UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended January 30, 2016
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-12107
ABERCROMBIE & FITCH CO.
(Exact name of registrant as specified in its charter)
Delaware | 31-1469076 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
6301 Fitch Path, New Albany, Ohio | 43054 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code: (614) 283-6500
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Class A Common Stock, $0.01 Par Value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes ¨ No
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer x | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) | ||||||
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No
Aggregate market value of the Registrant’s Class A Common Stock (the only outstanding common equity of the Registrant) held by non-affiliates of the Registrant (for this purpose, executive officers and directors of the Registrant are considered affiliates) as of July 31, 2015: $1,366,862,497.
Number of shares outstanding of the Registrant’s common stock as of March 23, 2016: 67,585,850 shares of Class A Common Stock.
DOCUMENT INCORPORATED BY REFERENCE:
Portions of the Registrant’s definitive proxy statement for the Annual Meeting of Stockholders, to be held on June 16, 2016, are incorporated by reference into Part III of this Annual Report on Form 10-K.
ABERCROMBIE & FITCH CO.
TABLE OF CONTENTS
ITEM 1. | ||
ITEM 1A. | ||
ITEM 1B. | ||
ITEM 2. | ||
ITEM 3. | ||
ITEM 4. | ||
ITEM 5. | ||
ITEM 6. | ||
ITEM 7. | ||
ITEM 7A. | ||
ITEM 8. | ||
ITEM 9. | ||
ITEM 9A. | ||
ITEM 9B. | ||
ITEM 10. | ||
ITEM 11. | ||
ITEM 12. | ||
ITEM 13. | ||
ITEM 14. | ||
ITEM 15. | ||
PART I
ITEM 1. | BUSINESS. |
GENERAL.
Abercrombie & Fitch Co. (“A&F”), a company incorporated in Delaware in 1996, through its subsidiaries (collectively, A&F and its subsidiaries are referred to as “Abercrombie & Fitch” or the “Company”), is a specialty retailer that primarily operates stores and direct-to-consumer operations. Through these channels, the Company sells a broad array of products, including: casual sportswear apparel, including knit tops and woven shirts, graphic t-shirts, fleece, jeans and woven pants, shorts, sweaters, and outerwear; personal care products; and accessories for men, women and kids under the Abercrombie & Fitch, abercrombie kids, and Hollister brands. As of January 30, 2016, the Company operated 754 stores in the United States (“U.S.”) and 178 stores outside of the U.S.
The Company’s fiscal year ends on the Saturday closest to January 31, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. Fiscal years are designated in the consolidated financial statements and notes, as well as the remainder of this Annual Report on Form 10-K, by the calendar year in which the fiscal year commenced. All references herein to “Fiscal 2015” represent the fifty-two week fiscal year ended January 30, 2016; to “Fiscal 2014” represent the fifty-two week fiscal year ended January 31, 2015; and to “Fiscal 2013” represent the fifty-two week fiscal year ended February 1, 2014. In addition, all references herein to “Fiscal 2016” represent the fifty-two week fiscal year that will end on January 28, 2017.
A&F makes available free of charge on its Internet website, www.abercrombie.com, under “Investors, SEC Filings,” its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as A&F’s definitive proxy materials filed pursuant to Section 14 of the Exchange Act, as soon as reasonably practicable after A&F electronically files such material with, or furnishes it to, the Securities and Exchange Commission (“SEC”). The SEC maintains a website that contains electronic filings by A&F and other issuers at www.sec.gov. In addition, the public may read and copy any materials A&F files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The Company has included its Internet website addresses throughout this filing as textual references only. The information contained within these Internet websites is not incorporated into this Annual Report on Form 10-K.
DESCRIPTION OF OPERATIONS.
Brands.
Abercrombie & Fitch. Abercrombie & Fitch stands for effortless American style. Since 1892, the brand has been known for its attention to detail with designs that embody simplicity and casual luxury. Rooted in a heritage of quality craftsmanship, Abercrombie & Fitch continues to bring its customers iconic, modern classics with an aspirational look, feel, and attitude.
abercrombie kids. abercrombie kids stands for American style with a fun, youthful attitude. Known for its made-to-play durability, comfort and on-trend designs, abercrombie kids makes cool, classic clothing that kids truly want to wear.
Hollister. Hollister is the fantasy of Southern California. Inspired by beautiful beaches, open blue skies, and sunshine, Hollister lives the dream of an endless summer. Hollister's laidback lifestyle makes every design effortlessly cool and totally accessible. Hollister brings Southern California to the world.
Refer to the “RESULTS OF OPERATIONS” in “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of this Annual Report on Form 10-K for information regarding net sales by brand and by geography.
3
FINANCIAL INFORMATION ABOUT SEGMENTS.
The Company determines its segments on the same basis that it uses to allocate resources and assess performance. All of the Company’s operating segments sell a similar group of products — casual sportswear apparel, personal care products and accessories for men, women and kids. During the first quarter of Fiscal 2015, the Company substantially completed its transition to a branded organizational structure. In conjunction with the change, the Company determined its brand-based operating segments as of January 30, 2016 to be Abercrombie, which includes the Company's Abercrombie & Fitch and abercrombie kids brands, and Hollister. These operating segments have similar economic characteristics, class of consumers, products and production and distribution methods, and have been aggregated into one reportable segment. Refer to Note 18, “SEGMENT REPORTING,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K for further discussion of the Company’s operating segments and reportable segment.
STORE OPERATIONS.
At the end of Fiscal 2015, the Company operated 932 stores. The following table details the number of retail stores operated by the Company at January 30, 2016:
Abercrombie(1) | Hollister | Total | ||||
U.S. | 340 | 414 | 754 | |||
International | 39 | 139 | 178 | |||
Total | 379 | 553 | 932 | |||
(1) | Includes Abercrombie & Fitch and abercrombie kids brands. |
DIRECT-TO-CONSUMER AND OMNICHANNEL OPERATIONS .
The Company operates websites for each brand, both domestically and internationally. The websites reinforce each particular brand’s lifestyle, and are designed to complement the in-store experience. Total net sales through direct-to-consumer operations, including shipping and handling revenue, were $840.2 million for Fiscal 2015, representing 24% of total net sales. The Company operates 42 websites, including both desktop and mobile versions. In addition, the websites are available in 10 languages, accept 29 currencies and ship to over 120 countries.
As our customers increasingly shop across multiple channels, we have developed, and continue to expand, our omnichannel capabilities. These capabilities include "ship-from-store," "order-in-store," "reserve-in-store" and "in-store-pickup." The Company continues to invest in these and other omnichannel initiatives in order to create a more seamless and convenient shopping experience.
MARKETING AND ADVERTISING.
The Company's customer engagement strategy includes the in-store and digital experience which are designed to reinforce the lifestyle represented by each brand. The brands also have a strong base of globally diverse followers on key social platforms, such as Facebook, Twitter, Instagram, Snapchat and Weibo. The brands engage with customers as well as key influencers such as celebrities, bloggers and stylists to communicate fashion stories. In addition, the A&F and Hollister customer relationship management programs provide a platform to develop direct relationships with more than 10 million marketable contacts in the Company's database.
MERCHANDISE SUPPLIERS.
During Fiscal 2015, the Company sourced merchandise through approximately 150 vendors located throughout the world, primarily in Asia and Central America. The Company did not source more than 10% of its merchandise from any single factory or supplier during Fiscal 2015. The Company pursues a global sourcing strategy that includes relationships with vendors in 11 countries, as well as the U.S. The Company’s foreign sourcing of merchandise is negotiated and settled in U.S. Dollars.
All product sources, including independent manufacturers and suppliers, must achieve and maintain the Company’s high quality standards, which are an integral part of the Company’s identity. The Company has established supplier product quality standards to ensure the high quality of fabrics and other materials used in the Company’s products. The Company utilizes both home office and field employees to help monitor compliance with the Company’s supplier product quality standards.
4
Before the Company begins production with any factory, the factory must first go through a quality assurance assessment to ensure it meets Company standards. This includes factories that are subcontractors to the factories and vendors with whom the Company works. All factories are contractually required to adhere to our Vendor Code of Conduct, and all factories go through social audits, which include a factory walk-through to appraise the physical working conditions and health and safety practices, as well as payroll and age documentation review. Social audits of the factories are performed at least every two years after the initial audit. The Company strives to partner with suppliers that respect local laws and share our dedication to utilizing best practices in human rights, labor rights, environmental practices and workplace safety.
DISTRIBUTION AND MERCHANDISE INVENTORY.
