Business Context and Reporting Period
American Eagle Outfitters, Inc. operates the American Eagle Outfitters and aerie brands through company-operated stores, e-commerce sites and international third-party operators. The company had 1,056 company-operated stores at January 31, 2015, including 955 American Eagle stores and 101 aerie stores, plus 99 third-party-operated stores in 16 countries. AEO Direct shipped to 81 countries.
The provided filing is a Form 10-K for Fiscal 2014, the 52-week year ended January 31, 2015, compared primarily with Fiscal 2013, ended February 1, 2014. It is not a 2013 Q4 filing; the fourth-quarter information is included within the annual report.
Financial Performance and Position
| Metric | Fiscal 2014 | Fiscal 2013 |
|---|---|---|
| Total net revenue | $3.283 billion | $3.306 billion |
| Comparable sales | Down 5% | Down 6% |
| Gross profit | $1.155 billion | $1.114 billion |
| Gross margin | 35.2% | 33.7% |
| Operating income | $155.8 million | $141.1 million |
| Operating margin | 4.7% | 4.3% |
| Income from continuing operations | $88.8 million | $83.0 million |
| Diluted income from continuing operations per share | $0.46 | $0.43 |
| Net income | $80.3 million | $83.0 million |
| Diluted net income per share | $0.42 | $0.43 |
| Cash flow from operating activities | $338.4 million | $229.9 million |
| Capital expenditures | $245.0 million | $278.5 million |
| Cash and cash equivalents | $410.7 million | $418.9 million |
| Merchandise inventory | $279.0 million | $291.5 million |
Gross margin improved by 150 basis points, principally due to reduced markdowns and favorable product costs, partly offset by higher delivery costs and rent deleverage. Selling, general and administrative expense increased 1% to $806.5 million, or 24.6% of revenue.
The company reported no borrowings under its new $400 million asset-based revolving credit facilities at year-end. It had $8.1 million of standby letters of credit and $13.7 million of trade letters of credit outstanding. Working capital was $431.4 million and the current ratio was 1.94.
The company paid $97.2 million in dividends during Fiscal 2014, or $0.50 per share. No shares were repurchased under the public repurchase program during the year, although $7.5 million was spent repurchasing shares from employees for tax withholding obligations.
Material Changes Versus the Prior Comparable Period
- Revenue declined 1%, while total comparable sales declined 5%. American Eagle brand comparable sales decreased 6%; aerie comparable sales increased 6%.
- Gross profit increased 4% and gross margin expanded from 33.7% to 35.2%, despite lower sales.
- Operating income increased 10%, but reported results included $17.8 million of restructuring charges and $33.5 million of asset impairment charges.
- Adjusted diluted earnings from continuing operations were $0.63 per share versus $0.74 in the prior year. Management’s adjustment excluded $51.2 million of after-tax impairment and restructuring effects in Fiscal 2014 and $60.9 million of after-tax unusual items in Fiscal 2013.
- Net income declined modestly because Fiscal 2014 included an $8.5 million after-tax loss from discontinued 77kids operations. The loss resulted primarily from lease obligations after the third-party purchaser defaulted.
- Operating cash flow increased substantially to $338.4 million, while capital expenditures declined to $245.0 million. Cash nevertheless decreased by $8.2 million after investing, financing and foreign exchange effects.
- The store base declined by 10 locations, as 60 stores opened and 70 closed. A new 1 million-square-foot omni-channel distribution center in Hazleton, Pennsylvania opened during the year.
Guidance, Outlook, Risks and Unusual Items
For Fiscal 2015, management expected approximately $150 million of capital expenditures, 20 to 25 new American Eagle stores primarily in the Factory format, approximately 25 remodels or refurbishments, about 50 American Eagle store closures and 20 aerie store closures. Management also expected continued international expansion, including approximately 30 new third-party-operated international stores.
Management’s strategy emphasizes improving product assortments and customer experiences, expanding omni-channel fulfillment and digital capabilities, growing aerie, and improving store profitability through portfolio repositioning. Management stated that operating cash flow and existing cash were expected to fund anticipated North American capital expenditures and working capital requirements.
- Reported unusual items included $33.5 million of asset impairments, $17.8 million of restructuring charges and an $8.5 million after-tax discontinued-operations loss.
- The 77kids lease issue produced $13.7 million of pre-tax expense above proceeds from an $11.5 million standby letter of credit. Related cash termination costs were expected to be paid in Fiscal 2015.
- Material risks include changing fashion trends, discretionary consumer spending, inventory markdowns, store underperformance and additional impairment charges, supply-chain disruption, import and trade restrictions, foreign currency movements, technology failures and cybersecurity breaches.
- The company had approximately $1.697 billion of future operating lease obligations and $684.6 million of purchase obligations at January 31, 2015.
- Foreign currency translation losses reduced accumulated other comprehensive income by $22.1 million during Fiscal 2014. The company did not use currency hedges.
- Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the American Eagle brand can reverse its continuing comparable-sales declines while aerie sustains its positive momentum.
- Whether gross-margin improvement from lower markdowns and better product costs is sustainable despite rent, delivery, labor and sourcing-cost pressures.
- The cash impact and final resolution of the remaining 77kids lease obligations.
- Execution of the planned store closures, Factory-store openings, remodels and distribution-center transition.
- Whether the $400 million secured credit facility remains undrawn and available under borrowing-base and covenant requirements.
- The effect of the $1.697 billion operating lease commitment and other purchase obligations on future liquidity.
- The potential for further store or corporate asset impairments if sales and cash-flow forecasts do not improve.