American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and first 39 weeks ended November 2, 2019, compared with the corresponding periods ended November 3, 2018. The provided metadata states “2018 Q3,” but the filing is for fiscal 2019 Q3. American Eagle operates American Eagle, Aerie, AEO Direct, Tailgate and Todd Snyder businesses in one reportable segment.
Business Context and Reporting Period
- Results are seasonal, with a significant portion of revenue and operating income generated during the back-to-school and holiday periods.
- At quarter-end, the company had 1,094 consolidated stores, including 945 American Eagle retail stores, 142 standalone Aerie stores and 170 Aerie side-by-side locations. It also had 241 international licensed or franchised stores in 24 countries.
- Management reported the 19th consecutive quarter of comparable-sales growth and record third-quarter revenue.
Key Financial Metrics
| Metric | 13 Weeks Ended Nov. 2, 2019 | 13 Weeks Ended Nov. 3, 2018 | 39 Weeks Ended Nov. 2, 2019 | 39 Weeks Ended Nov. 3, 2018 |
|---|---|---|---|---|
| Net revenue | $1.066 billion | $1.004 billion | $2.994 billion | $2.792 billion |
| Gross profit | $407.1 million | $399.5 million | $1.115 billion | $1.057 billion |
| Gross margin | 38.2% | 39.8% | 37.2% | 37.9% |
| Operating income | $103.1 million | $108.6 million | $232.9 million | $235.7 million |
| Operating margin | 9.7% | 10.8% | 7.8% | 8.5% |
| Net income | $80.8 million | $85.5 million | $186.5 million | $185.7 million |
| Diluted EPS | $0.48 | $0.48 | $1.09 | $1.04 |
- Third-quarter comparable sales increased 5%, including AEO Direct; American Eagle comparable sales increased 2% and Aerie comparable sales increased 20%.
- Year-to-date comparable sales increased 4%; American Eagle increased 1% and Aerie increased 17%.
- Third-quarter gross margin declined 160 basis points, primarily because of increased markdowns. SG&A increased 4% but improved to 24.3% of revenue from 24.8%.
- Year-to-date revenue included $40.0 million of license royalties from a third-party operator of American Eagle stores in Japan.
- Effective income tax rates were 23.6% for the quarter and 23.4% year to date.
Cash Flow, Liquidity, Debt and Capital Allocation
- Cash flow from operations was $178.2 million for the first 39 weeks, down from $243.6 million in the prior-year period.
- Capital expenditures were $149.9 million, compared with $143.9 million. Fiscal 2019 capital expenditures were expected to be $200 million to $215 million.
- Cash and cash equivalents were $214.5 million, and short-term investments were $50.0 million, for total cash and short-term investments of $264.5 million, compared with $359.7 million a year earlier.
- Working capital was $268.4 million and the current ratio was 1.33, compared with $516.3 million and 1.85, respectively, at November 3, 2018. Adoption of ASC 842 accounted for a $226.5 million reduction in working capital.
- Merchandise inventory increased 9% year over year to $647.3 million, raising potential markdown and inventory-turnover risk.
- The company had a $400 million senior secured asset-based revolving credit facility expiring in January 2024. No loans were outstanding at November 2, 2019, and $8.1 million of standby letters of credit were outstanding. The company was in compliance with the credit agreement.
- Financing cash uses included $112.4 million of share repurchases, $69.8 million of dividends and $8.0 million of employee-share repurchases for tax withholding.
- The quarterly dividend was $0.1375 per share. Future dividends remain subject to board approval and the company’s earnings, cash flow, financial condition and capital requirements.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue rose 6%, but net income fell 6% because of lower gross margin, higher SG&A and lower other income. Diluted EPS remained $0.48 because of the reduced share count.
- Year-to-date revenue increased 7% and net income increased modestly by $0.8 million, while operating income declined $2.9 million.
- Gross margin declined year to date to 37.2% from 37.9%, despite the benefit of Japan license royalties, due primarily to markdowns and higher delivery expense.
- Average unit retail price declined in the low-single digits in the quarter and year to date, while traffic and transactions increased.
- The company adopted ASC 842 on February 3, 2019. It recognized approximately $1.6 billion of operating lease assets and liabilities at adoption and a $44.4 million net-of-tax transition adjustment to beginning retained earnings. At quarter-end, operating lease liabilities totaled $1.646 billion.
- Year-to-date restructuring charges increased to $4.3 million from $1.6 million, primarily for corporate severance and closure costs for company-operated stores in China.
- The company repurchased 6.3 million shares under public programs year to date, compared with 3.3 million in the prior-year period. A new authorization for 30.0 million shares increased total remaining authorization to 35.4 million shares.
Guidance, Outlook, Commentary and Risks
- Fiscal 2019 plans included opening 25 to 30 American Eagle stores, 35 to 40 standalone Aerie stores and 25 to 35 Aerie side-by-side stores; remodeling approximately 40 to 50 American Eagle stores; and closing approximately 10 to 15 American Eagle and 5 to 10 Aerie stores.
- Management identified Aerie growth, American Eagle jeans, omni-channel capabilities, store investments and shareholder returns as strategic priorities.
- The company planned to terminate its Japanese license agreement and was evaluating its future business model in Japan.
- Key risks include inventory markdowns, holiday-season performance, consumer spending, foreign trade restrictions and tariffs, raw-material costs, foreign exchange, international expansion, store impairment, and the availability of sufficient cash flow for capital expenditures, dividends and working capital.
- Management stated that existing cash and operating cash flow were expected to fund anticipated requirements. Additional debt or equity financing could be required for future acquisitions or expansion.
- The company reported no material changes in market-risk exposure, no off-balance-sheet arrangements and no material changes to previously disclosed risk factors.
- Pending legal proceedings were not expected by management to have a material adverse effect, although outcomes could differ based on subsequently discovered facts or judicial determinations.
- Disclosure controls were deemed effective as of November 2, 2019. New lease-accounting software and related controls were implemented for ASC 842.
Investor Verification Checklist
- Verify whether higher inventory levels translate into additional markdowns and further gross-margin pressure during the holiday season.
- Assess the sustainability and profitability of Aerie’s 20% quarterly and 17% year-to-date comparable-sales growth.
- Reconcile the effect of the $40 million Japan license royalty on year-to-date revenue, gross profit and comparability.
- Review operating lease obligations, store closure plans and potential impairment or restructuring charges.
- Monitor cash generation after capital expenditures, dividends and share repurchases, particularly given the decline in cash and operating cash flow.
- Confirm the status of the Japanese license transition, international strategy and planned store openings and closures.
- Review the company’s ability to maintain dividends and repurchases while funding projected capital expenditures of $200 million to $215 million.