The Company’s merchandise is shipped to the Company’s distribution centers (“DCs”) where it is received and inspected before being shipped to stores or direct-to-consumer customers. The Company uses its two DCs in New Albany, Ohio to support its North American stores and direct-to-consumer business for customers outside of Europe and Asia. During Fiscal 2015, the Company completed a $50 million conversion of one of its New Albany DCs to a dedicated direct-to-consumer facility. The Company uses a third-party DC in the Netherlands for the distribution of merchandise to stores and direct-to-consumer customers located in Europe, a third-party DC in China for the distribution of merchandise to stores and direct-to-consumer customers located in China, a third-party DC in Hong Kong for the distribution of merchandise to stores and direct-to-consumer customers located in Asia, and a third-party DC in the United Arab Emirates for the distribution of merchandise to stores located in the Middle East. The Company utilizes primarily one contract carrier to ship merchandise and related materials to its North American stores and direct-to-consumer customers, and several contract carriers for its European and Asian stores and direct-to-consumer customers.
The Company strives to maintain sufficient quantities of inventory in its retail stores and DCs to offer customers a full selection of current merchandise. The Company attempts to balance in-stock levels and inventory turnover, and to take markdowns when required to keep merchandise fresh and current with fashion trends.
INFORMATION SYSTEMS.
The Company’s management information systems consist of a full range of retail, merchandising and financial systems. The systems include applications related to point-of-sale, direct-to-consumer, inventory management, supply chain, planning, sourcing, merchandising and financial reporting. The Company continues to invest in technology to upgrade core systems to make the Company scalable and enhance efficiencies, including the support of its direct-to-consumer operations and international store operations.
SEASONAL BUSINESS.
The retail apparel market has two principal selling seasons: the Spring season which includes the first and second fiscal quarters (“Spring”); and the Fall season which includes the third and fourth fiscal quarters (“Fall”). As is typical in the apparel industry, the Company experiences its greatest sales activity during the Fall season due to the Back-to-School (August) and Holiday (November and December) selling periods, particularly in the U.S.
TRADEMARKS.
The trademarks Abercrombie & Fitch®, abercrombie®, Hollister®, Gilly Hicks® and the “Moose” and “Seagull” logos are registered with the U.S. Patent and Trademark Office and registered or pending with the registries of countries where stores are located or likely to be located in the future. In addition, these trademarks are either registered, or the Company has applications for registration pending, with the registries of many of the foreign countries in which the manufacturers of the Company’s products are located. The Company has also registered, or has applied to register, certain other trademarks in the U.S. and around the world. The Company believes its products are identified by its trademarks and, therefore, its trademarks are of significant value. Each registered trademark has a duration of ten to 20 years, depending on the date it was registered, and the country in which it is registered, and is subject to an indefinite number of renewals for a like period upon continued use and appropriate application. The Company intends to continue using its core trademarks and to renew each of its registered trademarks that remain in use.
OTHER INFORMATION.
Additional information about the Company’s business, including its revenues and profits for the last three fiscal years and gross square footage of stores, is set forth under “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of this Annual Report on Form 10-K.
5
COMPETITION.
The sale of apparel, accessories and personal care products through stores and direct-to-consumer channels is a highly competitive business with numerous participants, including individual and chain fashion specialty stores, as well as regional and national department stores. As the Company continues expanding internationally, it also faces competition in local markets from established chains, as well as local specialty stores. Brand recognition, fashion, price, service, store location, selection and quality are the principal competitive factors in retail store and direct-to-consumer sales.
The competitive challenges facing the Company include: anticipating and quickly responding to changing fashion trends and maintaining the aspirational positioning of its brands. Furthermore, the Company faces additional competitive challenges as many retailers continue promotional activities, particularly in the U.S. In response to these conditions, the Company has engaged in promotional activity and increased its focus on operating efficiency while seeking to preserve the value of its brands.
ASSOCIATE RELATIONS.
As of March 24, 2016, the Company employed approximately 49,000 associates, of which approximately 41,000 were part-time associates, which equates to approximately 5,000 full-time equivalents. On average, the Company employed approximately 16,000 full-time equivalents during Fiscal 2015.
The Company believes it maintains a good relationship with its associates. However, in the normal course of business, the Company is party to lawsuits involving former and current associates.
ENVIRONMENTAL MATTERS.
Compliance with domestic and international regulations related to environmental matters has not had, nor is it expected to have, any material effect on the Company's capital expenditures, earnings or competitive position based on information and circumstances known to us at this time.
6
EXECUTIVE OFFICERS OF THE REGISTRANT.
Set forth below is certain information regarding the executive officers of A&F as of March 24, 2016:
Jonathan E. Ramsden, 51, has been Chief Operating Officer of A&F since January 2014, and Interim Principal Executive Officer and a member of the Office of the Chairman of A&F since December 2014. Mr. Ramsden served as Executive Vice President and Chief Financial Officer of A&F from December 2008 to May 2014. From December 1998 to December 2008, Mr. Ramsden served as Chief Financial Officer and a member of the Executive Committee of TBWA Worldwide, a large advertising agency network and a division of Omnicom Group Inc. Prior to becoming Chief Financial Officer of TWBA Worldwide, he served as Controller and Principal Accounting Officer of Omnicom Group Inc. from June 1996 to December 1998.
Robert E. Bostrom, 63, has been Senior Vice President, General Counsel and Corporate Secretary of A&F since January 2014. Since August 2014, Mr. Bostrom has been a member of the Board of Directors of NeuLion, Inc. From December 2012 until December 2013, Mr. Bostrom was Co-Chairman of the Financial Regulatory and Compliance Practice of Greenberg Traurig LLP, an international law firm. From August 2011 until November 2012, Mr. Bostrom was Co-Head of the Global Financial Institutions and Funds Sector of Dentons US LLP (formerly, SNR Denton), an international law firm. From February 2006 to August 2011, Mr. Bostrom was Executive Vice President, General Counsel and Corporate Secretary of the Federal Home Loan Mortgage Corporation (also known as Freddie Mac). Prior to Freddie Mac, Mr. Bostrom was the Managing Partner of the New York office of Winston & Strawn LLP, a Member of that firm’s Executive Committee and Head of its Financial Institutions Practice.
Diane Chang, 60, has been Executive Vice President — Sourcing of A&F since May 2004. Prior thereto, Ms. Chang held the position of Senior Vice President — Sourcing of A&F from February 2000 to May 2004 and the position of Vice President — Sourcing of A&F from May 1998 to February 2000.
Joanne C. Crevoiserat, 52, has been Executive Vice President and Chief Financial Officer of A&F since May 2014 and a member of the Office of the Chairman of A&F since October 2015. Prior to joining A&F, she served in a number of senior management roles at Kohl's Inc., which operates family-oriented department stores and a website featuring apparel, footwear, accessories, soft home products and housewares. From June 2012 to April 2014, Ms. Crevoiserat was the Executive Vice President of Finance of Kohl's and from November 2008 to June 2012, she served as the Executive Vice President of Merchandise Planning and Allocation of Kohl's. Prior to her time with Kohl's, Ms. Crevoiserat held senior finance positions with Wal-Mart Stores and May Department Stores, including Chief Financial Officer of the Filene's, Foley's and Famous-Barr brands.
Fran Horowitz, 52, has been President & Chief Merchandising Officer for all brands of A&F since December 2015 and a member of the Office of the Chairman of A&F since December 2014. Ms. Horowitz held the position of Brand President of Hollister from October 2014 to December 2015. Before joining Hollister, from October 2013 to October 2014, Ms. Horowitz served as the President of Ann Taylor Loft, a division of Ann Inc., the parent company of three specialty retail fashion brands in North America. Prior to her time with Ann Taylor Loft, from February 2005 to October 2012, she held various roles at Express, Inc., a specialty apparel and accessories retailer of women's and men's merchandise, including Executive Vice President of Women's Merchandising and Design from May 2010 to November 2012. Before her time with Express, Inc., Ms. Horowitz spent 13 years at Bloomingdale's in various women's merchandising roles, including Vice President Divisional Merchandise Manager.
The Office of the Chairman is responsible for overseeing and providing strategic direction to management. The executive officers serve at the pleasure of the Board of Directors of A&F.
7
ITEM 1A. | RISK FACTORS |
FORWARD-LOOKING STATEMENTS AND RISK FACTORS.
We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this Annual Report on Form 10-K or made by us, our management or our spokespeople involve risks and uncertainties and are subject to change based on various factors, many of which may be beyond our control. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend” and similar expressions may identify forward-looking statements. Except as may be required by applicable law, we assume no obligation to publicly update or revise our forward-looking statements.
