Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen and thirty-nine weeks ended November 1, 2014, compared with the periods ended November 2, 2013. The filing is for Fiscal 2014 third quarter, although the request metadata identifies “2013 Q3.” The interim financial statements are unaudited and were reviewed by PricewaterhouseCoopers LLP.
Business Context
Abercrombie & Fitch is a specialty apparel retailer operating the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands through U.S. and international stores and direct-to-consumer channels. At November 1, 2014, the Company operated 1,000 stores, including 834 U.S. stores and 166 international stores. Gilly Hicks stand-alone stores had been closed.
Financial Performance
| Metric | Q3 2014 | Q3 2013 | Year-to-date 2014 | Year-to-date 2013 |
|---|---|---|---|---|
| Net sales | $911.5 million | $1,033.3 million | $2,624.5 million | $2,817.8 million |
| Gross profit | $567.1 million | $651.0 million | $1,631.7 million | $1,808.3 million |
| Gross margin | 62.2% | 63.0% | 62.2% | 64.2% |
| Operating income (loss) | $33.4 million | $(35.4) million | $21.4 million | $(30.1) million |
| Net income (loss) | $18.2 million | $(15.6) million | $7.4 million | $(11.5) million |
| Diluted EPS | $0.25 | $(0.20) | $0.10 | $(0.15) |
Q3 operating margin was 3.6%, versus negative 3.4% in the prior-year quarter. Year-to-date operating margin was 0.8%, versus negative 1.1%. The reported improvement reflected lower restructuring and impairment charges, expense reductions and lower corporate costs, partly offset by weaker sales and gross margin.
Adjusted non-GAAP net income was $30.4 million, or $0.42 per diluted share, in Q3 2014, compared with $40.5 million, or $0.52, in Q3 2013. Year-to-date adjusted net income was $31.5 million, or $0.43 per diluted share, compared with $46.4 million, or $0.59.
Cash Flow, Liquidity and Capital Structure
- Cash and equivalents were $320.6 million at November 1, 2014, compared with $600.1 million at February 1, 2014.
- Year-to-date operating cash flow was $29.5 million, versus cash used of $230.2 million in the prior-year period.
- Capital expenditures were $132.2 million year to date; full-year Fiscal 2014 capital expenditures were expected to be approximately $200 million.
- The Company repurchased approximately 7.3 million shares for $285.0 million and paid $43.5 million in dividends during the year-to-date period.
- Gross borrowings were $300.0 million under a new term loan facility, presented net at $293.9 million after discount and fees. No borrowings were outstanding under the $400 million asset-based revolving credit facility; approximately $9.4 million of letters of credit were outstanding as of December 8, 2014.
- The term loan bears interest at a rate tied to LIBOR or the alternate base rate; the rate was 4.75% at November 1, 2014. The Company was in compliance with applicable credit facility covenants.
- Inventory was $617.5 million, up from $530.2 million at February 1, 2014, while total stockholders’ equity declined to $1.395 billion from $1.729 billion, primarily reflecting treasury-stock purchases and comprehensive losses.
Material Changes Versus the Prior Comparable Period
- Q3 net sales decreased 12%; total comparable sales declined 10%, with U.S. comparable sales down 7%, international comparable sales down 15% and direct-to-consumer comparable sales up 8%.
- Direct-to-consumer sales increased 7% in Q3 and 15% year to date, reaching 20.6% and 20.2% of total sales, respectively, versus 16.9% and 16.4% in the prior periods.
- Gross margin declined 80 basis points in Q3 and 200 basis points year to date, primarily because of increased promotional activity and shipping promotions.
- U.S. Stores sales declined 15% in Q3, International Stores declined 16%, and Direct-to-Consumer sales increased 7%.
- Hollister remained the largest brand but Q3 sales decreased to $468.1 million from $534.0 million. Gilly Hicks sales declined to $3.6 million from $21.6 million following the closure of stand-alone stores.
- Q3 2014 included $16.7 million of non-cash asset impairment charges, primarily involving the Ginza flagship store and other stores, compared with $43.6 million of impairment charges in the comparable year-to-date 2013 period.
- Gilly Hicks restructuring charges were $6.1 million year to date, compared with $44.7 million in the prior-year period. Aggregate restructuring charges incurred through November 1, 2014 were $87.6 million, with approximately $1.4 million of additional charges expected.
- The Company completed a refinancing on August 7, 2014, replacing prior facilities with the new $400 million ABL Facility and $300 million Term Loan Facility.
Guidance, Outlook and Unusual Items
- Management expected Fiscal 2014 adjusted non-GAAP diluted EPS of $1.50 to $1.65, based on fourth-quarter total comparable sales declining by a mid-to-high single-digit percentage.
- Guidance assumed fourth-quarter gross margin above the prior year but below the year-to-date rate, a full-year effective tax rate in the upper 30% range, and approximately 73.1 million weighted-average shares.
- Guidance excluded Gilly Hicks restructuring, profit improvement, corporate governance, potential impairment and store closure charges, and charges related to former CEO Michael Jeffries’ retirement.
- The Company expected to close approximately 60 U.S. stores in Fiscal 2014 and a similar number in each of the following years, primarily through natural lease expirations.
- Management cited continued pressure among younger consumers, weak logo-product trends, promotional activity, foreign exchange exposure and difficult international retail conditions. Non-logo comparable sales were slightly positive in Q3.
- Management was expanding redesigned Hollister stores, omnichannel capabilities, localized Asian direct-to-consumer operations and international franchising. Ship-from-store was operating in approximately 370 U.S. stores and order-in-store in approximately 660 stores.
- Michael Jeffries retired as CEO and director effective December 8, 2014. The Company established an Office of the Chairman and began a CEO search. The retirement agreement is expected to result in approximately $5.5 million of additional cash and benefits and a pre-tax charge of approximately $4.6 million in Q4 Fiscal 2014.
- The filing identifies risks involving consumer demand, fashion trends, inventory, international expansion, direct-to-consumer execution, foreign currency, store impairments, litigation, credit facility covenants, leadership transition and the Gilly Hicks exit. Legal proceedings were described as ordinary-course matters, but actual liabilities could exceed recorded reserves.
Important Facts for Investors to Verify
- Confirm the filing period distinction: the source is a November 1, 2014 Form 10-Q, not a 2013 third-quarter filing.
- Assess whether the projected Fiscal 2014 adjusted EPS range was achieved and reconcile it to GAAP results and excluded charges.
- Evaluate the sustainability of positive direct-to-consumer trends against continued store and comparable-sales declines.
- Monitor inventory levels, promotional intensity and future gross-margin performance.
- Review liquidity after share repurchases, dividends, capital expenditures and the new term-loan obligations.
- Track remaining Gilly Hicks lease obligations, possible impairment or store-closure charges and the estimated $4.6 million CEO retirement charge.
- Follow the CEO search and transition to the brand-based organizational model, including retention of key executives.
- Verify the impact of foreign exchange movements, international store performance and the Company’s ability to realize approximately $18.8 million of net deferred tax assets in Japan.