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AEO > SEC Filings for AEO > Form 10-Q on 30-May-2013All Recent SEC Filings

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Form 10-Q for AMERICAN EAGLE OUTFITTERS INC


30-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our Fiscal 2012 Management's Discussion and Analysis of Financial Condition and Results of Operations which can be found in our Fiscal 2012 Annual Report on Form 10-K.

In addition, the following discussion and analysis of financial condition and results of operations are based upon our Consolidated Financial Statements and should be read in conjunction with these statements and notes thereto.

This report contains various "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events, including the following:

the planned opening of approximately 50 to 55 new American Eagle Outfitters stores in North America and internationally during Fiscal 2013;

the success of our efforts to expand internationally, engage in future franchise/license agreements, and/or grow through acquisitions or joint ventures;

the selection of approximately 50 to 65 American Eagle Outfitters stores in the United States and Canada for remodeling and refurbishing during Fiscal 2013;

the potential closure of approximately 20 to 30 American Eagle Outfitters and 15 to 20 aerie stores in the United States and Canada during Fiscal 2013;

the planned opening of approximately 20 new franchised American Eagle Outfitters stores during Fiscal 2013;

the success of our core American Eagle Outfitters and aerie brands through our omni-channel outlets within North America and internationally;

the possibility that economic pressures and other business factors will have a significant negative impact on our continued growth and results of operations;

the expected payment of a dividend in future periods;

the possibility that our credit facilities may not be available for future borrowings;

the possibility that rising prices of raw materials, labor, energy and other inputs to our manufacturing process, if unmitigated, will have a significant impact to our profitability; and

the possibility that we may be required to take additional store impairment charges related to underperforming stores.

We caution that these forward-looking statements, and those described elsewhere in this report, involve material risks and uncertainties and are subject to change based on factors beyond our control as discussed within Item 1A of this Quarterly Report on Form 10-Q and Item 1A of our Fiscal 2012 Annual Report on Form 10-K. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements.

Key Performance Indicators

Our management evaluates the following items, which are considered key performance indicators, in assessing our performance:

Comparable sales - Comparable sales provide a measure of sales growth for stores and channels open at least one year over the comparable prior year period. In fiscal years following those with 53 weeks, including Fiscal 2013, the prior year period is shifted by one week to compare similar calendar weeks. A store is included in comparable sales in the thirteenth month of operation. However, stores that have a gross square footage increase of 25% or greater due to a remodel are removed from the comparable sales base, but are included in total sales. These stores are returned to the comparable sales base in the thirteenth month following the remodel. Sales from American Eagle Outfitters and aerie stores, as well as sales from AEO Direct, are included in total comparable sales. Sales from franchise stores are not included in comparable sales. Individual American Eagle Outfitters and aerie brand comparable sales disclosures represent sales from stores and AEO Direct.

We began to include AEO Direct sales in the individual American Eagle Outfitters and aerie brand comparable sales metric in Fiscal 2013 for the following reasons:

our approach to customer engagement continues to evolve as "omni-channel", which provides a seamless customer experience through both traditional and non-traditional channels, including four wall store locations, web, mobile/tablet devices, social networks, email, in-store displays and kiosks;



shopping behavior has continued to evolve across multiple channels that work in tandem to meet all customer needs. Management believes that presenting a brand level performance metric that includes all channels (i.e., stores and AEO Direct) to be the most appropriate, given customer behavior.

Our management considers comparable sales to be an important indicator of our current performance. Comparable sales results are important to achieve leveraging of our costs, including store payroll, store supplies, rent, etc. Comparable sales also have a direct impact on our total net revenue, cash and working capital.

Gross profit-Gross profit measures whether we are optimizing the price and inventory levels of our merchandise and achieving an optimal level of sales. Gross profit is the difference between total net revenue and cost of sales. Cost of sales consists of: merchandise costs, including design, sourcing, importing and inbound freight costs, as well as markdowns, shrinkage, certain promotional costs and buying, occupancy and warehousing costs. Buying, occupancy and warehousing costs consist of compensation, employee benefit expenses and travel for our buyers and certain senior merchandising executives; rent and utilities related to our stores, corporate headquarters, distribution centers and other office space; freight from our distribution centers to the stores; compensation and supplies for our distribution centers, including purchasing, receiving and inspection costs; and shipping and handling costs related to our e-commerce operation. The inability to obtain acceptable levels of sales, initial markups or any significant increase in our use of markdowns could have an adverse effect on our gross profit and results of operations.

Operating income-Our management views operating income as a key indicator of our success. The key drivers of operating income are comparable sales, gross profit, our ability to control selling, general and administrative expenses, and our level of capital expenditures. Management also uses earnings before interest and taxes ("EBIT") as an indicator of successful operating results, as it is impacted by the same key drivers as operating income.

