American Eagle Outfitters, Inc. Form 10-Q Summary
Business Context and Reporting Period
This quarterly report covers the 13 and 39 weeks ended October 29, 2011, compared with the corresponding periods ended October 30, 2010. The filing metadata identifies “2010 Q3,” but the filing itself is for the third quarter of Fiscal 2011. American Eagle Outfitters operated one reportable segment comprising American Eagle retail stores, aerie stores, 77kids stores and AEO Direct. The former MARTIN+OSA brand was reported as a discontinued operation.
At quarter-end, the company operated 1,116 company-owned stores and had 12 international franchised stores. The company reported 193.7 million common shares outstanding at November 28, 2011.
Key Financial Metrics
| Metric | 13 Weeks Ended Oct. 29, 2011 | 13 Weeks Ended Oct. 30, 2010 | 39 Weeks Ended Oct. 29, 2011 | 39 Weeks Ended Oct. 30, 2010 |
|---|---|---|---|---|
| Net sales | $831.8 million | $751.5 million | $2.117 billion | $2.051 billion |
| Gross profit | $309.0 million | $312.3 million | $772.8 million | $809.7 million |
| Gross margin | 37.1% | 41.6% | 36.5% | 39.5% |
| Operating income | $83.2 million | $91.5 million | $150.9 million | $183.1 million |
| Operating margin | 10.0% | 12.2% | 7.1% | 8.9% |
| Income from continuing operations | $52.4 million | $33.2 million | $100.4 million | $94.9 million |
| Net income | $52.4 million | $33.0 million | $100.4 million | $53.6 million |
| Diluted earnings per share | $0.27 | $0.17 | $0.51 | $0.26 |
Third-quarter comparable store sales increased 5%, including 5% for American Eagle and 8% for aerie. AEO Direct sales increased 21%. For the 39-week period, comparable store sales declined 1%, while AEO Direct sales increased 13%.
Cash and cash equivalents were $380.3 million at October 29, 2011. Short-term and long-term investments were $101.7 million, producing total cash and investments of approximately $482.0 million. Merchandise inventory was $571.8 million, compared with $409.5 million a year earlier.
Working capital was $809.3 million and the current ratio was 3.04. The company had no demand-line borrowings and $43.7 million of outstanding demand letters of credit. Available credit facilities totaled $295.0 million U.S. dollars and $25.0 million Canadian dollars, subject to lender acceptance and periodic review.
Net cash used in operating activities from continuing operations was $48.1 million for the first 39 weeks, compared with $146.4 million of cash provided in the prior-year period. Capital expenditures were $96.7 million, intangible-asset purchases were $33.9 million, dividends paid were $64.3 million and share repurchases totaled $15.2 million. Ending cash and cash equivalents declined by $287.3 million from the beginning of the fiscal year to $380.3 million.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 11%, but gross profit declined 1% because higher product costs, primarily cotton, and increased promotions reduced merchandise margins.
- Third-quarter gross margin fell 450 basis points to 37.1%; operating margin declined 220 basis points to 10.0%.
- SG&A increased by $5.5 million in the quarter but improved as a percentage of sales to 22.9% from 24.6%, reflecting sales leverage and expense savings.
- Third-quarter continuing-operations earnings increased despite lower operating income, primarily because the prior-year period included a $24.2 million realized investment loss and had a higher effective tax rate.
- For the first 39 weeks, sales increased 3%, while gross profit decreased 5% and operating income decreased 18%.
- Inventory increased approximately 40% year over year, reflecting a key-item investment strategy and a low double-digit increase in average unit cost. This contributed to the significant operating cash use.
- Share repurchases declined to $15.2 million for the first 39 weeks, compared with $192.3 million in the prior-year period. Approximately 13.1 million shares remained authorized for repurchase.
- The prior-year 39-week results included a $41.3 million after-tax loss from discontinued MARTIN+OSA operations, including $43.4 million of pre-tax closure charges. No discontinued-operation loss was recorded in the current period.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management expected approximately $100 million of Fiscal 2011 capital expenditures, including investments in stores, remodeling and a holiday accessory expansion initiative. The filing describes plans for new stores, store remodels, possible store closures, international franchising and continued development of aerie and 77kids, but it does not provide a clear earnings or sales guidance range.
Management attributed third-quarter sales strength to merchandise improvements, promotions during peak shopping periods and inventory investments in key items. Traffic and conversion improved, transactions increased in the high single digits and units sold increased in the low double digits, while average unit retail declined in the low single digits.
Principal risks include higher raw-material, labor and energy costs; promotional pressure and markdowns; inventory levels and potential slow-moving merchandise; underperforming-store impairment charges; seasonality; uncertainty regarding availability of credit facilities; foreign-currency exposure; and the execution risk associated with new brands, international expansion, acquisitions or additional franchise agreements.
The company held $6.1 million of Level 3 investments, consisting of $5.5 million of state and local government auction-rate securities and a $0.6 million auction-rate securities call option. Valuation depends partly on discounted cash-flow assumptions and unobservable inputs. No impairment loss was recorded in the current 39-week period.
The company declared a quarterly cash dividend of $0.11 per share payable January 6, 2012. Management stated that cash on hand and expected operating cash flow should fund anticipated capital expenditures and working-capital requirements. Ernst & Young performed a limited review of the interim financial statements and reported no material modifications; the review was not an audit.
Important Facts for Investors to Verify
- Confirm the reporting-period designation: the filing covers the quarter ended October 29, 2011, notwithstanding the “2010 Q3” request metadata.
- Monitor gross margin and merchandise margin for continued effects from cotton costs, promotions and markdowns.
- Assess whether the 40% year-over-year inventory increase converts to sales without materially higher markdowns.
- Reconcile operating cash use with inventory growth and planned capital expenditures.
- Review liquidity of the Level 3 auction-rate securities and assumptions supporting their valuation.
- Track store openings, remodels, closures and performance of aerie, 77kids, AEO Direct and international franchise operations.
- Confirm availability and terms of the company’s undrawn credit facilities and outstanding letters of credit.
- Consider the effect of discontinued operations and prior-year investment losses when comparing reported net income.