Business Context and Reporting Period
Abercrombie & Fitch Co. is a specialty apparel retailer operating the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands through stores and direct-to-consumer channels. The filing covers the thirteen and thirty-nine weeks ended November 2, 2013, corresponding to Fiscal 2013 third quarter and year-to-date results. The requested metadata identifies “2012 Q3,” but the filing itself is a Fiscal 2013 third-quarter Form 10-Q.
Financial Performance and Position
| Metric | Q3 Fiscal 2013 | Q3 Fiscal 2012 | 39 Weeks Fiscal 2013 | 39 Weeks Fiscal 2012 |
|---|---|---|---|---|
| Net sales | $1.033 billion | $1.170 billion | $2.818 billion | $3.042 billion |
| Gross profit / margin | $651.0 million / 63.0% | $752.5 million / 64.3% | $1.808 billion / 64.2% | $1.886 billion / 62.0% |
| Operating income (loss) / margin | $(35.4) million / (3.4)% | $133.3 million / 11.4% | $(30.1) million / (1.1)% | $129.4 million / 4.3% |
| Net income (loss) | $(15.6) million | $84.0 million | $(11.5) million | $79.8 million |
| Diluted EPS | $(0.20) | $1.02 | $(0.15) | $0.95 |
- Comparable sales declined 14% in the quarter and 13% year to date. Q3 sales fell 12%; U.S. sales declined 18% while international sales increased 2%.
- Direct-to-consumer sales increased 10% to $174.6 million in Q3 and represented 16.9% of sales, compared with 13.5% in the prior-year quarter.
- Q3 gross margin declined 130 basis points, primarily because of increased promotional activity. Year-to-date gross margin increased 220 basis points, driven by selling mix and lower product costs.
- Year-to-date operating cash flow was a use of $230.2 million versus $219.3 million of cash provided in the prior-year period, principally due to a $341.8 million inventory investment.
- Capital expenditures were $124.0 million year to date, compared with $278.0 million in the prior-year period. Financing uses included $115.8 million of share repurchases and $46.6 million of dividends.
- Cash and equivalents were $257.5 million at November 2, 2013, down from $643.5 million at February 2, 2013. Restricted cash was $30.0 million.
- Total borrowings were $138.8 million under the Term Loan Agreement, compared with no borrowings at February 2, 2013. The company also had a $350 million unsecured revolving credit facility, with no borrowings outstanding.
- Inventory was $768.9 million, up from $427.0 million at fiscal year-end and approximately 22% above the prior-year third-quarter balance.
Material Changes Versus the Prior Comparable Period
- The company moved from substantial profitability to losses as weak comparable sales caused store-cost deleveraging and higher promotional activity.
- Q3 included $43.6 million of store-related asset impairment charges, $44.7 million of Gilly Hicks restructuring charges and $7.6 million of profit-improvement initiative charges. Total identified operating charges were approximately $95.9 million.
- The company reported adjusted non-GAAP net income of $40.5 million, or $0.52 diluted EPS, for Q3, and $46.4 million, or $0.59 diluted EPS, year to date, excluding specified charges.
- The Board approved closure of all stand-alone Gilly Hicks stores. The company expects approximately $90 million of aggregate pre-tax charges, including $44.7 million recognized through Q3 and approximately $45 million expected primarily in Q4 Fiscal 2013 and Q1 Fiscal 2014.
- The company recorded $43.6 million of non-cash impairment charges, primarily involving 23 Abercrombie & Fitch stores, three abercrombie kids stores and 70 Hollister stores. A 10% reduction in projected sales assumptions would have increased the impairment charge by approximately $4.7 million.
- The company retroactively adopted weighted-average inventory costing. Prior-year results were restated; the change increased Q3 Fiscal 2012 net income by $12.5 million and year-to-date net income by $10.2 million.
- The filing also corrected certain prior-period errors, increasing current-period net income by $3.0 million for Q3 and $4.7 million year to date.
Guidance, Outlook, Commentary and Risks
- Management expects difficult fourth-quarter conditions and assumes fourth-quarter comparable sales will decline by low double digits.
- Full-year adjusted non-GAAP diluted EPS guidance was $1.40 to $1.50, assuming significant Q4 gross-margin erosion and a flat full-year gross-margin rate versus the prior year. Guidance excludes potential impairment, store-closure, Gilly Hicks restructuring, profit-improvement and additional share-repurchase effects.
- Management expects at least $100 million of incremental annualized savings from the profit-improvement initiative beyond savings realized in the current year.
- Fiscal 2013 capital expenditures were expected to be approximately $200 million. The company expected approximately 20 international Hollister openings and approximately 50 U.S. store closures, excluding Gilly Hicks closures.
- On November 4, 2013, debt amendments permitted add-back of up to $60 million of cash Gilly Hicks restructuring charges for covenant calculations and temporarily reduced the minimum Coverage Ratio from 1.75x to 1.60x before a phased return to 1.75x.
- Key risks include continued weak consumer demand and fashion execution, elevated inventory and markdown risk, international expansion, foreign exchange, store impairment, liquidity and debt covenant compliance, lease obligations, litigation, supply-chain and technology disruptions, and uncertainty surrounding Gilly Hicks closure costs.
- The company stated that it was in compliance with its debt covenants at November 2, 2013. It also stated that litigation accruals may not cover all potential claims and that additional Japanese deferred-tax valuation allowances could become necessary if taxable profits are insufficient.
Important Facts for Investors to Verify
- Reconcile the requested “2012 Q3” period with the filing’s actual November 2, 2013 Fiscal 2013 reporting period.
- Monitor comparable sales, particularly U.S. and Hollister performance, and whether direct-to-consumer growth offsets store weakness.
- Assess inventory liquidation, markdowns and working-capital needs given the sharp inventory increase and negative operating cash flow.
- Verify the timing and final amount of the estimated $90 million Gilly Hicks restructuring costs and related covenant adjustments.
- Evaluate liquidity after seasonal cash requirements, capital expenditures, dividends, repurchases and scheduled term-loan amortization.
- Distinguish GAAP losses from management’s adjusted results and review the assumptions underlying impairments and non-GAAP exclusions.
- Review the retroactive inventory-accounting change and prior-period error corrections when comparing reported historical results.