Abercrombie & Fitch Co. Form 10-Q Summary
Reporting period: Thirteen weeks ended May 4, 2013, representing the first quarter of Fiscal 2013. The request metadata identifies “2012 Q1,” but the filing is for Fiscal 2013 and compares against the thirteen weeks ended April 28, 2012. The interim financial statements are unaudited and were reviewed by PricewaterhouseCoopers LLP.
Business Context
Abercrombie & Fitch is a specialty retailer of casual apparel, accessories, personal care products and related merchandise under the Abercrombie & Fitch, abercrombie kids, Hollister and Gilly Hicks brands. It operates stores in North America, Europe, Asia and Australia and direct-to-consumer operations in North America and Europe. At May 4, 2013, the Company operated 1,053 stores totaling approximately 8.0 million gross square feet.
Financial Results and Position
| Metric | Q1 Fiscal 2013 | Q1 Fiscal 2012 |
|---|---|---|
| Net sales | $838.8 million | $921.2 million |
| Gross profit | $553.2 million | $541.1 million |
| Gross margin | 65.9% | 58.7% |
| Operating loss | $13.9 million | $28.9 million |
| Net loss | $7.2 million | $21.3 million |
| Diluted loss per share | $0.09 | $0.25 |
| Net cash used in operating activities | $143.6 million | $44.5 million |
| Capital expenditures | $42.4 million | $103.8 million |
- Sales declined 9%, while comparable sales, including direct-to-consumer sales, declined 15%; comparable store sales declined 17% and comparable direct-to-consumer sales declined 6%.
- U.S. sales decreased 17% to $534.9 million, while international sales increased 10% to $303.9 million, partly reflecting new international stores. Foreign currency translation reduced sales by approximately $5.1 million.
- Gross profit increased despite lower sales. The 720-basis-point gross-margin improvement reflected a favorable mix toward spring merchandise and lower product costs.
- Stores and distribution expense declined in dollars to $449.1 million but increased to 53.5% of sales from 49.5%, reflecting deleveraging from negative comparable sales. Marketing, general and administrative expense increased 2% to $118.8 million.
- The effective tax rate was a 53.7% benefit, partly due to the settlement of certain state tax audits. Management expects a full-year effective tax rate of approximately 33% to 34%.
- Cash and equivalents were $555.9 million at May 4, 2013, down from $643.5 million at February 2, 2013. Inventory increased to $458.6 million from $427.0 million.
- Total borrowings were $146.3 million under the Term Loan Agreement, compared with no borrowings at February 2, 2013. The Company had no borrowings under its $350 million revolving credit agreement and was in compliance with its financial covenants.
- Current assets were $1.26 billion versus current liabilities of $533.5 million. Restricted cash was $30.9 million and was not freely available for general corporate purposes.
- The Company paid $15.7 million in dividends and repurchased approximately 350,000 shares for $16.3 million during the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue weakened materially, driven by a 15% comparable-sales decline, inventory shortages, cool weather and macroeconomic pressure in Europe.
- Profitability improved substantially because of stronger gross margin, new international stores and expense reductions; the net loss narrowed by $14.1 million.
- Operating cash use increased by $99.1 million, primarily because of inventory investment and changes in income taxes and working-capital accounts.
- Capital expenditures fell by $61.5 million, reflecting fewer new international stores and lower home-office, distribution-center and information-technology investment.
- The Company adopted the weighted-average-cost method for inventory effective February 2, 2013, with prior periods retroactively restated. The restatement reduced Q1 Fiscal 2012 gross profit by $35.3 million and changed reported net income of $3.0 million to a net loss of $21.3 million.
- Q1 Fiscal 2013 also included out-of-period corrections consisting of a $2.5 million pretax loss reduction and an unrelated $1.2 million tax charge. Management stated that these corrections were not material to the affected periods.
Guidance, Outlook, Risks and Unusual Items
- Management projected Fiscal 2013 diluted earnings per share of approximately $3.15 to $3.25, assuming comparable sales, including direct-to-consumer sales, are slightly down for the remainder of the year. The guidance excludes potential impairment and store-closure charges and share repurchases.
- Full-year gross margin was expected to be in the mid-60% range. Management expected positive Fiscal 2013 free cash flow, defined as operating cash flow less capital expenditures.
- Management identified annual savings opportunities of $35 million to $55 million in general non-merchandise expense and marketing. Implementation was expected to take six to twelve months, with only modest benefits expected during Fiscal 2013.
- The Company expected approximately $200 million of Fiscal 2013 capital expenditures, primarily for new stores and information technology. It planned international store openings and approximately 40 to 50 U.S. store closures, including three already closed in the quarter.
- Key risks include weak consumer spending, fashion and inventory execution, supply-chain disruption, international expansion, foreign-exchange volatility, seasonal sales concentration, store-level impairment, litigation, tax-rate variability, information-technology disruption and compliance with debt covenants.
- The Company was party to ordinary-course litigation. Some claims had no established accrual, and actual liabilities could exceed recorded reserves. No material off-balance-sheet arrangements were reported.
- Foreign-currency forward contracts were used to hedge exposures; the filing reported $9.5 million of net unrealized derivative gains in other comprehensive income for the quarter and a $17.3 million foreign-currency translation loss.
Most Important Facts to Verify
- Whether the projected $3.15 to $3.25 Fiscal 2013 diluted EPS range was achieved and whether it included later impairment, closure or repurchase effects.
- Whether comparable-sales trends and inventory availability improved as management expected in the second quarter and the remainder of the year.
- Inventory levels, markdown reserves and gross-margin sustainability, particularly after the change to weighted-average inventory costing.
- Operating cash flow and liquidity through the seasonal spring period, including the impact of the $146.3 million term loan and required quarterly repayments.
- Progress and realized savings from the $35 million to $55 million profit-improvement initiative.
- The number and financial impact of U.S. store closures, international openings and any related impairment or restructuring charges.
- Potential tax exposure, including the realizability of approximately $21.3 million of net deferred tax assets in Japan.