10-Q 1 aeo-10q_20160730.htm 10-Q aeo-10q_20160730.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 30, 2016

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 1-33338

 

American Eagle Outfitters, Inc.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

No. 13-2721761

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

77 Hot Metal Street, Pittsburgh, PA

 

15203-2329

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (412) 432-3300

Former name, former address and former fiscal year, if changed since last report:

N/A

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

x

  

Accelerated filer

 

o

 

 

 

 

Non-accelerated filer

 

o  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  o    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 181,763,310 Common Shares were outstanding at August 19, 2016.

 

 

 

 


 

AMERICAN EAGLE OUTFITTERS, INC.

TABLE OF CONTENTS

 

 

 

 

 

Page

Number

 

 

 

PART I - FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

3

 

 

Consolidated Balance Sheets: July 30, 2016 , January 30, 2016 and August 1, 2015

 

3

 

 

Consolidated Statements of Operations and Retained Earnings: 13 weeks and 26 weeks ended July 30, 2016 and August 1, 2015

 

4

 

 

Consolidated Statements of Comprehensive Income: 13 weeks and 26 weeks ended July 30, 2016 and August 1, 2015

 

5

 

 

Consolidated Statements of Cash Flows:  26 weeks ended July 30, 2016 and August 1, 2015

 

6

 

 

Notes to Consolidated Financial Statements

 

7

 

 

Report of Independent Registered Public Accounting Firm

 

17

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

18

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

26

Item 4.

 

Controls and Procedures

 

26

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

N/A

Item 1A.    

 

Risk Factors

 

28

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

28

Item 3.

 

Defaults Upon Senior Securities

 

N/A

Item 4.

 

Mine Safety Disclosures

 

N/A

Item 5.

 

Other Information

 

N/A

Item 6.

 

Exhibits

 

29

 

2


 

PART I - FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS.

AMERICAN EAGLE OUTFITTERS, INC.

CONSOLIDATED BALANCE SHEETS

 

 

 

July 30,

 

 

January 30,

 

 

August 1,

 

(In thousands, except per share amounts)

 

2016

 

 

2016

 

 

2015

 

 

 

(Unaudited)

 

 

 

 

 

 

(Unaudited)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

247,934

 

 

$

260,067

 

 

$

327,290

 

Merchandise inventory

 

 

422,151

 

 

 

305,178

 

 

 

408,541

 

Accounts receivable

 

 

65,282

 

 

 

80,912

 

 

 

50,693

 

Prepaid expenses and other

 

 

90,852

 

 

 

77,218

 

 

 

72,106

 

Total current assets

 

 

826,219

 

 

 

723,375

 

 

 

858,630

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property and equipment, at cost, net of accumulated depreciation

 

 

700,270

 

 

 

703,586

 

 

 

715,650

 

Intangible assets, at cost, net of accumulated amortization

 

 

50,761

 

 

 

51,832

 

 

 

47,154

 

Goodwill

 

 

17,399

 

 

 

17,186

 

 

 

13,006

 

Non-current deferred income taxes

 

 

44,370

 

 

 

64,927

 

 

 

74,140

 

Other assets

 

 

54,169

 

 

 

51,340

 

 

 

51,629

 

Total assets

 

$

1,693,188

 

 

$

1,612,246

 

 

$

1,760,209

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

286,691

 

 

$

182,789

 

 

$

263,145

 

Accrued compensation and payroll taxes

 

 

35,908

 

 

 

79,302

 

 

 

37,851

 

Accrued rent

 

 

78,621

 

 

 

77,482

 

 

 

77,127

 

Accrued income and other taxes

 

 

10,250

 

 

 

22,223

 

 

 

14,654

 

Unredeemed gift cards and gift certificates

 

 

31,532

 

 

 

48,274

 

 

 

30,502

 

Current portion of deferred lease credits

 

 

12,810

 

 

 

12,711

 

 

 

13,240

 

Other liabilities and accrued expenses

 

 

42,719

 

 

 

40,901

 

 

 

55,625

 

Total current liabilities

 

 

498,531

 

 

 

463,682

 

 

 

492,144

 

Non-current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Deferred lease credits

 

 

51,100

 

 

 

50,104

 

 

 

56,421

 

Non-current accrued income taxes

 

 

4,795

 

 

 

4,566

 

 

 

5,441

 

Other non-current liabilities

 

 

38,365

 

 

 

42,518

 

 

 

40,525

 

Total non-current liabilities

 

 

94,260

 

 

 

97,188

 

 

 

102,387

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value; 5,000 shares authorized; none

   issued and outstanding

 

 

 

 

 

 

 

 

 

Common stock, $0.01 par value; 600,000 shares authorized;

   249,566 shares issued; 180,907, 180,135  and 195,429 shares

   outstanding, respectively

 

 

2,496

 

 

 

2,496

 

 

 

2,496

 

Contributed capital

 

 

591,532

 

 

 

590,820

 

 

 

577,146

 

Accumulated other comprehensive loss

 

 

(29,356

)

 

 

(29,868

)

 

 

(18,378

)

Retained earnings

 

 

1,693,371

 

 

 

1,659,267

 

 

 

1,553,380

 

Treasury stock, 68,659, 69,431 and 54,137 shares, respectively

 

 

(1,157,646

)

 

 

(1,171,339

)

 

 

(948,966

)

Total stockholders’ equity

 

 

1,100,397

 

 

 

1,051,376

 

 

 

1,165,678

 

Total liabilities and stockholders’ equity

 

$

1,693,188

 

 

$

1,612,246

 

 

$

1,760,209

 

