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.