Abercrombie & Fitch Co. — Form 10-Q Summary
Reporting period: Thirteen weeks ended April 30, 2011, compared with May 1, 2010. The provided request metadata identifies “2010 Q1,” but the filing is for the first quarter of Fiscal 2011. The financial statements are unaudited and were reviewed by PricewaterhouseCoopers LLP.
Business context
Abercrombie & Fitch is a specialty retailer of casual apparel and accessories operated through the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands. The Company reports one operating segment and sells through stores and direct-to-consumer channels. At April 30, 2011, it operated 1,071 stores, including 542 Hollister stores and 19 Gilly Hicks stores.
Financial performance and liquidity
| Metric | Q1 Fiscal 2011 | Q1 Fiscal 2010 | Change |
|---|---|---|---|
| Net sales | $836.7 million | $687.8 million | 22% increase |
| Gross profit | $543.7 million | $431.4 million | 26% increase |
| Gross margin | 65.0% | 62.7% | 230 basis-point increase |
| Operating income (loss) | $38.7 million | $(18.7) million | Improved by $57.5 million |
| Net income (loss) | $25.1 million | $(11.8) million | Returned to profitability |
| Diluted EPS | $0.28 | $(0.13) | Improved by $0.41 |
| Net cash used in operating activities | $(8.8) million | $(36.2) million | Lower cash use |
| Capital expenditures | $51.5 million | $19.2 million | Increase of $32.3 million |
Sales growth reflected a 10% increase in comparable store sales, a 32% increase in direct-to-consumer sales including shipping and handling, and international store growth. Brand sales increased 13% for Abercrombie & Fitch, 10% for abercrombie kids, 32% for Hollister and 92% for Gilly Hicks. International sales increased 64% to $195.7 million, while U.S. sales increased 13% to $641.0 million.
Operating leverage was significant: stores and distribution expense declined to 47.7% of sales from 51.5%, and marketing, general and administrative expense declined to 12.9% from 14.0%. Gross margin benefited from lower average unit cost, favorable international mix, foreign currency effects and freight-related factors.
At April 30, 2011, cash and equivalents were $741.8 million, compared with $826.4 million at January 29, 2011 and $600.5 million at May 1, 2010. Total current assets were $1.34 billion and total current liabilities were $491.8 million. Inventory was $358.4 million, up 13% from $316.4 million a year earlier, but below the rate of sales growth.
Long-term debt was $69.9 million, including $44.3 million outstanding under the amended unsecured credit agreement and $25.6 million of landlord financing obligations. The Company had approximately $320.6 million available under the facility as of June 3, 2011, less outstanding letters of credit. The Company was in compliance with its debt covenants at April 30, 2011.
Material changes versus the prior comparable period
- Net sales increased $148.9 million, or 22%, driven by stronger comparable store sales, international expansion and direct-to-consumer growth.
- The Company moved from an operating loss of $18.7 million to operating income of $38.7 million.
- Gross margin expanded 230 basis points to 65.0%, while expense ratios improved through operating leverage.
- Net income improved from a loss of $11.8 million to income of $25.1 million. Fiscal 2011 included $0.8 million, or $0.01 per diluted share, from discontinued operations related to RUEHL lease settlements.
- Operating cash use declined from $36.2 million to $8.8 million, but capital expenditures increased substantially to support international stores, information technology and distribution infrastructure.
- The Company repurchased approximately 0.4 million shares for $25.5 million and paid $15.3 million in dividends; no open-market repurchases occurred in the prior-year quarter.
- International exposure increased, with Europe sales rising to $152.4 million from $79.6 million and international sales becoming a larger contributor to results.
Outlook, commentary and unusual items
- Management expects to open four additional international Abercrombie & Fitch flagship locations and up to 40 international mall-based Hollister stores during Fiscal 2011, including initial stores in mainland China and Hong Kong.
- The Company expects to close approximately 50 U.S. stores during Fiscal 2011, primarily through natural lease expirations, and targets returning U.S. store productivity to at least 90% of 2007 levels by 2012.
- Fiscal 2011 capital expenditures are expected to be approximately $350 million, primarily for new stores, store refreshes and remodels.
- Management expects second-quarter margin pressure from lower year-over-year gross margin, higher pre-opening costs, direct-to-consumer investments, increased incentive and equity compensation, additional distribution-center depreciation and marketing timing.
- Higher raw material costs, particularly cotton, are expected to erode gross margin during the second half of Fiscal 2011. Management expects a full-year effective tax rate of approximately 35%, subject to the domestic and international profit mix.
- The Company is consolidating its two domestic distribution centers, with completion expected by mid-Fiscal 2012. The project is intended to reduce operating costs and facilitate the sale of the second distribution center.
- RUEHL closure obligations were reduced by $15.0 million of cash payments during the quarter; approximately $0.9 million remained accrued at April 30, 2011.
- The Company held $101.6 million of auction rate securities classified as Level 3 assets, with $13.9 million of cumulative temporary impairment. Management reported no credit-related losses but noted limited market liquidity and valuation sensitivity.
- Pending litigation includes California wage-and-hour matters and a derivative action remanded for further proceedings. The Company cannot quantify potential exposure and states that actual liabilities could exceed recorded reserves.
Key investor verification points
- Verify that the applicable period is Q1 Fiscal 2011, ended April 30, 2011, rather than the “2010 Q1” period in the request metadata.
- Assess whether gross-margin pressure from cotton and other input costs materialized as projected in subsequent quarters.
- Evaluate the cash requirements and returns associated with approximately $350 million of planned Fiscal 2011 capital expenditures and international store expansion.
- Monitor comparable store sales, international profitability, direct-to-consumer growth and the planned U.S. store closures.
- Review liquidity after capital expenditures, dividends, share repurchases and seasonal working-capital needs.
- Assess valuation risk associated with the $101.6 million of auction rate securities and the related unobservable assumptions.
- Track covenant compliance, variable-rate debt exposure and the availability of the amended credit facility.
- Follow the unresolved litigation matters, for which the filing does not provide a clear quantified exposure.