 

Refer to Notes to Consolidated Financial Statements

 

 

3


 

AMERICAN EAGLE OUTFITTERS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS

(Unaudited)

 

 

 

13 Weeks Ended

 

26 Weeks Ended

 

 

 

July 30,

 

 

August 1,

 

July 30,

 

 

August 1,

 

(In thousands, except per share amounts)

 

2016

 

 

2015

 

2016

 

 

2015

 

Total net revenue

 

$

822,594

 

 

$

797,428

 

$

1,572,010

 

 

$

1,496,948

 

Cost of sales, including certain buying, occupancy and

   warehousing expenses

 

 

515,499

 

 

 

512,389

 

 

971,463

 

 

 

949,697

 

Gross profit

 

 

307,095

 

 

 

285,039

 

 

600,547

 

 

 

547,251

 

Selling, general and administrative expenses

 

 

199,536

 

 

 

195,791

 

 

395,529

 

 

 

380,882

 

Depreciation and amortization expense

 

 

38,900

 

 

 

36,109

 

 

77,683

 

 

 

71,237

 

Operating income

 

 

68,659

 

 

 

53,139

 

 

127,335

 

 

 

95,132

 

Other (expense) income, net

 

 

(3,134

)

 

 

(2,237

)

 

1,801

 

 

 

3,733

 

Income before income taxes

 

 

65,525

 

 

 

50,902

 

 

129,136

 

 

 

98,865

 

Provision for income taxes

 

 

23,933

 

 

 

17,637

 

 

47,068

 

 

 

36,547

 

Net income

 

$

41,592

 

 

$

33,265

 

$

82,068

 

 

$

62,318

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income per basic share

 

$

0.23

 

 

$

0.17

 

$

0.45

 

 

$

0.32

 

Net income per diluted share

 

$

0.23

 

 

$

0.17

 

$

0.45

 

 

$

0.32

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends per common share

 

$

0.125

 

 

$

0.125

 

$

0.250

 

 

$

0.250

 

Weighted average common shares outstanding - basic

 

 

181,048

 

 

 

195,508

 

 

180,872

 

 

 

195,241

 

Weighted average common shares outstanding - diluted

 

 

183,413

 

 

 

196,885

 

 

182,922

 

 

 

196,532

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Retained earnings, beginning

 

$

1,675,031

 

 

$

1,545,674

 

$

1,659,267

 

 

$

1,543,085

 

Net income

 

 

41,592

 

 

 

33,265

 

 

82,068

 

 

 

62,318

 

Cash dividends and dividend equivalents

 

 

(23,246

)

 

 

(24,428

)

 

(46,405

)

 

 

(49,417

)

Reissuance of treasury stock

 

 

(6

)

 

 

(1,131

)

 

(1,559

)

 

 

(2,606

)

Retained earnings, ending

 

$

1,693,371

 

 

$

1,553,380

 

$

1,693,371

 

 

$

1,553,380

 

 

Refer to Notes to Consolidated Financial Statements

 

 

4


 

AMERICAN EAGLE OUTFITTERS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

13 Weeks Ended

 

 

 

26 Weeks Ended

 

 

 

July 30,

 

 

August 1,

 

 

 

July 30,

 

 

August 1,

 

(In thousands)

 

2016

 

 

2015

 

 

 

2016

 

 

2015

 

Net income

 

$

41,592

 

 

$

33,265

 

 

 

$

82,068

 

 

$

62,318

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation (loss) income

 

 

(4,873

)

 

 

(7,334

)

 

 

 

511

 

 

 

(8,434

)

Other comprehensive (loss) income:

 

 

(4,873

)

 

 

(7,334

)

 

 

 

511

 

 

 

(8,434

)

Comprehensive income

 

$

36,719

 

 

$

25,931

 

 

 

$

82,579

 

 

$

53,884

 

 

Refer to Notes to Consolidated Financial Statements

 

 

5


 

AMERICAN EAGLE OUTFITTERS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

26 Weeks Ended

 

 

 

July 30,

 

 

August 1,

 

(In thousands)

 

2016

 

 

2015

 

Operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

82,068

 

 

$

62,318

 

Adjustments to reconcile net income to net cash from operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

78,142

 

 

 

71,582

 

Share-based compensation

 

 

16,748

 

 

 

22,091

 

Deferred income taxes

 

 

20,262

 

 

 

(1,272

)

Foreign currency transaction gain

 

 

(2,268

)

 

 

(1,062

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Merchandise inventory

 

 

(115,371

)

 

 

(131,345

)

Accounts receivable

 

 

14,081

 

 

 

16,189

 

Prepaid expenses and other

 

 

(13,360

)

 

 

(1,800

)

Other assets

 

 

(3,482

)

 

 

(16,074

)

Accounts payable

 

 

92,027

 

 

 

67,869

 

Unredeemed gift cards and gift certificates

 

 

(16,953

)

 

 

(17,285

)

Deferred lease credits

 

 

718

 

 

 

2,349

 

Accrued compensation and payroll taxes

 

 

(42,796

)

 

 

(6,407

)

Accrued income and other taxes

 

 

(12,020

)

 

 

(22,926

)

Accrued liabilities

 

 

3,570

 

 

 

3,289

 

Total adjustments

 

 

19,298

 

 

 

(14,802

)

Net cash provided by operating activities

 

 

101,366

 

 

 

47,516

 

Investing activities:

 

 

 

 

 

 

 

 

Capital expenditures for property and equipment

 

 

(60,539

)

 

 

(78,927

)

Acquisition of intangible assets

 

 

