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AEO > SEC Filings for AEO > Form 10-Q on 28-Aug-2014All Recent SEC Filings

Show all filings for AMERICAN EAGLE OUTFITTERS INC

Form 10-Q for AMERICAN EAGLE OUTFITTERS INC


28-Aug-2014

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 2013 Management's Discussion and Analysis of Financial Condition and Results of Operations which can be found in our Fiscal 2013 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 25 AEO stores in the Factory store format in North America and continued international expansion in Mexico, Asia and the United Kingdom during Fiscal 2014;

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

the selection of approximately 45 American Eagle Outfitters stores in the United States and Canada for remodeling and refurbishing during Fiscal 2014;

the potential closure of approximately 150 stores in North America through Fiscal 2016;

the planned opening of approximately 40 new international third party operated American Eagle Outfitters stores during Fiscal 2014;

the success of our continued omni-channel transformation and the success of our American Eagle Outfitters and aerie brands within North America and internationally;

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 2013 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.

AEO Direct sales are included in the individual American Eagle Outfitters and aerie brand comparable sales metric for the following reasons:

Our approach to customer engagement is "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; and

The Company no longer presents AEO Direct separately due to the continued evolution of omni-channel engagement and the reasons discussed above.


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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. Design costs consist of:
compensation, rent, depreciation, travel, supplies and samples. 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 as an indicator of successful operating results.

Return on invested capital - Our management uses return on invested capital 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 and the number of units per transaction, 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 cash position. 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.

Results of Operations

Overview

Our second quarter performance came in slightly ahead of our expectations and reflected weak sales and fixed expense deleverage compared to last year. Markdowns stabilized as the quarter progressed, reflecting an improvement in our inventory positioning for the back-to-school season.

Our second quarter total net revenue decreased 2% to $710.6 million and consolidated comparable sales, including AEO Direct, decreased 7%, following a 7% decrease last year. By brand, American Eagle Outfitters comparable sales decreased 8% while aerie increased 9%.

Gross profit decreased 3% to $237.5 million compared to $245.5 million last year and declined 40 basis points to 33.4% as a rate to total net revenue. The decline is the result of deleverage of buying, occupancy and warehousing costs on negative comparable sales, which was largely offset by favorability in merchandise and design costs and a slight improvement in the markdown rate.


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Operating income for the second quarter was $12.0 million compared to $29.4 million last year. Net income this year was $5.8 million, or $0.03 per diluted share compared to net income of $19.6 million, or $0.10 per diluted shared, last year.

The following discussion and analysis of financial condition and results of operations 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. 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.

                                                                26 Weeks
                                                                 Ended
                                                               August 3,
                                                                  2013
        Net income per diluted share - GAAP Basis              $     0.24
        Add back: Asset write-offs and corporate charges (1)         0.04

        Net income per diluted share - Non-GAAP Basis          $     0.28

(1)- 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 $262.6 million in cash and cash equivalents as of August 2, 2014. Merchandise inventory at the end of the second quarter was $393.3 million, compared to $461.1 million last year, a decrease of 18% on a cost per foot basis. Inventories reflect a change to ownership terms completed late last year, as we began taking ownership of inventory at the receiving port rather than the port of departure. Excluding the change in terms, inventory at cost per foot increased in the mid single-digits.

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.


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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                        26 Weeks Ended
                                           August 2,          August 3,          August 2,          August 3,
                                             2014               2013               2014               2013
Total net revenue                               100.0 %            100.0 %            100.0 %            100.0 %
Cost of sales, including certain
buying, occupancy and warehousing
expenses                                         66.6               66.2               65.8               63.8

Gross profit                                     33.4               33.8               34.2               36.2
Selling, general and administrative
expenses                                         26.7               25.6               27.7               26.2
Depreciation and amortization expense             5.0                4.1                5.0                4.6

Operating income                                  1.7                4.1                1.5                5.4
Other income, net                                 0.1                0.1                0.1                 -