The following factors could affect our financial performance and could cause actual results to differ materially from those expressed or implied in any of the forward-looking statements:
• | changes in global economic and financial conditions, and the resulting impact on consumer confidence and consumer spending, as well as other changes in consumer discretionary spending habits, could have a material adverse effect on our business, results of operations and liquidity; |
• | our inability to anticipate customer demand and changing fashion trends and to manage our inventory commensurately could adversely impact our sales levels and profitability; |
• | a significant component of our growth strategy is international expansion, which requires significant capital investment, the success of which is dependent on a number of factors that could affect the profitability of our international operations; |
• | direct-to-consumer sales channels are a significant component of our growth strategy, and the failure to successfully develop our position in these channels could have an adverse impact on our results of operations; |
• | our market share may be negatively impacted by increasing competition and pricing pressures from companies with brands or merchandise competitive with ours; |
• | we have currently suspended our search for a new Chief Executive Officer and the continuance of our interim governance structure may create uncertainty; |
• | our inability to successfully implement our strategic plans could have a negative impact on our growth and profitability; |
• | our failure to protect our reputation could have a material adverse effect on our brands; |
• | our business could suffer if our information technology systems are disrupted or cease to operate effectively; |
• | we may be exposed to risks and costs associated with cyber-attacks, credit card fraud and identity theft that would cause us to incur unexpected expenses and reputation loss; |
• | fluctuations in foreign currency exchange rates could adversely impact our financial condition and results of operations; |
• | fluctuations in the cost, availability and quality of raw materials, labor and transportation, could cause manufacturing delays and increase our costs; |
• | we depend upon independent third parties for the manufacture and delivery of all our merchandise, and a disruption of the manufacture or delivery of our merchandise could result in lost sales and could increase our costs; |
• | our ability to attract customers to our stores depends, in part, on the success of the shopping malls or area attractions that our stores are located in or around; |
• | we rely on the experience and skills of our senior executive officers, the loss of whom could have a material adverse effect on our business; |
• | our reliance on two distribution centers domestically and third-party distribution centers internationally makes us susceptible to disruptions or adverse conditions affecting our distribution centers; |
• | our litigation exposure could have a material adverse effect on our financial condition and results of operations; |
• | our inability or failure to adequately protect our trademarks could have a negative impact on our brand image and limit our ability to penetrate new markets; |
• | fluctuations in our tax obligations and effective tax rate may result in volatility in our operating results; |
• | extreme weather conditions and the seasonal nature of our business may cause net sales to fluctuate and negatively impact our results of operations; |
• | our facilities, systems and stores, as well as the facilities and systems of our vendors and manufacturers, are vulnerable to natural disasters, pandemic disease and other unexpected events, any of which could result in an interruption to our business and adversely affect our operating results; |
• | the impact of war or acts of terrorism could have a material adverse effect on our operating results and financial condition; |
• | changes in the regulatory or compliance landscape could adversely affect our business and results of operations; |
• | our Asset-Based Revolving Credit Agreement and our Term Loan Agreement include restrictive covenants that limit our flexibility in operating our business; and, |
• | compliance with changing regulations and standards for accounting, corporate governance and public disclosure could adversely affect our business, results of operations and reported financial results. |
8
The following sets forth a description of the preceding risk factors that we believe may be relevant to an understanding of our business. These risk factors could cause actual results to differ materially from those expressed or implied in any of our forward-looking statements.
Changes in global economic and financial conditions, and the resulting impact on consumer confidence and consumer spending, as well as other changes in consumer discretionary spending habits, could have a material adverse effect on our business, results of operations and liquidity.
Our business depends on consumer demand for our merchandise. Consumer purchases of discretionary items, including our merchandise, generally decline during recessionary periods and other periods where disposable income is adversely affected. Our performance is subject to factors that affect worldwide economic conditions including unemployment, consumer credit availability, consumer debt levels, reductions in net worth based on declines in the financial, residential real estate and mortgage markets, sales tax rates and tax rate increases, fuel and energy prices, interest rates, consumer confidence in future economic and political conditions, consumer perceptions of personal well-being and security, the value of the U.S. Dollar versus foreign currencies and other macroeconomic factors. Additionally, changes in consumer preferences and discretionary spending habits may negatively impact the retail apparel market. Global economic uncertainty and changing consumer preferences and discretionary spending habits could have a material adverse effect on our results of operations, liquidity and capital resources if reduced consumer demand for our merchandise should occur. It could also impact our ability to fund growth and/or result in our becoming reliant on external financing, the availability and cost of which may be uncertain.
The economic conditions and factors described above could adversely affect the productivity of our stores, as well as adversely affect the pace of opening new stores, or their productivity once opened. Finally, the economic environment may exacerbate some of the risks noted below, including consumer demand, strain on available resources, our international growth strategy, availability of real estate, interruption of the flow of merchandise from key vendors and manufacturers, and foreign currency exchange rate fluctuations.
Our inability to anticipate customer demand and changing fashion trends and to manage our inventory commensurately could adversely impact our sales levels and profitability.
Our success largely depends on our ability to anticipate and gauge the fashion preferences of our customers and provide merchandise that satisfies constantly shifting demands in a timely manner. Because we enter into agreements for the manufacture and purchase of merchandise well in advance of the applicable selling season, we are vulnerable to changes in consumer preferences and demand, pricing shifts, and the sub-optimal selection and timing of merchandise purchases. Moreover, there can be no assurance that we will continue to anticipate consumer demands and accurately plan inventory successfully in the future. Changing consumer preferences and fashion trends, whether we are able to anticipate, identify and respond to them or not, could adversely impact our sales. Inventory levels for certain merchandise styles no longer considered to be “on trend” may increase, leading to higher markdowns to sell through excess inventory and therefore, lower than planned margins. A distressed economic and retail environment, in which many of our competitors continue to engage in aggressive promotional activities increases the importance of reacting appropriately to changing consumer preferences and fashion trends. Conversely, if we underestimate consumer demand for our merchandise, or if our manufacturers fail to supply quality products in a timely manner, we may experience inventory shortages, which may negatively impact customer relationships, diminish brand loyalty and result in lost sales. Any of these events could significantly harm our operating results and financial condition.
A significant component of our growth strategy is international expansion, which may require significant capital investment, the success of which is dependent on a number of factors that could affect the profitability of our international operations.
As we expand internationally, we may incur significant costs related to starting up and maintaining foreign operations. Costs may include, but are not limited to, obtaining prime locations for stores, setting up foreign offices and distribution centers, hiring experienced management, maintaining good relations with individual associates and groups of associates and establishing online retail presence. International expansion has placed, and will continue to place, increased demands on our operational, managerial and administrative resources at all levels of the Company. These increased demands may cause us to operate our business less efficiently, which in turn could cause deterioration in the performance of our existing stores or could adversely affect our inventory levels. Furthermore, our ability to conduct business in international markets may be adversely affected by legal, regulatory, political and economic risks. We are subject to domestic laws, including the Foreign Corrupt Practices Act, in addition to the laws of the foreign countries in which we operate. If any of our overseas operations, or our associates or agents, violate such laws, we could become subject to sanctions or other penalties that could negatively affect our reputation, business and operating results.
9
We may be unable to successfully grow our international business, or we may face operational issues that delay our intended pace of international growth and, in any such case, our growth may be limited, unless we can:
• | address the different operational characteristics present in each country to which we expand, including employment and labor, transportation, logistics, real estate, lease provisions and local reporting or legal requirements; |
• | identify suitable markets and sites for store locations; |
• | negotiate acceptable lease terms, in some cases in locations in which the relative rights and obligations of landlords and tenants differ significantly from the customs and practices in the U.S.; |
• | integrate new stores into existing operations and expand infrastructure to accommodate growth; |
• | hire, train and retain qualified personnel; |
• | avoid work stoppages or other labor-related issues in our European stores where associates are represented by workers' councils and unions; |
• | gain and retain acceptance from foreign customers; |
• | localize our online brand experience and e-commerce capabilities; |
• | secure franchise or other business venture partners; |
• | foster current relationships and develop new relationships with vendors that are capable of supplying a greater volume of merchandise; |
• | manage inventory effectively to meet the needs of new and existing stores on a timely basis; |
• | achieve acceptable operating margins from new store and online operations; |
• | generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plan; and, |
• | manage foreign currency exchange risks effectively. |
Failure to successfully implement our international expansion initiatives as a result of one or more of the factors above could have a material adverse effect on our results of operations or could otherwise adversely affect our ability to achieve our growth strategy objectives.
Direct-to-consumer sales channels are a significant component of our growth strategy, and the failure to successfully develop our position in these channels could have an adverse impact on our results of operations.
