Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: The provided filing covers the thirteen and thirty-nine weeks ended November 3, 2018, compared with October 28, 2017. Although the request metadata identifies “2017 Q3,” the filing itself is for Fiscal 2018 third quarter. A&F is a global specialty retailer operating Hollister, Abercrombie & Fitch and abercrombie kids brands through stores, direct-to-consumer, wholesale, franchise and licensing channels.
Financial performance and position
| Metric | Q3 FY2018 | Q3 FY2017 | 39 weeks FY2018 | 39 weeks FY2017 |
|---|---|---|---|---|
| Net sales | $861.2 million | $859.1 million | $2.435 billion | $2.300 billion |
| Gross profit | $527.8 million | $526.6 million | $1.477 billion | $1.386 billion |
| Gross margin | 61.3% | 61.3% | 60.7% | 60.3% |
| Operating income (loss) | $39.7 million | $22.7 million | $(2.3) million | $(68.3) million |
| Net income (loss) attributable to A&F | $23.9 million | $10.1 million | $(22.4) million | $(67.1) million |
| Diluted EPS | $0.35 | $0.15 | $(0.33) | $(0.98) |
| Operating cash flow | Not separately provided | Not separately provided | $77.2 million | $31.4 million |
Q3 comparable sales increased 3% on a constant-currency basis, following 4% growth in the prior-year quarter. Hollister sales increased 1% to $515.1 million, while Abercrombie sales declined 1% to $346.1 million. U.S. sales increased 1%; international sales declined 2% on a reported basis.
At November 3, 2018, cash and equivalents were $520.5 million, inventories were $572.2 million and total current assets were $1.290 billion. Gross borrowings under the term loan were $253.3 million, reported net at $250.1 million. No borrowings were outstanding under the $400 million asset-based revolving credit facility, and reported availability was $398.9 million. The Company was in compliance with its debt covenants.
Year-to-date investing cash outflows were $98.8 million, primarily capital expenditures. Financing outflows included $68.7 million for repurchases of approximately 2.9 million shares and $40.6 million of dividends. Cash, cash equivalents and restricted cash declined by $155.6 million year to date, partly reflecting share repurchases, capital spending, dividends and foreign-exchange effects.
Material changes versus the prior comparable period
- Q3 reported sales were essentially flat, but comparable sales rose 3%; the quarter was adversely affected by approximately $20 million from the loss of Fiscal 2017’s 53rd week and approximately $7 million from foreign exchange.
- Year-to-date sales increased 6%, driven primarily by higher units sold, with comparable sales up 3%.
- Year-to-date gross margin improved 40 basis points to 60.7%, while stores and distribution expense declined to 45.5% of sales from 48.1%.
- Reported Q3 operating income increased $17.0 million. However, adjusted operating income was $36.7 million versus $37.3 million, reflecting a $3.0 million legal benefit in 2018 versus $11.1 million of legal charges in 2017.
- Year-to-date reported operating loss improved substantially, and adjusted operating income improved to $9.0 million from an adjusted operating loss of $47.6 million.
- Interest expense, net declined to $2.9 million in Q3 and $8.9 million year to date, primarily because of higher interest income.
- Inventory increased to $572.2 million from $424.4 million at fiscal year-end, consistent with seasonal buildup but requiring monitoring for sell-through and markdown risk.
- The Company adopted new revenue recognition guidance using the modified retrospective method, increasing beginning retained earnings by $6.9 million; the impact on net income was immaterial.
Guidance, outlook and management commentary
Management cited the fifth consecutive quarter of positive comparable sales, 16% global digital sales growth, a strong U.S. omnichannel business and continued gross-margin stabilization. The transformation program focuses on store-network optimization, digital and omnichannel capabilities, supply-chain speed and analytics, and more effective marketing and loyalty investments.
- Q4 FY2018: Sales expected down mid-single digits, including approximately $60 million from the lost 53rd week and foreign-exchange effects; comparable sales expected up low single digits.
- Q4 gross margin expected flat to slightly above the prior-year 58.4%; operating expense, excluding other operating income, expected down 1% to 2% from adjusted prior-year expense.
- Full-year FY2018: Sales expected up 2% to 4%; comparable sales up 2% to 4%; gross margin slightly above the prior-year 59.7%.
- Full-year capital expenditures expected at approximately $145 million, including about $90 million for stores and $55 million for omnichannel, loyalty, information technology and related investments.
- Management planned approximately 70 new store experiences and up to 40 store closures, primarily in the United States.
Risks, contingencies and unusual items
- Two employment-related class action settlements had accrued obligations of approximately $10.1 million and $9.6 million, expected to be paid in the fourth quarter of Fiscal 2018. The latter settlement remained subject to possible appeal.
- Store impairment charges were $0.7 million in Q3 and $10.4 million year to date, primarily involving international Abercrombie & Fitch stores.
- Tax results were affected by provisional Tax Cuts and Jobs Act charges, share-based compensation-related tax charges and jurisdictional earnings mix. The Company had recognized aggregate provisional tax charges of $22.4 million related to the Act since enactment.
- The Company planned to repatriate $250 million of undistributed foreign earnings to the United States in Q4, with related state tax implications.
- Most retail locations are operating leases. Adoption of the new lease accounting standard was expected to materially increase reported assets and liabilities and reduce opening retained earnings due to pre-existing impairment of right-of-use assets.
- Key risks include consumer spending and fashion trends, inventory management, competition and pricing pressure, foreign-exchange volatility, international operations, supply-chain disruption, cybersecurity, litigation, tax-rate volatility and restrictive debt covenants.
- A 100-basis-point increase in market interest rates was estimated to increase annual interest expense by approximately $2.6 million. A hypothetical 10% U.S. dollar devaluation would reduce derivative fair value by approximately $17.6 million, largely offset by underlying hedged exposures.
Investor verification checklist
- Verify the filing period against the request metadata: the filing is for Q3 FY2018, ended November 3, 2018, not Q3 FY2017.
- Assess whether comparable-sales momentum and digital growth offset the expected Q4 calendar-shift and foreign-exchange headwinds.
- Monitor inventory growth, holiday sell-through, markdowns and the ability to achieve the projected gross-margin expansion.
- Reconcile GAAP results with adjusted results, particularly the effects of legal settlements, impairments, foreign exchange and tax charges.
- Confirm cash generation after capital expenditures, dividends, share repurchases and the planned $250 million foreign-earnings repatriation.
- Review the final cash payments and any appeals related to the employment class action settlements.
- Evaluate the effect of lease-accounting adoption on reported leverage, assets, liabilities and retained earnings.