(1,034

)

 

 

(1,680

)

Net cash used for investing activities

 

 

(61,573

)

 

 

(80,607

)

Financing activities:

 

 

 

 

 

 

 

 

Payments on capital leases

 

 

(3,902

)

 

 

(3,084

)

Repurchase of common stock from employees

 

 

(6,868

)

 

 

(5,149

)

Net proceeds from stock options exercised

 

 

1,905

 

 

 

6,362

 

Excess tax benefit from share-based payments

 

 

486

 

 

 

653

 

Cash dividends paid

 

 

(45,213

)

 

 

(48,809

)

Net cash used for financing activities

 

 

(53,592

)

 

 

(50,027

)

Effect of exchange rates changes on cash

 

 

1,666

 

 

 

(289

)

Net decrease in cash and cash equivalents

 

 

(12,133

)

 

 

(83,407

)

Cash and cash equivalents - beginning of period

 

 

260,067

 

 

 

410,697

 

Cash and cash equivalents - end of period

 

$

247,934

 

 

$

327,290

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

Cash paid during the period for income taxes

 

$

63,631

 

 

$

60,936

 

Cash paid during the period for interest

 

$

610

 

 

$

611

 

 

Refer to Notes to Consolidated Financial Statements

 

 

6


 

AMERICAN EAGLE OUTFITTERS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.  Interim Financial Statements

The accompanying Consolidated Financial Statements of American Eagle Outfitters, Inc. (the “Company”) at July 30, 2016 and August 1, 2015 and for the 13 week and 26 week periods ended July 30, 2016 and August 1, 2015 have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Certain notes and other information have been condensed or omitted from the interim Consolidated Financial Statements presented in this Quarterly Report on Form 10-Q. Therefore, these Consolidated Financial Statements should be read in conjunction with the Company’s Fiscal 2015 Annual Report. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments and those described in the footnotes that follow) considered necessary for a fair presentation have been included. The existence of subsequent events has been evaluated through the filing date of this Quarterly Report on Form 10-Q.

As used in this report, all references to “we,” “our” and the “Company” refer to American Eagle Outfitters, Inc. and its wholly owned subsidiaries. “American Eagle Outfitters,” “American Eagle,” “AEO” and the “AE Brand” refer to our American Eagle Outfitters stores. “Aerie” refers to our Aerie® by American Eagle® stores. “AEO Direct” refers to our e-commerce operations, ae.com and aerie.com.

The Company’s 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.

 

 

2.  Summary of Significant Accounting Policies

Principles of Consolidation

The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.  At July 30, 2016, the Company operated in one reportable segment.

Fiscal Year

The Company’s financial year is a 52/53 week year that ends on the Saturday nearest to January 31. As used herein, “Fiscal 2016” refers to the 52 week period ending January 28, 2017. “Fiscal 2015” refers to the 52 week period ended January 30, 2016.

Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of our contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, our management reviews the Company’s estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.

7


 

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”).  ASU 2014-09 is a comprehensive new revenue recognition model that expands disclosure requirements and requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. Originally, ASU 2014-09 was effective for annual reporting periods beginning after December 15, 2016. In July 2015, the FASB voted to approve amendments deferring the effective date by one year to be effective for annual reporting periods beginning after December 15, 2017. Accordingly, the Company will adopt ASU 2014-09 on February 4, 2018. The Company does not expect a material impact of the adoption of this guidance on its Consolidated Financial Statements, results of operations or cash flows.

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes (“ASU 2015-17”), which requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. The ASU may be applied prospectively or retrospectively. The Company adopted the ASU on January 30, 2016, applied retrospectively.

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016–02”) which replaces the existing guidance in ASC 840, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.   The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and requires retrospective application. The Company will adopt in Fiscal 2019 and is currently evaluating the impact of ASU 2016-02 to its Consolidated Financial Statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718) (“ASU 2016-09”).  ASU 2016-09 makes several modifications to Topic 718 related to the accounting for forfeitures, employer tax withholding on share-based compensation and the financial statement presentation of excess tax benefits or deficiencies. ASU 2016-09 also clarifies the statement of cash flows presentation for certain components of share-based awards. The standard is effective for interim and annual reporting periods beginning after December 15, 2016. The Company will adopt in Fiscal 2017 and is currently evaluating the impact to its Consolidated Financial Statements.

Foreign Currency Translation

In accordance with Accounting Standards Codification (“ASC”) 830, Foreign Currency Matters, assets and liabilities denominated in foreign currencies were translated into United States dollars (“USD”) (the reporting currency) at the exchange rates prevailing at the balance sheet date. Revenues and expenses denominated in foreign currencies were translated into USD at the monthly average exchange rates for the period. Gains or losses resulting from foreign currency transactions are included in the results of operations, whereas, related translation adjustments are reported as an element of other comprehensive income in accordance with ASC 220, Comprehensive Income.

Revenue Recognition

Revenue is recorded for store sales upon the purchase of merchandise by customers. The Company’s e-commerce operation records revenue upon the estimated customer receipt date of the merchandise. Shipping and handling revenues are included in total net revenue. Sales tax collected from customers is excluded from revenue and is included as part of accrued income and other taxes on the Company’s Consolidated Balance Sheets.

Revenue is recorded net of estimated and actual sales returns and deductions for coupon redemptions and other promotions. The Company records the impact of adjustments to its sales return reserve quarterly within total net revenue and cost of sales. The sales return reserve reflects an estimate of sales returns based on projected merchandise returns determined through the use of historical average return percentages.

