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AEO > SEC Filings for AEO > Form 10-Q on 9-Dec-2013All Recent SEC Filings

Show all filings for AMERICAN EAGLE OUTFITTERS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for AMERICAN EAGLE OUTFITTERS INC


9-Dec-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 60 to 65 new American Eagle Outfitters stores in North America and internationally during Fiscal 2013;

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

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 15 to 20 American Eagle Outfitters and 25 to 30 aerie stores in the United States and Canada 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 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;


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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.

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.

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 a ROIC in the range of 14% to 17%.

Results of Operations

Overview

Our third quarter results were negatively impacted by a competitive retail segment, with high promotional competition and tepid consumer spending. Weak store traffic and increased promotional activity negatively impacted both comparable sales and margins. We cleared through inventories and controlled our expenses during a volatile period.

Our third quarter total net revenue decreased 6% to $857.3 million and consolidated comparable sales, including AEO Direct, decreased 5%, compared to a 10% increase last year. By brand, American Eagle Outfitters brand comparable sales decreased 5% and aerie brand decreased 3%. Comparable sales for AEO Direct, which is included in the consolidated and brand comparable sales, increased 17%.


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Gross profit decreased 21% to $298.9 million compared to $379.1 million last year and declined 670 basis points to 34.9% as a rate to total net revenue. The decline is the result of higher markdowns, increased delivery costs and deleverage of rent on negative comparable sales.

Operating income for the third quarter was $41.8 million, which includes $19.3 million of pre-tax asset impairment charges resulting from the decision to close a distribution center. This compares to $128.5 million of operating income a year ago. Net income this year was $24.9 million, or $0.13 per diluted share. On an adjusted basis, which excludes $0.06 per diluted share of asset impairments, earnings were $0.19 per diluted share. This compares to income from continuing operations last year of $0.41 per diluted share.

The preceding paragraph contains non-GAAP financial measures ("non-GAAP" or "adjusted"), comprised of earnings per share information excluding certain 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
                                                                  November 2,
                                                                     2013
   Net income per diluted share - GAAP Basis                     $        0.13
   Add back: Non-cash asset impairment charges, net of tax (1)            0.06

   Net income per diluted share - Non-GAAP Basis                 $        0.19

(1) Non-GAAP adjustments consist of $19.3 million of pre-tax asset impairments ($11.9 million after-tax) related to the Warrendale Distribution Center.

We had $366.8 million in cash and cash equivalents and investments as of November 2, 2013. Merchandise inventory at the end of the third quarter was $518.9 million, compared to $481.2 million last year, an increase of 6% on a cost per foot basis. The increase is due to a 3% increase in both ending units per foot and ending average cost per unit.

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.


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                                              13 Weeks Ended                            39 Weeks Ended
                                     November 2,          October 27,          November 2,          October 27,
                                        2013                 2012                 2013                 2012
Total net revenue                           100.0 %              100.0 %              100.0 %              100.0 %
Cost of sales, including
certain buying, occupancy and
warehousing expenses                         65.1                 58.4                 64.3                 60.5

Gross profit                                 34.9                 41.6                 35.7                 39.5
Selling, general and
administrative expenses                      24.0                 24.1                 25.4                 24.6
Loss on impairment of assets                  2.3                   -                   0.8                   -
Depreciation and amortization
expense                                       3.8                  3.4                  4.3                  4.1

Operating income                              4.8                 14.1                  5.2                 10.8
Other income, net                             0.1                  0.3                  0.0                  0.3

Income before income taxes                    4.9                 14.4                  5.2                 11.1
Provision for income taxes                    2.0                  5.4                  2.0                  3.9

Income from continuing
operations                                    2.9                  9.0                  3.2                  7.2
Loss from discontinued
operations, net of tax                         -                  (0.4 )                 -                  (1.4 )

Net income                                    2.9 %                8.6 %                3.2 %                5.8 %

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

                                               13 Weeks Ended                      39 Weeks Ended
                                       November 2,       October 27,       November 2,       October 27,
                                           2013              2012              2013              2012
Number of stores:
Beginning of period                           1,056             1,063             1,044             1,069
Opened                                           13                 4                46                13
Closed                                           (5 )              (4 )             (26 )             (19 )

End of period                                 1,064             1,063             1,064             1,063

Total gross square feet at end of
period                                    6,455,497         6,300,662         6,455,497         6,300,662

International franchise stores at
end of period (1)                                61                44                61                44

(1) International franchise stores are not included in the consolidated store data or the total gross square feet calculation. International franchise stores at October 27, 2012 include the six stores in Hong Kong and China which were acquired in 2013. Refer to Note 12 to the Consolidated Financial Statements for additional information on the Company's acquisition of its Hong Kong and China operations.

