Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: The filing covers the thirteen and twenty-six weeks ended August 3, 2013, compared with the periods ended July 28, 2012. The request metadata identifies “2012 Q2,” but the filing is for the second quarter of Fiscal 2013. Fiscal 2013 is a 52-week year ending February 1, 2014. Results are unaudited and prior periods were restated for an inventory accounting change and certain error corrections.
Business Context
Abercrombie & Fitch is a specialty apparel retailer operating the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands through U.S. and international stores and direct-to-consumer operations. At August 3, 2013, the Company operated 1,057 stores, including 907 U.S. stores and 150 international stores.
Financial Results and Key Metrics
| Metric | Q2 Fiscal 2013 | Q2 Fiscal 2012 | Year-to-date Fiscal 2013 | Year-to-date Fiscal 2012 |
|---|---|---|---|---|
| Net sales | $945.7 million | $951.4 million | $1.784 billion | $1.873 billion |
| Gross profit | $604.1 million | $592.5 million | $1.157 billion | $1.134 billion |
| Gross margin | 63.9% | 62.3% | 64.9% | 60.5% |
| Operating income (loss) | $19.2 million | $25.0 million | $5.2 million | $(3.9) million |
| Net income (loss) | $11.4 million | $17.1 million | $4.2 million | $(4.3) million |
| Diluted EPS | $0.14 | $0.20 | $0.05 | $(0.05) |
- Second-quarter comparable sales declined 10%, including direct-to-consumer sales; U.S. comparable sales declined 11% and international comparable sales declined 7%.
- Second-quarter sales fell 1%, while gross profit increased 2% and gross margin expanded 160 basis points, primarily from lower product and product-related costs.
- Year-to-date sales declined 5%, but gross margin expanded 440 basis points and the Company returned to operating and net profitability.
- Direct-to-consumer sales rose 21% in the quarter to $154.3 million and represented 16.3% of sales, compared with 13.4% in the prior-year quarter. Year-to-date direct-to-consumer sales increased 4% to $287.0 million.
- Second-quarter operating margin was approximately 2.0%, compared with 2.6% in the prior-year quarter. Year-to-date operating margin was approximately 0.3%, compared with negative 0.2%.
Liquidity, Cash Flow and Capital Structure
- Cash and equivalents were $335.0 million at August 3, 2013, down from $643.5 million at February 2, 2013. Restricted cash was $29.5 million.
- Year-to-date operating cash flow was negative $208.7 million, compared with negative $24.3 million in the prior-year period, primarily reflecting inventory purchases.
- Inventory was $633.5 million, up from $427.0 million at the prior fiscal year-end, although management stated inventory was 9% below the second-quarter prior-year balance of $694.2 million.
- Capital expenditures were $81.2 million year-to-date, compared with $200.0 million in the prior-year period. Fiscal 2013 capital expenditures were expected to be approximately $200 million.
- The Company had $142.5 million outstanding under its Term Loan Agreement, consisting of $15.0 million classified as current borrowings and $127.5 million classified as long-term borrowings. No borrowings were outstanding at February 2, 2013.
- The unsecured revolving credit facility provided up to $350 million of availability, subject to outstanding letters of credit. No revolving borrowings were outstanding, and the Company was in compliance with its debt covenants.
- Year-to-date financing uses included $115.8 million for repurchases of approximately 2.4 million shares and $31.4 million of dividends. Approximately 16.3 million shares remained available for repurchase at August 3, 2013.
Material Changes Versus the Prior Comparable Period
- Sales performance weakened, particularly in July, with continued softness in the female business. Hollister comparable sales declined 13%, while Abercrombie & Fitch declined 6% and abercrombie kids declined 3%.
- U.S. sales declined 8% in the quarter, while international sales increased 15%; international growth and direct-to-consumer operations partially offset negative comparable sales.
- Stores and distribution expense increased to 49.9% of sales from 48.1%, reflecting deleveraging from negative comparable sales despite expense reductions. Marketing, general and administrative expense increased 6% to $117.6 million.
- The quarter included $2.6 million of charges related to the profit improvement initiative and a $4.5 million reduction in stores and distribution expense related to prior periods. Year-to-date results included a $5.5 million pre-tax prior-period correction and a $1.2 million related tax charge.
- The Company changed inventory accounting from the retail method to the weighted-average cost method effective February 2, 2013, with prior periods retrospectively adjusted. The change reduced prior-year year-to-date operating income by $37.2 million and changed prior-year year-to-date net income from $18.5 million as reported to a $4.3 million net loss as restated.
- The Company repurchased fewer shares than in the prior-year period but increased debt through the $150 million term loan drawdown, while cash declined substantially because of seasonal inventory investment and shareholder returns.
Guidance, Outlook, Risks and Unusual Items
- Management projected third-quarter diluted EPS of $0.40 to $0.45, assuming comparable sales decline slightly more than the second-quarter percentage decline.
- The Company provided no guidance beyond the third quarter because of limited visibility following recent traffic trends. The EPS projection excludes potential impairment, store-closure and additional profit-improvement charges.
- Management expects annualized savings from the profit improvement initiative to exceed $100 million, spanning non-merchandise expense, marketing, supply chain, planning and allocation, home office, store operations, and real estate and construction.
- The Company expected to open approximately 20 international Hollister stores and additional outlet stores, while closing approximately 40 to 50 U.S. stores during Fiscal 2013. Seven U.S. stores and one Canadian store had already closed.
- Management expected a full-year effective tax rate in the mid-30% range. The year-to-date tax benefit was unusually high because of the settlement of certain state tax audits.
- Key risks include weak consumer traffic and comparable sales, fashion and inventory risk, promotional pressure, international expansion and foreign currency exposure, supply-chain and information-technology disruptions, store impairment or closure costs, litigation, tax-rate volatility, and compliance with debt covenants.
- The Company had approximately $22.2 million of net deferred tax assets in Japan whose realization depends on future taxable profits. Additional valuation allowances could create future tax expense.
- The Company disclosed ordinary-course litigation and warned that actual liabilities could exceed recorded reserves. No material changes to previously disclosed risk factors were reported.
Investor Verification Priorities
- Verify the period designation: the filing is for Fiscal 2013, not Fiscal 2012, despite the request metadata.
- Reconcile reported sales and profitability with the 10% comparable-sales decline, gross-margin expansion, profit-improvement charges and prior-period corrections.
- Monitor inventory levels, markdown exposure and the significant seasonal cash-flow use before the Fall selling season.
- Assess liquidity after the $142.5 million term loan draw, share repurchases, dividends and expected capital expenditures, including compliance with leverage and coverage covenants.
- Evaluate whether projected savings exceeding $100 million can offset continued negative comparable sales and higher store and corporate expenses.
- Track third-quarter performance against the $0.40 to $0.45 diluted EPS outlook and the assumption of a comparable-sales decline slightly worse than in the second quarter.