Business Context and Reporting Period
American Eagle Outfitters, Inc. filed this Form 10-Q for the 13 and 39 weeks ended November 1, 2014, compared with the periods ended November 2, 2013. Although the request metadata identifies “2013 Q3,” the filing itself reports Fiscal 2014 third-quarter results. The company operates American Eagle Outfitters and aerie retail stores, AEO Direct e-commerce operations, and international licensed and franchise stores, presented as one reportable segment.
Key Financial Metrics
| Metric | 13 weeks ended Nov. 1, 2014 | 13 weeks ended Nov. 2, 2013 | 39 weeks ended Nov. 1, 2014 | 39 weeks ended Nov. 2, 2013 |
|---|---|---|---|---|
| Net revenue | $854.3 million | $857.3 million | $2.211 billion | $2.264 billion |
| Gross profit | $315.5 million | $298.9 million | $778.9 million | $808.0 million |
| Gross margin | 36.9% | 34.9% | 35.2% | 35.7% |
| Operating income | $23.1 million | $41.8 million | $43.6 million | $117.1 million |
| Net income | $9.0 million | $24.9 million | $18.7 million | $72.5 million |
| Diluted EPS | $0.05 | $0.13 | $0.10 | $0.37 |
| Operating cash flow | Not separately reported | Not separately reported | $134.8 million | $73.2 million |
- Third-quarter comparable sales declined 5% overall, with American Eagle Outfitters down 6% and aerie up 3%. For the first 39 weeks, comparable sales declined 7% overall, with American Eagle Outfitters down 8% and aerie up 3%.
- Third-quarter gross profit increased 6%, and gross margin expanded 200 basis points, primarily from lower markdowns and favorable product costs. SG&A decreased 1% and remained 24.0% of revenue.
- Third-quarter operating results included $33.5 million of asset impairment charges and $17.8 million of restructuring charges. Excluding these items, adjusted diluted EPS was $0.22 versus $0.19 in the prior-year quarter; this is a non-GAAP measure.
- Cash and cash equivalents were $280.4 million at November 1, 2014, down from $354.3 million a year earlier and $418.9 million at February 1, 2014. Working capital was $385.0 million and the current ratio was 1.70.
- Inventory was $468.6 million, down 10% from $518.9 million a year earlier. Management stated that inventory at cost per square foot decreased 14%, or by mid-single digits excluding a change in inventory ownership terms.
- Capital expenditures were $210.5 million for the first 39 weeks, while cash dividends paid were $72.9 million. Net cash used in investing activities was $201.6 million and net cash used in financing activities was $76.3 million.
- The company had no borrowings under its $150.0 million unsecured revolving credit facility at November 1, 2014. It had $8.2 million of outstanding letters of credit and $44.6 million of trade letters of credit.
Material Changes Versus the Prior Comparable Period
- Revenue was approximately flat in the quarter but declined 2% for the first 39 weeks, reflecting negative comparable sales and only partial offset from new-store growth.
- Net income declined 64% in the quarter and 74% for the first 39 weeks. The decreases reflected lower sales, higher depreciation, elevated income tax rates, asset impairments, and restructuring costs.
- The effective tax rate increased to 61.9% from 41.2% in the quarter and to 59.1% from 38.6% for the first 39 weeks, primarily due to valuation allowances on foreign losses and lower earnings.
- Store and corporate asset impairments totaled $33.5 million in the quarter, including $25.1 million related to 79 stores and $8.4 million related to corporate assets. The prior-year quarter included $19.3 million related to the planned closure of the Warrendale distribution center.
- The company recorded $17.8 million of restructuring charges for office-space consolidation, severance, and other corporate actions. No comparable restructuring charge was recorded in the prior-year quarter.
- Operating cash flow increased to $134.8 million from $73.2 million, primarily due to working-capital effects, including the change in inventory ownership terms and incentive-pay timing, despite lower earnings.
- The company opened 54 stores and closed 28 during the first 39 weeks, ending with 1,092 company-operated stores versus 1,064 a year earlier. It also had 94 international licensed or franchise stores in 14 countries.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management described third-quarter performance as ahead of expectations, citing expense control and reduced markdowns. Management stated that the quarter represented a meaningful recovery from the first half.
- Fiscal 2014 capital expenditures were expected to be approximately $230 million, including stores, technology, e-commerce, and distribution-center investments. Fiscal 2015 capital expenditures were expected to be approximately $150 million.
- Planned initiatives included approximately 25 AEO Factory stores, international expansion, approximately 45 store remodels, and continued omni-channel investment. Management also referenced the potential closure of approximately 150 North American stores through Fiscal 2016.
- On December 2, 2014, after the quarter-end, the company entered into a five-year, $400 million asset-based secured revolving credit facility, replacing the $150 million unsecured facility. No loans were outstanding under the new facility on that date.
- Key risks include negative comparable sales, inventory markdowns, underperforming-store impairment charges, retail seasonality, rising raw-material and labor costs, international expansion execution, availability of credit facilities, and the ability to generate sufficient cash flow.
- The company stated that pending legal proceedings were not expected to materially affect its consolidated financial position or results of operations. Management reported no material changes to previously disclosed risk factors.
- The interim financial statements were reviewed, not audited, by Ernst & Young LLP. The auditor reported that it was not aware of material modifications needed for conformity with U.S. GAAP.
Investor Verification Items
- Verify whether comparable-sales trends, especially the American Eagle brand, improved after the reporting date and whether aerie growth continued.
- Assess the sustainability of gross-margin improvement after the quarter’s markdown reductions and the impact of occupancy, delivery, and other fixed costs.
- Review the store-closure, restructuring, and impairment program, including whether additional charges are likely.
- Reconcile projected capital expenditures with operating cash flow, cash balances, dividend commitments, and future liquidity needs.
- Evaluate inventory levels and aging, including the effect of the change in inventory ownership terms and potential future markdown exposure.
- Confirm the terms, borrowing-base availability, covenants, collateral, and letters-of-credit capacity under the new $400 million secured credit facility.
- Consider the effect of the elevated effective tax rate and foreign-loss valuation allowances on future earnings and cash taxes.