Return on invested capital-Our management uses return on invested capital ("ROIC") as a key measure to assess our efficiency at allocating capital to profitable investments. This measure is critical in determining which strategic alternatives to pursue. ROIC is calculated as net income divided by average stockholder's equity for a given period.

Store productivity-Store productivity, including total net revenue per average square foot, sales per productive hour, average unit retail price ("AUR"), conversion rate, the number of transactions per store, the number of units sold per store, the number of units per transaction and four wall profit, is evaluated by our management in assessing our operational performance.

Inventory turnover-Our management evaluates inventory turnover as a measure of how productively inventory is bought and sold. Inventory turnover is important as it can signal slow moving inventory. This can be critical in determining the need to take markdowns on merchandise.

Cash flow and liquidity-Our management evaluates cash flow from operations, investing and financing in determining the sufficiency of our liquidity. Cash flow from operations has historically been sufficient to cover our uses of cash. Our management believes that cash flow from operations will be sufficient to fund anticipated capital expenditures and working capital requirements.

Our management's goals are to drive improvements to our gross profit performance, bring greater consistency to our results and to deliver profitable growth over the long term. Specifically, our targets are to deliver a total net revenue compounded annual growth rate ("CAGR") of 7% to 9%, an EBIT CAGR of 12% to 15% and an annual ROIC in the range of 14% to 17%.

Results of Operations

Overview

In the first quarter of Fiscal 2013, the macroeconomic environment presented challenges. Additionally, cold weather following last year's record warmth and soft consumer demand for spring apparel negatively impacted store traffic. Within this context, it was difficult to generate growth against a very strong quarter last year. However, our execution of strong inventory principles, fleet repositioning and the growth of our online business, led to profitability.

Our first quarter total net revenue decreased 4% to $679.5 million and comparable sales, including AEO Direct, decreased 5%, compared to a 17% increase last year. By brand, including AEO Direct, American Eagle Outfitters brand comparable sales decreased 6% and aerie brand increased 4%. AEO Direct increased 24%. A decrease in total net revenue resulted in the deleverage of fixed costs, which increased slightly to last year. Additionally, promotions were higher than last year.


Gross profit decreased 4% to $263.6 million compared to $274.9 million last year and was 38.8% as a rate to total net revenue for both periods. This year, favorable product costs benefited the gross margin rate but were offset by higher markdowns and an increase in the buying, occupancy and warehousing costs rate to revenue from higher delivery costs and the deleverage of rent on negative comparable sales.

Operating income for the first quarter was $45.8 million compared to $64.3 million last year, and includes $11.5 million of asset write-offs and corporate charges. Operating income as a rate to total net revenue was 6.7% this year compared to 9.1% last year. On an adjusted basis, income from continuing operations this year was $0.18 per diluted share, which excludes a ($0.04) per diluted share impact from asset write-offs and corporate charges. This compares to income from continuing operations last year of $0.22 per diluted share.

The preceding paragraph contains non-GAAP financial measures ("non-GAAP" or "adjusted"), comprised of earnings per share information excluding non-GAAP items. This financial measure is not based on any standardized methodology prescribed by U.S. generally accepted accounting principles ("GAAP") and is not necessarily comparable to similar measures presented by other companies. We believe that this non-GAAP information is useful as an additional means for investors to evaluate our operating performance, when reviewed in conjunction with our GAAP financial statements. These amounts are not determined in accordance with GAAP and therefore, should not be used exclusively in evaluating our business and operations. The table below reconciles the GAAP financial measure to the non-GAAP financial measure discussed above.

                                                                       13 Weeks
                                                                        Ended
                                                                        May 4,
                                                                         2013
 Income from continuing operations per diluted share-GAAP Basis       $     0.14
 Add back: Asset write-offs and corporate charges (1)                       0.04

 Income from continuing operations per diluted share-Non-GAAP Basis   $     0.18

(1) Adjustment consists of $10.1 million of pre-tax corporate and store asset write-offs and $1.4 million of pre-tax severance and related employee costs.

We had $496.2 million in cash and cash equivalents and short-term investments as of May 4, 2013 after repurchasing 1.6 million shares of common stock for $33.1 million. Merchandise inventory at May 4, 2013 was $340.5 million, compared to $367.7 million last year, a decrease of 6% on a cost per foot basis. The decrease is due to a 10% decrease in ending units per foot, partially offset by a 5% increase in ending average cost per unit, driven by a change in product mix.

Our business is affected by the pattern of seasonality common to most retail apparel businesses. The results for the current and prior periods are not necessarily indicative of future financial results.

The following table shows the percentage relationship to total net revenue of the listed line items included in our Consolidated Statements of Operations.

