American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: 13 weeks ended May 4, 2013, compared with the 13 weeks ended April 28, 2012. The supplied metadata labels the period “2012 Q1,” but the filing is for the first quarter of Fiscal 2013. The interim financial statements are unaudited and were reviewed, not audited, by Ernst & Young LLP.
Business Context
American Eagle Outfitters operated one reportable segment comprising 896 American Eagle Outfitters stores, 141 aerie stand-alone stores and AEO Direct e-commerce operations. At quarter-end, the company had 1,037 consolidated stores, 57 international franchise stores and approximately 192.7 million common shares outstanding.
Management attributed the quarter’s performance to cold weather following the prior year’s unusually warm spring, weaker consumer demand and difficult comparisons. The company continued its omni-channel, store-remodeling and international expansion initiatives. The 77kids business was exited in Fiscal 2012 and is presented as a discontinued operation.
Financial Performance
| Metric | Q1 Fiscal 2013 | Q1 Fiscal 2012 | Change |
|---|---|---|---|
| Total net revenue | $679.5 million | $708.7 million | Down 4% |
| Comparable sales, including AEO Direct | Down 5% | Up 17% | Down 22 percentage points |
| Gross profit | $263.6 million | $274.9 million | Down 4% |
| Gross margin | 38.8% | 38.8% | Flat |
| Operating income | $45.8 million | $64.3 million | Down 29% |
| Operating margin | 6.7% | 9.1% | Down 240 basis points |
| Income from continuing operations | $28.0 million | $44.0 million | Down 36% |
| Net income | $28.0 million | $39.7 million | Down 29% |
| Diluted earnings per share | $0.14 | $0.20 | Down $0.06 |
| Net cash from operating activities | $(38.7) million | $18.3 million | Decreased $57.0 million |
American Eagle Outfitters comparable sales declined 6%, aerie comparable sales increased 4% and AEO Direct sales increased 24%. American Eagle women’s and men’s comparable sales declined 7% and 3%, respectively. Transactions and average transaction value decreased, while average unit retail price declined in the low single digits because of increased promotions.
Gross margin was maintained through favorable product costs, which were offset by higher markdowns, delivery costs, occupancy deleverage and corporate charges. Selling, general and administrative expense increased 2% to $182.3 million, or 26.8% of revenue versus 25.2% in the prior-year quarter. The effective tax rate was 38.0%, compared with 35.1%.
Operating income included $11.5 million of asset write-offs, corporate charges, severance and related employee costs. Management reported adjusted income from continuing operations of $0.18 per diluted share, excluding a $0.04 per-share impact from these items; the filing identifies this as a non-GAAP measure.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $383.2 million and short-term investments were $113.0 million at May 4, 2013, for total cash and investments of $496.2 million.
- Working capital was $689.5 million and the current ratio was 2.99.
- Cash decreased by $125.9 million during the quarter, primarily reflecting negative operating cash flow, capital expenditures and share repurchases.
- Capital expenditures were $45.7 million, including store investments, information technology, distribution centers and e-commerce.
- Inventory was $340.5 million, down 7% from $367.7 million at April 28, 2012; inventory decreased 6% on a cost-per-foot basis.
- The company had no borrowings under its $150.0 million unsecured revolving credit facility and was in compliance with its covenants. Letters of credit outstanding under that facility were $7.9 million, and trade letters of credit outstanding under separate facilities were $28.1 million.
- Financing cash outflows included $33.1 million for public-program share repurchases and $23.3 million for employee share repurchases related to tax withholding. The company repurchased 1.6 million shares under its public program and had 18.4 million shares remaining authorized for repurchase.
Material Changes Versus the Prior Comparable Period
- Revenue, operating income, continuing-operations income and diluted EPS declined materially because of negative comparable sales, higher promotions and fixed-cost deleverage.
- Gross margin remained unchanged at 38.8%, but higher markdowns and occupancy and delivery costs offset product-cost benefits.
- Operating cash flow shifted from a $18.3 million inflow to a $38.7 million outflow, partly because of lower profitability and payments of accrued bonuses and other operating liabilities after fiscal year-end.
- Capital expenditures increased from $24.1 million to $45.7 million.
- The prior-year quarter included a $4.3 million after-tax loss from discontinued 77kids operations; the current quarter had no discontinued-operations loss.
- Prior-year other income of $3.5 million, primarily related to auction-rate securities recovery proceeds, changed to $0.7 million of other expense.
- Share-based compensation expense fell to $5.3 million from $21.3 million, reflecting lower performance-based awards and fewer outstanding awards.
Outlook, Commentary, Risks and Unusual Items
- For Fiscal 2013, management expected approximately 50 to 55 new American Eagle Outfitters stores, approximately 50 to 65 store remodels, and potential closures of approximately 20 to 30 American Eagle Outfitters stores and 15 to 20 aerie stores.
- Capital expenditures were expected to be approximately $250 million to $280 million for Fiscal 2013, including a new distribution center, stores, information technology and e-commerce.
- Management stated that cash on hand and expected operating cash flow should fund anticipated capital expenditures and working-capital requirements, although first-quarter operating cash flow was negative.
- Long-term management targets were total revenue CAGR of 7% to 9%, EBIT CAGR of 12% to 15% and annual ROIC of 14% to 17%.
- The company agreed to acquire six Hong Kong and China franchise stores after paying $10.0 million to terminate the franchise partner’s rights to open additional stores. The acquisition was expected to close in the second quarter of Fiscal 2013, for approximately $11.0 million subject to adjustments.
- Key risks include weak consumer demand, weather and seasonality, markdown and inventory risk, raw-material and labor cost inflation, store impairment charges, international expansion execution, availability of credit facilities and the ability to sustain comparable-sales growth.
- The company remained secondarily liable for 21 former 77kids store leases through expiration dates extending to 2022, subject to reimbursement rights and a standby letter of credit from the purchaser. No liability was accrued for these guarantees.
- The filing reported no material changes in market-risk exposure, no material changes to previously disclosed risk factors and effective disclosure controls as of May 4, 2013.
Important Facts for Investors to Verify
- Confirm the reporting-period distinction: this filing covers Q1 Fiscal 2013, not Q1 Fiscal 2012.
- Assess whether negative comparable sales and increased promotions are temporary weather-related effects or evidence of broader demand and merchandising pressure.
- Review the $11.5 million of asset write-offs and corporate charges and determine whether similar charges may recur.
- Monitor operating cash flow, capital spending and share repurchases relative to the company’s liquidity and stated growth plans.
- Evaluate inventory levels, markdown exposure and gross-margin sustainability as new seasonal merchandise sells through.
- Track the planned acquisition of the six Hong Kong and China stores and the company’s broader international expansion commitments.
- Review the 77kids lease guarantees, credit-facility covenants and outstanding letters of credit for potential future liquidity obligations.