Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen weeks ended May 4, 2019, compared with the thirteen weeks ended May 5, 2018. Although the request metadata references “2018 Q1,” the filing is for the first quarter of Fiscal 2019.
Business Context
Abercrombie & Fitch is a global multi-brand omnichannel specialty retailer operating the Hollister, Abercrombie & Fitch and abercrombie kids brands through company-operated stores, direct-to-consumer channels, wholesale, franchise and licensing arrangements. The company reported Hollister and Abercrombie as operating segments aggregated into one reportable segment.
Key Financial Metrics
| Metric | Q1 Fiscal 2019 | Q1 Fiscal 2018 | Change |
|---|---|---|---|
| Net sales | $734.0 million | $730.9 million | Up $3.1 million |
| Comparable sales | Up 1% | Up 5% | Decelerated |
| Gross profit | $444.1 million | $442.3 million | Up $1.7 million |
| Gross margin | 60.5% | 60.5% | Flat |
| Operating loss | $(27.3) million | $(42.2) million | Improved $14.9 million |
| Operating loss margin | (3.7)% | (5.8)% | Improved 210 basis points |
| Net loss attributable to A&F | $(19.2) million | $(42.5) million | Improved $23.3 million |
| Diluted loss per share | $(0.29) | $(0.62) | Improved $0.33 |
| Net cash used in operating activities | $(71.3) million | $(16.2) million | Outflow increased $55.1 million |
| Capital expenditures | $43.9 million | $23.7 million | Up $20.2 million |
Hollister sales increased 1% to $428.4 million, while Abercrombie sales declined 1% to $305.5 million. U.S. sales increased 5%; international sales declined 6%, including an approximately $16 million adverse foreign-exchange impact on total sales.
Financial Position, Debt and Liquidity
- Cash and equivalents were $586.1 million at May 4, 2019, down from $723.1 million at February 2, 2019. Cash, including restricted cash, was $607.7 million.
- Gross term-loan borrowings were $253.3 million, with net borrowings of $250.7 million. No borrowings were outstanding under the $400 million asset-based revolving credit facility; approximately $277.0 million of borrowing-base capacity was available, subject to facility conditions.
- Inventories were $432.4 million, compared with $437.9 million at fiscal year-end.
- The company paid $13.2 million in dividends during the quarter and did not repurchase shares under its public authorization.
- Operating lease right-of-use assets and liabilities totaled $1.25 billion and $1.49 billion, respectively, at May 4, 2019. The company adopted the new lease accounting standard on February 3, 2019, increasing reported assets and liabilities by approximately $1.2 billion and reducing opening retained earnings by $75.2 million.
Material Changes Versus the Prior Period
- Sales were broadly flat, but comparable sales remained positive at 1% and both brands delivered positive comparable sales.
- Operating performance improved primarily from sales growth and expense leverage. Stores and distribution expense declined to 48.8% of sales from 49.4%, while marketing, general and administrative expense declined to 15.3% from 17.1%.
- Interest expense, net declined to $0.6 million from $3.0 million, partly due to the elimination of leasehold financing obligations following lease-standard adoption and higher interest income.
- The tax benefit increased to $9.6 million from $3.7 million. The effective tax rate was 34.4%, compared with 8.2% in the prior-year quarter, reflecting changes in jurisdictional earnings mix and discrete tax items.
- Cash used in operations increased substantially, primarily because of higher vendor payments, while capital expenditures also increased.
- The store base declined to 857 locations from 861 at February 2, 2019 and 869 at May 5, 2018.
Guidance, Outlook and Management Commentary
- Fiscal 2019 net sales are expected to increase 2% to 4%, driven by positive comparable sales and net new-store contribution, partly offset by foreign-exchange headwinds.
- Comparable sales are expected to increase at a low-single-digit rate, following a 3% increase in Fiscal 2018.
- Gross margin is expected to increase slightly from the Fiscal 2018 rate of 60.2%, assuming no changes to tariffs in place as of May 4, 2019.
- Operating expense is expected to increase 4% to 5% from Fiscal 2018 adjusted non-GAAP operating expense of $2.03 billion, including approximately $45 million of expected lease-related charges associated with flagship-store closures.
- The effective tax rate is expected to be in the mid-20% range, diluted weighted-average shares approximately 68 million, and Fiscal 2019 capital investments approximately $200 million.
- Management stated that the company remained on track for its Fiscal 2020 targets, including doubling the Fiscal 2017 adjusted non-GAAP operating-income margin of 2.9%.
Unusual Items, Risks and Contingencies
- The company expects approximately $45 million of pretax net lease-related charges in the second quarter of Fiscal 2019 from the planned closure of the SoHo Hollister flagship in New York and the Fukuoka, Japan A&F flagship. Future lease payments related to these stores are estimated at approximately $105 million through Fiscal 2028.
- The company expects to close up to 40 stores and deliver approximately 85 new store experiences in Fiscal 2019, including new, remodeled and right-sized stores.
- Tariffs on certain China-origin imports increased from 10% to 25% in May 2019. Management did not expect the increase then in effect to materially affect Fiscal 2019, but additional proposed tariffs on apparel and footwear could materially affect results.
- Foreign-exchange fluctuations, consumer spending, fashion trends, competition, supply-chain disruptions, cybersecurity, international trade conditions, Brexit-related uncertainty, litigation and restrictive debt covenants remain material risks.
- The company reported $1.7 million of store asset impairment charges in the quarter and had significant lease-related assets subject to impairment estimates based on projected store cash flows.
Investor Verification Checklist
- Verify whether the 2% to 4% Fiscal 2019 sales outlook and low-single-digit comparable-sales outlook were achieved or revised in subsequent filings.
- Track the actual timing and amount of the expected $45 million flagship-store lease charges and the related future cash payments.
- Assess operating cash-flow conversion, particularly vendor-payment timing and seasonal reliance on Fall cash generation.
- Monitor tariff developments, foreign-exchange effects and international comparable-sales performance.
- Review lease-adjusted leverage and liquidity after adoption of the lease accounting standard, including the company’s approximately $1.49 billion of operating lease liabilities.
- Confirm the company’s ability to fund approximately $200 million of capital investments, dividends, debt service and potential share repurchases while maintaining adequate liquidity.