Abercrombie & Fitch Co. — Form 10-K Summary
Period covered: The supplied filing is the Form 10-K for the 53-week fiscal year ended February 2, 2013 (“Fiscal 2012”), compared primarily with the 52-week fiscal year ended January 28, 2012 (“Fiscal 2011”). This does not match the request metadata identifying “2011 Q4.” Fourth-quarter figures are included, but the filing is an annual report.
Business Context and Reporting Period
Abercrombie & Fitch is a specialty apparel retailer operating the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands through stores and direct-to-consumer channels. At year-end, the Company operated 1,051 stores: 912 in the United States and 139 internationally. Direct-to-consumer sales represented 16% of total sales.
The Company reports three segments: U.S. Stores, International Stores and Direct-to-Consumer. Fiscal 2012 included an additional 53rd week, and prior-period financial statements were retrospectively restated for a change in inventory accounting from the retail method to the weighted-average cost method.
Key Financial Metrics
| Metric | Fiscal 2012 | Fiscal 2011 | Change |
|---|---|---|---|
| Net sales | $4.511 billion | $4.158 billion | Up 8% |
| Gross profit | $2.817 billion | $2.550 billion | Up 10% |
| Gross margin | 62.4% | 61.3% | Up 110 basis points |
| Operating income | $374.2 million | $221.4 million | Up 69% |
| Operating margin | 8.3% | 5.3% | Up 300 basis points |
| Net income | $237.0 million | $143.9 million | Up 65% |
| Diluted earnings per share | $2.85 | $1.61 | Up 77% |
| Operating cash flow | $684.2 million | $365.2 million | Up 87% |
| Capital expenditures | $339.9 million | $318.6 million | Up 7% |
| Free cash flow | $344.3 million | $46.6 million | Up materially |
| Cash and equivalents | $643.5 million | $583.5 million | Up $60.0 million |
| Borrowings at year-end | None under credit facilities | None under credit facilities | Excludes leasehold financing |
The current ratio declined to 1.89 from 2.23, and working capital declined to $617.0 million from $858.2 million. Year-end inventory was $427.0 million, compared with $679.9 million on a restated basis in the prior year.
Revenue and Operating Trends
- U.S. Stores sales declined to $2.615 billion from $2.711 billion, while International Stores sales increased to $1.195 billion from $894.6 million.
- Direct-to-consumer sales increased 27% to $700.7 million, representing 16% of total sales versus 13% in Fiscal 2011.
- Total comparable sales declined 1%; comparable store sales declined 5%, while comparable direct-to-consumer sales increased 24%.
- U.S. comparable sales increased 1%, while international comparable sales declined 8%, reflecting a 19% decline in international comparable store sales partly offset by 46% growth in international direct-to-consumer sales.
- Gross margin improved primarily because of lower average unit cost. Stores and distribution expense increased in dollars but declined as a percentage of sales to 44.1% from 45.4%.
- Fiscal 2012 included $7.4 million of store-related impairment charges, versus $68.0 million of impairments, $14.6 million of asset write-downs and $19.0 million of store closure and lease-exit charges in Fiscal 2011.
Cash Flow, Liquidity and Capital Allocation
Operating cash flow of $684.2 million was primarily driven by a favorable inventory change, partly offset by lower accounts payable and accrued expenses. Investing cash outflows were $247.2 million, including $339.9 million of capital expenditures and $102.0 million of proceeds from marketable securities. Financing cash outflows were $380.1 million, including $321.7 million of share repurchases and $57.6 million of dividends.
The Company had $643.5 million of cash and equivalents, no borrowings under its $350 million revolving credit facility or $150 million term loan at year-end, and $63.9 million of leasehold financing obligations. On February 21, 2013, after year-end, the Company borrowed the full $150 million available under the term loan at an effective interest rate of 1.96%.
Non-cancelable contractual obligations totaled $2.839 billion, including $2.636 billion of operating lease obligations. These amounts exclude certain potentially cancelable lease commitments, taxes associated with uncertain tax positions and future dividend payments.
Guidance, Outlook and Management Commentary
- Management targeted approximately 15% annual earnings-per-share growth over the long term.
- Fiscal 2013 capital expenditures were expected to be approximately $200 million, with approximately $30 million of store pre-opening costs.
- The Company expected to open Abercrombie & Fitch flagship stores in Seoul and Shanghai and approximately 20 international Hollister stores, including planned entries into Australia, Dubai through a joint venture and Japan.
- Management planned to simplify processes, eliminate lower-value activities, improve efficiency, reduce expenses and increase average unit retail, particularly in U.S. stores and U.S. direct-to-consumer operations.
- The Company expected positive free cash flow in Fiscal 2013 and intended to continue returning excess cash through dividends and, subject to market conditions, share repurchases.
Material Changes and Unusual Items
- The inventory accounting change increased Fiscal 2011 gross profit by $31.4 million and net income by $16.3 million on a restated basis. Investors should use the restated comparative figures when assessing trends.
- The Company sold its remaining auction rate securities and recognized a $2.5 million gain in Fiscal 2012. Fiscal 2011 included a $13.4 million other-than-temporary impairment related to those securities.
- Fiscal 2012 included $4.8 million of business interruption insurance recoveries related to Superstorm Sandy.
- The Company repurchased approximately 7.5 million shares for $321.7 million in Fiscal 2012, compared with approximately 3.5 million shares for $196.6 million in Fiscal 2011.
- Share-based compensation expense was $52.9 million. Outstanding stock appreciation rights and the CEO’s equity-based compensation arrangements could create future expense and potential dilution.
Risks, Contingencies and Other Considerations
- Results remain sensitive to fashion trends, consumer demand, promotional competition, inventory execution, weather and seasonal Back-to-School and Holiday sales.
- International expansion exposes the Company to foreign currency movements, economic and political conditions, labor requirements, lease commitments and execution risk. International comparable store performance was weak in Fiscal 2012.
- Higher raw-material, labor and transportation costs may pressure gross margins if they cannot be passed to customers.
- The Company relies on third-party manufacturers, contract carriers and a limited distribution-center network, creating supply-chain and disruption risks.
- Revolving credit and term-loan agreements contain leverage, coverage and other covenants. Noncompliance could accelerate repayment obligations and impair liquidity.
- The Company is involved in ordinary-course litigation, including employment and wage-related matters. Management states that actual liabilities could exceed recorded reserves.
- Approximately $99.6 million of foreign subsidiary earnings were treated as indefinitely reinvested and had no U.S. tax provision. Uncertain tax positions totaled $11.1 million, with $7 million to $12 million potentially changing within the following 12 months.
- A 10% decrease in the sales assumptions used in the Fiscal 2012 impairment analysis would have increased the impairment charge by approximately $17.0 million.
Investor Verification Checklist
- Verify that comparisons use the retrospectively restated inventory-accounting figures and account for Fiscal 2012’s 53rd week.
- Assess whether international store productivity and comparable sales can recover while the Company continues opening stores.
- Reconcile reported earnings growth with the effects of lower impairments, the accounting change, insurance recoveries and other unusual items.
- Review the subsequent $150 million term-loan draw, interest terms, maturity, amortization schedule and covenant calculations.
- Evaluate the sustainability of direct-to-consumer growth and its effect on fulfillment costs and store economics.
- Review lease commitments, store impairment assumptions, pending litigation and uncertain tax positions.
- Consider the effect of continued share repurchases and CEO-related equity awards on cash usage, earnings per share and potential dilution.