American Eagle Outfitters, Inc. — Form 10-Q Summary
Reporting period: 13 and 26 weeks ended August 4, 2018, compared with July 29, 2017. The filing is for the second quarter of Fiscal 2018, despite the request metadata indicating “2017 Q2.” American Eagle Outfitters operates American Eagle, Aerie, AEO Direct, Tailgate and Todd Snyder businesses in one reportable segment. Results are seasonal, with a greater share of revenue and operating income typically generated in the third and fourth quarters.
Financial Performance and Position
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Total net revenue | $964.9 million | $844.6 million | Up 14% |
| Gross profit | $353.1 million | $292.6 million | Up 21% |
| Gross margin | 36.6% | 34.7% | Up 170 basis points |
| Operating income | $76.4 million | $38.9 million | Up 96% |
| Net income | $60.3 million | $21.2 million | Up 184% |
| Diluted EPS | $0.34 | $0.12 | Up from $0.12 |
| Effective tax rate | 21.9% | 34.0% | Down 12.1 percentage points |
- Consolidated comparable sales, including AEO Direct, increased 9%; American Eagle comparable sales increased 7% and Aerie comparable sales increased 27%.
- Operating margin was 7.9%, compared with 4.6% in the prior-year quarter. Net margin was 6.2%, compared with 2.5%.
- SG&A increased 15% to $234.0 million and represented 24.3% of revenue, up from 24.1%. The increase reflected store payroll investments, higher wages, incentive expense and advertising.
- For the first 26 weeks, revenue was $1.788 billion, gross profit was $657.5 million, operating income was $127.1 million and net income was $100.3 million, compared with $1.606 billion, $570.5 million, $75.9 million and $46.5 million, respectively, in the prior-year period.
- Six-month operating cash flow was $152.4 million, compared with $53.2 million in the prior-year period. Capital expenditures were $101.4 million, including $59.5 million for stores.
- Cash and cash equivalents totaled $323.3 million at August 4, 2018, with an additional $40.0 million in short-term investments. Total cash and short-term investments were $363.3 million.
- Merchandise inventory was $466.1 million, up 8% from $433.5 million a year earlier.
- Working capital was $489.1 million and the current ratio was 1.96. No loans were outstanding under the $400 million asset-based revolving credit facility; $8.1 million of standby letters of credit were outstanding.
- The company returned $93.5 million to shareholders during the first half through $44.9 million of share repurchases and $48.6 million of dividends. The quarterly dividend was $0.1375 per share.
Material Changes Versus the Prior Comparable Period
- Revenue growth benefited from a 9% comparable-sales increase and approximately $40 million from the shifted retail calendar in the quarter, or approximately $50 million for the first half.
- Gross margin expanded primarily because of rent leverage. Prior-year gross profit also included $1.7 million of inventory charges related to international restructuring.
- The prior-year quarter included $9.7 million of restructuring charges, $1.7 million of restructuring-related inventory charges and $9.3 million of costs related to exiting a joint business venture. The 2018 quarter had no restructuring charge, although first-half 2018 included $1.6 million of corporate severance charges.
- The effective tax rate declined primarily because the Tax Cuts and Jobs Act reduced the U.S. federal corporate tax rate from 35% to 21%, together with excess tax benefits from share-based compensation.
- Aerie continued to materially outperform the American Eagle brand, with quarterly comparable sales growth of 27% versus 7% for American Eagle.
- Store count increased modestly to 1,054 consolidated stores from 1,057 a year earlier, while international licensed or franchised stores increased to 223 from 195.
- The company adopted the new revenue-recognition standard using the modified retrospective method, recording a $0.2 million increase to opening retained earnings. The adoption affected loyalty-program accounting and sales-return presentation.
Guidance, Outlook, Risks and Unusual Items
- Fiscal 2018 capital expenditures are expected to be $180 million to $190 million.
- Planned Fiscal 2018 activities include opening approximately 15 to 20 American Eagle stores and 10 to 15 Aerie stores, converting 20 to 25 Aerie side-by-side locations, remodeling approximately 60 to 70 American Eagle stores, and potentially closing approximately 10 to 15 American Eagle and 5 to 10 Aerie stores. The company also expects approximately 45 to 50 new international third-party-operated American Eagle stores.
- Management expects operating cash flow and existing cash to fund anticipated capital expenditures, dividends and working-capital needs. Future dividends remain subject to board approval and financial conditions.
- The revolving credit facility expires in December 2019 and could provide up to $400 million of borrowing capacity, subject to borrowing-base limitations. The company was in compliance with its covenants at August 4, 2018.
- The company expects adoption of the new lease standard in Fiscal 2019 to significantly increase reported long-term assets and liabilities. Undiscounted future minimum operating lease commitments were approximately $1.6 billion at August 4, 2018.
- Key risks include fashion and consumer-demand changes, excess inventory and markdown exposure, cost inflation for raw materials, labor, energy and tariffs, store impairment risk, execution of omni-channel and international expansion, availability of credit facilities, foreign-currency effects and legal or tax contingencies.
- Management stated that pending legal matters are not expected to materially affect financial position, results or cash flows, although outcomes could change with new facts or judicial determinations.
- The company had not completed its accounting for all Tax Act effects as of August 4, 2018 and continued to refine its estimates under SAB 118.
- No material changes in market-risk exposure, no off-balance-sheet arrangements and no material changes in internal control over financial reporting were reported.
Important Facts for Investors to Verify
- Confirm that comparable-sales momentum, particularly Aerie’s 27% quarterly increase, persists after the benefit from the shifted retail calendar.
- Monitor inventory growth of 8% against sales growth and assess future markdown requirements and gross-margin sustainability.
- Evaluate whether planned store openings, remodels, closures and $180 million to $190 million of capital expenditures generate acceptable returns.
- Review the effect of the Fiscal 2019 lease-accounting adoption on reported assets, liabilities, leverage and liquidity metrics.
- Assess cash deployment among capital expenditures, dividends and share repurchases, including the remaining 16.7 million shares authorized for repurchase.
- Verify the final accounting for the Tax Act and any resulting changes to the effective tax rate or deferred-tax balances.
- Review the December 2019 expiration and borrowing-base terms of the revolving credit facility, despite no borrowings being outstanding at quarter-end.