Abercrombie & Fitch Co. Form 10-Q Summary
Period: Thirteen and thirty-nine weeks ended October 29, 2016, compared with October 31, 2015. The request metadata identifies “2015 Q3,” but the filing is for third quarter Fiscal 2016.
Business Context and Reporting Period
Abercrombie & Fitch is a specialty apparel and accessories retailer operating Abercrombie, abercrombie kids and Hollister brands through stores and direct-to-consumer channels in North America, Europe, Asia and the Middle East. The company reported 930 stores at October 29, 2016, including 745 U.S. stores and 185 international stores. Results are seasonal, with the Fall period generally producing the highest sales.
Key Financial Metrics
| Metric | Q3 Fiscal 2016 | Q3 Fiscal 2015 | Year-to-date Fiscal 2016 |
|---|---|---|---|
| Net sales | $821.7 million | $878.6 million | $2.290 billion |
| Comparable sales change | (6)% | (1)% | (5)% |
| Gross profit rate | 62.2% | 63.7% | 61.7% |
| Operating income (loss) | $19.6 million | $41.0 million | $(46.1) million |
| Net income (loss) attributable to A&F | $7.9 million | $41.9 million | $(44.8) million |
| Diluted earnings (loss) per share | $0.12 | $0.60 | $(0.66) |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $21.4 million |
Q3 adjusted non-GAAP net income attributable to A&F was $1.4 million, or $0.02 per diluted share, compared with $32.9 million, or $0.48 per diluted share, in the prior-year quarter. Year-to-date adjusted non-GAAP net loss was $55.0 million, or $0.81 per diluted share, compared with adjusted net income of $4.3 million, or $0.06 per share.
At October 29, 2016, cash and equivalents were $469.7 million, inventories were $516.1 million and total current assets were $1.150 billion. Gross borrowings were $293.3 million, consisting primarily of the term loan; no borrowings were outstanding under the $400 million asset-based revolving credit facility. The term loan carried a 4.75% interest rate and matures in August 2021.
Year-to-date investing cash outflow was $92.7 million, including $96.8 million of capital expenditures. Financing cash outflow was $44.7 million, including $40.5 million of dividends. Cash declined by $118.9 million from the beginning of the fiscal year. The company held $270.6 million of cash at foreign affiliates.
Material Changes Versus the Prior Comparable Period
- Q3 sales declined 6%, driven primarily by a 13% decline in Abercrombie sales and a 14% comparable-sales decline for the brand. Hollister sales declined 1%, while its comparable sales were flat.
- Gross margin declined 150 basis points to 62.2%. Management cited foreign currency effects, lower average unit retail and weaker performance in seasonal Abercrombie categories that required increased promotions.
- Operating income fell 52% to $19.6 million. The operating margin declined to 2.4% from 4.7%; on an adjusted basis, Q3 operating margin was 1.7% versus 5.8%.
- Q3 net income attributable to A&F declined by $34.0 million. The prior-year quarter included a $12.1 million asset impairment charge, while the current quarter included a $6.0 million indemnification recovery, making reported comparisons unusually affected by special items.
- Year-to-date net loss attributable to A&F increased to $44.8 million from $22.2 million. Year-to-date adjusted results shifted from $4.3 million of net income to a $55.0 million net loss.
- Operating cash flow declined to $21.4 million from $66.5 million, partly reflecting the larger loss, inventory investment and the prior-year benefit from extended vendor payment terms.
- Inventory increased to $516.1 million from $436.7 million at the prior fiscal year-end, while cash declined from $588.6 million to $469.7 million.
Guidance, Outlook, Risks and Unusual Items
- For Q4 Fiscal 2016, management expected comparable sales to remain challenging but modestly improve from Q3, continued adverse foreign-currency effects, and gross margin of approximately 60.7%, slightly below the prior-year adjusted rate.
- Q4 operating expense was expected to increase approximately 1% from the prior-year adjusted level, including an estimated $16 million lease termination charge for the Hong Kong flagship store.
- The Hong Kong flagship closure was expected to be substantially complete by the end of Q2 Fiscal 2017, with estimated net cash outflows of approximately $16 million paid in two installments.
- Full-year capital expenditures were expected to be approximately $140 million. Management planned seven Q4 store openings, including five in China, and expected approximately 35 U.S. store closures through natural lease expirations.
- The outlook excluded potential asset impairment charges, litigation charges and insurance recoveries. The effective tax rate was expected to remain sensitive because of low pre-tax earnings and jurisdictional earnings mix.
- Key risks include weak consumer spending, fashion and inventory execution, international expansion, direct-to-consumer performance, foreign currency volatility, competition and pricing pressure, supply-chain disruption, cybersecurity, litigation, tax and trade-policy changes, and restrictive debt covenants.
- Brexit and uncertainty following the November 2016 U.S. elections could affect currency rates, trade policies, tariffs, taxes and regulations. The company operated 34 stores in the United Kingdom and sourced most merchandise outside the United States.
- The company had accrued approximately $4 million for certain legal contingencies, but additional claims were pending without accruals and actual liabilities could exceed reserves.
- The company’s disclosure controls were assessed as effective at a reasonable level of assurance, with no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Confirm the applicable period: the supplied filing is Fiscal 2016 Q3, not Fiscal 2015 Q3.
- Assess whether Hollister’s improving comparable-sales trend offset continued weakness at Abercrombie and in international flagship and tourist locations.
- Monitor gross margin, promotional activity, average unit retail and inventory levels for evidence of further markdown risk.
- Evaluate liquidity after planned capital expenditures, dividends, store closures, the Hong Kong lease termination and potential share repurchases.
- Review the sustainability of reported earnings in light of indemnification and claims-settlement benefits, impairment charges and other excluded non-GAAP items.
- Track foreign-currency exposure, the $293.3 million term loan, interest-rate sensitivity and availability under the revolving credit facility.
- Review pending litigation, unrecognized tax and legal exposures, and the potential effects of tariffs or other changes in international trade policy.