American Eagle Outfitters, Inc. — Form 10-Q Summary
Business context and reporting period
This filing covers the 13 and 39 weeks ended October 30, 2010, compared with the periods ended October 31, 2009. Although the request metadata identifies “2009 Q3,” the filing itself is the Fiscal 2010 third-quarter report. American Eagle operated one reportable segment comprising American Eagle stores, aerie stores, 77kids stores and AEO Direct. At quarter-end, the company operated 1,089 stores: 935 American Eagle, 147 aerie and seven 77kids locations.
The company completed the closure of the MARTIN+OSA (“M+O”) brand during the 13 weeks ended July 31, 2010; its results are presented as discontinued operations.
Financial performance and key metrics
| Metric | Q3 2010 | Q3 2009 | 39 weeks 2010 | 39 weeks 2009 |
|---|---|---|---|---|
| Net sales | $751.5 million | $736.0 million | $2.051 billion | $1.984 billion |
| Gross profit | $312.3 million | $304.2 million | $809.7 million | $781.7 million |
| Gross margin | 41.6% | 41.3% | 39.5% | 39.4% |
| Operating income | $91.5 million | $84.6 million | $183.1 million | $183.0 million |
| Operating margin | 12.2% | 11.5% | 8.9% | 9.2% |
| Income from continuing operations | $33.2 million | $67.9 million | $94.9 million | $133.8 million |
| Net income | $33.0 million | $59.2 million | $53.6 million | $109.7 million |
| Diluted EPS | $0.17 | $0.28 | $0.26 | $0.53 |
Third-quarter comparable store sales increased 1%. Management attributed the improvement to strong back-to-school performance, improved assortments and higher transactions and average transaction value in the American Eagle brand. AE women’s comparable sales increased in the low single digits, while AE men’s comparable sales declined in the low single digits.
Merchandise margin improved 90 basis points in the quarter and 50 basis points year to date, primarily because of lower markdown activity. Quarterly SG&A was essentially flat in dollars and declined to 24.6% of sales from 25.1%; year-to-date SG&A increased 4% and rose to 25.3% of sales. The quarterly effective tax rate increased to 52.1% from 19.2%, principally because no tax benefit was recognized on certain auction-rate securities losses.
Cash flow, liquidity and capital structure
- Cash and cash equivalents were $630.8 million at October 30, 2010, compared with $512.6 million at October 31, 2009 and $694.0 million at January 30, 2010.
- Total cash, short-term investments and long-term investments were $640.4 million, including $9.2 million of auction-rate securities.
- Working capital was $820.4 million and the current ratio was 3.23, compared with $673.5 million and 2.60, respectively, at October 31, 2009.
- Operating cash flow from continuing operations was $146.4 million for the first 39 weeks, compared with $164.9 million in the prior-year period.
- Investing activities provided $110.3 million, including $177.5 million of investment-security proceeds, partly offset by $65.4 million of capital expenditures.
- Financing activities used $303.1 million, including $192.3 million for repurchases of 14.0 million shares, $64.7 million of dividends, $30.0 million to repay notes payable and $18.0 million of employee share repurchases for tax withholding.
- The company had no demand-line borrowings at October 30, 2010 and $42.1 million of outstanding demand letters of credit. Borrowing facilities totaled $310.0 million in U.S. dollars and $25.0 million in Canadian dollars, subject to lender acceptance and facility expiration dates.
- Capital expenditures were $65.4 million year to date. Fiscal 2010 capital expenditures were expected to be $90 million to $100 million.
Material changes and unusual items
- The company liquidated approximately 95% of its auction-rate securities portfolio during the quarter, receiving $149.6 million plus accrued interest and recognizing a $24.2 million realized loss. The loss reduced quarterly diluted EPS by approximately $0.12.
- Year-to-date net impairment loss recognized in earnings on investment securities was $1.2 million. Management warned that additional impairment charges could result if market conditions deteriorate or expected recoveries do not occur.
- M+O discontinued operations produced a year-to-date after-tax loss of $41.3 million, including $43.4 million of pretax closure charges: $18.0 million of non-cash asset impairments, $15.4 million of lease-related charges, $7.6 million of severance and employee-related costs and $2.4 million of inventory charges.
- Net income and EPS declined substantially despite higher sales and operating income because of the investment-securities loss, higher taxes and M+O closure costs. Year-to-date net income declined 51% to $53.6 million.
- Share count declined materially due to repurchases; diluted weighted-average shares were 197.3 million in the quarter versus 209.4 million in the prior-year quarter.
Guidance, outlook, management commentary and risks
Management stated that recent merchandising improvements, inventory management, organizational streamlining and expense reductions were contributing to improved profitability. The company planned 14 new American Eagle stores, 11 new aerie stores and nine new 77kids stores during Fiscal 2010, along with approximately 25 to 35 American Eagle remodels and 15 to 25 American Eagle closures. Results remain subject to retail seasonality and are not necessarily indicative of full-year performance.
Management expected operating cash flow and existing cash holdings to fund anticipated capital expenditures and working capital needs. Potential risks include weak consumer demand, markdowns and inventory pressure, underperforming-store impairment charges, additional auction-rate securities impairments, limited availability or renewal of credit facilities, execution of new brands and international franchise arrangements, and the possibility that future dividends may not be paid.
The filing states that there were no material changes to previously disclosed risk factors or market-risk exposure. Management concluded that disclosure controls and procedures were effective as of October 30, 2010, and the independent registered public accounting firm performed a review, not an audit, of the interim financial statements.
Important facts for investors to verify
- Confirm that the intended period is Q3 Fiscal 2010, ended October 30, 2010, rather than Q3 2009 as indicated in the request metadata.
- Assess the sustainability of the 1% comparable-store sales increase and the improvement in merchandise margin after the back-to-school period.
- Separate recurring operating performance from the $24.2 million auction-rate securities loss, $1.2 million investment impairment and $43.4 million M+O closure charges.
- Review remaining auction-rate securities exposure, valuation assumptions and the potential for additional impairment charges.
- Verify the company’s store-opening, remodeling, closure and $90 million to $100 million capital-expenditure plans.
- Monitor liquidity after $210.3 million of year-to-date share repurchases, dividends and employee share repurchases, as well as the expiration dates of credit facilities.
- Evaluate inventory levels, markdown requirements, tax-rate normalization and performance of the American Eagle, aerie, 77kids and AEO Direct businesses.