Revenue is not recorded on the issuance of gift cards. A current liability is recorded upon issuance, and revenue is recognized when the gift card is redeemed for merchandise. Additionally, the Company recognizes revenue on unredeemed gift cards based on an estimate of the amounts that will not be redeemed (“gift card breakage”), determined through historical redemption trends. Gift card breakage revenue is recognized in proportion to actual gift card redemptions as a component of total net revenue. For further information on the Company’s gift card program, refer to the Gift Cards caption below.

8


 

The Company recognizes royalty revenue generated from its licensee or franchise agreements based on a percentage of merchandise sales by the licensee/franchisee.  This revenue is recorded as a component of total net revenue when earned.

Cost of Sales, Including Certain Buying, Occupancy and Warehousing Expenses

Cost of sales consists of merchandise costs, including design, sourcing, importing and inbound freight costs, as well as markdowns, shrinkage and certain promotional costs (collectively “merchandise costs”) and buying, occupancy and warehousing costs.

Design costs are related to the Company's Design Center operations and include compensation, travel, supplies and samples for our design teams, as well as rent and depreciation for our Design Center. These costs are included in cost of sales as the respective inventory is sold.

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. Gross profit is the difference between total net revenue and cost of sales.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of compensation and employee benefit expenses, including salaries, incentives and related benefits associated with our stores and corporate headquarters. Selling, general and administrative expenses also include advertising costs, supplies for our stores and home office, communication costs, travel and entertainment, leasing costs and services purchased. Selling, general and administrative expenses do not include compensation, employee benefit expenses and travel for our design, sourcing and importing teams, our buyers and our distribution centers as these amounts are recorded in cost of sales.

Other (Expense) Income, Net

Other (expense) income, net consists primarily of foreign currency transaction gain/loss, interest income/expense and investment gain/loss.

Cash and Cash Equivalents and Investments

The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.

As of July 30, 2016 and August 1, 2015, the Company held no short or long term investments.

Refer to Note 3 to the Consolidated Financial Statements for information regarding cash and cash equivalents.

Merchandise Inventory

Merchandise inventory is valued at the lower of average cost or market, utilizing the retail method. Average cost includes merchandise design and sourcing costs and related expenses. The Company records merchandise receipts when both title and risk of loss for the merchandise have transferred to the Company.

The Company reviews its inventory levels to identify slow-moving merchandise and generally uses markdowns to clear merchandise. Additionally, the Company estimates a markdown reserve for future planned permanent markdowns related to current inventory. Markdowns may occur when inventory exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference, lack of consumer acceptance of fashion items, competition, or if it is determined that the inventory in stock will not sell at its currently ticketed price. Such markdowns may have a material adverse impact on earnings, depending on the extent and amount of inventory affected. The Company also estimates a shrinkage reserve for the period between the last physical count and the balance sheet date. The estimate for the shrinkage reserve, based on historical results, can be affected by changes in merchandise mix and changes in actual shrinkage trends.

9


 

Income Taxes

The Company calculates income taxes in accordance with ASC 740, Income Taxes (“ASC 740”), which requires the use of the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the difference between the Consolidated Financial Statement carrying amounts of existing assets and liabilities and their respective tax bases as computed pursuant to ASC 740. Deferred tax assets and liabilities are measured using the tax rates, based on certain judgments regarding enacted tax laws and published guidance, in effect in the years when those temporary differences are expected to reverse. A valuation allowance is established against the deferred tax assets when it is more likely than not that some portion or all of the deferred taxes may not be realized. Changes in the Company’s level and composition of earnings, tax laws or the deferred tax valuation allowance, as well as the results of tax audits may materially impact the Company’s effective income tax rate.

The Company evaluates its income tax positions in accordance with ASC 740, which prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. Under ASC 740, a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable based on its technical merits.

The calculation of the deferred tax assets and liabilities, as well as the decision to recognize a tax benefit from an uncertain position and to establish a valuation allowance require management to make estimates and assumptions. The Company believes that its assumptions and estimates are reasonable, although actual results may have a positive or negative material impact on the balances of deferred tax assets and liabilities, valuation allowances or net income.

Refer to Note 10 to the Consolidated Financial Statements for additional information regarding income taxes.

Property and Equipment

Property and equipment is recorded on the basis of cost, including costs to prepare the asset for use, with depreciation computed utilizing the straight-line method over the assets’ estimated useful lives. The useful lives of our major classes of assets are as follows:

 

Buildings

 

25 years

Leasehold improvements

 

Lesser of 10 years or the term of the lease

Fixtures, equipment and technology

 

5 years

 

In accordance with ASC 360, Property, Plant, and Equipment (“ASC 360”), the Company evaluates long-lived assets for impairment at the individual store level, which is the lowest level at which individual cash flows can be identified, for stores that have been open for a period of time sufficient to reach maturity.  Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets are impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded. No long-lived asset impairment charges were recorded during the 13 weeks or 26 weeks ended July 30, 2016 or August 1, 2015.

Refer to Note 6 to the Consolidated Financial Statements for additional information regarding property and equipment.

Goodwill

The Company’s goodwill is related to the acquisition of its importing operations, Canada, Hong Kong and China businesses and the recent acquisition of Tailgate Clothing Co. in Fiscal 2015. In accordance with ASC 350, Intangibles – Goodwill and Other (“ASC 350”), the Company evaluates goodwill for possible impairment on at least an annual basis and last performed an annual impairment test as of January 30, 2016.  As a result of the Company’s annual goodwill impairment test, the Company concluded that its goodwill was not impaired.