Income before income taxes                        1.8                4.2                1.6                5.4
Provision for income taxes                        1.0                1.5                0.9                2.0

Net income                                        0.8 %              2.7 %              0.7 %              3.4 %

The following table shows our adjusted consolidated store data:

                                                13 Weeks Ended                      26 Weeks Ended
                                          August 2,         August 3,         August 2,         August 3,
                                            2014              2013              2014              2013
Number of stores:
Beginning of period                            1,057             1,037             1,066             1,044
Opened                                            20                26                31                33
Closed                                            (5 )              (7 )             (25 )             (21 )

End of period                                  1,072             1,056             1,072             1,056

Total gross square feet at end of
period                                     6,632,056         6,373,055         6,632,056         6,373,055

International franchise stores at end
of period (1)                                     84                57                84                57

(1) International franchise stores are not included in the consolidated store data or the total gross square feet calculation.

Our operations are conducted in one reportable segment, which includes 966 American Eagle Outfitters retail stores, 106 aerie stand-alone retail stores and AEO Direct.

Comparison of the 13 weeks ended August 2, 2014 to the 13 weeks ended August 3, 2013

Total net revenue

Total net revenue decreased 2% to $710.6 million compared to $727.3 million last year. The decline resulted primarily from a consolidated comparable sales decrease of 7% for the period. By brand, including the respective AEO Direct sales, American Eagle Outfitters brand comparable sales decreased 8%, or $50.7 million, and aerie brand comparable sales increased 9%, or $3.6 million.


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Total comparable sales for AE women's and men's decreased 6% and 11%, respectively. For the second quarter, transactions and the average transaction value declined. The average unit retail declined 6% largely driven by spring and summer clearance.

Gross Profit

Gross profit decreased 3% to $237.5 million compared to $245.5 million last year. As a rate to total net revenue, gross profit was 33.4% compared to 33.8% in the same quarter last year. Favorable product costs provided 100 basis points of improvement combined with 40 basis points of total markdown expense leverage. Additionally, buying, occupancy and warehousing costs increased 180 basis points as a rate to total net revenue from deleverage of rent on negative comparable sales and increased delivery costs.

There was $1.5 million and $1.7 million of share-based payment expense included in gross profit for the periods ended August 2, 2014 and August 3, 2013, respectively, comprised of both time and performance-based 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 ("SG&A") expenses increased 2% to $190.1 million from $186.3 million last year. As a rate to total net revenue, SG&A expenses increased 110 basis points to 26.7%. The increase is attributed to investments in advertising, international growth, new factory stores and omni-channel initiatives, partially offset by reductions in overhead and variable expenses.

There was $1.9 million and $2.7 million of share-based payment expense included in SG&A expenses for the periods ended August 2, 2014 and August 3, 2013, 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 $35.4 million, compared to $29.7 million last year. As a rate to total net revenue, depreciation and amortization expense was 5.0% this year as compared to 4.1% last year. The increase was driven by omni-channel and technology investments, new factory and international stores, and the new fulfillment center.

Other Income, Net

Other income was $0.9 million, compared to $1.1 million last year. The change resulted primarily from foreign currency fluctuations.

Provision for Income Taxes

The provision for income taxes 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 based on actual operating results for the 13 weeks ended August 2, 2014 was 54.9% compared to 35.9% for the 13 weeks ended August 3, 2013. The increase in the effective income tax rate this year is primarily due to valuation allowances on foreign losses and lower earnings.

Net Income

Net income decreased to $5.8 million, or 0.8% as a percent to total net revenue, from $19.6 million, or 2.7% as a percent to total net revenue last year. Net income per diluted share decreased to $0.03 per diluted share from $0.10 per diluted share in the prior year. The change in net income is attributable to the factors noted above.


