American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: 13 weeks ended May 4, 2019. The request metadata identifies “2018 Q1,” but the filing is for the first quarter of fiscal 2019 and compares with the 13 weeks ended May 5, 2018.
Business Context and Reporting Period
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 and operated 1,061 consolidated stores at quarter-end, including 936 American Eagle retail stores with 151 Aerie side-by-side locations and 119 Aerie standalone locations. It also had 235 international licensed or franchised stores in 24 countries.
Retail results are seasonal, with a greater portion of revenue and operating income generally generated in the third and fourth fiscal quarters.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Total net revenue | $886.3 million | $823.0 million | +8% |
| Gross profit | $324.9 million | $304.4 million | +7% |
| Gross margin | 36.7% | 37.0% | -30 bps |
| Operating income | $47.8 million | $50.7 million | -6% |
| Operating margin | 5.4% | 6.2% | -80 bps |
| Net income | $40.8 million | $39.9 million | +2% |
| Diluted EPS | $0.23 | $0.22 | +5% |
| Adjusted diluted EPS | $0.24 | $0.23 | +4% |
| Net cash from operating activities | $7.7 million | $28.0 million | -$20.3 million |
Revenue, Profitability, Cash Flow, Debt and Liquidity
- Consolidated comparable sales, including AEO Direct, increased 6%, following a 9% increase in the prior-year quarter. American Eagle comparable sales increased 4%; Aerie comparable sales increased 14%.
- Revenue growth was supported by high-single-digit increases in comparable traffic and transactions and low-single-digit growth in units per transaction, partly offset by a low-single-digit decline in average unit retail price.
- SG&A increased 10% to $230.7 million, or 26.0% of revenue versus 25.5%, primarily reflecting store-organization investments, higher compensation, advertising and professional services.
- Gross margin declined because rent leverage and improved product costs were more than offset by increased markdowns and delivery expense.
- Cash and cash equivalents were $304.7 million and short-term investments were $45.0 million, totaling $349.7 million at May 4, 2019, compared with $309.7 million a year earlier.
- Merchandise inventory increased 13% to $456.2 million from $404.3 million, requiring monitoring for turnover and markdown risk.
- Operating cash flow was $7.7 million. Capital expenditures were $36.6 million, and financing cash outflows included $20.0 million of share repurchases and $23.6 million of dividends.
- The company had no borrowings under its $400 million senior secured asset-based revolving credit facility and had $8.1 million of standby letters of credit outstanding. The facility expires in January 2024.
- Working capital was $300.8 million and the current ratio was 1.46. Adoption of the new lease standard reduced reported working capital by $215.1 million through recognition of current operating lease liabilities.
- Operating lease right-of-use assets were $1.44 billion and operating lease liabilities totaled $1.60 billion at quarter-end.
Material Changes Versus the Prior Comparable Period
- Revenue and comparable sales continued to grow, with Aerie remaining the faster-growing brand, although Aerie comparable-sales growth moderated from 38% to 14%.
- Operating income declined despite higher revenue because gross margin contracted and SG&A grew faster than sales.
- Net income and diluted EPS increased modestly, aided in part by higher other income and a slightly lower effective tax rate of 21.7% versus 22.0%.
- Other income increased to $4.2 million from $0.5 million, primarily due to increased interest income and foreign-currency fluctuations.
- Cash flow from operations decreased substantially, primarily reflecting inventory investment and lower accrued compensation and other liabilities.
- The company adopted ASC 842, recognizing approximately $1.6 billion of operating lease assets and liabilities and recording a $44.4 million after-tax reduction to retained earnings related to impaired store assets.
- Restructuring charges were $1.5 million, primarily for severance and closure costs related to company-owned stores in China, compared with $1.6 million of primarily corporate severance charges in the prior-year quarter.
Guidance, Outlook, Risks and Unusual Items
- Fiscal 2019 plans included opening 15 to 20 American Eagle stores, 35 to 40 Aerie standalone stores, and 25 to 35 Aerie side-by-side locations; remodeling approximately 40 to 50 American Eagle stores; and potentially closing approximately 10 to 15 American Eagle and 5 to 10 Aerie stores.
- The company planned approximately 15 to 20 new international third-party-operated American Eagle stores during fiscal 2019.
- Fiscal 2019 capital expenditures were expected to range from $200 million to $215 million.
- Management stated that existing cash and expected operating cash flow should fund anticipated capital expenditures, dividends and working capital needs.
- Key risks include inventory turnover and markdown exposure, weaker consumer demand, store impairment charges, foreign trade restrictions and tariffs, raw-material costs, currency fluctuations, political instability, international expansion, and the availability of credit facilities.
- The company may incur additional corporate and international restructuring charges during fiscal 2019; the amount was not clearly quantified.
- Management reported no material changes in market-risk exposure, no off-balance-sheet arrangements, and no material changes to previously disclosed risk factors.
- Pending legal matters were not expected to have a material adverse effect, although management noted that future facts or legal determinations could change that assessment.
Important Facts for Investors to Verify
- Whether Aerie can sustain growth as comparable-sales momentum moderates from the prior year.
- Whether the 13% inventory increase converts into sales without materially higher markdowns.
- Progress toward improving gross margin and controlling SG&A growth.
- Operating cash flow generation relative to the planned $200 million to $215 million capital-expenditure program and ongoing dividends and repurchases.
- The effect of ASC 842 lease obligations on liquidity, leverage assessments and store economics.
- The timing and cost of planned store openings, remodels, closures and China restructuring activities.
- Remaining share-repurchase authorization of approximately 10.8 million shares and the sustainability of quarterly dividends.