Intangible Assets

Intangible assets are recorded on the basis of cost with amortization computed utilizing the straight-line method over the assets’ estimated useful lives.  The Company’s intangible assets, which primarily include trademark assets, are generally amortized over 15 to 25 years.

10


 

The Company evaluates intangible assets for impairment in accordance with ASC 350 when events or circumstances indicate that the carrying value of the asset may not be recoverable. Such an evaluation includes the estimation of undiscounted future cash flows to be generated by those assets. If the sum of the estimated future undiscounted cash flows are less than the carrying amounts of the assets, then the assets are impaired and are adjusted to their estimated fair value. No intangible asset impairment charges were recorded during the 13 or 26 weeks ended July 30, 2016 or August 1, 2015.

Refer to Note 7 to the Consolidated Financial Statements for additional information regarding intangible assets.

Gift Cards

The value of a gift card is recorded as a current liability upon issuance, and revenue is recognized when the gift card is redeemed for merchandise.  The Company estimates gift card breakage and recognizes revenue in proportion to actual gift card redemptions as a component of total net revenue. The Company determines an estimated gift card breakage rate by continuously evaluating historical redemption data and the time when there is a remote likelihood that a gift card will be redeemed. The Company recorded $1.7 million and $1.5 million of revenue related to gift card breakage during the 13 weeks ended July 30, 2016 and August 1, 2015, respectively.  During the 26 weeks ended July 30, 2016 and August 1, 2015, the Company recorded $3.8 million and $3.2 million, respectively, of revenue related to gift card breakage.

Deferred Lease Credits

Deferred lease credits represent the unamortized portion of construction allowances received from landlords related to the Company’s retail stores. Construction allowances are generally comprised of cash amounts received by the Company from its landlords as part of the negotiated lease terms. The Company records a receivable and a deferred lease credit liability at the lease commencement date (date of initial possession of the store). The deferred lease credit is amortized on a straight-line basis as a reduction of rent expense over the term of the original lease (including the pre-opening build-out period). The receivable is reduced as amounts are received from the landlord.

Co-branded Credit Card and Customer Loyalty Program

The Company offers a co-branded credit card (the “AEO Visa Card”) and a private label credit card (the “AEO Credit Card”) under the AEO and Aerie brands. These credit cards are issued by a third-party bank (the “Bank”) in accordance with a credit card agreement (“the Agreement”). The Company has no liability to the Bank for bad debt expense, provided that purchases are made in accordance with the Bank’s procedures. We receive additional funding from the Bank based on the Agreement and card activity. We recognize revenue for the additional funding when the amounts are fixed or determinable and collectability is reasonably assured.  This revenue is recorded as a component of total net revenue.

Once a customer is approved to receive the AEO Visa Card or the AEO Credit Card and the card is activated, the customer is eligible to participate in the credit card rewards program. Customers who make purchases at AEO and Aerie earn discounts in the form of savings certificates when certain purchase levels are reached. Also, AEO Visa Card customers who make purchases at other retailers where the card is accepted earn additional discounts. Savings certificates are valid for 90 days from issuance.

Points earned under the credit card rewards program on purchases at AEO and Aerie are accounted for by analogy to ASC 605-25, Revenue Recognition, Multiple Element Arrangements  (“ASC 605-25”).  The Company believes that points earned under its point and loyalty programs represent deliverables in a multiple element arrangement rather than a rebate or refund of cash.  Accordingly, the portion of the sales revenue attributed to the award points is deferred and recognized when the award is redeemed or when the points expire. Additionally, credit card reward points earned on non-AEO or Aerie purchases are accounted for in accordance with ASC 605-25.  As the points are earned, a current liability is recorded for the estimated cost of the award, and the impact of adjustments is recorded in cost of sales.

The Company offers its customers the AEREWARDS® loyalty program (the “Program”).  Under the Program, customers accumulate points based on purchase activity and earn rewards by reaching certain point thresholds during three-month earning periods. Rewards earned during these periods are valid through the stated expiration date, which is approximately one month from the mailing date of the reward. These rewards can be redeemed for a discount on a purchase of merchandise. Rewards not redeemed during the one-month redemption period are forfeited.  The Company determined that rewards earned using the Program should be accounted for in accordance with ASC 605-25.  Accordingly, the portion of the sales revenue attributed to the award credits is deferred and recognized when the awards are redeemed or expire. 

11


 

Segment Information

In accordance with ASC 280, Segment Reporting (“ASC 280”), the Company has identified three operating segments (American Eagle Brand retail stores, Aerie retail stores and AEO Direct) that reflect the basis used internally to review performance and allocate resources. All of the operating segments have been aggregated and are presented as one reportable segment, as permitted by ASC 280.  

 

 

3.  Cash and Cash Equivalents and Investments

The following table summarizes the fair market values for the Company’s cash and marketable securities, which are recorded on the Consolidated Balance Sheets:

 

(In thousands)

 

July 30,

2016

 

 

January 30,

2016

 

 

August 1,

2015

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

173,921

 

 

$

205,359

 

 

$

248,824

 

Interest Bearing Deposits and Money Market Funds

 

 

74,013

 

 

 

54,708

 

 

 

78,466

 

Total cash and cash equivalents

 

$

247,934

 

 

$

260,067

 

 

$

327,290

 

 

 

 

4.  Fair Value Measurements

ASC 820, Fair Value Measurement Disclosures (“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 July 30, 2016 and August 1, 2015, the Company held certain assets that are required to be measured at fair value on a recurring basis.  These include cash and cash equivalents.