Our operations are conducted in one reportable segment, which includes 932 American Eagle Outfitters retail stores, 132 aerie stand-alone retail stores and AEO Direct.

Comparison of the 13 weeks ended November 2, 2013 to the 13 weeks ended October 27, 2012

Total net revenue

Total net revenue decreased 6% to $857.3 million compared to $910.3 million last year. The decline resulted primarily from a consolidated comparable sales decrease of 5% for the period. By brand, including the respective AEO Direct sales, American Eagle Outfitters brand comparable sales decreased 5%, or $43.3 million, and aerie brand comparable sales decreased 3%, or $1.5 million. Third quarter 2013 comparable sales are compared to the 13 weeks ended November 3, 2012.


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Total comparable sales for AE women's and men's have both decreased 5%. For the third quarter, AUR and average dollar sale declined approximately 9% as a result of an increase in promotional activity. Store traffic was below last year; however, conversion was up approximately 1%, resulting in higher transactions and unit sales per store.

Gross Profit

Gross profit decreased 21% to $298.9 million compared to $379.1 million last year. As a rate to total net revenue, gross profit was 34.9% compared to 41.6% in the same quarter last year. The 670 basis point decline in gross margin was due to competitive pricing pressures and increased markdowns. Additionally, buying, occupancy and warehousing costs increased 150 basis points as a rate to total net revenue from deleverage of rent on negative comparable sales and increased delivery costs.

There was a net benefit of $7.5 million of share-based payment expense included in gross profit for the period ended November 2, 2013. This is due to a reversal of previously recorded performance-based expense resulting from current business performance compared to targets. The net benefit is compared to $9.5 million of share-based payment expense for the period ended October 27, 2012.

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 decreased 6% to $205.7 million from $219.1 million last year. As a rate to total net revenue, SG&A expenses improved 10 basis points to 24.0%. Lower incentive and travel costs were partially offset by incremental costs related to filling open positions at the corporate office and expense related to the opening of factory stores and our omni-channel initiatives.

There was a net benefit of $4.0 million of share-based payment expense included in selling, general and administrative expenses for the period ended November 2, 2013. This is due to a reversal of previously recorded performance-based expense resulting from current business performance compared to targets. The net is compared to $8.1 million of share-based payment expense for the period ended October 27, 2012.

Loss on Impairment of Assets

Loss on impairment of assets was $19.3 million for the third quarter this year. The impairment loss resulted from the announced plan to close the Warrendale, Pennsylvania distribution center.

Refer to Note 14 to the Consolidated Financial Statements for additional information regarding exit and disposal costs.

Depreciation and Amortization Expense

Depreciation and amortization expense increased to $32.0 million, compared to $31.4 million last year. As a rate to total net revenue, depreciation and amortization expense was 3.8% this year as compared to 3.4% last year. The increase in rate primarily was a result of the decrease in total net revenue.

Other Income, Net

Other income decreased to $0.5 million this year, compared to $2.8 million last year. The decrease is primarily a result of the settlement recoveries received last year from auction rate securities that were previously held.

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 quarterly events. The effective income tax rate from continuing operations based on actual operating results for the 13 weeks ended November 2, 2013 was 41.2% compared to 37.2% for the 13 weeks ended October 27, 2012. The increase in the effective income tax rate this year is primarily due to a change in the mix of income contribution between domestic and international operations and favorable state income tax settlements last year.


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Income from Continuing Operations

Income from continuing operations for the third quarter was $24.9 million, or $0.13 per diluted share, compared to $82.4 million, or $0.41 per diluted share, last year. Included in income from continuing operations this year was $19.3 million, or $0.06 per diluted share, of pre-tax asset impairment charges. The remaining 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 last year, the results of 77kids are presented as a discontinued operation. Loss from discontinued operations, net of tax, was $3.8 million, or a $0.02 loss per diluted share, for the period ended October 27, 2012. There were no results from discontinued operations this year.

