Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen and twenty-six weeks ended August 2, 2014, compared with August 3, 2013. The provided filing is for Fiscal 2014 second quarter, despite request metadata referencing 2013 Q2. Abercrombie & Fitch is a specialty retailer operating stores and direct-to-consumer channels across North America, Europe, Asia, Australia and the Middle East.
Financial Performance
| Metric | Q2 2014 | Q2 2013 | Year-to-date 2014 | Year-to-date 2013 |
|---|---|---|---|---|
| Net sales | $890.6 million | $945.7 million | $1.713 billion | $1.784 billion |
| Gross profit | $553.0 million | $604.1 million | $1.065 billion | $1.157 billion |
| Gross margin | 62.1% | 63.9% | 62.1% | 64.9% |
| Operating income (loss) | $19.5 million | $19.2 million | $(12.0) million | $5.2 million |
| Net income (loss) | $12.9 million | $11.4 million | $(10.8) million | $4.2 million |
| Diluted earnings (loss) per share | $0.17 | $0.14 | $(0.15) | $0.05 |
- Q2 sales declined 6%, primarily reflecting a 7% decrease in total comparable sales. Year-to-date sales declined 4%, with comparable sales down 6%.
- Q2 operating income increased slightly despite lower sales because of expense savings. Year-to-date profitability deteriorated because of restructuring, profit-improvement and corporate-governance-related charges.
- Q2 adjusted non-GAAP net income was $14.1 million, or $0.19 per diluted share. Year-to-date adjusted non-GAAP net income was $1.1 million, or $0.01 per diluted share.
- Direct-to-consumer sales increased 12% in Q2 to $173.5 million and 20% year-to-date to $343.9 million. Direct-to-consumer sales represented 19.5% of Q2 sales and 20.1% of year-to-date sales.
- Comparable Q2 sales declined 1% for Abercrombie & Fitch, 6% for abercrombie kids and 10% for Hollister. Comparable direct-to-consumer sales increased 11%.
Cash Flow, Liquidity and Capital Structure
- Cash and equivalents were $310.7 million at August 2, 2014, compared with $600.1 million at February 1, 2014.
- Year-to-date operating cash flow was negative $24.3 million, an improvement from negative $208.7 million in the prior-year period.
- Capital expenditures were $80.9 million year-to-date. Management expects Fiscal 2014 capital expenditures of approximately $210 million to $220 million.
- The Company used $210.0 million for share repurchases and paid $29.2 million in dividends during the first twenty-six weeks.
- Borrowings at quarter-end included $127.5 million under the term loan and $60.0 million under the revolving credit facility. The Company was in compliance with applicable covenants.
- On August 7, 2014, after quarter-end, the Company refinanced its debt with a $400 million senior secured asset-based revolving facility and a $300 million term loan facility. The ABL Facility was undrawn as of September 4, 2014, with approximately $9.0 million of letters of credit outstanding.
- Inventory was $550.2 million, up from $530.2 million at February 1, 2014 but down 13% from the prior-year second-quarter balance.
Material Changes and Unusual Items
- The Company closed its stand-alone Gilly Hicks stores and continues selling the brand through Hollister stores and direct-to-consumer channels. Aggregate Gilly Hicks restructuring charges reached $87.6 million through August 2, 2014, against an estimated total of approximately $89 million; approximately $1.6 million of additional lease-related charges may remain.
- Year-to-date 2014 operating results included $6.1 million of Gilly Hicks charges, $5.0 million of profit-improvement charges and $6.9 million of legal, advisory and other charges related to corporate-governance matters.
- The filing includes corrections of prior-period errors recorded out of period. Management states that the corrections were not material to affected interim or annual periods.
- Foreign currency translation and derivative activity produced a year-to-date increase of $5.8 million in other comprehensive income, while currency movements benefited reported sales by approximately $13.1 million in Q2 and $24.8 million year-to-date.
- The Company repurchased approximately 5.3 million shares year-to-date, including approximately 3.8 million shares under an accelerated share repurchase agreement. Approximately 11.0 million shares remained available under repurchase authorizations at quarter-end.
Outlook, Management Commentary and Risks
- Management expects Fiscal 2014 adjusted non-GAAP diluted EPS of $2.15 to $2.35, based on full-year comparable sales declining by a mid-single-digit percentage and a slightly lower gross margin rate than Fiscal 2013.
- The guidance assumes a mid-30% effective tax rate, approximately 73.6 million weighted-average shares and higher interest expense from the refinancing. It excludes additional share repurchases, tax-rate variability, Gilly Hicks restructuring charges, profit-improvement charges, corporate-governance matters and potential impairment or store-closure charges.
- Management expects total savings from the profit-improvement initiative to exceed $200 million, partially offset by approximately $30 million of additional 2014 marketing spending.
- Strategic priorities include assortment and brand repositioning, digital marketing, international direct-to-consumer expansion, omnichannel capabilities, store remodeling, international growth and closure of approximately 60 U.S. stores through natural lease expirations.
- Management expects approximately 14 full-price international stores and 8 to 10 international and U.S. outlet stores to open during Fiscal 2014.
- Principal risks include weak teen-retail demand, changing fashion preferences, promotional pressure and margin deterioration, inventory management, foreign exchange exposure, international expansion, technology and fulfillment execution, seasonality, litigation, impairment charges, tax-rate volatility and restrictive debt covenants.
- The Company identified approximately $16.8 million of net deferred tax assets in Japan whose realization depends on future taxable profits; a valuation allowance could create additional tax expense.
Investor Verification Points
- Verify the effect of the August 7, 2014 refinancing on interest expense, leverage, collateral requirements and covenant flexibility.
- Track comparable sales, gross margin and promotional intensity, particularly for Hollister and U.S. stores.
- Assess whether direct-to-consumer growth and planned omnichannel initiatives can offset continued store-sales declines.
- Reconcile reported GAAP results with management’s adjusted non-GAAP measures and confirm the timing and remaining amount of restructuring and other excluded charges.
- Monitor cash generation, inventory levels, planned capital expenditures, dividends and additional share repurchases given the decline in cash balances.
- Evaluate the assumptions supporting the $2.15 to $2.35 adjusted EPS guidance, including mid-single-digit comparable-sales declines, tax rate and gross margin.
- Review unresolved litigation, potential impairment or store-closure charges, foreign currency effects and the recoverability of Japanese deferred tax assets.