In accordance with ASC 820, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents) measured at fair value on a recurring basis at July 30, 2016 and August 1, 2015:

 

 

 

Fair Value Measurements at July 30, 2016

 

(In thousands)

 

Carrying Amount

 

 

Quoted Market

Prices in Active

Markets for

Identical

Assets

(Level 1)

 

 

Significant Other

Observable Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

173,921

 

 

$

173,921

 

 

 

 

 

 

 

Interest Bearing Deposits

 

 

74,013

 

 

 

74,013

 

 

 

 

 

 

 

Total cash and cash equivalents

 

$

247,934

 

 

$

247,934

 

 

 

 

 

 

 

12


 

 

 

 

Fair Value Measurements at August 1, 2015

 

(In thousands)

 

Carrying Amount

 

 

Quoted Market

Prices in Active

Markets for

Identical

Assets

(Level 1)

 

 

Significant Other

Observable Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

248,824

 

 

$

248,824

 

 

 

 

 

 

 

Interest Bearing Deposits and Money Market Funds

 

 

78,466

 

 

 

78,466

 

 

 

 

 

 

 

Total cash and cash equivalents

 

$

327,290

 

 

$

327,290

 

 

 

 

 

 

 

 

In the event the Company holds Level 3 investments, a discounted cash flow model is used to value those investments. There were no Level 3 investments at July 30, 2016 or August 1, 2015.

Non-Financial Assets

The Company’s non-financial assets, which include goodwill, intangible assets and property and equipment, are not required to be measured at fair value on a recurring basis.  However, if certain triggering events occur, or if an annual impairment test is required, and the Company is required to evaluate the non-financial instrument for impairment, a resulting asset impairment would require that the non-financial asset be recorded at the estimated fair value.

 

 

5.  Earnings per Share

The following is a reconciliation between basic and diluted weighted average shares outstanding:

 

 

 

13 Weeks Ended

 

 

26 Weeks Ended

 

 

 

July 30,

 

 

August 1,

 

 

July 30,

 

 

August 1,

 

(In thousands)

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic number of common shares outstanding

 

 

181,048

 

 

 

195,508

 

 

 

180,872

 

 

 

195,241

 

Dilutive effect of stock options and non-vested

   restricted stock

 

 

2,365

 

 

 

1,377

 

 

 

2,050

 

 

 

1,291

 

Diluted number of common shares outstanding

 

 

183,413

 

 

 

196,885

 

 

 

182,922

 

 

 

196,532

 

 

Equity awards to purchase 2.8 million shares of common stock during both the 13 and 26 weeks ended July 30, 2016, respectively, and approximately 40,000 shares of common stock during both the 13 and 26 weeks ended August 1, 2015 were outstanding, but were not included in the computation of weighted average diluted common share amounts as the effect of doing so would be anti-dilutive.

Additionally, approximately 0.1 million shares of restricted stock units for the 13 and 26 weeks ended July 30, 2016, respectively, were not included in the computation of weighted average diluted common share amounts because the number of shares ultimately issued is contingent on the Company’s performance compared to pre-established annual performance goals.

Refer to Note 9 to the Consolidated Financial Statements for additional information regarding share-based compensation.

 

 

6.  Property and Equipment

Property and equipment consists of the following:

 

 

 

July 30,

 

 

January 30,

 

 

August 1,

 

(In thousands)

 

2016

 

 

2016

 

 

2015

 

Property and equipment, at cost

 

$

1,824,869

 

 

$

1,792,382

 

 

$

1,757,957

 

Less:  Accumulated depreciation

 

 

(1,124,599

)

 

 

(1,088,796

)

 

 

(1,042,307

)

Property and equipment, net

 

$

700,270

 

 

$

703,586

 

 

$

715,650

 

13


 

 

 

7.  Intangible Assets

Intangible assets consist of the following:

 

 

 

July 30,

 

 

January 30,

 

 

August 1,

 

(In thousands)

 

2016

 

 

2016

 

 

2015

 

Trademarks and other intangibles, at cost

 

$

68,430

 

 

$

67,398

 

 

$

61,065

 

Less:  Accumulated amortization

 

 

(17,669

)

 

 

(15,566

)

 

 

(13,911

)

Intangible assets, net

 

$

50,761

 

 

$

51,832

 

 

$

47,154

 

 

 

8.  Other Credit Arrangements

The Company currently participates in a Credit Agreement (“Credit Agreement”) consisting of a five-year, syndicated, asset-based revolving credit facilities (the “Credit Facilities”). The Credit Agreement provides senior secured revolving credit for loans and letters of credit up to $400 million, subject to customary borrowing base limitations. The Credit Facilities provide increased financial flexibility and take advantage of a favorable credit environment.

All obligations under the Credit Facilities are unconditionally guaranteed by certain subsidiaries. The obligations under the Credit Agreement are secured by a first-priority security interest in certain working capital assets of the borrowers and guarantors, consisting primarily of cash, receivables, inventory and certain other assets and have been further secured by first-priority mortgages on certain real property.

As of July 30, 2016, the Company was in compliance with the terms of the Credit Agreement and had $8.1 million outstanding in stand-by letters of credit. No loans were outstanding under the Credit Agreement as of July 30, 2016.

Additionally, the Company has a borrowing agreement with one financial institution under which it may borrow an aggregate of $5.0 million USD for the purposes of trade letter of credit issuances. The availability of any future borrowings under the trade letter of credit facilities is subject to acceptance by the financial institution.

As of July 30, 2016, the Company had no outstanding trade letters of credit.

