Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen and twenty-six weeks ended August 1, 2015, compared with August 2, 2014. The filing metadata supplied refers to “2014 Q2,” but the filing is for the second quarter of Fiscal 2015. Fiscal 2015 ends January 30, 2016. The interim financial statements are unaudited and were reviewed by PricewaterhouseCoopers LLP.
Business context
Abercrombie & Fitch is a specialty retailer of branded apparel and accessories operating through Abercrombie, abercrombie kids and Hollister brands, with stores and direct-to-consumer operations in North America, Europe, Asia and the Middle East. At August 1, 2015, the Company operated 954 stores, compared with 989 stores at August 2, 2014.
Key financial metrics
| Metric | Q2 Fiscal 2015 | Q2 Fiscal 2014 | Year-to-date Fiscal 2015 | Year-to-date Fiscal 2014 |
|---|---|---|---|---|
| Net sales | $817.8 million | $890.6 million | $1.527 billion | $1.713 billion |
| Gross profit | $509.9 million | $553.0 million | $921.4 million | $1.065 billion |
| Gross margin | 62.3% | 62.1% | 60.3% | 62.1% |
| Operating income (loss) | $2.0 million | $19.5 million | $(88.2) million | $(12.0) million |
| Operating margin | 0.2% | 2.2% | (5.8)% | (0.7)% |
| Net income (loss) attributable to A&F | $(0.8) million | $12.9 million | $(64.1) million | $(10.8) million |
| Diluted EPS | $(0.01) | $0.17 | $(0.92) | $(0.15) |
| Net cash used in operating activities | Not separately provided | Not separately provided | $(20.8) million | $(24.3) million |
Balance sheet and liquidity at August 1, 2015: Cash and equivalents were $408.3 million, versus $520.7 million at January 31, 2015. Current assets were $1.103 billion and current liabilities were $529.1 million. Inventory was $478.6 million, up from $460.8 million at year-end. Gross borrowings under the term loan were $297.8 million, or $291.9 million net of discount and fees. No borrowings were outstanding under the $400 million ABL facility; its borrowing base was $339.1 million. Standby letters of credit totaled approximately $8.9 million.
Cash uses: Year-to-date capital expenditures were $69.1 million, dividends paid were $27.8 million, and cash used in investing activities was $58.0 million, including proceeds from the sale of the Company-owned aircraft. Cash decreased by $112.4 million during the first 26 weeks, ending at $408.3 million.
Material changes versus the prior comparable period
- Q2 sales declined 8%, driven by approximately $45 million of unfavorable foreign exchange impact and a 4% constant-currency comparable-sales decline. Year-to-date sales declined 11%, including approximately $91 million of foreign exchange impact and a 6% comparable-sales decline.
- Q2 gross margin increased modestly to 62.3%, but year-to-date gross margin fell to 60.3%, primarily due to a $24.2 million net inventory write-down related to accelerating the disposition of aged merchandise.
- Q2 operating income fell to $2.0 million from $19.5 million. The decline reflected $15.8 million of proposed legal settlement charges, negative sales deleverage and foreign exchange pressure, partly offset by expense reductions.
- Year-to-date operating loss widened to $88.2 million from $12.0 million. Significant items included the inventory write-down, $15.8 million of legal settlement charges, $6.1 million of asset impairment, and store fixture and closure-related costs.
- Net interest expense increased to $4.6 million in Q2 and $9.2 million year-to-date, versus $2.0 million and $4.0 million, respectively, primarily because of higher debt balances and interest rates.
- The Company began presenting noncontrolling interest in Q2 Fiscal 2015. The $1.4 million of Q2 net income attributable to noncontrolling interest included $1.1 million related to prior periods.
- Year-to-date cash used in operations improved modestly from $24.3 million to $20.8 million, principally due to changes in accounts payable and accrued expenses associated with extended vendor payment terms.
Guidance, outlook, risks and unusual items
Management reported sequential improvement in comparable sales, stabilized gross margins and continued operating expense reductions, while noting that turnaround initiatives remain at an early stage. For the second half of Fiscal 2015, management expected continued foreign-exchange headwinds, comparable-sales improvement weighted toward the fourth quarter, gross margin approximately flat year over year but higher on a constant-currency basis, and operating expense dollars approximately flat year over year after restoring incentive compensation provisions. The expected diluted share count was approximately 70 million, excluding potential share buybacks.
Management maintained a full-year capital expenditure target of approximately $150 million. Planned real estate activity included 15 full-price international stores, six full-price North American stores and 10 U.S. outlet stores, while approximately 60 U.S. stores were expected to close through natural lease expirations. Potential impairment, store-closing and other strategic-initiative charges were excluded from the outlook.
The effective tax rate was unusually high at 123.4% for Q2 and 35.7% year-to-date, reflecting low pretax earnings, jurisdictional mix and discrete items. Management stated that the tax rate should return over time to the mid-to-upper 30% range but may remain volatile at low levels of pretax income or loss.
Other unusual items included a $1.6 million year-to-date restructuring benefit related to Gilly Hicks lease exits, $6.1 million of asset impairment charges, and $15.8 million accrued for proposed legal settlements. The Company cautioned that litigation liabilities could exceed recorded reserves. Foreign currency risk remains material; the Company uses forward contracts and estimated that a hypothetical 10% U.S. dollar devaluation would reduce derivative contract fair values by approximately $13.1 million, largely offset by changes in hedged items.
Principal disclosed risks include weak consumer spending, fashion and inventory execution, foreign exchange volatility, international expansion, direct-to-consumer execution, store and strategic-plan implementation, CEO selection, cybersecurity and information-technology disruptions, supply-chain and distribution-center dependence, litigation, tax-rate volatility, seasonality and restrictive credit-facility covenants.
Most important facts for investors to verify
- Whether comparable-sales trends improved as projected, particularly in the fourth quarter, and whether foreign exchange continued to pressure reported revenue.
- Whether inventory levels and valuation reserves normalized after the aged-merchandise write-down.
- The final amount and timing of the proposed legal settlements and any additional litigation exposure.
- Progress toward restoring operating profitability while maintaining planned capital expenditures, dividends and store investments.
- Liquidity development through the fall selling season, including operating cash generation, term-loan amortization and any use of the ABL facility.
- Whether planned store openings, closures and strategic initiatives produced the expected returns without additional impairment or restructuring charges.
- The sustainability of the dividend and any future share repurchases given negative year-to-date operating cash flow and substantial term debt.