Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen weeks ended April 28, 2012, compared with April 30, 2011. The requested metadata identifies “2011 Q1,” but the filing is the first quarter of Fiscal 2012. Fiscal 2012 is a 53-week year ending February 2, 2013. Financial statements are unaudited and were reviewed by PricewaterhouseCoopers LLP.
Business Context
Abercrombie & Fitch is a specialty retailer of casual apparel, accessories and personal-care products operated through Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands. Operations include U.S. stores, international stores and direct-to-consumer channels across North America, Europe and Asia. The company operated 1,049 stores at April 28, 2012, compared with 1,071 at April 30, 2011.
Key Financial Metrics
| Metric | Q1 Fiscal 2012 | Q1 Fiscal 2011 | Change |
|---|---|---|---|
| Net sales | $921.2 million | $836.7 million | Up 10% |
| Gross profit | $576.4 million | $543.7 million | Up 6% |
| Gross margin | 62.6% | 65.0% | Down 240 basis points |
| Operating income | $6.3 million | $38.7 million | Down $32.4 million |
| Operating margin | 0.7% | 4.6% | Down 390 basis points |
| Net income | $3.0 million | $25.1 million | Down $22.2 million |
| Diluted earnings per share | $0.03 | $0.28 | Down $0.25 |
| Net cash used in operating activities | $44.5 million | $10.2 million | Greater cash use |
| Capital expenditures | $103.8 million | $51.5 million | Up $52.3 million |
Sales mix: U.S. Stores generated $543.9 million, International Stores $225.0 million and Direct-to-Consumer $148.2 million. International sales increased 42%, while direct-to-consumer sales increased 40% and represented 16.1% of total sales versus 12.6% in the prior-year quarter. U.S. sales declined 4% within the U.S. Stores segment, although U.S. sales including direct-to-consumer increased 1%.
Comparable sales: Total comparable store sales decreased 5%. Abercrombie & Fitch declined 4%, abercrombie kids declined 11% and Hollister declined 5%. U.S. comparable sales including direct-to-consumer increased 4%; international comparable sales were significantly negative.
Liquidity and balance sheet: Cash and equivalents were $321.6 million at April 28, 2012, compared with $583.5 million at January 28, 2012. Marketable securities were $37.9 million, and total current assets were $1.11 billion against current liabilities of $545.2 million. The company had no borrowings under its $350 million revolving credit facility or $300 million term loan agreement. Leasehold financing obligations were $65.7 million. The company reported compliance with debt covenants and approximately $350 million available under the revolving facility as of June 1, 2012.
Shareholder returns: The company paid $14.8 million in dividends and repurchased approximately 3.3 million shares for $159.1 million during the quarter. The quarterly dividend was $0.175 per share. On May 15, 2012, the board increased the share repurchase authorization by 10 million shares.
Material Changes Versus the Prior Comparable Period
- Sales grew 10%, driven primarily by international expansion, new stores and direct-to-consumer growth, but comparable sales declined 5%.
- Gross margin contracted 240 basis points, primarily because of a significant increase in average unit cost.
- Stores and distribution expense increased to 49.5% of sales from 47.7%, reflecting higher direct-to-consumer costs, store payroll and store management costs.
- Operating income fell approximately 84%, and net income fell approximately 88%, despite higher sales.
- Cash used in operations increased to $44.5 million from $10.2 million, while capital expenditures more than doubled due to international stores, flagship locations and infrastructure projects.
- The company used substantially more cash for share repurchases: $159.1 million versus $25.5 million in the prior-year quarter.
- Weighted-average diluted shares decreased to 86.2 million from 90.4 million, primarily reflecting share repurchases.
- Foreign currency reduced reported sales by approximately $5.8 million, or approximately 0.6% of sales.
Guidance, Outlook, Risks and Unusual Items
Management projected full-year comparable store sales to decline by a mid-single-digit percentage and reduced the expected sales contribution from new stores. The company offset part of the lower sales outlook with expectations for a higher gross margin rate and lower expenses, supported by average unit cost reductions. Full-year diluted EPS guidance remained $3.50 to $3.75, including the effect of the lower share count. Management projected a full-year effective tax rate slightly below 35%, compared with the 43.0% quarterly rate, which was elevated by discrete items and the low level of quarterly income.
Fiscal 2012 capital expenditures were expected to be approximately $400 million, primarily for new stores, refreshes and remodels. Planned expansion included international Abercrombie & Fitch flagship locations and approximately 40 international Hollister stores. Management cited difficult European macroeconomic conditions and weak European comparable sales but maintained its long-term international growth strategy.
- Cash declined materially because of operating cash use, capital expenditures, dividends and share repurchases. Retail seasonality means cash generation is expected to be stronger during the fall season.
- The company held $37.9 million of auction-rate securities with a $7.3 million cumulative other-than-temporary impairment; these securities have limited liquidity and were classified as Level 3 assets.
- Inventory was $517.6 million, with a $34.7 million valuation reserve and a $7.1 million shrink reserve. A 10% change in the valuation reserve would have affected quarterly pre-tax income by approximately $3.5 million.
- Foreign currency exposure was managed through forward contracts; other comprehensive income included a $7.1 million unrealized loss on derivative financial instruments.
- A California wage-and-hour class action had received preliminary settlement approval, with final approval scheduled for August 29, 2012. The company had increased its litigation reserve as of January 28, 2012. A separate California employee seating action remained in litigation.
- The company identified risks related to consumer spending, fashion trends, inventory management, international expansion, foreign exchange, supply chain and distribution disruptions, technology, litigation, taxation, store impairment and debt covenants.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Facts Investors Should Verify
- Whether the projected mid-single-digit comparable-sales decline and $3.50–$3.75 full-year EPS guidance were achieved or revised.
- Whether gross-margin improvement from average unit cost reductions offset weaker comparable sales and international trends.
- The pace and returns of international store expansion, including flagship locations and planned Hollister openings.
- Liquidity after approximately $400 million of planned annual capital expenditures, dividends and continuing share repurchases.
- The valuation, liquidity and eventual disposition of the remaining auction-rate securities.
- The final resolution and financial impact of the California wage-and-hour settlement and the separate employee seating litigation.
- Subsequent changes in foreign exchange rates, European consumer demand, inventory reserves and store impairment indicators.