 

 

9.  Share-Based Compensation

The Company accounts for share-based compensation under the provisions of ASC 718, Compensation - Stock Compensation (“ASC 718”), which requires companies to measure and recognize compensation expense for all share-based payments at fair value. Total share-based compensation expense included in the Consolidated Statements of Operations for the 13 weeks and 26 weeks ended July 30, 2016 was $7.9 million ($5.0 million, net of tax) and $16.7 million ($10.6 million, net of tax), respectively, and for the 13 and 26 weeks ended August 1, 2015 was $14.0 million ($8.6 million, net of tax) and $22.1 million ($13.5 million, net of tax) respectively.

14


 

Stock Option Grants

The Company grants both time-based and performance-based stock options. A summary of the Company’s stock option activity for the 26 weeks ended July 30, 2016 follows:

 

 

 

 

 

 

 

Weighted-

Average

 

 

Weighted-

Average

Remaining

Contractual

 

 

Aggregate

 

 

 

Options

 

 

Exercise Price

 

 

Term

 

 

Intrinsic Value

 

 

 

(In thousands)

 

 

 

 

 

 

(In years)

 

 

(In thousands)

 

Outstanding - January 30, 2016

 

 

1,213

 

 

$

14.83

 

 

 

 

 

 

 

 

 

Granted

 

 

2,211

 

 

$

15.35

 

 

 

 

 

 

 

 

 

Exercised (1)

 

 

121

 

 

$

13.74

 

 

 

 

 

 

 

 

 

Cancelled

 

 

42

 

 

$

14.50

 

 

 

 

 

 

 

 

 

Outstanding - July 30, 2016

 

 

3,261

 

 

$

15.23

 

 

 

4.8

 

 

 

8,802

 

Vested and expected to vest - July 30, 2016

 

 

3,079

 

 

$

15.22

 

 

 

4.7

 

 

 

8,336

 

Exercisable - July 30, 2016 (2)

 

 

1,036

 

 

$

14.90

 

 

 

0.6

 

 

 

3,125

 

 

(1)

Options exercised during the 26 weeks ended July 30, 2016 had exercise prices ranging from $11.50 to $14.50.

(2)

Options exercisable represent “in-the-money” vested options based upon the weighted-average exercise price of vested options compared to the Company’s stock price at July 30, 2016.

Cash received from the exercise of stock options was $1.9 million for the 26 weeks ended July 30, 2016 and $6.4 million for the 26 weeks ended August 1, 2015.  The actual tax benefit realized from stock option exercises totaled $0.1 million for the 26 weeks ended July 30, 2016 and $0.6 million for the 26 weeks ended August 1, 2015.

The fair value of stock options was estimated based on the closing market price of the Company’s common stock on the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:    .

 

 

 

26 Weeks Ended

 

 

 

July 30,

 

Black-Scholes Option Valuation Assumptions

 

2016

 

Risk-free interest rate (1)

 

 

1.3

%

Dividend yield

 

 

3.0

%

Volatility factor (2)

 

 

35.4

%

Weighted-average expected term (3)

 

4.4 years

 

Expected forfeiture rate (4)

 

 

8.0

%

 

(1)

Based on the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected life of our stock options.

 

(2)

Based on a combination of historical volatility of the Company’s common stock and implied volatility.

 

(3)

Represents the period of time options are expected to be outstanding, based on historical experience.

 

(4)

Based upon historical experience.

As of July 30, 2016, there was $7.2 million of unrecognized compensation expense related to non-vested time-based stock option awards that is expected to be recognized over a weighted average period of 3.1 years.

Restricted Stock Grants

Time-based restricted stock awards are comprised of time-based restricted stock units.  These awards vest over three years.  Time-based restricted stock units receive dividend equivalents in the form of additional time-based restricted stock units, which are subject to the same restrictions and forfeiture provisions as the original award.

Performance-based restricted stock awards include performance-based restricted stock units.  These awards cliff vest at the end of a three year period based upon the Company’s achievement of pre-established goals throughout the term of the award.  Performance-based restricted stock units receive dividend equivalents in the form of additional performance-based restricted stock units, which are subject to the same restrictions and forfeiture provisions as the original award.

15


 

The grant date fair value of all restricted stock awards is based on the closing market price of the Company’s common stock on the date of grant.

A summary of the Company’s restricted stock activity is presented in the following tables:

 

 

 

Time-Based Restricted

Stock Units

 

 

Performance-Based Restricted

Stock Units

 

 

 

26 Weeks Ended

 

 

26 Weeks Ended

 

 

 

July 30, 2016

 

 

July 30, 2016

 

(Shares in thousands)

 

Shares

 

 

Weighted

-Average

Grant Date

Fair Value

 

 

Shares

 

 

Weighted

-Average

Grant Date

Fair Value

 

Nonvested - January 30, 2016

 

 

1,935

 

 

$

15.17

 

 

 

2,609

 

 

$

16.02

 

Granted

 

 

946

 

 

$

16.02

 

 

 

1,077

 

 

$

15.70

 

Vested

 

 

(885

)

 

$

16.11

 

 

 

(195

)

 

$

14.82

 

Cancelled

 

 

(44

)

 

$

10.50

 

 

 

(700

)

 

$

19.72

 

Nonvested - July 30, 2016

 

 

1,952

 

 

$

15.26

 

 

 

2,791

 

 

$

15.05

 

 

As of July 30, 2016, there was $26.6 million of unrecognized compensation expense related to non-vested, time-based restricted stock unit awards that is expected to be recognized over a weighted-average period of 2.3 years. Based on current probable performance, there is $13.6 million of unrecognized compensation expense related to performance-based restricted stock unit awards which will be recognized as achievement of performance goals is probable over a one to three year period.