We sell merchandise for each brand over the Internet, both domestically and internationally. We have made significant investments in capital spending and labor to develop these channels, invested in digital media to attract new customers and developed localized fulfillment, shipping and customer service operations. There is no assurance that we will be able to continue to successfully maintain or expand our direct-to-consumer sales channels. Our reliance on direct-to-consumer sales channels makes us vulnerable to shifting consumer traffic patterns, customer data breaches, direct-to-consumer buying trends and strength of brand perception. As omnichannel retailing continues to grow and evolve, our customers increasingly interact with our brands through a variety of mediums including smart phones and tablets, and our success depends on our ability to introduce innovative means of engaging our customers. Our inability to adequately respond to these risks and uncertainties or to successfully maintain and expand our direct-to-consumer business may have an adverse impact on our results of operations.
In addition, direct-to-consumer operations are subject to numerous risks, including reliance on third-party computer hardware/software and service providers, violations of state, federal or international laws, including those relating to online privacy, credit card fraud, telecommunication failures and electronic break-ins and similar disruptions, and disruption of Internet service. Changes in foreign governmental regulations may also negatively impact our ability to deliver product to our customers. Our failure to successfully respond to these risks might adversely affect sales in our direct-to-consumer business as well as damage our reputation and brands.
10
Our market share may be negatively impacted by increasing competition and pricing pressures from companies with brands or merchandise competitive with ours.
The sale of apparel and personal care products through stores and direct-to-consumer channels is a highly competitive business with numerous participants, including individual and chain fashion specialty stores, as well as regional, national and international department stores. The substantial sales growth in the direct-to-consumer channel within the last few years has encouraged the entry of many new competitors and an increase in competition from established companies. We face a variety of competitive challenges, including:
• | anticipating and quickly responding to changing consumer demands or preferences better than our competitors; |
• | maintaining favorable brand recognition and effective marketing of our products to consumers in several diverse demographic markets; |
• | sourcing merchandise efficiently; |
• | developing innovative, high-quality merchandise in styles that appeal to our consumers and in ways that favorably distinguish us from our competitors; and, |
• | countering the aggressive pricing and promotional activities of many of our competitors without diminishing the aspirational nature of our brands and brand equity. |
In light of the competitive challenges we face, we may not be able to compete successfully in the future. Further, increases in competition could reduce our sales and harm our operating results and business.
We have currently suspended our search for a new Chief Executive Officer and the continuance of our interim governance structure may create uncertainty.
In December 2014 we initiated a selection process to identify a new Chief Executive Officer. At that time, our Board of Directors appointed Arthur C. Martinez to serve as Executive Chairman of the Company and created the Office of the Chairman as our interim governance structure. The Chief Executive Officer selection process was suspended one year later as a result of our encouraging performance under the leadership of the Office of the Chairman. We are not currently actively conducting a search for a Chief Executive Officer. The continuance of our interim governance structure for an extended period of time may create uncertainty.
Our inability to successfully implement our strategic plans could have a negative impact on our growth and profitability.
Our long-term strategy includes six key objectives: putting the customer at the center of everything we do, delivering compelling and differentiated assortments, optimizing our brand reach and channel performance, defining clear positionings for our brands, continuing to improve efficiency and reduce expense, and ensuring we are organized to succeed. Our ability to execute these strategies successfully and in a timely fashion is subject to various risks and uncertainties as described under this “Risk Factors” section. Specifically, these risks can be categorized into market risk, execution risk and customer acceptance risk. Market risk includes consumer spending, actions of brand competitors and changes in demographics or preferences of our target customer. Achieving the goals of our long-term strategy is also dependent on us executing the strategy successfully. Finally, the initiatives we implement in connection with our long-term strategy may not resonate with our customers. It may take longer than anticipated to generate the expected benefits from our long-term strategy and there can be no guarantee that these initiatives will result in improved operating results. In addition, failure to successfully implement our long-term strategy could have a negative impact on our growth and profitability.
Our failure to protect our reputation could have a material adverse effect on our brands.
Our ability to maintain our reputation is critical to our brands. Our reputation could be jeopardized if we fail to maintain high standards for merchandise quality and integrity, if our third-party vendors fail to comply with our vendor code of conduct, if any third parties with which we have a business relationship fail to represent our brands in a manner consistent with our brand image and customer experience standards or as a result of a cyber-attack. Any negative publicity about these types of concerns may reduce demand for our merchandise. Failure to comply with ethical, social, product, labor, health and safety, accounting or environmental standards, or related political considerations, could also jeopardize our reputation and potentially lead to various adverse consumer actions, including boycotts. Public perception about our products or our stores, whether justified or not, could impair our reputation, involve us in litigation, damage our brands and have a material adverse effect on our business. Damage to our reputation or loss of consumer confidence for any of these or other reasons could have a material adverse effect on our results of operations and financial condition, as well as require additional resources to rebuild our reputation.
11
Our business could suffer if our information technology systems are disrupted or cease to operate effectively.
We rely heavily on our information technology systems to operate our websites; record and process transactions; respond to customer inquiries; manage inventory; purchase, sell and ship merchandise on a timely basis; and maintain cost-efficient operations. Given the significant number of transactions that are completed annually, it is vital to maintain constant operation of our computer hardware and software systems and maintain cyber security. Despite efforts to prevent such an occurrence, our information technology systems may be vulnerable from time to time to damage or interruption from computer viruses, power outages, third-party intrusions, inadvertent or intentional breach by our employees and other technical malfunctions. If our systems are damaged, or fail to function properly, we may have to make monetary investments to repair or replace the systems, and we could endure delays in our operations.
While we regularly evaluate our information technology systems and requirements, we are aware of the inherent risks associated with replacing and modifying these systems, including inaccurate system information, system disruptions and user acceptance and understanding. Any material disruption or slowdown of our systems, including a disruption or slowdown caused by our failure to successfully upgrade our systems, could cause information, including data related to customer orders, to be lost or delayed. Such a loss or delay, especially if the disruption or slowdown occurred during our peak selling seasons, could have a material adverse effect on our results of operations.
We may be exposed to risks and costs associated with cyber-attacks, credit card fraud and identity theft that would cause us to incur unexpected expenses and reputation loss.
In the standard course of business, we process customer information, including payment information, through our stores and direct-to-consumer programs. Rapidly evolving technologies and types of cyber-attacks may result in this information being compromised or breached. The retail industry in particular has been the target of many recent cyber-attacks, and as a result, there is heightened concern over the security of personal information transmitted over the Internet, consumer identity theft and user privacy. We endeavor to protect consumer identity and payment information through the implementation of security technologies, processes and procedures. It is possible that an individual or group could defeat our security measures and access sensitive customer and associate information. Actual or anticipated cyber-attacks may cause us to incur increasing costs, including costs to deploy additional personnel and protective technologies, train employees, and engage third-party experts and consultants. Exposure of customer data through any means could materially harm the Company by, but not limited to, reputation loss, regulatory fines and penalties, legal liability and costs of litigation.
Fluctuations in foreign currency exchange rates could adversely impact our financial condition and results of operations.
The functional currency of our foreign subsidiaries is generally the local currency in which each entity operates, while our consolidated financial statements are presented in U.S. Dollars. Therefore, we must translate revenues, expenses, assets and liabilities from functional currencies into U.S. Dollars at exchange rates in effect during, or at the end of the reporting period. In addition, our international subsidiaries transact in currencies other than their functional currency, including intercompany transactions, which results in foreign currency transaction gains or losses. Furthermore, we purchase substantially all of our inventory in U.S. Dollars. As a result, our sales and gross profit rate from international operations will be negatively impacted during periods of a strengthened U.S. dollar relative to the functional currencies of our foreign subsidiaries, as was the case in Fiscal 2015. Additionally, tourism spending may be affected by changes in currency exchange rates, and as a result, sales in our flagship stores and other stores with higher tourism traffic have, at times, been adversely impacted, and may continue to be adversely impacted, by fluctuations in currency exchange rates.
Fluctuations in the cost, availability and quality of raw materials, labor and transportation, could cause manufacturing delays and increase our costs.
Fluctuations in the cost, availability and quality of the fabrics or other raw materials used to manufacture our merchandise could have a material adverse effect on our cost of sales, or our ability to meet customer demand. The prices for such fabrics depend largely on the market prices for the raw materials used to produce them, particularly cotton, as well as the cost of compliance with sourcing laws. The price and availability of such raw materials may fluctuate significantly, depending on many factors, including crop yields and weather patterns. Such factors may be exacerbated by legislation and regulations associated with global climate change. In addition, the cost of labor at many of our third-party manufacturers has been increasing significantly, and as the middle class in developing countries continues to grow, it is unlikely such cost pressure will abate. The Company is also susceptible to fluctuations in the cost of transportation. We may not be able to pass all or a portion of higher raw materials prices or labor or transportation costs on to our customers, which could adversely affect our gross margin and results of our operations.