--------------------------------------------------------------------------------
                                                                   13 Weeks Ended
                                                             May 4,          April 28,
                                                              2013             2012
Total net revenue                                              100.0 %            100.0 %
Cost of sales, including certain buying, occupancy and
warehousing expenses                                            61.2               61.2

Gross profit                                                    38.8               38.8
Selling, general and administrative expenses                    26.8               25.2
Depreciation and amortization expense                            5.3                4.5

Operating income                                                 6.7                9.1
Other (expense) income, net                                     (0.1 )              0.5

Income before income taxes                                       6.6                9.6
Provision for income taxes                                       2.5                3.4

Income from continuing operations                                4.1                6.2
Loss from discontinued operations, net of tax                     -                (0.6 )

Net income                                                       4.1                5.6

The following table shows our adjusted consolidated store data, which excludes 77kids stores:

                                                              13 Weeks Ended
                                                         May 4,          April 28,
                                                          2013             2012
 Number of stores:
 Beginning of period                                         1,044            1,069
 Opened                                                          7                6
 Closed                                                        (14 )             (7 )

 End of period                                               1,037            1,068

 Total gross square feet at end of period                6,191,638        6,301,843

 International franchise stores at end of period (1)            57               34

(1) International franchise stores are not included in the consolidated store data or the total gross square feet calculation. Additionally, international franchise stores include the six stores in Hong Kong and China, which we have executed an agreement to acquire. The agreement is expected to close in the second quarter of Fiscal 2013.

Our operations are conducted in one reportable segment, which includes 896 American Eagle Outfitters retail stores, 141 aerie stand-alone retail stores and AEO Direct.

Comparison of the 13 weeks ended May 4, 2013 to the 13 weeks ended April 28, 2012

Total net revenue

Total net revenue decreased 4% to $679.5 million compared to $708.7 million last year. The change in total net revenue resulted primarily from a comparable sales decrease of 5%, or $35.6 million, for the period. By brand, including the respective AEO Direct sales, American Eagle Outfitters brand comparable sales decreased 6%, or $37.4 million, and aerie brand increased 4%, or $1.8 million. First quarter 2013 comparable sales are compared to the 13 weeks ended May 5, 2012.


AE women's and men's comparable sales decreased 7% and 3%, respectively. For the first quarter, both transactions and average transaction value decreased. AUR decreased in the low single-digits, primarily due to greater promotions.

Gross Profit

Gross profit decreased 4% to $263.6 million compared to $274.9 million last year. As a rate to total net revenue, gross profit was 38.8%, flat to last year. Included in gross profit was $2.4 million of corporate charges. Favorable product costs provided 230 basis points of improvement. This favorability was offset by 70 basis points of decline due to higher markdowns. Buying, occupancy and warehousing costs deleveraged 160 basis points from corporate charges, higher delivery costs and deleverage of rent on negative comparable sales.

There was $2.3 million and $11.0 million of share-based payment expense included in gross profit for the periods ended May 4, 2013 and April 28, 2012, respectively, comprised of both time and performance-based awards. The decrease is due to a change in performance this year and reduced levels of outstanding share awards.

Our gross profit may not be comparable to that of other retailers, as some retailers include all costs related to their distribution network as well as design costs in cost of sales and others may exclude a portion of these costs from cost of sales, including them in a line item such as selling, general and administrative expenses. Refer to Note 2 to the Consolidated Financial Statements for a description of our accounting policy regarding cost of sales, including certain buying, occupancy and warehousing expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 2% to $182.3 million from $178.5 million last year and increased 160 basis points, as a rate to total net revenue, to 26.8% from 25.2% last year. Included in selling, general and administrative expense is $1.5 million of severance and related employee costs. The minimal dollar increase was driven primarily by corporate charges, advertising investments and fortifying our corporate team, partially offset by lower incentive compensation costs.

There was $3.0 million and $10.3 million of share-based payment expense included in selling, general and administrative expenses for the periods ended May 4, 2013 and April 28, 2012, respectively, comprised of both time and performance-based awards. The decrease is due to a change in performance this year and reduced levels of outstanding share awards.

Depreciation and Amortization Expense

Depreciation and amortization expense increased to $35.5 million, compared to $32.1 million last year, as result of $7.6 million of corporate and store write-offs, partially offset by the impact of prior year store impairments and maturing assets.

Other (Expense) Income, Net

Other expense was $0.7 million, compared to income of $3.5 million last year. Other income last year primarily resulted from recovery proceeds received from previously sold Auction Rate Securities.

