Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: The provided filing is for the thirteen and twenty-six weeks ended July 31, 2010, compared with August 1, 2009. The request metadata identifies “2009 Q2,” but the filing itself is a Fiscal 2010 second-quarter report filed September 8, 2010. The company is a specialty retailer operating Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks stores and direct-to-consumer channels.
Financial Performance and Position
| Metric | Q2 Fiscal 2010 | Q2 Fiscal 2009 | Year-to-date Fiscal 2010 | Year-to-date Fiscal 2009 |
|---|---|---|---|---|
| Net sales | $745.8 million | $637.2 million | $1.434 billion | $1.239 billion |
| Gross profit | $485.3 million | $424.5 million | $916.8 million | $806.0 million |
| Gross margin | 65.1% | 66.6% | 63.9% | 65.1% |
| Operating income (loss) | $27.6 million | $8.9 million | $8.8 million | $(25.0) million |
| Operating margin | 3.7% | 1.4% | 0.6% | (2.0)% |
| Net income (loss) | $19.5 million | $(26.7) million | $7.7 million | $(86.0) million |
| Diluted EPS | $0.22 | $(0.30) | $0.09 | $(0.98) |
- Q2 comparable-store sales increased 5%; year-to-date comparable-store sales increased 3%.
- Direct-to-consumer sales, including shipping and handling, represented 10.7% of Q2 sales versus 8.5% in the prior-year quarter. Year-to-date penetration was 11.2% versus 9.0%.
- International sales increased to $133.2 million in Q2 from $72.2 million and to $252.2 million year-to-date from $131.0 million.
- Cash and equivalents were $613.6 million at July 31, 2010, compared with $680.1 million at January 30, 2010 and $366.5 million at August 1, 2009.
- Working capital was $800.6 million. Inventory was $480.1 million, up 47% year over year and substantially above the January 30, 2010 balance of $310.6 million.
- Net cash used in operating activities was $21.7 million year-to-date, compared with $47.0 million provided in the prior-year period. Capital expenditures were $59.8 million, and dividends paid were $30.8 million.
- Long-term debt was $76.0 million, including $53.2 million outstanding under the amended unsecured credit agreement and $22.8 million of landlord financing obligations.
- The company had $296.8 million of additional credit capacity, less outstanding letters of credit, and was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Sales growth and improved expense leverage drove a return to operating and net profitability, although gross margin declined 150 basis points in Q2 and 120 basis points year-to-date.
- Stores and distribution expense declined as a percentage of sales to 48.9% from 52.1% in Q2 and to 50.1% from 53.5% year-to-date, primarily because of lower store occupancy costs relative to sales.
- The gross-margin decline was primarily attributable to a 15% Q2 decrease in average unit retail, partially offset by lower average unit cost. Year-to-date average unit retail declined 12%.
- The prior-year results included RUEHL discontinued-operation losses of $18.6 million in Q2 and $54.7 million year-to-date. RUEHL closures were completed in Fiscal 2009, making the comparison favorable.
- Year-to-date operating cash flow weakened because inventory increased $169.5 million, compared with a $47.9 million inventory-related source of cash in the prior-year period.
- The company recorded a $2.2 million non-cash asset-impairment charge in Q2 related to expected underperforming-store closures, or approximately $0.02 per diluted share.
Outlook, Commentary, Risks and Unusual Items
- Management expects Fiscal 2010 capital expenditures of approximately $200 million, including approximately $160 million for new stores, refreshes and remodels and $40 million for information technology, distribution centers and home-office projects.
- The company expects to close approximately 60 domestic stores in Fiscal 2010 and approximately 50 additional stores in Fiscal 2011, predominantly through natural lease expirations.
- Fiscal 2010 plans include approximately 20 international mall-based Hollister stores, flagship openings in Fukuoka and Copenhagen, a Hollister Fifth Avenue store, one Canadian Abercrombie & Fitch store and the first international Gilly Hicks store in the United Kingdom. The international Hollister opening plan was reduced from approximately 25 stores.
- Management expects inventory to remain significantly elevated year over year at the end of the third quarter before moderating by fiscal year-end.
- Management expects a full-year effective tax rate of approximately 37%, subject to domestic/international profit mix and tax adjustments.
- Key risks include consumer and economic conditions, fashion and weather sensitivity, elevated inventory and markdown exposure, store-closure costs, international expansion, foreign-exchange volatility, supply-chain and distribution-center disruptions, litigation, information-technology disruption and debt-covenant compliance.
- The company held $127.5 million of auction-rate securities classified as Level 3 assets, with $9.0 million of cumulative temporary impairment. The securities market remained illiquid, and valuation depended substantially on discounted-cash-flow assumptions.
- RUEHL closure liabilities were $25.3 million at July 31, 2010; the company expected approximately $29.5 million of gross cash payments in Fiscal 2010 and an aggregate $19.2 million in later fiscal years.
- A securities class-action settlement in principle required a $12 million payment by the company’s insurers, subject to court approval. The company stated that it could not quantify potential exposure for other identified legal matters.
Important Facts for Investors to Verify
- Confirm the intended reporting period, because the supplied metadata says 2009 Q2 while the filing reports July 31, 2010 results.
- Assess whether the 47% inventory increase can be reduced without materially higher markdowns or further gross-margin pressure.
- Review the sustainability of the sales recovery, particularly comparable-store sales, lower average unit retail and direct-to-consumer growth.
- Evaluate cash generation after planned capital expenditures, dividends, store-closure payments and seasonal working-capital requirements.
- Monitor the valuation and liquidity of the $127.5 million auction-rate securities portfolio.
- Review expected store closures, impairment charges and the execution risk associated with international expansion and Gilly Hicks productivity improvements.
- Track debt-covenant headroom, letters of credit, lease obligations and unresolved litigation contingencies.