ABERCROMBIE & FITCH CO quarterly report, Q2 FY2019

Abercrombie & Fitch Co. Form 10-Q Summary

Reporting period: The filing covers the thirteen and twenty-six weeks ended August 3, 2019, with comparisons to August 4, 2018. Although the request identifies “2018 Q2,” the source filing is the second quarter of Fiscal 2019. A&F is a global omnichannel specialty retailer operating the Hollister, Abercrombie and abercrombie kids brands across North America, Europe and Asia.

Financial performance and position

Metric	Q2 Fiscal 2019	Q2 Fiscal 2018	26 weeks Fiscal 2019	26 weeks Fiscal 2018
Net sales	$841.1 million	$842.4 million	$1.575 billion	$1.573 billion
Gross profit	$498.6 million	$506.9 million	$942.7 million	$949.2 million
Gross margin	59.3%	60.2%	59.9%	60.3%
Operating income (loss)	$(39.5) million	$0.2 million	$(66.7) million	$(42.0) million
Operating margin	(4.7)%	0.0%	(4.2)%	(2.7)%
Net loss attributable to A&F	$(31.1) million	$(3.9) million	$(50.3) million	$(46.3) million
Diluted loss per share	$(0.48)	$(0.06)	$(0.76)	$(0.68)

Q2 comparable sales were flat; reported sales declined 0.2%, but increased approximately 1% on a constant-currency basis. Year-to-date comparable sales increased 1%.
Hollister Q2 sales increased 1% to $504.8 million, while Abercrombie segment sales declined 2% to $336.3 million.
U.S. Q2 sales increased 2%; international sales declined 4% reported and 1% on a constant-currency basis.
Q2 cost of sales increased to 40.7% of sales from 39.8%, primarily due to product mix, higher average unit costs and slightly lower average unit retail.
Marketing, general and administrative expense declined 6.6% year over year to $115.7 million, or 13.8% of sales, reflecting lower performance-based compensation, consulting and technology depreciation costs.
Net interest expense declined to $1.4 million in Q2 and $2.0 million year to date, partly because leasehold financing obligations were eliminated upon adoption of the new lease standard and interest income increased.
Q2 and year-to-date income tax benefits were $11.3 million and $20.9 million, respectively. The year-to-date effective tax rate was 30.4%.

Cash flow, liquidity and debt

Year-to-date operating cash flow was an outflow of $36.1 million, compared with an inflow of $50.5 million in the prior-year period. Management attributed the change primarily to payment timing with vendors and lower incentive compensation payments.
Capital expenditures were $94.2 million year to date, compared with $54.1 million in the prior-year period. Fiscal 2019 capital investment is expected to be approximately $200 million.
Cash, cash equivalents and restricted cash totaled $521.2 million at August 3, 2019, including $499.8 million of cash and equivalents. Cash and equivalents declined from $723.1 million at February 2, 2019.
Gross term-loan borrowings were $253.3 million, with net borrowings of $251.0 million. No borrowings were outstanding under the revolving facility.
The asset-based revolving facility had a $345.1 million borrowing base and $344.7 million of availability, subject to required excess availability.
Inventories were $487.1 million, up from $437.9 million at fiscal year-end.
The company paid $26.4 million in dividends and repurchased approximately 3.5 million shares for $57.8 million during the first half.

Material changes versus the prior comparable period

Flagship store exit charges increased substantially to $45.0 million in Q2 and $46.7 million year to date, versus none in Q2 2018 and $3.8 million year to date. The charges primarily related to the SoHo Hollister closure in New York City and other announced flagship exits.
The flagship charges reduced Q2 operating margin by approximately 530 basis points and diluted earnings per share by an estimated $0.50.
Excluding certain prior-year impairment and legal items, management reported that adjusted Q2 operating margin declined approximately 580 basis points, or 530 basis points on a constant-currency basis.
The company adopted the new lease accounting standard on February 3, 2019. This increased reported assets and liabilities by approximately $1.2 billion and reduced opening retained earnings by approximately $75.2 million, without a significant effect on liquidity, cash-flow classification or debt-covenant compliance.
Operating lease right-of-use assets were $1.217 billion and operating lease liabilities totaled approximately $1.504 billion at August 3, 2019.
Asset impairment declined to $0.7 million in Q2 and $2.4 million year to date, excluding flagship exit charges, compared with $8.7 million and $9.7 million, respectively, in the prior-year periods.

Guidance, outlook, commentary and risks

Fiscal 2019 net sales guidance was flat to up 2%, including an expected adverse foreign-exchange effect of approximately $45 million.
Fiscal 2019 comparable sales guidance was flat to up 2%, compared with 3% growth in Fiscal 2018.
Management expected the Fiscal 2019 gross profit rate to decline 50 to 90 basis points from the Fiscal 2018 rate of 60.2%, including approximately 40 basis points from foreign exchange and 20 basis points from anticipated China tariffs.
Operating expense, excluding other operating income, was expected to increase 2% to 3% from Fiscal 2018 adjusted expense of $2.03 billion, including the $45 million of Q2 flagship exit charges. The expected effective tax rate was in the mid-20% range.
The company planned approximately 85 new, remodeled or right-sized store experiences and up to 40 store closures in Fiscal 2019. It had 17 flagship stores at the end of Q2, compared with 19 at Fiscal 2018 year-end.
China tariffs were expected to adversely affect fall Fiscal 2019 merchandise cost and gross profit by approximately $6 million. Management was shifting sourcing to other countries and regions.
Potential Brexit-related trade barriers, duties, delivery delays and currency effects remained uncertain. The company was developing contingency plans for its U.K. operations and Netherlands distribution center.
Other principal risks include weak consumer spending, changing fashion trends, inventory mismanagement, competition and pricing pressure, foreign-exchange volatility, supply-chain disruption, cybersecurity, litigation, regulatory changes and restrictive debt covenants.
Additional flagship store closures could result in unpredictable lease-exit charges and future cash expenditures. Future lease payments associated with disclosed closures are expected to continue through Fiscal 2028 and not exceed $15 million in any fiscal year.
Management stated that disclosure controls were effective at a reasonable level of assurance and that no material changes occurred in internal control over financial reporting.

Facts investors should verify

Whether comparable sales and gross margin improve sufficiently to support the Fiscal 2019 sales and profitability outlook.
The cash-flow impact of inventory purchases, seasonal working-capital requirements and planned capital expenditures.
The effect of China tariffs, Brexit-related developments, Hong Kong unrest and foreign-exchange movements on international sales and merchandise costs.
The timing and final cost of announced or potential flagship store closures and other store-network optimization actions.
Available revolver capacity, term-loan interest costs, covenant compliance and any required debt repayments.
Whether the company can maintain dividends and opportunistic share repurchases while operating cash flow remains negative in the first half.
The effect of the lease accounting adoption on leverage and balance-sheet comparisons, distinguishing accounting presentation from underlying liquidity.