Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Quarter ended August 4, 2018, covering 13 and 26 weeks. The request metadata identifies “2017 Q2,” but the filing itself is the second-quarter Fiscal 2018 report, with comparative periods ended July 29, 2017.
Business Context
Abercrombie & Fitch is a global specialty retailer operating the Hollister, Abercrombie & Fitch and abercrombie kids brands through stores, direct-to-consumer channels, wholesale, franchise and licensing arrangements. Operations span North America, Europe, Asia and the Middle East. The company had 870 company-operated stores at August 4, 2018, comprising 679 U.S. and 191 international stores.
Key Financial Metrics
| Metric | Q2 Fiscal 2018 | Q2 Fiscal 2017 | 26 Weeks Fiscal 2018 | 26 Weeks Fiscal 2017 |
|---|---|---|---|---|
| Net sales | $842.4 million | $779.3 million | $1.573 billion | $1.440 billion |
| Gross profit | $506.9 million | $460.9 million | $949.2 million | $859.8 million |
| Gross margin | 60.2% | 59.1% | 60.3% | 59.7% |
| Operating income (loss) | $0.2 million | $(21.1) million | $(42.0) million | $(91.0) million |
| Net loss attributable to A&F | $(3.9) million | $(15.5) million | $(46.3) million | $(77.2) million |
| Diluted loss per share | $(0.06) | $(0.23) | $(0.68) | $(1.13) |
| Operating cash flow | Not separately provided for the quarter | $50.5 million | $(48.0) million |
Q2 comparable sales increased 3% on a constant-currency basis, including 4% for Hollister and 2% for Abercrombie. Year-to-date comparable sales increased 4%. Q2 sales rose 8%, while year-to-date sales increased 9%. U.S. sales grew 13% in Q2 and 12% year to date; international sales grew 1% and 6%, respectively.
At August 4, 2018, cash and equivalents were $581.2 million, inventories were $454.9 million and total assets were $2.261 billion. Gross borrowings were $253.3 million, presented net at $249.9 million. The company had no borrowings under its $400 million asset-based revolving facility and reported $328.1 million of availability. Stockholders’ equity was $1.147 billion.
Year-to-date investing cash use was $54.1 million, primarily capital expenditures. Financing cash use was $77.7 million, including $43.7 million for repurchases of approximately 1.7 million shares and $27.2 million of dividends. Cash and equivalents decreased by $94.8 million during the first 26 weeks, partly due to financing uses and foreign-exchange effects.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher units sold, favorable foreign-exchange effects and the calendar shift from Fiscal 2017’s 53rd week. Management estimated the calendar shift benefited Q2 sales by approximately $30 million and year-to-date sales by approximately $40 million.
- Gross margin expanded 110 basis points in Q2 and 60 basis points year to date, primarily due to lower costs.
- Stores and distribution expense declined to 44.5% of Q2 sales from 47.4%, and to 46.8% year to date from 50.6%, reflecting sales leverage and expense reductions, partly offset by higher direct-to-consumer expense.
- Marketing, general and administrative expense increased to 14.7% of Q2 sales from 14.0% and to 15.8% year to date from 15.2%, driven by marketing, performance compensation and transformation-related spending. Year-to-date expense included $5.6 million of legal charges.
- Q2 operating performance improved to break-even GAAP operating income from a $21.1 million loss. Excluding asset impairment, adjusted operating income was $8.9 million versus an adjusted loss of $15.0 million.
- Year-to-date GAAP operating loss improved to $42.0 million from $91.0 million. Adjusted operating loss improved to $27.7 million from $84.9 million.
- The company adopted new revenue recognition guidance and the revised cash-flow presentation. The revenue standard increased beginning retained earnings by $6.9 million and primarily changed gift-card breakage and direct-to-consumer revenue timing; management stated the ongoing income-statement impact was immaterial.
- The term loan was repriced in June 2018, reducing applicable margins by 25 basis points. The reported interest rate was 5.59% at August 4, 2018.
Guidance, Outlook and Management Commentary
- Management stated that the strategic transformation remained on track, focused on optimizing the store network, improving digital and omnichannel fulfillment, streamlining concept-to-customer processes and optimizing marketing investments.
- Fiscal 2018 comparable sales and net sales are expected to increase 2% to 4%.
- Fiscal 2018 gross margin is expected to be slightly above the Fiscal 2017 rate of 59.7%.
- Fiscal 2018 GAAP operating expense is expected to increase approximately 2.5% from Fiscal 2017 adjusted operating expense of $2.0 billion.
- Management expects third-quarter sales to be approximately flat year over year, including calendar-shift and currency effects, and expects third-quarter inventories to increase by low- to mid-single digits.
- The full-year effective tax rate is expected to be in the mid-to-upper 30s, including approximately $9 million of discrete non-cash charges related to expired share-based compensation awards and a $2 million Tax Cuts and Jobs Act adjustment.
- Full-year capital expenditures are expected to be $135 million to $140 million. The company plans to open 22 full-price stores, remodel or right-size approximately 50 stores and potentially close up to 60 stores, primarily in the United States.
Risks, Contingencies and Unusual Items
- Store asset impairment charges were $8.7 million in Q2 and $9.7 million year to date, primarily related to international Abercrombie & Fitch stores.
- The company recorded a $2.0 million second-quarter measurement-period tax charge related to the Tax Cuts and Jobs Act. Cumulative provisional tax charges related to the Act totaled $21.9 million, and final amounts remained subject to additional analysis and regulatory guidance.
- The company had approximately $23 million accrued for legal contingencies and stated that incremental losses could be as much as approximately $20 million. Proposed settlements included a $25.0 million wage-and-hour class action settlement and a separate $9.6 million settlement, both subject to court approval and potential appeals.
- Retail results are seasonal, with the greatest sales activity generally occurring in the fall and holiday periods. First-half results are therefore not necessarily indicative of full-year performance.
- Key risks include consumer discretionary spending, fashion and inventory execution, competition and pricing pressure, foreign-currency volatility, international operations, supply-chain and technology disruptions, cybersecurity, litigation, tax-rate volatility and restrictive debt covenants.
- The company used foreign-currency forward contracts for hedging. A hypothetical 10% U.S. dollar devaluation against currencies under contract would reduce derivative fair values by approximately $27.7 million, largely offset by changes in the underlying hedged items.
Investor Verification Checklist
- Verify the filing period: August 4, 2018, rather than a 2017 second-quarter filing.
- Assess how much reported sales growth came from the 53rd-week calendar shift and foreign-currency benefits versus underlying comparable sales.
- Monitor the sustainability of gross-margin expansion and stores-and-distribution expense leverage.
- Reconcile GAAP results with management’s adjusted results, including asset impairments, legal charges and tax items.
- Review inventory growth ahead of the holiday season and the potential effect on markdowns and cash flow.
- Track store closures, remodels and new openings under the transformation program.
- Confirm final Tax Cuts and Jobs Act amounts and the company’s effective tax rate.
- Follow court approval and ultimate amounts for the disclosed legal settlements, including potential incremental exposure.
- Evaluate liquidity after dividends, share repurchases, capital expenditures and seasonal inventory requirements.