American Eagle Outfitters, Inc. Form 10-Q Summary
Business context and reporting period
This filing covers the 13 and 26 weeks ended July 28, 2012, with comparisons to July 30, 2011. The filing is identified as a 2012 second-quarter report, despite the request metadata referencing 2011 Q2. American Eagle operated one reportable segment comprising American Eagle retail stores, aerie stores and AEO Direct. At quarter-end, the company had 908 American Eagle stores, 155 aerie stores, AEO Direct operations and 39 international franchise stores in 12 countries.
Results exclude 77kids from continuing operations because the company announced its exit from the business and completed its sale on August 3, 2012. The interim financial statements are unaudited and were reviewed, but not audited, by Ernst & Young LLP.
Key financial metrics
| Metric | 13 weeks ended July 28, 2012 | 13 weeks ended July 30, 2011 | 26 weeks ended July 28, 2012 | 26 weeks ended July 30, 2011 |
|---|---|---|---|---|
| Net sales | $739.7 million | $669.1 million | $1.448 billion | $1.272 billion |
| Gross profit | $276.6 million | $236.2 million | $551.5 million | $470.0 million |
| Gross margin | 37.4% | 35.3% | 38.1% | 36.9% |
| Operating income | $61.8 million | $38.1 million | $126.1 million | $82.2 million |
| Operating margin | 8.4% | 5.7% | 8.7% | 6.4% |
| Income from continuing operations | $42.8 million | $25.1 million | $86.9 million | $57.0 million |
| Diluted EPS from continuing operations | $0.21 | $0.13 | $0.44 | $0.29 |
| Net income | $19.0 million | $19.7 million | $58.7 million | $48.0 million |
| Diluted EPS | $0.09 | $0.10 | $0.30 | $0.24 |
- Second-quarter comparable sales increased 9%, including American Eagle up 7%, aerie up 13% and AEO Direct up 28%. First-half comparable sales increased 13%, with AEO Direct up 25%.
- Continuing-operations sales increased 11% in the quarter and 14% year to date. Gross profit increased 17% in both periods.
- Second-quarter merchandise margin improved 120 basis points, while buying, occupancy and warehousing costs improved 90 basis points as a percentage of sales.
- Cash flow from continuing operations was $47.7 million for the first half, compared with cash used of $67.4 million in the prior-year period. Capital expenditures were $48.2 million.
- Cash and cash equivalents were $696.1 million at July 28, 2012. Cash and short-term investments totaled $702.1 million. Working capital was $960.6 million and the current ratio was 3.49.
- Inventory was $462.0 million, up 3% from the prior year on a cost-per-square-foot basis. Units increased 10%, while average unit costs declined in the high single digits.
- The company had no borrowings under its $150.0 million unsecured revolving credit agreement and was in compliance with its covenants. Letters of credit totaled $7.6 million under the agreement and $57.9 million under trade-letter-of-credit facilities.
- Quarterly dividends were $0.11 per share; $43.1 million of dividends were paid during the first half. No public-program share repurchases occurred.
Material changes versus the prior comparable period
- Operating performance improved substantially, with quarterly operating income increasing approximately 62% and operating margin expanding 270 basis points.
- Quarterly income from continuing operations increased approximately 71%, supported by higher sales, improved merchandise margins, expense leverage and a lower effective tax rate.
- The effective tax rate on continuing operations declined to 30.3% from 36.5% in the quarter and to 32.8% from 35.4% for the first half, primarily because of income-tax settlements and changes in tax reserves.
- Net income declined slightly in the quarter despite stronger continuing operations because of significantly higher losses from discontinued 77kids operations. First-half net income increased to $58.7 million from $48.0 million.
- Share-based compensation increased materially to $28.0 million for the first half from $5.5 million in the prior-year period.
- Property and equipment, net, declined to $544.8 million from $635.5 million a year earlier, reflecting depreciation, store impairments and asset maturation.
Outlook, unusual items, risks and contingencies
- Management expected Fiscal 2012 capital expenditures of approximately $100 million, including store investments, information technology and e-commerce. Plans included approximately 15 new American Eagle stores and remodeling or refurbishing approximately 55 to 65 stores.
- Management also disclosed potential closures of approximately 20 to 30 American Eagle stores and 5 to 10 aerie stores during Fiscal 2012, as well as approximately 28 new franchised American Eagle stores.
- The 77kids exit generated $27.8 million of reported exit and disposal costs in the first half, including $16.6 million of asset impairments, $7.8 million of inventory charges and $3.4 million of severance charges.
- Following the August 3, 2012 sale of 77kids, the company expected an approximately $35 million after-tax loss, including approximately $19 million of impairments, inventory write-downs and severance, $6 million of purchaser support payments and $10 million of operating costs. Remaining charges were expected in the third quarter of Fiscal 2012.
- Key risks include seasonal retail volatility, markdown and inventory risk, input-cost inflation, underperforming-store impairments, execution of the 77kids exit, potential limitations on credit-facility availability, international expansion and the success of aerie and AEO Direct.
- Management stated that operating cash flow and existing cash were expected to fund anticipated capital expenditures and working-capital needs. No material changes to market-risk exposures or risk-factor disclosures were reported.
- Legal proceedings were described as routine; management believed existing reserves were adequate and that pending matters would not materially affect consolidated financial position or results of operations.
Most important facts for investors to verify
- Confirm the final financial impact, cash requirements and purchaser support payments associated with the 77kids sale.
- Monitor whether strong comparable-sales trends and gross-margin gains persist after the quarter’s favorable product costs and reduced markdowns.
- Reconcile inventory growth, unit growth and planned promotional activity with future markdown risk and cash generation.
- Assess the effect of elevated share-based compensation on reported earnings and future dilution.
- Verify execution of the store-opening, remodeling and potential-closure plans and the related capital-expenditure outlook.
- Review compliance with revolving-credit covenants and availability of trade-letter-of-credit facilities.
- Evaluate the sustainability of the lower effective tax rate, including the effect of tax settlements and changes in unrecognized tax benefits.