12
We depend upon independent third parties for the manufacture and delivery of all our merchandise, and a disruption of the manufacture or delivery of our merchandise could result in lost sales and could increase our costs.
We do not own or operate any manufacturing facilities. As a result, the continued success of our operations is tied to our timely receipt of quality merchandise from third-party manufacturers. We source the majority of our merchandise outside of the U.S. through arrangements with approximately 150 vendors which includes foreign manufacturers located throughout the world, primarily in Asia and Central America. Political, social or economic instability in Asia and Central America, or in other regions in which our manufacturers are located, could cause disruptions in trade, including exports to the U.S. A manufacturer’s inability to ship orders in a timely manner or meet our quality standards could cause delays in responding to consumer demands and negatively affect consumer confidence or negatively impact our competitive position, any of which could have a material adverse effect on our financial condition and results of operations. Other events that could disrupt the timely delivery of our merchandise include new trade law provisions or regulations, reliance on a limited number of shipping carriers, significant labor disputes and significant delays in the delivery of cargo due to port security considerations. Furthermore, we are susceptible to increases in fuel costs which may increase the cost of distribution. If we are not able to pass this cost on to our customers, our financial condition and results of operations could be adversely affected.
Our ability to attract customers to our stores depends, in part, on the success of the shopping malls or area attractions that our stores are located in or around.
In order to generate customer traffic, we locate many of our stores in prominent locations within successful shopping malls or street locations. Our stores benefit from the ability of the malls’ “anchor” tenants, generally large department stores and other area attractions, to generate consumer traffic in the vicinity of our stores. We cannot control the loss of an anchor or other significant tenant in a shopping mall in which we have a store; the development of new shopping malls in the U.S. or around the world; the availability or cost of appropriate locations; competition with other retailers for prominent locations; or the success of individual shopping malls. All of these factors may impact our ability to meet our productivity targets for our domestic stores and our growth objectives for our international stores and could have a material adverse effect on our financial condition or results of operations. In addition, some malls that were in prominent locations when we opened our stores may cease to be viewed as prominent. If this trend continues or if the popularity of mall shopping continues to decline generally among our customers, our sales may decline, which would impact our gross profits and net income.
Part of our future growth is dependent on our ability to operate stores in desirable locations with capital investment and lease costs providing the opportunity to earn a reasonable return. We cannot be sure as to when or whether such desirable locations will become available at reasonable costs.
We rely on the experience and skills of our senior executive officers, the loss of whom could have a material adverse effect on our business.
Our senior executive officers closely supervise all aspects of our business including the design of our merchandise and the operation of our stores. Our senior executive officers have substantial experience and expertise in the retail business and have an integral role in the growth and success of our brands. If we were to lose the benefit of the involvement of multiple senior executives, our business could be adversely affected. Competition for such senior executive officers is intense, and we cannot be sure we will be able to attract, retain and develop a sufficient number of qualified senior executive officers in future periods.
Our reliance on two distribution centers domestically and third-party distribution centers internationally makes us susceptible to disruptions or adverse conditions affecting our distribution centers.
We rely on two distribution centers domestically and four third-party distributions centers internationally to manage the receipt, storage, sorting, packing and distribution of our merchandise. Our two distribution centers located in New Albany, Ohio, service our North American stores and direct-to-consumer customers outside of Europe and Asia. We also use a third-party distribution center in the Netherlands to service our stores and direct-to-consumer customers in Europe; a third-party distribution center in Hong Kong and a third-party distribution center in China to service our stores and direct-to-consumer customers in Asia; and a third-party distribution center in the United Arab Emirates to service our stores in the Middle East. As a result, our operations are susceptible to local and regional factors, such as system failures, accidents, economic and weather conditions, natural disasters, demographic and population changes, as well as other unforeseen events and circumstances. If our distribution operations were disrupted, our ability to replace inventory in our stores and process direct-to-consumer orders could be interrupted and sales could be negatively impacted.
13
Our litigation exposure could have a material adverse effect on our financial condition and results of operations.
We, along with third parties we do business with, are involved, from time to time, in litigation arising in the ordinary course of business. Litigation matters may include, but are not limited to, contract disputes, employment-related actions, labor relations, commercial litigation, intellectual property rights and shareholder actions. Any litigation that we become a party to could be costly and time consuming and could divert our management and key personnel from our business operations. Our current litigation exposure could be impacted by litigation trends, discovery of damaging facts with respect to legal matters pending against us or determinations by judges, juries or other finders of fact that are not in accordance with management’s evaluation of existing claims. Should management’s evaluation prove incorrect, our exposure could greatly exceed expectations and have a material adverse effect on our financial condition, results of operations or cash flows.
Our inability or failure to adequately protect our trademarks could have a negative impact on our brand image and limit our ability to penetrate new markets.
We believe our core trademarks, Abercrombie & Fitch®, abercrombie®, Hollister®, Gilly Hicks® and the “Moose” and “Seagull” logos, are an essential element of our strategy. We have obtained or applied for federal registration of these trademarks with the U.S. Patent and Trademark Office and the registries of countries where stores are located or likely to be located in the future. In addition, we own registrations and have pending applications for other trademarks in the U.S. and have applied for or obtained registrations from the registries in many foreign countries in which our stores or our manufacturers are located. There can be no assurance that we will obtain registrations that have been applied for or that the registrations we obtain will prevent the imitation of our products or infringement of our intellectual property rights by others. Although brand security initiatives are in place, we cannot guarantee that our efforts against the counterfeiting of our brands will be successful. If a third-party copies our products in a manner that projects lesser quality or carries a negative connotation, our brand image could be materially adversely affected.
Because we have not yet registered all of our trademarks in all categories, or in all foreign countries in which we source or offer our merchandise now, or may in the future, our international expansion and our merchandising of products using these marks could be limited. The pending applications for international registration of various trademarks could be challenged or rejected in those countries because third parties of whom we are not currently aware have already registered similar marks in those countries. Accordingly, it may be possible, in those foreign countries where the status of various applications is pending or unclear, for a third-party owner of the national trademark registration for a similar mark to prohibit the manufacture, sale or exportation of branded goods in or from that country. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from, or manufacture in, less costly markets or penetrate new markets should our business plan include selling our merchandise in those non-U.S. jurisdictions.
Fluctuations in our tax obligations and effective tax rate may result in volatility in our operating results.
We are subject to income taxes in many U.S. and foreign jurisdictions. In addition, our products are subject to import and excise duties and/or sales, consumption or value-added taxes ("VAT") in many jurisdictions. We record tax expense based on our estimates of future payments, which include reserves for estimates of probable settlements of foreign and domestic tax audits. At any one time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. As a result, we expect that throughout the year there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are evaluated. In addition, our effective tax rate in any given financial reporting period may be materially impacted by changes in the mix and level of earnings or losses by taxing jurisdictions or by changes to existing accounting rules or regulations. Fluctuations in duties could also have a material impact on our financial condition, results of operations or cash flows. In some international markets, we are required to hold and submit VAT to the appropriate local tax authorities. Failure to correctly calculate or submit the appropriate amounts could subject us to substantial fines and penalties that could have an adverse effect on our financial condition, results of operations or cash flows. In addition, tax law may be enacted in the future, domestically or abroad, that impacts our current or future tax structure and effective tax rate.
14
Extreme weather conditions and the seasonal nature of our business may cause net sales to fluctuate and negatively impact our results of operations.
Historically, our operations have been seasonal, with a significant amount of net sales and operating income occurring in the fourth fiscal quarter. Severe weather conditions and changes in weather patterns can influence customer trends, consumer traffic and shopping habits. Unseasonably warm temperatures in the winter or cool temperatures in the summer may diminish demand for our seasonal merchandise. In addition, severe weather can also decrease customer traffic in our stores and reduce sales and profitability. As a result of this seasonality, net sales and net income during any fiscal quarter cannot be used as an accurate indicator of our annual results. Any factors negatively affecting us during the third and fourth fiscal quarters of any year, including inclement weather, could have a material adverse effect on our financial condition and results of operations for the entire year.
Our facilities, systems and stores, as well as the facilities and systems of our vendors and manufacturers, are vulnerable to natural disasters, pandemic disease and other unexpected events, any of which could result in an interruption to our business and adversely affect our operating results.
Our retail stores, corporate offices, distribution centers, infrastructure projects and direct-to-consumer operations, as well as the operations of our vendors and manufacturers, are vulnerable to damage from natural disasters, pandemic disease and other unexpected events. If any of these events result in damage to our facilities, systems or stores, or the facilities or systems of our vendors or manufacturers, we may experience interruptions in our business until the damage is repaired, resulting in the potential loss of customers and revenues. In addition, we may incur costs in repairing any damage which exceeds our applicable insurance coverage.
