American Eagle Outfitters, Inc. Form 10-Q Summary
Reporting period: The supplied filing is for the 13 and 26 weeks ended July 31, 2010, compared with August 1, 2009. The request metadata identifies “2009 Q2,” which does not match the filing period. The interim financial statements were unaudited and reviewed by Ernst & Young LLP.
Business Context
American Eagle operated one reportable segment comprising 934 American Eagle U.S. and Canadian stores, 144 aerie stores, five 77kids stores and AEO Direct. The company ended the quarter with 1,083 stores, including 28 fewer stores primarily because all MARTIN+OSA stores were closed.
Management approved closure of the underperforming MARTIN+OSA brand in March 2010 and completed the store and e-commerce closures during the quarter. MARTIN+OSA is presented as a discontinued operation.
Financial Performance
| Metric | 13 Weeks Ended July 31, 2010 | 13 Weeks Ended August 1, 2009 | 26 Weeks Ended July 31, 2010 | 26 Weeks Ended August 1, 2009 |
|---|---|---|---|---|
| Net sales | $651.5 million | $646.8 million | $1.300 billion | $1.248 billion |
| Gross profit | $239.7 million | $253.9 million | $497.4 million | $477.5 million |
| Gross margin | 36.8% | 39.3% | 38.3% | 38.2% |
| Operating income | $38.2 million | $59.6 million | $91.7 million | $98.4 million |
| Operating margin | 5.9% | 9.2% | 7.1% | 7.9% |
| Income from continuing operations | $25.8 million | $36.8 million | $61.7 million | $65.8 million |
| Net income | $9.7 million | $28.6 million | $20.6 million | $50.5 million |
| Diluted EPS | $0.05 | $0.14 | $0.10 | $0.24 |
Second-quarter comparable-store sales decreased 1%, primarily because the summer assortment underperformed expectations. Increased promotions and markdowns reduced merchandise margin by 210 basis points and gross margin by 250 basis points. Selling, general and administrative expense increased to 25.4% of sales from 24.9%, while depreciation and amortization increased to $36.0 million from $33.4 million.
For the first 26 weeks, sales increased 4%, supported by a 5% comparable-store sales increase in the first quarter, partially offset by the second-quarter comparable-store decline. First-half gross margin was broadly stable, but operating margin declined because of higher SG&A and depreciation expense.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents at July 31, 2010 were $425.5 million, compared with $694.0 million at January 30, 2010 and $500.3 million at August 1, 2009.
- Total cash, short-term investments and long-term investments were $598.0 million, including $172.5 million of auction-rate securities and auction-rate preferred securities classified as Level 3 investments.
- Operating cash flow from continuing operations was $21.9 million for the first 26 weeks, down from $90.8 million in the prior-year period.
- Capital expenditures were $39.3 million, compared with $72.7 million in the prior-year period. Fiscal 2010 capital expenditures were expected to be $90 million to $110 million.
- Financing cash outflows were $282.4 million, including $192.3 million for repurchases, $43.1 million for dividends and $30.0 million to repay demand-line borrowings.
- The company had no demand-line borrowings at quarter-end and $51.2 million of outstanding demand letters of credit. Available facilities totaled $310.0 million of U.S. capacity and $25.0 million of Canadian capacity, subject to lender acceptance.
- Working capital was $631.6 million and the current ratio was 2.91 at July 31, 2010.
Material Changes and Unusual Items
- MARTIN+OSA generated a discontinued-operations loss of $16.2 million after tax in the quarter and $41.1 million for the first half, versus $8.2 million and $15.3 million, respectively, in the comparable periods.
- First-half MARTIN+OSA closure charges totaled $43.7 million before tax, including $18.0 million of non-cash asset impairments, $15.5 million of lease-related charges, $7.8 million of severance charges and $2.4 million of inventory charges.
- The company recorded a $1.2 million net impairment loss in earnings on investment securities, compared with $0.2 million in the prior-year quarter.
- Cash repurchases totaled $192.3 million for 14.0 million shares under publicly announced programs, with 16.0 million shares remaining authorized at quarter-end. The company also repurchased approximately 1.0 million employee shares for $18.0 million to fund tax withholding.
- The quarterly dividend increased to $0.11 per share from $0.10 per share in the comparable period.
- Share-based compensation from continuing operations increased to $18.4 million for the first half from $9.2 million.
Guidance, Outlook and Risks
- Management planned to open 14 American Eagle stores, 11 aerie stores and nine 77kids stores during Fiscal 2010, remodel approximately 25 to 35 American Eagle stores and close 15 to 25 American Eagle stores.
- The corporate profit initiative includes merchandise-margin improvement, inventory reduction, organizational streamlining, expense reductions and evaluation of 50 to 100 underperforming stores for closure over two to five years.
- Management expected cash on hand and operating cash flow to fund anticipated capital expenditures and working-capital needs.
- Key risks include weak consumer spending, promotional pressure, inventory markdowns, underperforming stores, additional investment-security impairment, possible limitations on credit-facility availability and uncertainty regarding recovery of auction-rate investments.
- The company stated that additional impairment charges could be required if market conditions for auction-rate securities deteriorate or expected recoveries do not occur. A 100-basis-point increase in discount rate and illiquidity premium was estimated to reduce ARS fair value by approximately $8.7 million.
- No material changes to previously disclosed market-risk exposures or risk factors were reported.
Investor Verification Items
- Confirm the intended reporting period, because the supplied metadata says 2009 Q2 while the filing covers Q2 Fiscal 2010.
- Assess the sustainability of sales and margins after the 1% second-quarter comparable-store sales decline and increased markdown activity.
- Review the cash impact and remaining obligations from the MARTIN+OSA closure, especially lease-related liabilities of $17.7 million included in accrued rent.
- Evaluate liquidity and valuation risk associated with the $172.5 million Level 3 auction-rate investment portfolio.
- Reconcile substantial share repurchases and dividends with the decline in cash and operating cash flow.
- Monitor execution of the corporate profit initiative, planned store openings and closures, and the projected $90 million to $110 million Fiscal 2010 capital-expenditure program.