American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: 13 weeks ended April 30, 2011, compared with the 13 weeks ended May 1, 2010. The supplied metadata identifies “2010 Q1,” but the filing is for the first quarter of fiscal 2011. The financial statements are unaudited and were reviewed, not audited, by Ernst & Young LLP.
Business Context
American Eagle Outfitters operated one reportable segment comprising 931 U.S. and Canadian American Eagle stores, 150 aerie stores, 15 77kids stores and AEO Direct. The company had 1,096 company-operated stores at quarter-end and five international franchised stores. The former M+O brand was closed during the second quarter of fiscal 2010 and is presented as a discontinued operation.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $609.6 million | $648.5 million | Down 6% |
| Gross profit | $231.8 million | $257.7 million | Down 10% |
| Gross margin | 38.0% | 39.7% | Down 170 basis points |
| Operating income | $38.4 million | $53.5 million | Down 28% |
| Operating margin | 6.3% | 8.2% | Down 190 basis points |
| Income from continuing operations | $28.3 million | $35.9 million | Down 21% |
| Diluted EPS from continuing operations | $0.14 | $0.17 | Down $0.03 |
| Net income | $28.3 million | $10.9 million | Up from discontinued-operation loss in prior year |
| Diluted EPS | $0.14 | $0.05 | Up $0.09 |
Comparable store sales decreased 8%, following a 5% increase in the prior-year quarter. AE comparable sales declined 8%, aerie declined 7%, and AEO Direct sales increased 3%. Transactions declined in the low double digits, while average transaction value increased in the mid-single digits, supported by a high-single-digit increase in average unit retail price.
Selling, general and administrative expense decreased 6% to $158.5 million and remained 26.0% of sales. Merchandise margin improved 70 basis points, but higher rent and other buying, occupancy and warehousing costs increased 240 basis points as a percentage of sales, causing the overall gross margin decline.
Cash Flow, Liquidity and Capital Structure
| Metric | April 30, 2011 | January 29, 2011 | May 1, 2010 |
|---|---|---|---|
| Cash and cash equivalents | $474.7 million | $667.6 million | $535.2 million |
| Short- and long-term investments | $136.4 million | $73.0 million | $196.5 million |
| Total cash and investments | $611.1 million | $740.6 million | $731.8 million |
| Working capital | $779.0 million | $786.6 million | $722.0 million |
| Current ratio | 3.41 | 3.03 | 3.23 |
- Net cash used in operating activities was $39.2 million, compared with $27.3 million used in the prior-year quarter.
- Net cash used in investing activities was $133.2 million, including $37.7 million of capital expenditures, $33.2 million for trademark assets and $111.2 million of investment purchases, partly offset by $48.9 million of investment-sale proceeds.
- Net cash used in financing activities was $21.7 million, primarily reflecting $21.4 million of dividends.
- The company had no demand-line borrowings and no note payable at April 30, 2011. It had $36.0 million of outstanding demand letters of credit.
- Borrowing arrangements provided aggregate capacity of $310.0 million in U.S. dollars and $25.0 million in Canadian dollars, subject to lender acceptance and facility terms.
Material Changes Versus the Prior Comparable Period
- Sales and comparable store sales weakened materially, reflecting reduced depth in key items and a competitive, promotional retail environment.
- Profitability declined despite expense reductions and improved merchandise margin because of lower sales and higher occupancy costs as a percentage of sales.
- Net income and diluted EPS increased on a reported basis because the prior-year period included a $24.9 million after-tax loss from discontinued M+O operations. The prior-year discontinued-operation loss included $25.8 million of pre-tax closure charges, including an $18.0 million non-cash asset impairment charge.
- There were no publicly announced program share repurchases in the quarter, compared with $71.8 million of such repurchases in the prior-year quarter. Approximately $2.2 million of employee tax-withholding share repurchases occurred.
- Share-based compensation expense decreased to $2.5 million from $12.1 million.
- Net intangible assets increased to $40.5 million from $7.5 million at January 29, 2011, primarily due to $33.2 million of trademark purchases supporting international expansion.
Guidance, Outlook and Management Commentary
- Management stated that quarterly sales were below plan while earnings were within the expected range, citing inventory discipline and cost savings from its profit initiative.
- For fiscal 2011, the company expected capital expenditures of approximately $90 million to $100 million, with about half directed to store growth and renovation.
- Planned fiscal 2011 expansion included 14 new American Eagle stores, 12 new 77kids stores, 10 new aerie stores, approximately 60 to 65 remodels, 15 to 25 American Eagle closures and approximately 20 new franchised American Eagle stores.
- Management believed cash flow from operations, existing cash and investments would fund anticipated capital expenditures and working-capital requirements.
- The company renewed its $60.0 million facility through May 21, 2012 and renewed its $50.0 million letter-of-credit facility through May 31, 2012, voluntarily reducing that facility to $35.0 million.
Risks, Contingencies and Unusual Items
- Retail performance remains exposed to comparable-store sales declines, fashion and consumer-demand shifts, promotional intensity, inventory markdowns and competitive conditions.
- Rising raw-material, labor, energy and other input costs could pressure profitability.
- Underperforming stores could require additional impairment charges.
- The company held $9.6 million of Level 3 investments, including auction-rate securities and an auction-rate securities call option, valued using subjective discounted-cash-flow assumptions. Further market deterioration could require impairment charges.
- Legal proceedings and claims are ongoing; management believes reserves are adequate and does not expect pending matters to materially affect consolidated financial position or results of operations.
- The business is seasonal, and quarterly results are not necessarily indicative of full-year performance.
Investor Verification Checklist
- Verify the filing period because the supplied metadata says 2010 Q1, while the filing reports the quarter ended April 30, 2011.
- Assess whether the 8% comparable-store sales decline and lower transactions persisted after the quarter.
- Track gross margin, merchandise margin, occupancy costs and inventory levels for evidence of markdown or promotional pressure.
- Review the use of cash for trademark acquisitions, store expansion and investments, and reconcile the decline in total cash and investments.
- Evaluate the performance and capital requirements of aerie, 77kids, AEO Direct and international franchise expansion.
- Monitor auction-rate securities, Level 3 valuation assumptions and the possibility of future impairment charges.
- Confirm renewal and availability terms for credit facilities and outstanding letters of credit.
- Consider the effect of discontinued M+O operations when comparing reported net income with prior-year results.