filing is for the 13 and 26 weeks ended August 3, 2013, corresponding to the second quarter and first half of Fiscal 2013. The request metadata identifies “2012 Q2,” but the filing itself reports 2013 results and compares them with the periods ended July 28, 2012. Results are unaudited and seasonality affects comparability.
Business Context
American Eagle Outfitters operated one reportable segment comprising the American Eagle brand, aerie stores and AEO Direct. At quarter-end, the company operated 1,056 consolidated stores, including 921 American Eagle and 135 aerie stores, plus 57 international franchised stores. The company acquired six franchised American Eagle stores in Hong Kong and China for $20.8 million on May 31, 2013.
The former 77kids business is presented as a discontinued operation. There were no 77kids losses in 2013; the prior-year periods included significant 77kids losses.
Key Financial Metrics
| Metric | 13 weeks ended Aug. 3, 2013 | 13 weeks ended July 28, 2012 | 26 weeks ended Aug. 3, 2013 | 26 weeks ended July 28, 2012 |
|---|---|---|---|---|
| Net revenue | $727.3 million | $739.7 million | $1.407 billion | $1.448 billion |
| Gross profit | $245.5 million | $276.6 million | $509.1 million | $551.5 million |
| Gross margin | 33.8% | 37.4% | 36.2% | 38.1% |
| Operating income | $29.4 million | $61.8 million | $75.2 million | $126.1 million |
| Income from continuing operations | $19.6 million | $42.8 million | $47.6 million | $86.9 million |
| Net income | $19.6 million | $19.0 million | $47.6 million | $58.7 million |
| Diluted EPS | $0.10 | $0.09 | $0.24 | $0.30 |
Second-quarter comparable sales, including AEO Direct, declined 7%; American Eagle comparable sales declined 8%, aerie declined 2%, and AEO Direct increased 11%. First-half comparable sales declined 6%, with American Eagle down 7% and aerie up 1%.
- SG&A: $186.3 million in the quarter and $368.6 million year to date, up from $182.1 million and $360.7 million, respectively. SG&A increased as a percentage of revenue to 25.6% from 24.6% in the quarter and to 26.2% from 24.9% year to date.
- Taxes: Effective tax rates were 35.9% for the quarter and 37.2% year to date, compared with 30.3% and 32.8%, respectively, in the prior-year periods.
- Cash flow: Operating cash flow was negative $9.5 million for the first half, compared with positive $47.7 million in the prior year. Capital expenditures were $123.9 million, and net cash used in investing activities was $83.7 million.
- Liquidity: Cash and cash equivalents were $345.2 million and short-term investments were $59.7 million at August 3, 2013, for total cash and investments of $404.9 million. Working capital was $609.2 million and the current ratio was 2.31.
- Debt and credit: The company had no borrowings under its $150.0 million unsecured revolving credit agreement and was in compliance with its covenants. It had $8.3 million of letters of credit outstanding under that facility and $88.8 million of trade letters of credit outstanding under separate facilities.
- Inventory: Merchandise inventory was $461.1 million, approximately 1% below the prior-year level on a cost-per-foot basis. Ending units per foot declined 7%, while average cost per unit increased 6%.
- Shareholder returns: The company paid $24.1 million of dividends during the first half and declared a quarterly dividend of $0.125 per share. It repurchased $33.1 million of common stock under its public program and $23.3 million from employees for tax withholding.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue declined 2%, while first-half revenue declined 3%, primarily because of lower comparable sales.
- Second-quarter gross profit fell 11% and gross margin contracted 360 basis points, reflecting increased markdowns, higher delivery costs and rent deleverage from negative comparable sales.
- Second-quarter operating income declined approximately 52% to $29.4 million. First-half operating income declined approximately 40% to $75.2 million.
- Continuing-operations income declined 54% in the quarter and 45% year to date. Net income increased in the quarter only because the prior-year period included a $23.8 million after-tax loss from 77kids discontinued operations; first-half net income declined 19%.
- The effective tax rate increased because the prior-year tax rate benefited from income tax settlements and changes in tax reserves.
- Operating cash flow deteriorated to a use of cash, primarily due to lower profitability, payment of accrued bonuses and other operating items after the prior fiscal year-end.
- Capital expenditures increased substantially from $48.2 million to $123.9 million, supporting stores, remodeling, technology, distribution infrastructure and e-commerce.
Guidance, Outlook, Risks and Unusual Items
- Management expected Fiscal 2013 capital expenditures of approximately $230 million to $250 million.
- Planned Fiscal 2013 activity included approximately 55 to 60 new American Eagle stores, approximately 20 new franchised stores, remodeling or refurbishing approximately 50 to 65 American Eagle stores, and potential closure of approximately 20 to 30 American Eagle and 15 to 20 aerie stores in the United States and Canada. The company had completed 30 remodels or refurbishments by August 3, 2013.
- Management identified a disappointing women’s assortment, uneven and declining store traffic, a competitive promotional environment and broader markdowns as key second-quarter pressures.
- Long-term management targets were revenue CAGR of 7% to 9%, EBIT CAGR of 12% to 15% and ROIC of 14% to 17%.
- Key risks include merchandise acceptance and markdown exposure, economic conditions, rising raw-material, labor and energy costs, store impairment charges, international expansion and acquisitions, availability of credit facilities, and the company’s ability to maintain dividends.
- The company acquired Hong Kong and China operations for $20.8 million; purchase-price allocation remained preliminary, particularly for intangible assets and deferred taxes.
- The company remained secondarily liable for 21 former 77kids store leases through expiration dates extending to 2022 if the purchaser fails to perform. No liability was accrued because management expected reimbursement and considered the potential loss not probable.
- There were no material changes in market-risk exposures, no material changes in internal control over financial reporting, and management reported effective disclosure controls.
Investor Verification Items
- Verify the filing period, since the supplied metadata says 2012 Q2 while the filing is explicitly for August 3, 2013 and Fiscal 2013 second quarter.
- Assess whether comparable-sales weakness and elevated markdowns are temporary or indicate continuing merchandise and traffic problems.
- Track gross-margin recovery, inventory productivity and the effect of the planned store openings, remodels and closures.
- Reconcile the substantial capital-expenditure plan with operating cash flow, cash balances and future shareholder distributions.
- Review the preliminary accounting for the Hong Kong and China acquisition and the potential exposure from former 77kids lease guarantees.
- Consider the effect of higher tax rates and the discontinuation of the prior-year 77kids losses when comparing reported net income.