As of July 30, 2016, the Company had 3.5 million shares available for all equity grants.

 

 

10.  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 for the 13 weeks ended July 30, 2016 was 36.5% compared to 34.7% for the 13 weeks ended August 1, 2015.  The effective income tax rate for the 26 weeks ended July 30, 2016 was 36.4% compared to 37.0% for the 26 weeks ended August 1, 2015. The increase in the effective income tax rate for the 13 weeks ended July 30, 2016, and the decrease in the effective income tax rate for the 26 weeks ended July 30, 2016 was primarily due to prior year income tax settlements, offset by changes to foreign deferred tax assets.

The Company records accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company recognizes income tax liabilities related to unrecognized tax benefits in accordance with ASC 740 and adjusts these liabilities when its judgment changes as the result of the evaluation of new information not previously available. Unrecognized tax benefits did not change significantly during the 13 weeks ended July 30, 2016.  Over the next twelve months, the Company believes that it is reasonably possible that unrecognized tax benefits may decrease by approximately $3.3 million due to settlements, expiration of statute of limitations or other changes in unrecognized tax benefits.

 

 

11.  Legal Proceedings

The Company is subject to certain legal proceedings and claims arising out of the conduct of its business. In accordance with ASC 450, Contingencies (“ASC 450”), management records a reserve for estimated losses when the loss is probable and the amount can be reasonably estimated. If a range of possible loss exists and no anticipated loss within the range is more likely than any other anticipated loss, the Company records the accrual at the low end of the range, in accordance with ASC 450.  As the Company believes that it has provided adequate reserves, it anticipates that the ultimate outcome of any matter currently pending against the Company will not materially affect the consolidated financial position or results of the operations of the Company.

 

 

16


 

Review by Independent Registered Public Accounting Firm

Ernst & Young LLP, our independent registered public accounting firm, has performed a limited review of the unaudited Consolidated Financial Statements for the thirteen and twenty-six week periods ended July 30, 2016 and August 1, 2015, as indicated in their report on the limited review included below. Since they did not perform an audit, they express no opinion on the unaudited Consolidated Financial Statements referred to above.

Review Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

American Eagle Outfitters, Inc.

We have reviewed the consolidated balance sheets of American Eagle Outfitters, Inc. (the Company) as of July 30, 2016 and August 1, 2015, and the related consolidated statements of operations and retained earnings and comprehensive income for the thirteen and twenty-six week periods ended July 30, 2016 and August 1, 2015 and the consolidated statements of cash flows for the twenty-six week periods ended July 30, 2016 and August 1, 2015. These financial statements are the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of American Eagle Outfitters, Inc. as of January 30, 2016, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for the year then ended (not presented herein) and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated March 10, 2016. In our opinion, the accompanying consolidated balance sheet of American Eagle Outfitters, Inc. as of January 30, 2016, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

Pittsburgh, Pennsylvania

August 24, 2016

 

 

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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 2015 Management’s Discussion and Analysis of Financial Condition and Results of Operations which can be found in our Fiscal 2015 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 15 to 20 AEO stores, 10 to 15 Aerie stores and conversion of 20 to 25 stores to Aerie side-by-side format in North America and continued international expansion during Fiscal 2016;

·

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 55 to 65 American Eagle Outfitters stores in the United States and Canada for remodeling and refurbishing during Fiscal 2016;

·

the potential closure of approximately 20 to 25 American Eagle Outfitters and 10 Aerie stores in the United States and Canada during Fiscal 2016;

·

the planned opening of approximately 40 new international third party operated American Eagle Outfitters stores during Fiscal 2016;

·

the success of our core American Eagle Outfitters and Aerie brands through our omni-channel outlets 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 2015 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 open at least one year over the comparable prior year period, as well as the AEO Direct business. In fiscal years following those with 53 weeks, 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.

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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.

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 and certain promotional costs (collectively “merchandise 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.

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Results of Operations

Overview

We continued to deliver positive momentum in the second quarter, demonstrating sequential growth and building on the improvements we achieved last year.  Top line growth, strong merchandise profitability, combined with controlled expenses, drove a 35% increase in the second quarter earnings per diluted share.  Comparable sales were positive for both the AE and Aerie brands, despite continued softness in mall traffic. Gross margin expansion and leverage of operating expense led to an overall increase in our operating profit.  We ended the quarter in solid financial condition, with $248 million in cash and no debt.

Total net revenue increased 3% to $823 million and consolidated comparable sales, including AEO Direct, increased 3%, following an 11% increase last year.  By brand, American Eagle Outfitters comparable sales increased 1% while Aerie increased 24%.

Gross profit rose 8% to $307 million compared to $285 million last year and increased 160 basis points to 37.3% as a rate to total net revenue. The increase was the result of lower costs and higher realized selling prices, offset by an increase in delivery costs related to growth in our digital business.

Operating income for the second quarter was $68.7 million compared to $53.1 million last year and leveraged 160 basis points.  Net income for the quarter was $41.6 million, or $0.23 per diluted share, compared to $33.2 million, or $0.17 per diluted share, last year. 

We had $247.9 million in cash and cash equivalents as of July 30, 2016.  Merchandise inventory at the end of the second quarter was $422.2 million, an increase of 3% last year from timing of new inventory receipts.

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

 

 

 

26 Weeks Ended

 

 

 

July 30,

 

 

August 1,

 

 

 

July 30,

 

 

 

August 1,

 

 

 

2016

 

 

2015

 

 

 

2016

 

 

 

2015

 

 

Total net revenue

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