American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 and 39 weeks ended October 28, 2017, compared with the periods ended October 29, 2016. The request metadata identifies “2016 Q3,” but the filing itself is for the third quarter of Fiscal 2017. Results are unaudited and seasonally affected by back-to-school and holiday demand.
Business Context and Operations
American Eagle Outfitters operates the American Eagle and Aerie brands, AEO Direct e-commerce operations, and smaller Tailgate and Todd Snyder businesses. The company reported one reportable segment. At quarter-end, it had 1,058 company-operated stores, including 943 American Eagle retail stores, 110 Aerie stand-alone locations, 114 Aerie side-by-side locations, four Tailgate stores and one Todd Snyder store. It also had 205 international licensed or franchised stores in 24 countries.
Third-quarter comparable sales increased 3%, with American Eagle up 1% and Aerie up 19%. Management reported the eleventh consecutive quarter of positive comparable sales growth.
Financial Performance
| Metric | 13 Weeks Ended Oct. 28, 2017 | 13 Weeks Ended Oct. 29, 2016 | 39 Weeks Ended Oct. 28, 2017 | 39 Weeks Ended Oct. 29, 2016 |
|---|---|---|---|---|
| Net revenue | $960.4 million | $940.6 million | $2.567 billion | $2.513 billion |
| Gross profit | $374.9 million | $377.8 million | $945.4 million | $978.4 million |
| Gross margin | 39.0% | 40.2% | 36.8% | 38.9% |
| SG&A expense | $217.1 million | $219.9 million | $615.8 million | $615.5 million |
| Operating income | $110.9 million | $118.3 million | $186.8 million | $245.6 million |
| Net income | $63.7 million | $75.8 million | $110.2 million | $157.8 million |
| Diluted EPS | $0.36 | $0.41 | $0.61 | $0.86 |
Third-quarter net revenue increased 2%, while gross profit declined 1%. Gross margin contracted 120 basis points because of increased promotions and higher shipping costs associated with digital sales. SG&A declined 1% and leveraged 80 basis points to 22.6% of revenue. Net income declined 16%, and diluted EPS declined from $0.41 to $0.36.
For the first 39 weeks, revenue increased 2%, but gross profit declined 3% and gross margin contracted 210 basis points. Net income declined 30%, principally due to margin pressure, restructuring costs and other expense items.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $257.5 million at October 28, 2017, compared with $291.7 million a year earlier and $378.6 million at January 28, 2017.
- Operating cash flow was $188.1 million for the first 39 weeks, compared with $202.9 million in the prior-year period.
- Capital expenditures were $134.9 million, compared with $107.6 million in the prior-year period.
- Cash used in financing activities was $174.8 million, including $87.7 million of share repurchases, $66.4 million of dividends, $12.3 million of employee share repurchases for tax withholding and $8.7 million of capital-lease payments.
- The company had no borrowings under its $400 million asset-based revolving credit facilities and $8.1 million of standby letters of credit outstanding. It was in compliance with the credit agreement.
- Working capital was $377.4 million and the current ratio was 1.68 at October 28, 2017.
- Merchandise inventory increased 8% year over year to $534.0 million.
Material Changes and Unusual Items
- Third-quarter restructuring charges were $3.7 million, consisting of $2.4 million of corporate severance costs and $1.3 million of corporate lease buyout costs.
- Year-to-date restructuring-related charges totaled $29.9 million, including $18.9 million of cash restructuring charges, $9.3 million related to the planned exit of a joint business venture and $1.7 million of non-cash inventory charges.
- Other expense included a $13.9 million discrete charge in the quarter related to a reserve against a receivable. The year-to-date charge was $16.0 million.
- Management reported adjusted third-quarter diluted EPS of $0.37, excluding $0.01 per share of restructuring charges. The filing states that GAAP diluted EPS also reflected approximately $0.05 per share from the receivable reserve charge.
- The company completed the closure of its United Kingdom stores and continued evaluating the conversion or closure of company-operated stores in Hong Kong, China and other international markets.
- The company adopted the new stock-compensation guidance prospectively in Fiscal 2017 without a material impact. It expects the new lease standard, to be adopted in Fiscal 2019, to significantly increase long-term assets and liabilities.
Guidance, Outlook and Risks
- Fiscal 2017 capital expenditures were expected to total approximately $160 million to $170 million.
- Planned Fiscal 2017 activity included approximately 15 to 20 new AEO stores, 15 Aerie stand-alone stores, 15 to 20 Aerie side-by-side conversions or remodels, approximately 50 American Eagle store remodels, and potential closures of approximately 20 to 23 American Eagle and four to seven Aerie stores, primarily in North America.
- Management stated that cash on hand and operating cash flow were expected to fund anticipated capital expenditures, dividends and working-capital needs.
- Key risks include promotional and markdown pressure, inventory levels, rising labor and input costs, digital shipping costs, store impairment, international restructuring, execution of brand and omni-channel initiatives, availability of credit facilities, and the uncertain outcome of legal and tax matters.
- The company stated that no material changes had occurred in its previously disclosed risk factors or market-risk exposure. Management concluded that disclosure controls were effective as of October 28, 2017.
Important Facts for Investors to Verify
- Reconcile the metadata’s “2016 Q3” designation with the filing’s actual October 28, 2017 reporting date.
- Assess whether the 8% inventory increase and lower gross margin could lead to additional markdowns or earnings pressure.
- Track the remaining restructuring obligations, including the $9.8 million accrued liability and expected additional Fiscal 2017 charges.
- Evaluate the sustainability of Aerie’s 19% quarterly and 23% year-to-date comparable-sales growth versus the weaker American Eagle brand performance.
- Verify the effect and collectability of the receivable reserve that generated $13.9 million of quarterly other expense.
- Monitor cash generation after capital expenditures, dividends and share repurchases, as well as the company’s ability to maintain its dividend and repurchase program.
- Review the expected balance-sheet impact of adopting the new lease accounting standard in Fiscal 2019.