Business Context and Reporting Period
Abercrombie & Fitch Co. is a global omnichannel specialty apparel retailer operating the Hollister, Abercrombie & Fitch and abercrombie kids brands through company-operated stores, digital channels, wholesale, franchise and licensing arrangements.
The provided filing is the Fiscal 2018 Form 10-K for the 52 weeks ended February 2, 2019, compared primarily with Fiscal 2017, a 53-week year ended February 3, 2018. The request metadata references “2017 Q4,” but the source is an annual filing; fourth-quarter data is included in the filing.
- 861 company-operated stores at fiscal year-end; 663 in the United States and 198 internationally.
- Fiscal 2018 digital sales exceeded $1 billion, with more than 70% of digital traffic generated from mobile devices.
- Hollister represented $2.15 billion of sales, while Abercrombie, including abercrombie kids, represented $1.44 billion.
Financial Performance and Liquidity
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $3.590 billion | $3.493 billion | Up 3% |
| Comparable sales | Up 3% | Up 3% | Constant currency |
| Gross profit | $2.160 billion | $2.084 billion | Up 4% |
| Gross margin | 60.2% | 59.7% | Up 50 basis points |
| Operating income | $127.4 million | $72.1 million | Up $55.3 million |
| Operating margin | 3.5% | 2.1% | Up 140 basis points |
| Net income attributable to A&F | $74.5 million | $7.1 million | Up $67.4 million |
| Diluted earnings per share | $1.08 | $0.10 | Up $0.98 |
| Cash flow from operations | $352.9 million | $287.7 million | Up $65.3 million |
| Capital expenditures | $152.4 million | $107.0 million | Up $45.4 million |
| Free cash flow | $200.5 million | $180.7 million | Up $19.9 million |
At February 2, 2019, cash and equivalents were $723.1 million, working capital was $777.0 million and the current ratio was 2.39. Gross borrowings were $253.3 million, consisting primarily of the term loan; borrowings, net were $250.4 million. The $400 million asset-based revolving facility was undrawn and had approximately $275.6 million of availability. The Company was in compliance with its credit-facility covenants.
Fiscal 2018 financing outflows included $68.7 million for the repurchase of approximately 2.9 million shares and $53.7 million of dividends. The quarterly dividend was $0.20 per share, or $0.80 per share for the year.
Material Changes Versus the Prior Comparable Period
- Sales increased 3%, despite one fewer week than Fiscal 2017; management estimated the missing week reduced sales by approximately $37 million and operating income by approximately $5 million.
- Hollister sales increased 6% to $2.153 billion, with 5% comparable sales growth. Abercrombie sales declined 1% to $1.438 billion, despite 1% comparable sales growth.
- U.S. sales increased 5%, while international sales declined 1% as reported and 2% on a comparable basis, partly reflecting currency effects.
- Gross margin improved due to cost growth below the rate of sales growth. Stores and distribution expense declined slightly in absolute dollars and fell to 43.0% of sales from 44.2%, helped by occupancy leverage and expense reductions.
- Operating income benefited from improved gross margin, expense leverage and approximately $6 million of favorable foreign-exchange effects, net of hedging.
- Reported earnings included $11.6 million of asset impairment charges and $2.6 million of legal charges. The Company reported adjusted non-GAAP operating income of $138.6 million, or a 3.9% margin, versus $100.8 million and a 2.9% margin in Fiscal 2017.
- The effective tax rate declined to 32.3% from 80.9%, reflecting the lower U.S. federal tax rate under the Tax Cuts and Jobs Act and different discrete tax items. Fiscal 2018 included a $3.5 million net tax benefit related to measurement-period adjustments under the Act.
- Inventory increased to $437.9 million from $424.4 million. Store count declined by seven year over year, while the Company continued remodeling, rightsizing and opening selected stores.
- The Company adopted new revenue-recognition guidance in Fiscal 2018. The adoption increased opening retained earnings by $6.9 million and changed the treatment of gift-card breakage and direct-to-consumer revenue timing, with an immaterial income-statement impact.
Guidance, Outlook, Risks and Unusual Items
For Fiscal 2019, management expected sales growth of 2% to 4%, low-single-digit comparable-sales growth, a slight increase in gross margin from 60.2%, operating expense growth of approximately 2% on an adjusted basis, an effective tax rate in the mid-to-upper 20s, diluted shares of approximately 69 million excluding future buybacks, and capital investments of approximately $200 million.
- Management planned approximately 85 store experiences in Fiscal 2019, including about 40 new stores, 25 remodels and 20 rightsizes, while expecting to close up to 40 stores, primarily in the United States.
- Approximately 50% of leases were due for renewal by the end of Fiscal 2020, providing flexibility but also creating potential lease-exit, termination and impairment charges.
- The Company expected the new lease standard to increase assets by approximately $1.1 billion to $1.2 billion and liabilities by approximately $1.2 billion to $1.3 billion at adoption, without a material effect on liquidity or debt-covenant compliance.
- Supply-chain exposure remains significant: approximately 36% of sourced merchandise came from China and 29% from Vietnam in Fiscal 2018. The Company expected to reduce U.S. imports from China to below 20% in Fiscal 2019 and stated it could migrate up to half of this production if necessary.
- Key risks include discretionary consumer demand, fashion and inventory execution, promotional pressure, mall traffic, foreign currency, tariffs and trade policy, Brexit-related logistics, cybersecurity, information-technology disruption, third-party manufacturing and distribution dependence, labor costs, litigation and restrictive debt covenants.
- Two employment-related class-action settlements were paid in Fiscal 2018 for approximately $10.1 million and $9.6 million. The Company stated that other litigation exposures could not be reasonably estimated beyond accrued amounts.
- The Company repatriated $250 million of foreign earnings during Fiscal 2018. Approximately $258.4 million of cash remained held by foreign affiliates at year-end.
Most Important Facts for Investors to Verify
- Confirm that comparisons account for Fiscal 2017’s extra week and distinguish reported sales growth from constant-currency comparable-sales growth.
- Assess whether Hollister’s growth can offset the weaker reported performance of the Abercrombie segment.
- Review the sustainability of gross-margin improvement, promotional intensity and inventory valuation assumptions.
- Evaluate the effect of approximately $200 million of planned capital spending, store closures and lease renewals on free cash flow.
- Review the $253.3 million term-loan maturity in August 2021, mandatory excess-cash-flow prepayment provisions and borrowing-base availability under the ABL facility.
- Quantify the balance-sheet impact and presentation changes from the new lease-accounting standard.
- Monitor tariff exposure, China sourcing reductions, foreign-exchange sensitivity and international demand.
- Review legal contingencies, tax audits, deferred-tax-asset realizability and the unusual asset-impairment and settlement items excluded from management’s non-GAAP results.