Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen weeks ended May 5, 2018, compared with April 29, 2017. Although the request metadata states “2017 Q1,” the filing covers Fiscal 2018 first quarter. Financial statements are unaudited.
Business Context
Abercrombie & Fitch is a global specialty retailer selling apparel, personal care products and accessories through Hollister, Abercrombie & Fitch and abercrombie kids brands. Distribution channels include company-operated stores, direct-to-consumer, wholesale, franchise and licensing arrangements.
The company reported 680 U.S. and 189 international company-operated stores at May 5, 2018. Results are seasonal, with the largest sales activity generally occurring in the fall and holiday periods.
Financial Performance
| Metric | Q1 Fiscal 2018 | Q1 Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $730.9 million | $661.1 million | 11% |
| Comparable sales, constant currency | Up 5% | Down 3% | Improved |
| Gross profit | $442.3 million | $398.9 million | 11% |
| Gross margin | 60.5% | 60.3% | Up 20 basis points |
| Operating loss | $(42.2) million | $(69.9) million | Improved $27.7 million |
| Net loss attributable to A&F | $(42.5) million | $(61.7) million | Improved $19.2 million |
| Diluted loss per share | $(0.62) | $(0.91) | Improved |
| Net cash used in operating activities | $(16.2) million | $(84.1) million | Improved $68.0 million |
Hollister sales increased 13% to $423.6 million, with comparable sales up 6%. Abercrombie sales increased 7% to $307.3 million, with comparable sales up 3%. U.S. sales increased 10%, while international sales increased 12%; international comparable sales were flat.
Stores and distribution expense declined to 49.4% of sales from 54.4%, primarily reflecting higher sales and expense reductions. Marketing, general and administrative expense increased to 17.1% of sales from 16.6%, including $5.6 million of legal charges. Excluding those charges, adjusted expense was 16.3% of sales.
Adjusted operating loss, excluding the $5.6 million legal charge, was $36.6 million, or 5.0% of sales, compared with $69.9 million, or 10.6% of sales, in the prior-year quarter. Adjusted net loss attributable to A&F was $38.4 million, or $0.56 per diluted share.
Liquidity, Debt and Cash Flow
| Balance-sheet item | May 5, 2018 | February 3, 2018 |
|---|---|---|
| Cash and equivalents | $592.0 million | $675.6 million |
| Inventories | $405.1 million | $424.4 million |
| Total current assets | $1.175 billion | $1.265 billion |
| Term loan borrowings, gross | $253.3 million | $253.3 million |
| Term loan borrowings, net | $250.0 million | $249.7 million |
| Total stockholders’ equity | $1.189 billion | $1.252 billion |
- Capital expenditures were $23.7 million, compared with $32.1 million in the prior-year quarter.
- The company paid $13.6 million in dividends and repurchased approximately 0.8 million shares for $18.7 million under its share-repurchase authorization.
- Net cash used in operating, investing and financing activities was $16.2 million, $23.7 million and $37.5 million, respectively. Cash and equivalents, including restricted cash, ended at $614.7 million.
- The $400 million asset-based revolving facility had a $271.1 million borrowing base, no borrowings outstanding and approximately $1.1 million of letters of credit.
- The term loan carried a 5.66% interest rate at May 5, 2018. Management estimated that a 100-basis-point increase in market rates would increase annual interest expense by approximately $2.6 million, assuming no other changes.
Material Changes and Unusual Items
- Revenue recognition guidance was adopted on February 4, 2018 using the modified retrospective method. The adoption increased beginning retained earnings by $6.9 million and changed the timing or classification of gift-card breakage and direct-to-consumer revenue; the effect on first-quarter net loss was immaterial.
- The first quarter included $5.6 million of legal charges related to a proposed wage-and-hour class-action settlement and $3.9 million of lease termination charges related to the Copenhagen flagship store.
- Store asset impairment charges were $1.1 million, primarily related to certain international Abercrombie & Fitch flagship stores.
- The effective tax rate was 8.2%, compared with 17.6% in the prior-year quarter. The current quarter included $8.2 million of discrete, non-cash tax charges primarily related to expiring share-based compensation awards.
- The company accrued approximately $23 million for legal contingencies and disclosed potential incremental losses of up to approximately $20 million. A proposed $25 million claims-made settlement remained subject to final court approval.
Guidance, Outlook and Risks
- Fiscal 2018 comparable sales and net sales are expected to increase 2% to 4%.
- Second-quarter net sales are expected to increase at a high-single-digit rate, including foreign-exchange and calendar-shift benefits.
- Fiscal 2018 gross margin is expected to increase slightly from 59.7% in Fiscal 2017.
- Fiscal 2018 operating expense is expected to increase approximately 2% from Fiscal 2017 adjusted operating expense of $2.0 billion, including legal charges, lease termination charges and volume-related costs.
- The company expects a full-year effective tax rate in the mid-30s, including approximately $9 million of discrete non-cash tax charges, with the rate expected to be in the mid-to-upper 20s for the remainder of the year.
- Capital expenditures are planned at $135 million to $140 million, including store updates, new stores, direct-to-consumer, omnichannel and technology investments.
- Management plans to open 22 full-price stores, remodel 32 stores, right-size 17 stores and potentially close up to 60 U.S. stores through natural lease expirations.
- Key risks include discretionary consumer spending, fashion and inventory execution, competition and pricing pressure, foreign-exchange volatility, international operations, omnichannel execution, supply-chain disruption, cybersecurity, litigation, tax-rate volatility and restrictive debt covenants.
Investor Verification Checklist
- Verify that the filing period is Q1 Fiscal 2018, not Q1 Fiscal 2017, and reconcile the calendar-shift impact from Fiscal 2017’s 53rd week.
- Assess whether sales growth and positive comparable sales persist after the reported foreign-exchange and calendar benefits.
- Monitor inventory trends, gross margin, operating expense leverage and cash generation through the fall selling season.
- Review final approval and ultimate cost of the proposed wage-and-hour settlement and other unaccrued litigation exposure.
- Evaluate liquidity after dividends, share repurchases and planned capital expenditures, particularly given seasonal operating cash flows.
- Track implementation of the new revenue-recognition standard and the future adoption of lease accounting, which management expects to materially increase reported assets and liabilities.