The impact of war or acts of terrorism could have a material adverse effect on our operating results and financial condition.
The continued threat of terrorism and the associated heightened security measures and military actions in response to acts of terrorism have disrupted commerce. Further acts of terrorism or future conflicts may disrupt commerce and undermine consumer confidence and consumer spending by causing domestic and/or tourist traffic in malls and the Company's flagship and other stores to decline, which could negatively impact our sales revenue. Furthermore, an act of terrorism or war, or the threat thereof, or any other unforeseen interruption of commerce, could negatively impact our business by interfering with our ability to obtain merchandise from foreign manufacturers. Our inability to obtain merchandise from our foreign manufacturers or substitute other manufacturers, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.
Changes in the regulatory or compliance landscape could adversely affect our business and results of operations.
We are subject to numerous laws and regulations, including customs, truth-in-advertising, securities laws, consumer protection, general privacy, health information privacy, identity theft, online privacy, employee health and safety, international minimum wage laws, unsolicited commercial communication and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, intellectual property, promotion and sale of merchandise and the operation of retail stores, direct-to-consumer operations and distribution centers. Laws and regulations at the state, federal and international levels frequently change, and the ultimate cost of compliance cannot be precisely estimated. If these laws and regulations were to change, or were violated by our management, associates, suppliers, vendors or other parties with whom we do business, the costs of certain merchandise could increase, or we could experience delays in shipments of our merchandise, be subject to fines or penalties, temporary or permanent store closures, increased regulatory scrutiny or suffer reputational harm, which could reduce demand for our merchandise and adversely affect our business and results of operations. Any changes in regulations, the imposition of additional regulations, or the enactment of any new or more stringent legislation including the areas referenced above, could adversely affect our business and results of operations.
Our Asset-Based Revolving Credit Agreement and our Term Loan Agreement include restrictive covenants that limit our flexibility in operating our business.
Our Asset-Based Revolving Credit Agreement, as amended, expires on August 7, 2019 and our Term Loan Agreement, as amended, has a maturity date of August 7, 2021. Both our Asset-Based Revolving Credit Agreement and our Term Loan Agreement contain restrictive covenants that, subject to specified exemptions, restrict our ability to incur indebtedness, grant liens, make certain investments, pay dividends or distributions on our capital stock and engage in mergers. The inability to obtain credit on commercially reasonable terms in the future when these facilities expire could adversely impact our liquidity and results of operations. In addition, market conditions could potentially impact the size and terms of a replacement facility or facilities.
15
Compliance with changing regulations and standards for accounting, corporate governance and public disclosure could adversely affect our business, results of operations and reported financial results.
Changing regulatory requirements for corporate governance and public disclosure, including SEC regulations and the Financial Accounting Standards Board’s accounting standards requirements are creating additional complexities for public companies. For example, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act ("the Dodd-Frank Act"), was enacted. There are significant corporate governance and executive compensation related provisions in the Dodd-Frank Act that have required the SEC to adopt additional rules and regulations in these areas.
Stockholder activism, the current political environment, financial reform legislation and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations. In addition, the expected future requirement to transition to, or converge with, international financial reporting standards may create uncertainty and additional complexities. These changing regulatory requirements may lead to additional compliance costs, as well as the diversion of our management’s time and attention from strategic business activities and could have a significant effect on our reported results for the affected periods.
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
16
ITEM 2. | PROPERTIES |
The Company’s headquarters and support functions occupy 501 acres, consisting of the home office, distribution and shipping facilities centralized on a campus-like setting in New Albany, Ohio, all of which are owned by the Company. Additionally, the Company leases small facilities to house its design and sourcing support centers in Hong Kong, New York City, New York and Los Angeles, California, as well as offices in the United Kingdom, Japan, Switzerland, Italy, Hong Kong and China.
All of the retail stores operated by the Company, as of March 24, 2016, are located in leased facilities, primarily in shopping centers. The leases expire at various dates, between 2016 and 2031.
The Company’s home office, distribution and shipping facilities, design support centers and stores are currently suitable and adequate.
As of March 24, 2016, the Company’s 927 stores were located as follows:
U.S. & U.S. Territories: | ||||||||||
Alabama | 4 | Kentucky | 8 | North Dakota | 1 | |||||
Alaska | 1 | Louisiana | 5 | Ohio | 25 | |||||
Arizona | 15 | Maine | 3 | Oklahoma | 4 | |||||
Arkansas | 5 | Maryland | 14 | Oregon | 8 | |||||
California | 108 | Massachusetts | 30 | Pennsylvania | 33 | |||||
Colorado | 6 | Michigan | 20 | Rhode Island | 2 | |||||
Connecticut | 14 | Minnesota | 9 | South Carolina | 9 | |||||
Delaware | 5 | Mississippi | 3 | Tennessee | 14 | |||||
District Of Columbia | 1 | Missouri | 5 | Texas | 69 | |||||
Florida | 69 | Montana | 1 | Utah | 6 | |||||
Georgia | 21 | Nebraska | 2 | Vermont | 2 | |||||
Hawaii | 4 | Nevada | 10 | Virginia | 21 | |||||
Idaho | 2 | New Hampshire | 9 | Washington | 17 | |||||
Illinois | 28 | New Jersey | 38 | West Virginia | 3 | |||||
Indiana | 10 | New Mexico | 3 | Wisconsin | 9 | |||||
Iowa | 5 | New York | 41 | Puerto Rico | 2 | |||||
Kansas | 5 | North Carolina | 20 | |||||||
International: | ||||||||||
Austria | 6 | Hong Kong | 4 | Republic of Korea | 4 | |||||
Belgium | 3 | Ireland | 2 | Singapore | 1 | |||||
Canada | 18 | Italy | 11 | Spain | 12 | |||||
China | 17 | Japan | 10 | Sweden | 3 | |||||
Denmark | 1 | Kuwait | 2 | United Kingdom | 34 | |||||
France | 15 | Netherlands | 4 | United Arab Emirates | 5 | |||||
Germany | 25 | Poland | 1 | |||||||
17
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in lawsuits and other adversary proceedings arising in the ordinary course of business. Legal costs incurred in connection with the resolution of claims and lawsuits are generally expensed as incurred, and the Company establishes reserves for the outcome of litigation where losses are deemed probable and reasonably estimable. The Company’s assessment of the current exposure could change in the event of the discovery of additional facts with respect to legal matters pending against the Company or determinations by judges, juries, administrative agencies or other finders of fact that are not in accordance with the Company’s evaluation of claims. As of January 30, 2016, the Company had an accrual of approximately $19 million for certain legal contingencies. In addition, there are certain claims and legal proceedings pending against the Company for which accruals have not been established. Actual liabilities may exceed the amounts reserved, and there can be no assurance that final resolution of these matters will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
18
PART II
ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
A&F’s Class A Common Stock (the “Common Stock”) is traded on the New York Stock Exchange under the symbol “ANF.” The table below sets forth the high and low sales prices of A&F’s Common Stock on the New York Stock Exchange for Fiscal 2015 and Fiscal 2014:
Sales Price | ||||||||
High | Low | |||||||
Fiscal 2015 | ||||||||
4th quarter | $ | 28.21 | $ | 18.55 | ||||
3rd quarter | $ | 22.25 | $ | 15.42 | ||||
2nd quarter | $ | 23.72 | $ | 19.36 | ||||
1st quarter | $ | 26.50 | $ | 19.34 | ||||
Fiscal 2014 | ||||||||
4th quarter | $ | 35.14 | $ | 25.52 | ||||
3rd quarter | $ | 44.32 | $ | 31.47 | ||||
2nd quarter | $ | 42.89 | $ | 34.54 | ||||
1st quarter | $ | 40.99 | $ | 32.02 | ||||
Dividends are declared at the discretion of A&F's Board of Directors. A quarterly dividend, of $0.20 per share outstanding, was declared in each of February, May, August and November in Fiscal 2015 and Fiscal 2014. Dividends were paid in each of March, June, September and December in Fiscal 2015. A&F's Board of Directors reviews the dividend on a quarterly basis and establishes the dividend rate based on A&F's financial condition, results of operations, capital requirements, current and projected cash flows, business prospects and other factors which the directors deem relevant.
As of March 23, 2016, there were approximately 3,300 stockholders of record. However, when including investors holding shares in broker accounts under street name A&F estimates that there are approximately 37,200 stockholders.
