American Eagle Outfitters, Inc. Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the 13 and 39 weeks ended November 2, 2013, compared with the periods ended October 27, 2012. American Eagle Outfitters operated one reportable segment comprising American Eagle stores, aerie stores and AEO Direct e-commerce. The company operated 1,064 company-owned stores at quarter-end and had 61 international franchise stores in 12 countries. The filing reflects 77kids as a discontinued operation for prior periods.
Financial performance and liquidity
| Metric | 13 weeks ended November 2, 2013 | 13 weeks ended October 27, 2012 | 39 weeks ended November 2, 2013 | 39 weeks ended October 27, 2012 |
|---|---|---|---|---|
| Total net revenue | $857.3 million | $910.4 million | $2.264 billion | $2.359 billion |
| Gross profit | $298.9 million | $379.1 million | $808.0 million | $930.6 million |
| Gross margin | 34.9% | 41.6% | 35.7% | 39.5% |
| Operating income | $41.8 million | $128.5 million | $117.1 million | $254.6 million |
| Income from continuing operations | $24.9 million | $82.4 million | $72.5 million | $169.3 million |
| Net income | $24.9 million | $78.6 million | $72.5 million | $137.3 million |
| Diluted EPS | $0.13 | $0.39 | $0.37 | $0.69 |
| Net cash from operating activities | Not separately provided | Not separately provided | $73.2 million | $210.8 million |
Third-quarter consolidated comparable sales declined 5%; American Eagle brand comparable sales declined 5%, aerie declined 3%, and AEO Direct increased 17%. AUR and average dollar sale declined approximately 9% due to increased promotional activity.
At November 2, 2013, cash and cash equivalents were $354.3 million, and total cash, short-term investments and long-term investments were $366.8 million. Merchandise inventory was $518.9 million, up 6% on a cost-per-foot basis from the prior year. Working capital was $555.4 million and the current ratio was 2.03.
The company had no borrowings under its $150.0 million unsecured revolving credit facility, $8.3 million of outstanding letters of credit, and $69.2 million of trade letters of credit. Management stated that operating cash flow and existing cash holdings were expected to fund anticipated capital expenditures and working capital requirements.
Material changes versus the prior comparable period
- Third-quarter revenue decreased 6%, while year-to-date revenue decreased 4%.
- Third-quarter gross profit fell 21%, and gross margin contracted 670 basis points because of competitive pricing, higher markdowns, increased delivery costs and rent deleverage.
- Third-quarter operating income declined to $41.8 million from $128.5 million, including a $19.3 million pre-tax impairment charge related to the planned closure of the Warrendale, Pennsylvania distribution center.
- Excluding the impairment, adjusted diluted EPS was $0.19 versus reported diluted EPS of $0.13. This non-GAAP measure is not standardized.
- Year-to-date operating cash flow declined to $73.2 million from $210.8 million, primarily because of lower earnings and margins and a $185.5 million increase in cash invested in inventory.
- Capital expenditures increased to $217.2 million from $71.2 million, reflecting store investments, information technology, e-commerce and distribution-center projects.
- The company paid $48.2 million in dividends and repurchased $33.1 million of common stock under its public program during the first 39 weeks. The prior-year period included a $1.50-per-share special dividend, contributing to substantially higher prior-year financing cash outflows.
- Prior-year results included a $32.0 million after-tax loss from discontinued 77kids operations; there was no discontinued-operation loss in 2013.
Guidance, outlook, risks and unusual items
- Management cited a competitive retail environment, high promotional activity, tepid consumer spending and weak store traffic as principal pressures on sales and margins.
- Fiscal 2013 capital expenditures were expected to be approximately $250 million. The company planned approximately 50 to 65 AEO store remodels and continued expansion, particularly through Factory stores.
- The Warrendale distribution center closure and transition to the Hazelton, Pennsylvania facility is expected to be completed by July 2015. Management expects total after-tax charges of $14 million to $15 million, including $12 million of non-cash asset impairments and $2 million to $3 million of severance and employee-related costs.
- Management’s longer-term targets were revenue CAGR of 7% to 9%, EBIT CAGR of 12% to 15% and ROIC of 14% to 17%; these are targets rather than current-period guidance.
- Key risks include promotional pressure, markdown exposure, inventory levels, potential additional store impairment charges, rising input costs, economic weakness, international expansion execution, availability of credit facilities and the company’s ability to maintain dividends.
- The company remains secondarily liable for 21 former 77kids store leases through lease expirations, in some cases through 2022, although no liability was accrued because the purchaser provided a standby letter of credit and reimbursement rights.
- The effective tax rate increased to 41.2% for the quarter and 38.6% year to date, primarily because of changes in the domestic/international income mix and favorable state tax settlements in the prior year.
- Ernst & Young performed a review, not an audit, and reported no material modifications needed for conformity with U.S. GAAP. Management concluded disclosure controls were effective, and no material changes to internal controls were reported.
Important facts for investors to verify
- Whether promotional intensity and markdowns continue to pressure gross margin and inventory productivity.
- Progress, total cost and timing of the Warrendale closure and Hazelton distribution-center transition.
- Whether the company’s unusually high capital spending is producing expected store, technology and e-commerce returns.
- Inventory composition, clearance exposure and future working-capital requirements.
- Future dividend and share-repurchase decisions relative to operating cash flow and liquidity.
- Compliance with revolving-credit covenants and the availability of trade-letter-of-credit facilities.
- Potential additional impairments, lease obligations related to 77kids, tax settlements and other contingencies.
- The filing period: although the request metadata references “2012 Q3,” this Form 10-Q reports the quarter ended November 2, 2013, with October 27, 2012 as the comparable prior period.