Business Context and Reporting Period
Abercrombie & Fitch Co. is a specialty apparel retailer operating Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands through stores and direct-to-consumer channels. The supplied filing is a Form 10-K for the 52-week fiscal year ended January 29, 2011, referred to as Fiscal 2010; it is not a 2009 Q4 filing. Fiscal 2009 ended January 30, 2010.
The Company operated 1,069 stores at fiscal year-end, including 540 Hollister, 325 Abercrombie & Fitch, 185 abercrombie kids and 19 Gilly Hicks locations. Direct-to-consumer sales, including shipping and handling, were $405.0 million, or 11.7% of total net sales.
Financial Performance, Cash Flow and Liquidity
| Metric | Fiscal 2010 | Fiscal 2009 | Change |
|---|---|---|---|
| Net sales | $3.469 billion | $2.929 billion | 18.4% increase |
| Gross profit | $2.212 billion | $1.884 billion | 17.4% increase |
| Gross margin | 63.8% | 64.3% | Down 50 basis points |
| Operating income | $231.9 million | $117.9 million | 96.7% increase |
| Operating margin | 6.7% | 4.0% | Up 270 basis points |
| Net income | $150.3 million | $0.3 million | Significant increase |
| Diluted earnings per share | $1.67 | $0.00 | Improved |
| Cash flow from operations | $391.8 million | $395.5 million | Down $3.7 million |
| Capital expenditures | $160.9 million | $175.5 million | Down $14.5 million |
| Cash and equivalents | $826.4 million | $670.0 million | Up $156.4 million |
- Comparable store sales increased 7%, following a 23% decline in Fiscal 2009. Brand comparable sales increased 9% at Abercrombie & Fitch, 5% at abercrombie kids and 6% at Hollister.
- International sales, including direct-to-consumer sales, increased 79% to $646.8 million. Europe was the strongest comparable-sales region, while Canada and Japan were the weakest.
- Inventory increased to $385.9 million from $310.6 million, primarily to support higher sales. The inventory valuation reserve increased to $24.4 million from $11.4 million.
- Working capital was $874.4 million and the current ratio was 2.56 at January 29, 2011.
- Fiscal 2010 financing uses included $76.2 million for share repurchases and $61.7 million for dividends. The quarterly dividend was $0.175 per share, or $0.70 annually.
- Long-term debt was $68.6 million, including $43.8 million outstanding under the unsecured credit agreement and $24.8 million of landlord financing obligations. The credit facility had approximately $305.6 million available, net of outstanding letters of credit, as of March 18, 2011.
Material Changes Versus the Prior Comparable Period
- Sales recovery was driven by positive comparable store sales, a 40% increase in the direct-to-consumer business, and new stores, particularly internationally.
- Gross margin declined despite higher sales, primarily because average unit retail decreased 9%; lower average unit cost only partially offset the pressure.
- Stores and distribution expense improved to 45.8% of sales from 48.7%, aided by lower occupancy and payroll costs as a percentage of sales.
- Fiscal 2010 included $50.6 million of store-related asset impairment charges affecting 26 stores and $4.4 million of store closure charges related to 64 domestic store closures. Fiscal 2009 included $33.2 million of store-related impairments affecting 99 stores.
- RUEHL was fully closed during Fiscal 2009. Its Fiscal 2009 after-tax discontinued-operations loss was $78.7 million; Fiscal 2010 discontinued-operations results were immaterial.
- The Company ended Fiscal 2010 with 27 fewer stores than the prior year, reflecting 36 openings, one net remodel or conversion, and 64 closures.
Guidance, Outlook, Risks and Unusual Items
- Management maintained an objective of returning operating margin to approximately 15% by Fiscal 2012, but stated that the prior goal of returning gross margin to approximately 67% was no longer realistic because of sourcing-cost pressures.
- The Company targeted comparable store sales increases of 7% or greater in Fiscal 2011 and Fiscal 2012, expected approximately 50 additional domestic store closures in Fiscal 2011, and planned up to 40 international Hollister openings plus five Abercrombie & Fitch flagship stores.
- Fiscal 2011 capital expenditures were expected to be approximately $300 million to $350 million, compared with $160.9 million in Fiscal 2010.
- Management expected to consolidate its two New Albany, Ohio distribution centers by mid-2012 and planned an additional third-party distribution center to support Asian operations.
- Key risks include discretionary consumer demand, fashion and inventory execution, increased cotton, labor and transportation costs, promotional competition, foreign exchange, international expansion, supply-chain and distribution disruptions, information-technology failures, mall traffic, litigation, impairment charges and regulatory compliance.
- The Company held $100.5 million of auction-rate securities with a $15.1 million temporary impairment. These Level 3 investments were valued using models with significant unobservable assumptions and remain subject to liquidity and valuation risk.
- Pending employment and wage-and-hour litigation included class-action matters in California and a derivative action appeal. The Company stated that it could not quantify potential exposure.
- Contractual commitments totaled $2.756 billion, including $2.619 billion of operating lease obligations. These commitments exclude certain taxes and future dividends.
- The Company was in compliance with its credit agreement covenants at January 29, 2011. The leverage ratio was 2.43 versus a maximum of 3.75, and the coverage ratio was 2.51 versus a minimum of 1.75.
Most Important Facts for Investors to Verify
- Confirm that the relevant reporting period is Fiscal 2010 ended January 29, 2011, rather than 2009 Q4.
- Reconcile reported GAAP earnings with management’s non-GAAP diluted EPS of $2.05, including the effects of impairments and store closure charges.
- Assess whether international growth and direct-to-consumer expansion can offset declining average unit retail and sourcing-cost inflation.
- Monitor inventory growth, markdown reserves and gross-margin performance as the Company pursues higher ticket prices.
- Verify the funding capacity and covenant headroom of the unsecured credit facility before the planned increase in capital expenditures.
- Evaluate potential cash costs from domestic closures, RUEHL lease obligations, litigation and other contractual commitments.
- Review the valuation, liquidity and concentration of Level 3 auction-rate securities and restricted Rabbi Trust assets.