Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: The filing covers the thirteen and twenty-six weeks ended August 1, 2020, representing the second quarter and year-to-date periods of Fiscal 2020. The request metadata identifies “2019 Q2,” but the provided filing is for 2020 Q2, with comparison periods ended August 3, 2019.
Business context
Abercrombie & Fitch is a global omnichannel specialty retailer operating the Hollister, Abercrombie & Fitch and abercrombie kids brands through company-operated stores, digital channels, wholesale, franchise and licensing arrangements. The company reported 850 company-operated stores as of August 1, 2020.
Results were materially affected by COVID-19-related store closures, reduced customer traffic and continuing uncertainty regarding consumer demand, store operations and the global supply chain. Approximately 90% of company-operated stores had reopened for in-store service by August 1, 2020, often with modified hours.
Financial performance and key metrics
| Metric | Thirteen weeks ended August 1, 2020 | Thirteen weeks ended August 3, 2019 | Twenty-six weeks ended August 1, 2020 | Twenty-six weeks ended August 3, 2019 |
|---|---|---|---|---|
| Net sales | $698.3 million | $841.1 million | $1.184 billion | $1.575 billion |
| Sales change | Down 17.0% | Down 0.2% | Down 24.8% | Up 0.1% |
| Gross profit | $423.6 million | $498.6 million | $687.8 million | $942.7 million |
| Gross margin | 60.7% | 59.3% | 58.1% | 59.9% |
| Operating income (loss) | $14.1 million | $(39.5) million | $(195.0) million | $(66.7) million |
| Operating margin | 2.0% | (4.7)% | (16.5)% | (4.2)% |
| Net income (loss) attributable to A&F | $5.5 million | $(31.1) million | $(238.7) million | $(50.3) million |
| Diluted EPS | $0.09 | $(0.48) | $(3.82) | $(0.76) |
Second-quarter digital sales increased approximately 56% year over year; year-to-date digital sales increased approximately 41%. Segment sales declined 15% for Hollister and 20% for Abercrombie in the quarter, and 25% for each segment year to date.
Second-quarter adjusted non-GAAP operating income was $22.2 million, or 3.2% of sales, excluding $8.1 million of asset impairment charges. Year-to-date adjusted non-GAAP operating loss was $144.0 million, or 12.2% of sales, excluding $51.0 million of asset impairment charges.
Liquidity, cash flow and balance sheet
- Cash and equivalents were $766.7 million at August 1, 2020, compared with $671.3 million at February 1, 2020.
- Cash and restricted cash totaled $786.0 million at August 1, 2020, up $93.7 million from the beginning of the fiscal year.
- Operating cash flow was $96.2 million year to date, compared with $(36.1) million in the prior-year period.
- Capital expenditures were $75.6 million year to date, compared with $94.2 million in the prior-year period. Fiscal 2020 capital expenditures are expected to be approximately $100 million, versus $202.8 million in Fiscal 2019.
- Reported liquidity was $1.061 billion, consisting of cash and actual incremental ABL borrowing availability, compared with $913.8 million at February 1, 2020.
- Gross borrowings were $350.0 million at August 1, 2020, versus $233.3 million at February 1, 2020. Net long-term borrowings were $343.3 million.
- The company issued $350.0 million of 8.75% senior secured notes due July 15, 2025. Proceeds were used to repay the term loan and ABL borrowings.
- No ABL borrowings were outstanding at August 1, 2020; actual incremental availability was $294.6 million. The company stated that it was in compliance with its debt covenants.
Material changes versus the prior comparable period
- COVID-19 drove widespread temporary store closures and lower traffic, reducing sales by 17% in the quarter and 25% year to date.
- Digital growth partially offset store weakness, but the company stated that it historically generates most annual sales through stores and that digital performance may not continue at current levels.
- Second-quarter gross margin improved 140 basis points because of higher average unit retail and lower promotional and clearance activity. Year-to-date gross margin declined 180 basis points, primarily due to approximately $14.8 million of first-quarter inventory valuation charges.
- Year-to-date asset impairment charges increased to $51.0 million from $5.6 million, principally reflecting COVID-19 effects on store cash flows.
- Year-to-date income tax expense was $32.8 million despite a pretax loss, reflecting $84.1 million of adverse tax impacts, including unrecognized tax benefits on losses and valuation allowances.
- The company suspended share repurchases in March 2020 and dividends in May 2020 to preserve liquidity. Year-to-date shareholder returns before suspension included $15.2 million of repurchases and $12.6 million of dividends.
- Flagship store exit activity produced a $4.4 million benefit year to date, compared with $46.7 million of charges in the prior-year period.
Guidance, outlook, risks and unusual items
For the third quarter of Fiscal 2020, management expected net sales to decline 15% to 20% year over year. This expectation assumed that back-to-school demand would extend through September and potentially October. The company stated that it believed liquidity was adequate to fund operations over the following twelve months, but emphasized that COVID-19 conditions remained dynamic.
- Key risks include renewed store closures, weaker consumer demand, extended traffic declines, supply-chain disruptions, inventory imbalances, labor and occupancy costs, foreign exchange volatility and evolving government restrictions.
- The company continued negotiating rent abatements and payment terms with landlords and vendors. Future cash outflows could increase if extended terms or rent relief are not maintained.
- Debt agreements contain restrictive covenants governing additional debt, liens, asset sales, dividends, repurchases and other corporate actions. A default could accelerate obligations and permit remedies against collateral.
- Closed flagship stores have future fixed lease payments scheduled through Fiscal 2028, not expected to exceed $15 million in aggregate in any fiscal year; additional closure-related charges or benefits remain uncertain.
- COVID-19-related store impairments, inventory charges, tax valuation allowances, lease negotiations and hedge accounting effects make period-to-period comparisons less representative of ongoing performance.
- There were no material off-balance-sheet arrangements reported. The company stated that disclosure controls were effective as of August 1, 2020.
Important facts for investors to verify
- Whether store reopenings and sales productivity continue to improve without renewed COVID-19 closures.
- Whether the projected third-quarter sales decline of 15% to 20% was achieved and whether digital growth offsets store weakness.
- The sustainability of positive operating cash flow, including the effects of deferred rent, vendor payment extensions and government payroll tax credits.
- Inventory levels, markdown exposure and any additional impairment or valuation charges.
- Compliance with covenants and the company’s ability to service the 8.75% senior secured notes while maintaining adequate liquidity.
- Whether dividends and share repurchases remain suspended and the conditions for any reinstatement.
- Future tax valuation allowances, effective tax rates and the company’s ability to realize deferred tax assets.
- Final outcomes of lease negotiations, flagship store closures, legal contingencies and supply-chain disruptions.