The following table provides information regarding the purchase of shares of the Common Stock of A&F made by or on behalf of A&F or any “affiliated purchaser” as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended, during each fiscal month of the quarterly period ended January 30, 2016:
Period (fiscal month) | Total Number of Shares Purchased(1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Maximum Number of Shares that May Yet be Purchased under the Plans or Programs(3) | |||||||||
November 1, 2015 through November 28, 2015 | 4,296 | $ | 20.30 | — | 6,503,656 | ||||||||
November 29, 2015 through January 2, 2016 | 82,638 | $ | 25.49 | — | 6,503,656 | ||||||||
January 2, 2016 through January 30, 2016 | 6,074 | $ | 26.61 | — | 6,503,656 | ||||||||
Total | 93,008 | $ | 25.32 | — | 6,503,656 | ||||||||
(1) | All of the 93,008 shares of A&F’s Common Stock purchased during the thirteen-week period ended January 30, 2016 represented shares which were withheld for tax payments due upon the exercise of employee stock appreciation rights and the vesting of restricted stock units and restricted share awards. |
(2) | No shares were repurchased during the thirteen-week period ended January 30, 2016 pursuant to A&F’s publicly announced stock repurchase authorization. On August 14, 2012, A&F's Board of Directors authorized the repurchase of 10.0 million shares of A&F's Common Stock, which was announced on August 15, 2012. |
(3) | The number shown represents, as of the end of each period, the maximum number of shares of Common Stock that may yet be purchased under A&F’s publicly announced stock repurchase authorization described in footnote 2 above. The shares may be purchased, from time-to-time, depending on market conditions. |
During Fiscal 2015, A&F repurchased approximately 2.5 million shares of A&F’s Common Stock in the open market with a cost of approximately $50.0 million. During Fiscal 2014, A&F repurchased approximately 7.3 million shares of A&F’s Common Stock in the open market with a cost of approximately $285.0 million. Repurchases made during Fiscal 2015 and Fiscal 2014 were pursuant to authorizations of A&F’s Board of Directors.
19
The following graph shows the changes, over the five-year period ended January 30, 2016 (the last day of A&F’s Fiscal 2015) in the value of $100 invested in (i) shares of A&F’s Common Stock; (ii) the Standard & Poor’s 500 Stock Index (the “S&P 500 Index”); (iii) the Standard & Poor's Midcap 400 Stock Index (the "S&P Midcap 400 Index"); and (iv) the Standard & Poor’s Apparel Retail Composite Index (the “S&P Apparel Retail Index”), including reinvestment of dividends. The plotted points represent the closing price on the last trading day of the fiscal year indicated.
PERFORMANCE GRAPH(1)
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN*
Among Abercrombie & Fitch Co., the S&P 500 Index, the S&P Midcap 400 Index and the S&P Apparel Retail Index
*$100 invested on 1/29/11 in stock or 1/31/11 in index, including reinvestment of dividends. Indexes calculated on month-end basis.
Copyright© 2016 S&P, a division of McGraw Hill Financial. All rights reserved.
In Fiscal 2013, A&F was removed as a component of the S&P 500 Index and became a component of the S&P Midcap 400 Index.
(1) This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to SEC Regulation 14A or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), except to the extent that A&F specifically requests that the graph be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act of 1933, as amended, or the Exchange Act.
20
ITEM 6. | SELECTED FINANCIAL DATA |
The following financial information is derived from our Consolidated Financial Statements. The information presented below should be read in conjunction with "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION" and the Company's Consolidated Financial Statements and notes thereto included in "ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA" of this Annual Report on Form 10-K. We have also included certain non-financial information to enhance the understanding of our business.
(Thousands, except per share and per square foot amounts, ratios and store data)
Fiscal 2015 | Fiscal 2014 | Fiscal 2013 | Fiscal 2012(1) | Fiscal 2011 | |||||||||||||||
Statements of operations data | |||||||||||||||||||
Net sales | $ | 3,518,680 | $ | 3,744,030 | $ | 4,116,897 | $ | 4,510,805 | $ | 4,158,058 | |||||||||
Gross profit | $ | 2,157,543 | $ | 2,313,570 | $ | 2,575,435 | $ | 2,816,709 | $ | 2,550,224 | |||||||||
Operating income | $ | 72,838 | $ | 113,519 | $ | 80,823 | $ | 374,233 | $ | 221,384 | |||||||||
Net income attributable to A&F | $ | 35,576 | $ | 51,821 | $ | 54,628 | $ | 237,011 | $ | 143,934 | |||||||||
Net income per basic share attributable to A&F | $ | 0.52 | $ | 0.72 | $ | 0.71 | $ | 2.89 | $ | 1.66 | |||||||||
Net income per diluted share attributable to A&F | $ | 0.51 | $ | 0.71 | $ | 0.69 | $ | 2.85 | $ | 1.61 | |||||||||
Basic weighted-average shares outstanding | 68,880 | 71,785 | 77,157 | 81,940 | 86,848 | ||||||||||||||
Diluted weighted-average shares outstanding | 69,417 | 72,937 | 78,666 | 83,175 | 89,537 | ||||||||||||||
Cash dividends declared per share | $ | 0.80 | $ | 0.80 | $ | 0.80 | $ | 0.70 | $ | 0.70 | |||||||||
Balance sheet data | |||||||||||||||||||
Working capital(2) | $ | 644,277 | $ | 679,016 | $ | 752,344 | $ | 617,023 | $ | 858,248 | |||||||||
Current ratio(3) | 2.20 | 2.40 | 2.32 | 1.89 | 2.23 | ||||||||||||||
Total assets | $ | 2,433,039 | $ | 2,505,167 | $ | 2,850,997 | $ | 2,987,401 | $ | 3,117,032 | |||||||||
Borrowings, net | $ | 286,235 | $ | 293,412 | $ | 135,000 | $ | — | $ | — | |||||||||
Leasehold financing obligations | $ | 47,440 | $ | 50,521 | $ | 60,726 | $ | 63,942 | $ | 57,851 | |||||||||
Total stockholders’ equity | $ | 1,295,722 | $ | 1,389,701 | $ | 1,729,493 | $ | 1,818,268 | $ | 1,931,335 | |||||||||
Return on average stockholders’ equity(4) | 3 | % | 3 | % | 3 | % | 13 | % | 7 | % | |||||||||
Other financial and operating data | |||||||||||||||||||
Net cash provided by operating activities | $ | 309,941 | $ | 312,480 | $ | 175,493 | $ | 684,171 | $ | 365,219 | |||||||||
Net cash used for investing activities | $ | (122,567 | ) | $ | (175,074 | ) | $ | (173,861 | ) | $ | (247,238 | ) | $ | (340,689 | ) | ||||
Net cash used for financing activities | $ | (106,875 | ) | $ | (181,453 | ) | $ | (40,831 | ) | $ | (380,071 | ) | $ | (265,329 | ) | ||||
Capital expenditures | $ | 143,199 | $ | 174,624 | $ | 163,924 | $ | 339,862 | $ | 318,598 | |||||||||
Free cash flow(5) | $ | 166,742 | $ | 137,856 | $ | 11,569 | $ | 344,309 | $ | 46,621 | |||||||||
Comparable sales(6) | (3 | )% | (8 | )% | (11 | )% | (1 | )% | 5 | % | |||||||||
Net store sales per average gross square foot | $ | 360 | $ | 381 | $ | 417 | $ | 485 | $ | 463 | |||||||||
Total number of stores open | 932 | 969 | 1,006 | 1,041 | 1,045 | ||||||||||||||
Total store square footage at end of period | 7,292 | 7,517 | 7,736 | 7,958 | 7,778 | ||||||||||||||
(1) | Fiscal 2012 was a fifty-three week year. |
(2) | Working capital is computed by subtracting current liabilities from current assets. |
(3) | Current ratio is computed by dividing current assets by current liabilities. |
(4) | Return on average stockholders’ equity is computed by dividing net income attributable to A&F by the average stockholders’ equity balance. |
(5) | Free cash flow is computed by subtracting capital expenditures from the GAAP financial measure of net cash provided by operating activities, both of which are disclosed above in the table preceding the measure of free cash flow. The Company believes that the non-GAAP measure of free cash flow is useful to investors to understand available cash flows generated from operations less cash flows used for capital expenditures. The closest GAAP financial measure is net cash provided by operating activities. The non-GAAP financial measure of free cash flow should not be used in isolation or as an alternative to net cash provided by operating activities or an indicator of the ongoing performance of the Company. It is also not intended to supersede or replace the Company's GAAP financial measure. |
(6) | Comparable sales is defined as the aggregate of: (1) year-over-year sales for stores that have been open as the same brand at least one year and whose square footage has not been expanded or reduced by more than 20% within the past year, with prior year's net sales converted at the current year's exchange rate to remove the impact of currency fluctuation, and (2) year-over-year direct-to-consumer sales with prior year's net sales converted at the current year's exchange rate to remove the impact of currency fluctuation. Beginning with Fiscal 2012, comparable sales include comparable direct-to-consumer sales. Figures for Fiscal 2011 have not been restated and only include comparable store sales. |
21
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
OVERVIEW
BUSINESS SUMMARY
The Company is a specialty retailer that operates stores in North America, Europe, Asia and the Middle East and direct-to-consumer operations in North America, Europe and Asia that serve its customers throughout the world. The Company sells casual sportswear apparel, including knit tops and woven shirts, graphic t-shirts, fleece, jeans and woven pants, shorts, sweaters, and outerwear; personal care products; and accessories for men, women and kids under the Abercrombie & Fitch, abercrombie kids and Hollister brands.