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Comparison of the 26 weeks ended August 2, 2014 to the 26 weeks ended August 3, 2013

Total net revenue

Total net revenue decreased 4% to $1.357 billion compared to $1.407 billion last year. The change in total net revenue resulted primarily from a comparable sales decrease of 9% for the period. By brand, including the respective AEO Direct sales, American Eagle Outfitters brand comparable sales decreased 9%, or $112.7 million, and aerie brand comparable sales increased 2%, or $2.0 million.

AE women's and men's comparable sales decreased 8% and 12%, respectively. For the 26 week period, traffic, transactions and average transaction value decreased.

Gross Profit

Gross profit decreased 9% to $463.4 million compared to $509.1 million, which included $2.4 million of corporate charges last year. As a rate to total net revenue, gross profit was 34.2%, compared to 36.2% last year. Favorable product costs provided 150 basis points of improvement, offset by 170 basis points of decline due to markdowns. Buying, occupancy and warehousing costs deleveraged 180 basis points from higher delivery costs and deleverage of rent on negative comparable sales.

There was $2.9 million and $4.0 million of share-based payment expense included in gross profit for the periods ended August 2, 2014 and August 3, 2013, 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 to $375.1 million from $368.6 million last year and increased 150 basis points, as a rate to total net revenue, to 27.7% from 26.2% last year. Corporate charges of $1.5 million were included in selling, general and administrative expense last year. The dollar increase this year was driven primarily by investments in international growth, factory stores and omni-channel initiatives, partially offset by lower incentive compensation costs.

There was $3.7 million and $5.7 million of share-based payment expense included in selling, general and administrative expenses for the periods ended August 2, 2014 and August 3, 2013, 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 $67.8 million, compared to $65.3 million last year. Included in depreciation and amortization were $7.6 million of asset write-offs last year. As a rate to total net revenue, depreciation and amortization expense was 5.0% this year as compared to 4.6% last year. The increase was driven by omni-channel and technology investments, new factory and international stores, and the new fulfillment center.

Other Income, Net

Other income was $1.5 million this year, compared to $0.5 million last year. The change resulted primarily from foreign currency fluctuations.

Provision for Income Taxes

The provision for income taxes 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 based on actual operating results for the 26 weeks ended August 2, 2014 was 56.0% compared to 37.2% for the 26 weeks ended August 3, 2013. The increase in the effective income tax rate this year is primarily due to valuation allowances on foreign losses and lower earnings.


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Net Income

Net income decreased to $9.7 million, or 0.7% as a percent to total net revenue, from $47.6 million, or 3.4% as a percent to total net revenue last year. Net income per diluted share decreased to $0.05 per diluted share from $0.24 per diluted share in the prior year. Included in income from continuing operations last year was $0.04 per diluted share of loss related to asset write-offs and corporate charges. The change in net income is attributable to the factors noted above.

International Operations

We have agreements with multiple third party operators to expand our brands internationally. Through these agreements, a series of franchised, licensed or other brand-dedicated American Eagle Outfitters stores have opened and will continue to open in areas including Eastern Europe, the Middle East, Central and South America, Northern Africa and parts of Asia. These agreements do not involve a significant capital investment or operational involvement from the Company. We continue to increase the number of countries in which we enter into these types of arrangements as part of our strategy to expand internationally. As of August 2, 2014, we had 84 stores operated by our third party operators in 13 countries. International third party operated stores are not included in the consolidated store data or the total gross square feet calculation.

As of August 2, 2014, we had 98 company-operated stores in Canada, 11 in Mexico, three in Hong Kong, seven in China and six in Puerto Rico. We continue to evaluate further opportunities to expand internationally, which may include additional company-operated stores in Mexico, Asia and the United Kingdom as well as stores operated by third party operators under license, franchise and/or joint venture agreements.

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 August 2, 2014, we held certain assets that are required to be measured at fair value on a recurring basis. These include cash equivalents.


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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 August 2, 2014:

                                                             Fair Value Measurements at August 2, 2014
                                                             Quoted Market
                                                            Prices in Active                                       Significant
                                                              Markets for              Significant Other          Unobservable
. . .
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