Abercrombie & Fitch Co. Form 10-K Summary
Reporting period: Fiscal 2017, the 53-week year ended February 3, 2018, compared primarily with Fiscal 2016, the 52-week year ended January 28, 2017. The request metadata references “2016 Q4,” but the supplied filing is the Fiscal 2017 annual report and includes fourth-quarter data.
Business context
Abercrombie & Fitch is a global specialty apparel retailer operating the Hollister, Abercrombie & Fitch and abercrombie kids brands. Products are sold through company-operated stores, direct-to-consumer channels, and wholesale, franchise and licensing arrangements. The Company operated 868 stores at year-end, including 679 in the United States and 189 internationally. Direct-to-consumer sales were $973.9 million, approximately 28% of net sales.
Financial performance and liquidity
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Net sales | $3,492.7 million | $3,326.7 million | Up 5% |
| Comparable sales | Up 3% | Down 5% | Improved |
| Gross profit | $2,083.8 million | $2,028.6 million | Up 3% |
| Gross margin | 59.7% | 61.0% | Down 130 basis points |
| Operating income | $72.1 million | $15.2 million | Up $56.9 million |
| Operating margin | 2.1% | 0.5% | Up 160 basis points |
| Net income attributable to A&F | $7.1 million | $4.0 million | Up $3.1 million |
| Diluted earnings per share | $0.10 | $0.06 | Up $0.04 |
| Operating cash flow | $285.7 million | $185.3 million | Up $100.4 million |
| Free cash flow | $178.7 million | $44.5 million | Up $134.2 million |
Hollister sales increased 11% to $2.04 billion, with comparable sales up 8%. Abercrombie segment sales declined 2% to $1.45 billion, with comparable sales down 2%. U.S. sales rose 4% and international sales rose 7%; foreign exchange benefited reported sales by approximately $20 million. The additional fiscal week contributed approximately $41 million of sales.
At February 3, 2018, cash and equivalents were $675.6 million, working capital was $757.0 million and the current ratio was 2.49. Gross term-loan borrowings were $253.3 million, or $249.7 million net of discount and fees. No borrowings were outstanding under the $400 million asset-based revolving facility, and availability was approximately $259.3 million. The Company paid $54.4 million of dividends and repaid $15.0 million of debt during the year.
Capital expenditures were $107.0 million, compared with $140.8 million in Fiscal 2016. Total contractual obligations were $2.18 billion, including $1.52 billion of operating lease obligations and $253.3 million of term-loan principal.
Material changes versus the prior comparable period
- Sales and comparable sales returned to growth, supported by Hollister, improved customer engagement and higher digital sales.
- Operating income improved substantially as higher sales and expense controls more than offset lower gross margin and higher performance-based compensation and marketing costs.
- Stores and distribution expense declined to 44.2% of sales from 47.4%, benefiting from sales leverage, expense reductions and the absence of the prior-year $15.6 million Hong Kong flagship lease termination charge.
- Fiscal 2017 included $14.4 million of store asset impairment charges, primarily involving international Abercrombie stores, and $15.1 million of legal charges related principally to wage-and-hour matters.
- The effective tax rate increased to 80.9%, largely because of $19.9 million of discrete charges related to the Tax Cuts and Jobs Act and $10.6 million of noncash tax expense from new share-based compensation accounting requirements.
- The store fleet declined by 30 locations, from 898 to 868, while gross store square footage declined from 7.01 million to 6.71 million square feet.
Guidance, outlook and management commentary
- For Fiscal 2018, management expected comparable sales and net sales to increase by low-single digits. Reported sales were expected to benefit from foreign exchange, largely offset by the loss of the extra week in Fiscal 2017.
- Management expected the gross margin rate to increase slightly from 59.7%, with continued pressure in the first quarter.
- Operating expenses, excluding other operating income, were expected to increase approximately 1% from Fiscal 2017 adjusted expenses of approximately $2.0 billion.
- Fiscal 2018 capital expenditures were targeted at approximately $130 million, including $85 million for stores and $45 million for direct-to-consumer, omnichannel, information technology and other projects.
- The Company planned to open 21 full-price stores, remodel approximately 40 Hollister stores, convert 10 Abercrombie stores to smaller prototypes and close up to 60 U.S. stores through natural lease expirations.
- Management expected a Fiscal 2018 core tax rate in the mid-to-high 20% range, but a full-year effective tax rate in the mid-to-high 30% range because of approximately $10 million of discrete noncash tax charges.
Risks, contingencies and unusual items
- The Company operates in highly competitive and promotional apparel markets and remains exposed to changing fashion preferences, excess inventory, markdowns and consumer discretionary spending.
- International operations create exposure to foreign exchange, political, regulatory, trade, labor and economic risks. Approximately 36.8% of Fiscal 2017 sales were attributable to Europe and other geographic areas.
- The Company depends on approximately 150 third-party vendors, primarily in Asia and Central America, and relies on two owned and five third-party distribution centers.
- Cybersecurity, payment-card fraud, information-technology disruptions, supply-chain interruptions and extreme weather could affect operations and brand reputation.
- The Company accrued approximately $18 million for legal contingencies and disclosed potential incremental losses of up to approximately $25 million. A $25 million claims-made settlement agreement related to wage-and-hour class actions remained subject to final court approval and actual claims experience.
- The Tax Cuts and Jobs Act amounts were provisional and could change as additional analysis, regulatory guidance and tax-return filings are completed.
- The term loan matures August 7, 2021, with a final principal installment of approximately $253.3 million. Credit agreements contain restrictive covenants, although the Company was compliant at year-end.
- The Company adopted new share-based compensation accounting guidance in Fiscal 2017 and planned to adopt the new revenue-recognition standard in Fiscal 2018, primarily changing the classification of gift-card breakage from other operating income to net sales.
Investor verification points
- Confirm that the intended period is Fiscal 2017 or fourth-quarter Fiscal 2017, rather than “2016 Q4,” because the supplied filing covers the year ended February 3, 2018.
- Assess the sustainability of the improved comparable sales trend, particularly the divergent performance of Hollister and Abercrombie.
- Separate recurring operating performance from the extra fiscal week, foreign-exchange benefit, legal charges, impairment charges and Tax Cuts and Jobs Act effects.
- Review the Company’s ability to improve gross margin while maintaining investments in digital, omnichannel and store initiatives.
- Monitor store closures, lease obligations, the 2021 term-loan maturity and compliance with credit-facility covenants.
- Track final court approval and claims activity for the wage-and-hour settlement, as well as the finalization of provisional tax amounts.