Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: The supplied filing is for the thirteen and thirty-nine weeks ended October 30, 2010, compared with October 31, 2009. Although the request metadata states “2009 Q3,” the filing itself is the Fiscal 2010 third-quarter report, filed December 7, 2010.
Business Context
Abercrombie & Fitch is a specialty retailer of casual apparel and accessories operating the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands through stores and direct-to-consumer channels. The Company reported one aggregated segment. At October 30, 2010, it operated 1,106 stores, compared with 1,103 stores at October 31, 2009.
RUEHL operations were closed during Fiscal 2009 and are classified as discontinued operations in the prior-year comparison.
Key Financial Metrics
| Metric | Q3 2010 | Q3 2009 | 39 Weeks 2010 | 39 Weeks 2009 |
|---|---|---|---|---|
| Net sales | $885.8 million | $753.7 million | $2.319 billion | $1.993 billion |
| Gross profit | $564.4 million | $483.1 million | $1.481 billion | $1.289 billion |
| Gross margin | 63.7% | 64.1% | 63.9% | 64.7% |
| Operating income | $78.4 million | $47.5 million | $87.2 million | $22.5 million |
| Operating margin | 8.8% | 6.3% | 3.8% | 1.1% |
| Net income from continuing operations | $50.0 million | $49.2 million | $57.7 million | $17.9 million |
| Net income (loss) | $50.0 million | $38.8 million | $57.7 million | $(47.2) million |
| Diluted EPS | $0.56 | $0.44 | $0.64 | $(0.54) |
Net sales increased 18% in the quarter and 16% year to date. Comparable-store sales increased 7% in the quarter and 5% year to date. Direct-to-consumer sales, including shipping and handling, represented 10.6% of quarterly sales and 11.0% of year-to-date sales.
Cash and equivalents were $618.2 million at October 30, 2010, compared with $680.1 million at January 30, 2010 and $466.9 million at October 31, 2009. Year-to-date operating cash flow was $77.5 million, compared with $170.9 million in the prior-year period. Capital expenditures were $117.0 million, dividends paid were $46.3 million and treasury-stock purchases were $29.2 million.
Total long-term debt was $81.7 million, including $57.2 million outstanding under the amended unsecured credit agreement and $24.5 million of landlord financing obligations. The Company reported $292.8 million of additional credit availability, before considering $10.6 million of outstanding letters of credit, and was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Operating income increased 65% in the quarter and nearly quadrupled year to date, aided by higher sales and lower stores and distribution expense as a percentage of sales.
- Stores and distribution expense declined to 43.5% of sales from 46.4% in the quarter and to 47.6% from 50.8% year to date.
- Gross margin contracted 40 basis points in the quarter and 80 basis points year to date, primarily because average unit retail declined 11% and 12%, respectively.
- Inventory increased 47% year over year to $511.8 million, materially faster than sales growth. Management expected the increase to moderate toward sales growth.
- Year-to-date operating cash flow fell $93.4 million, primarily because inventory consumed $200.4 million of cash, compared with a $26.9 million source of cash in the prior-year period.
- The prior-year period included RUEHL discontinued-operation losses of $10.4 million for the quarter and $65.1 million year to date; current-period discontinued-operation results were immaterial.
- The third-quarter 2009 tax rate benefited from an $18.6 million year-to-date tax-rate true-up and a $2.2 million state-tax-audit settlement benefit. The third-quarter 2010 effective tax rate was 35.6% versus a 4.7% benefit in the prior-year quarter.
Guidance, Outlook, Risks and Unusual Items
- Management expected Fiscal 2010 capital expenditures of approximately $190 million, including approximately $140 million for stores and approximately $50 million for technology, distribution and home-office projects.
- The Company expected to close approximately 65 domestic stores during Fiscal 2010 and approximately 50 additional stores during Fiscal 2011, primarily at natural lease expirations.
- Management planned approximately 20 international mall-based Hollister openings in Fiscal 2010 and further Abercrombie & Fitch flagship openings in Europe during Fiscal 2011.
- Management expected the full-year effective tax rate to be approximately 35%, subject to domestic/international profit mix and other factors.
- Gross-margin recovery remained challenging because of raw-material, labor and transportation costs, with limited visibility into sourcing costs beyond the first half of Fiscal 2011.
- The Company recorded a $2.2 million non-cash impairment charge related to expected store closures and a $2.1 million charge correcting a cumulative under-accrual of the supplemental executive retirement plan.
- RUEHL closure liabilities totaled $25.2 million at October 30, 2010. The Company expected approximately $28.9 million of gross cash payments in Fiscal 2010 and an aggregate of $19.2 million in later fiscal years.
- The Company held $124.8 million of auction-rate securities classified as Level 3 assets, with $10.4 million of cumulative temporary impairment. Valuation depends on unobservable assumptions, including discount rates, marketability discounts and expected term.
- Pending matters included a California store-manager wage-and-hour class action and a derivative action. The Company stated that potential exposure could not be quantified. A separate securities class action settlement was approved and became final during the period.
- Key disclosed risks include consumer demand and fashion trends, economic conditions, seasonality, inventory markdowns, raw-material and labor costs, supply-chain and distribution disruptions, international expansion, foreign-currency movements, litigation, technology disruption and debt-covenant compliance.
Important Facts for Investors to Verify
- Confirm that the intended period is Fiscal 2010 Q3, not 2009 Q3, because the supplied filing covers October 30, 2010.
- Assess whether the 47% inventory increase can be reduced toward sales growth without causing higher markdowns or further gross-margin pressure.
- Review the sustainability of the improved operating margin despite lower average unit retail and rising sourcing and transportation costs.
- Verify cash conversion, particularly the effect of seasonal inventory investment on fourth-quarter operating cash flow.
- Monitor store closures, international openings and Gilly Hicks productivity against management’s stated plans.
- Evaluate the liquidity and valuation risks associated with the $124.8 million of Level 3 auction-rate securities.
- Review remaining RUEHL closure payments, pending litigation exposure and compliance with the credit agreement’s leverage, coverage and capital-expenditure covenants.