Provision for Income Taxes

The provision for income taxes from continuing operations is based on the current estimate of the annual effective income tax rate and is adjusted as necessary for discrete quarterly events. The effective income tax rate from continuing operations based on actual operating results for the 13 weeks ended May 4, 2013 was 38.0% compared to 35.1% for the 13 weeks ended April 28, 2012. The lower effective income tax rate for the 13 weeks ended April 28, 2012 was primarily due to state income tax settlements and proceeds on the sale of certain ARS investments for which no income tax expense was recognized.


Income from Continuing Operations

Income from continuing operations for the first quarter was $28.0 million, or $0.14 per diluted share, compared to $44.0 million, or $0.22 per diluted share, last year. Included in income from continuing operations this year was $0.04 per diluted share of loss related to asset write-offs and corporate charges. The change in income from continuing operations is attributable to the factors noted above.

Loss from Discontinued Operations

Due to the completion of the sale of the 77kids business to a third party in Fiscal 2012, the results of 77kids are presented as a discontinued operation. Loss from discontinued operations, net of tax, was $4.3 million, or a $0.02 loss per diluted share, for the period ended April 28, 2012.

Refer to Note 12 to the Consolidated Financial Statements for additional information regarding the discontinued operations of 77kids.

Net Income

Net income decreased to $28.0 million, or 4.1% as a percent to total net revenue, from $39.7 million, or 5.6% as a percent to total net revenue last year. Net income per diluted share decreased to $0.14 per diluted share from $0.20 per diluted share in the prior year. The change in net income is attributable to the factors noted above, including the impact of the discontinued operations of 77kids.

International Operations

We have entered into Country License Agreements with multiple partners to expand our brands internationally. Through these Country License Agreements, we plan to open a series of American Eagle Outfitters stores in Eastern Europe, Northern Africa and various parts of Asia. As of May 4, 2013, we had 57 franchised stores operated by our franchise partners in 14 countries. During the first quarter, we executed an agreement to acquire six franchise stores in Hong Kong and China from our franchise partner. This agreement is expected to close in the second quarter of Fiscal 2013. These six stores are included in total franchise stores as of May 4, 2013.

These Country License Agreements do not involve a capital investment from AEO and require minimal operational involvement. International franchise stores are not included in the consolidated store data or the total gross square feet calculation.

As of May 4, 2013, we operated 92 wholly owned stores in Canada, one in Mexico and six in Puerto Rico. We plan to open several additional wholly owned stores in Mexico throughout 2013. We continue to evaluate further opportunities to expand internationally, which may include additional Country License Agreements or wholly owned stores, as well as joint ventures.

Fair Value Measurements

ASC 820 defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. Fair value is defined under ASC 820 as the exit price associated with the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date.

Financial Instruments

Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. In addition, ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs (i.e., projections, estimates, interpretations, etc.) that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.


As of May 4, 2013, we held certain assets that are required to be measured at fair value on a recurring basis. These include cash equivalents and short-term investments.

In accordance with ASC 820, the following table represents the fair value hierarchy of our financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of May 4, 2013:

                                                              Fair Value Measurements at May 4, 2013
                                                             Quoted Market
                                                           Prices in Active                                       Significant
                                                              Markets for             Significant Other          Unobservable
                                       Carrying            Identical Assets              Observable                 Inputs
(In thousands)                          Amount                 (Level 1)              Inputs (Level 2)             (Level 3)
Cash and cash equivalents:
Cash                                 $    302,188          $         302,188         $                -          $          -
Money-market                               54,954                     54,954                          -                     -
Commercial paper                           20,000                     20,000                          -                     -
Treasury bills                              6,033                      6,033                          -                     -

Total cash and cash equivalents      $    383,175          $         383,175         $                -          $          -
Short-term investments:
Treasury bills                       $    103,144          $         103,144         $                -          $          -
Term-deposits                               9,897                      9,897                          -                     -

Total short-term investments         $    113,041          $         113,041         $                -          $          -

Total                                $    496,216          $         496,216         $                -          $          -

Percent to Total                            100.0 %                    100.0 %                       0.0 %                 0.0 %

Refer to Notes 3 and 4 to the Consolidated Financial Statements for additional information on our investment securities, including a description of the securities.

Liquidity and Capital Resources

Our uses of cash are generally for working capital, the construction of new stores and remodeling of existing stores, information technology upgrades, distribution center improvements and expansion, the purchase of both short and long-term investments, the repurchase of common stock and the payment of dividends. Historically, these uses of cash have been funded with cash flow from operations and existing cash on hand. We expect to be able to fund our future cash requirements through current cash holdings as well as cash generated from operations.

Our growth strategy includes internally developing our brands and the possibility of further international expansion or acquisitions. We periodically consider and evaluate these options to support future growth. In the event we do pursue such options, we could require additional debt financing. There can be no assurance that we would be successful in any endeavor we may undertake to increase our profitability.


The following sets forth certain measures of our liquidity:

. . .

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