Refer to Note 13 to the Consolidated Financial Statements for additional information regarding the discontinued operations of 77kids.

Net Income

Net income decreased to $24.9 million, or 2.9% as a percent to total net revenue, from $78.6 million, or 8.6% as a percent to total net revenue last year. Net income per diluted share decreased to $0.13 per diluted share from $0.39 per diluted share in the prior year. As noted above, net income this year includes $19.3 million, or $0.06 per diluted share, of pre-tax asset impairment charges. The change in net income is attributable to the factors noted above.

Comparison of the 39 weeks ended November 2, 2013 to the 39 weeks ended October 27, 2012

Total net revenue

Total net revenue decreased 4% to $2.264 billion compared to $2.359 billion last year. The change in total net revenue resulted primarily from a comparable sales decrease of 6% for the period. By brand, including the respective AEO Direct sales, American Eagle Outfitters brand comparable sales decreased 6%, or $131.0 million, and aerie brand comparable sales decreased 1%, or $0.9 million. Year-to-date 2013 comparable sales are compared to the 39 weeks ended November 3, 2012.

Total comparable sales for AE women's and men's have decreased 7% and 4%, respectively. For the 39 week period, traffic, transactions and average transaction value declined. AUR decreased in the mid single-digits, due to greater promotional activity.

Gross Profit

Gross profit decreased 13% to $808.0 million compared to $930.6 million last year. As a rate to total net revenue, gross profit was 35.7%, compared to 39.5% last year. Included in gross profit were $2.4 million of corporate charges this year. Favorable product costs provided 110 basis points of improvement, offset by 350 basis points of decline due to higher markdowns. Buying, occupancy and warehousing costs deleveraged 140 basis points from higher delivery costs and deleverage of rent on negative comparable sales.

There was a net benefit of $3.5 million share-based payment expense included in gross profit for the period ended November 2, 2013. This is due to a reversal of previously recorded performance-based expense resulting from current business performance compared to targets. The net benefit is compared to $23.7 million of share-based payment expense for the period ended October 27, 2012.

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.


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Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased to $574.3 million from $579.8 million last year, however increased 80 basis points, as a rate to total net revenue, to 25.4% from 24.6% last year. Corporate charges of $1.5 million this year and $3.9 million last year, were included in selling, general and administrative expense. Lower incentive and travel costs were partially offset by incremental costs related to filling open positions at the corporate office and expenses related to the opening of factory stores and our omni-channel initiatives.

There was a net benefit of $1.6 million of share-based payment expense included in selling, general and administrative expenses for the period ended November 2, 2013. This is due to a reversal of previously recorded performance-based expense resulting from current business performance compared to targets. The net benefit is compared to $21.7 million of share-based payment expense for the period ended October 27, 2012.

Loss on Impairment of Assets

Loss on impairment of assets was $19.3 million for the year-to-date period this year as compared to $0.4 million last year. The impairment loss this year resulted from the announced plan to close the Warrendale, Pennsylvania distribution center.

Refer to Note 14 to the Consolidated Financial Statements for additional information regarding exit and disposal costs.

Depreciation and Amortization Expense

Depreciation and amortization expense increased to $97.3 million, compared to $96.1 million last year. Depreciation and amortization expense includes $7.6 million of restructuring asset write-offs this year and $0.7 million last year. As a rate to total net revenue, depreciation and amortization expense was 4.3% this year compared to 4.1% last year.

Other Income, Net

Other income was $1.0 million this year, compared to $6.0 million last year, primarily as a result of the settlement recoveries from auction rate securities that were previously held.

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 quarterly events. The effective income tax rate from continuing operations based on actual operating results for the 39 weeks ended November 2, 2013 was 38.6% compared to 35.0% for the 39 weeks ended October 27, 2012. The increase in the effective income tax rate this year is primarily due to a change in the mix of income contribution between domestic and international operations and favorable state income tax settlements last year.


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Income from Continuing Operations

Income from continuing operations for the 39 week period ended November 2, 2013 . . .

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