The Company’s fiscal year ends on the Saturday closest to January 31, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. For purposes of this “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” the fifty-two week period ended January 30, 2016 is compared to the fifty-two week period ended January 31, 2015 and the fifty-two week period ended January 31, 2015 is compared to the fifty-two week period ended February 1, 2014.
During the first quarter of Fiscal 2015, the Company substantially completed its transition to a branded organizational structure. In conjunction with the change, the Company determined its brand-based operating segments to be Abercrombie, which includes the Company's Abercrombie & Fitch and abercrombie kids brands, and Hollister. These operating segments have similar economic characteristics, classes of consumers, products and production and distribution methods, and have been aggregated into one reportable segment.
For Fiscal 2015, net sales decreased 6% to $3.519 billion from $3.744 billion for Fiscal 2014. The gross profit rate was 61.3% for Fiscal 2015, compared to 61.8% for Fiscal 2014. Operating income was $72.8 million for Fiscal 2015, compared to operating income of $113.5 million for Fiscal 2014. Net income and net income per diluted share attributable to A&F was $35.6 million and $0.51, respectively, for Fiscal 2015, compared to net income and net income per diluted share attributable to A&F of $51.8 million and $0.71, respectively, for Fiscal 2014.
Excluding certain items, the adjusted non-GAAP gross profit rate was 61.9%, operating income was $136.5 million and net income and net income per diluted share attributable to Abercrombie & Fitch Co. was $78.0 million and $1.12, respectively, for Fiscal 2015, compared to an adjusted non-GAAP gross profit rate of 61.8%, operating income of $191.7 million and net income and net income per diluted share attributable to Abercrombie & Fitch Co. of $112.3 million and $1.54, respectively, for Fiscal 2014.
As of January 30, 2016, the Company had $588.6 million in cash and equivalents, and $293.3 million in gross borrowings outstanding under its term loan facility. Net cash provided by operating activities was $309.9 million for Fiscal 2015. The Company also used cash of $143.2 million for capital expenditures, $50.0 million to repurchase approximately 2.5 million shares of A&F's Common Stock and $55.1 million to pay dividends during Fiscal 2015.
REPORTING AND USE OF GAAP AND NON-GAAP MEASURES
The Company believes that the non-GAAP financial measures presented in this "ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" are useful to investors as they provide the ability to measure the Company’s operating performance as compared to historical periods, excluding the effect of certain items which the Company believes do not reflect its future operating outlook. Management used these non-GAAP financial measures during the periods presented to assess the Company's performance and to develop expectations for future operating performance. In addition, the Company provides certain financial information on a constant currency basis to enhance investors' understanding of underlying business trends and operating performance. These non-GAAP financial measures should be used in conjunction with, not as an alternative to, the Company's GAAP financial results. Such financial measures are presented on both a GAAP and non-GAAP basis under "RESULTS OF OPERATIONS," with excluded items specifically identified.
22
The tables below reconcile certain GAAP financial measures to non-GAAP financial measures for Fiscal 2015 and Fiscal 2014.
Fiscal 2015 | ||||||||||||
(in thousands, except gross profit rate and per share amounts) | GAAP | Excluded Items(1) | Non-GAAP | |||||||||
Gross profit rate | 61.3 | % | 0.6 | % | 61.9 | % | ||||||
Operating income | $ | 72,838 | $ | 63,657 | $ | 136,495 | ||||||
Net income attributable to A&F | $ | 35,576 | $ | 42,471 | $ | 78,047 | ||||||
Net income per diluted share attributable to A&F | $ | 0.51 | $ | 0.61 | $ | 1.12 | ||||||
Fiscal 2014 | ||||||||||||
(in thousands, except gross profit rate and per share amounts) | GAAP | Excluded Items(1) | Non-GAAP | |||||||||
Gross profit rate | 61.8 | % | — | % | 61.8 | % | ||||||
Operating income | $ | 113,519 | $ | 78,174 | $ | 191,693 | ||||||
Net income attributable to A&F | $ | 51,821 | $ | 60,488 | $ | 112,309 | ||||||
Net income per diluted share attributable to A&F | $ | 0.71 | $ | 0.83 | $ | 1.54 | ||||||
(1) | Refer to "RESULTS OF OPERATIONS" for details on excluded items. |
23
CURRENT TRENDS AND OUTLOOK
2015 was a year of tremendous change for Abercrombie & Fitch. We completed our transition to a brand-based organizational structure, strengthened our teams and improved our core processes. More importantly, we evolved our assortment and refocused our attention on our customer through greater accountability and empowerment at the store level, and through changes in our in-store experience. In addition, we continued to invest in direct-to-consumer and omnichannel and execute our store closure program. While we made progress across all of our strategic initiatives, our work to fulfill the potential of our brands is not done.
Our ongoing efforts to improve our business are focused on:
• | Putting the customer at the center of everything we do. |
• | Delivering compelling and differentiated assortments. |
• | Optimizing our brand reach and channel performance. |
• | Defining clear positionings for our brands. |
• | Continuing to improve efficiency and reduce expense. |
• | Ensuring we are organized to succeed. |
As we look ahead to Fiscal 2016, it is likely to remain a challenging retail environment, but we believe our ongoing efforts are laying the foundation for future growth and profitability.
For Fiscal 2016, we expect:
• | Flat to slightly positive comparable sales. |
• | Adverse effects from foreign currency exchange rates on sales. |
• | A gross margin rate approximately flat to Fiscal 2015's adjusted non-GAAP rate of 61.9%, but up on a constant currency basis. |
• | Slight leverage in operating expense relative to last year's adjusted non-GAAP rate of 58.3%. |
• | An improvement over Fiscal 2015's adjusted non-GAAP operating income, despite an adverse effect from foreign currency exchange rates; the effect from foreign currency exchange rates, calculated on a constant currency basis, is determined by applying Fiscal 2016 forecasted rates to Fiscal 2015 results and is net of the year-over-year impact from hedging. |
• | An effective tax rate in the mid-to-upper 30s. |
• | A weighted average diluted share count of approximately 68 million shares, excluding the effect of potential share buybacks. |
With regard to capital allocation, we are targeting capital expenditures in the range of $150 million to $175 million for Fiscal 2016, including approximately $70 million for new stores and store updates and approximately $70 million for direct-to-consumer/omnichannel and IT investments to support growth and continuous profit improvement initiatives.
We plan to open approximately 15 full-price stores in Fiscal 2016, including approximately 10 in international markets, primarily China, and approximately five in the U.S. We also plan to open approximately 10 new outlet stores, primarily in the U.S. In addition, we anticipate closing approximately 60 stores in the U.S. during Fiscal 2016 through natural lease expirations.
Excluded from our Fiscal 2016 outlook are the impacts of potential events, such as those related to impairments, which may affect our results of operations.
24
KEY BUSINESS INDICATORS
The following measurements are among the key business indicators reviewed by various members of management to gauge the Company’s results:
• | Comparable sales, defined as the aggregate of: (1) year-over-year sales for stores that have been open as the same brand at least one year and whose square footage has not been expanded or reduced by more than 20% within the past year, with prior year's net sales converted at the current year's foreign currency exchange rate to remove the impact of currency fluctuation, and (2) year-over-year direct-to-consumer sales with prior year's net sales converted at the current year's foreign currency exchange rate to remove the impact of currency fluctuation; |
• | Comparative results of operations with prior year's results converted at the current year's foreign currency exchange rate to remove the impact of currency fluctuation; |
• | Gross profit and gross margin rate; |
• | Cost of sales, exclusive of depreciation and amortization, as a percentage of net sales; |
• | Selling margin, defined as sales price less original cost, by brand and product category; |
• | Stores and distribution expense as a percentage of net sales; |
• | Marketing, general and administrative expense as a percentage of net sales; |
• | Operating income and operating income as a percentage of net sales; |
• | Net income and net income attributable to A&F; |
• | Inventory per gross square foot and inventory to sales ratio; |
• | Cash flow and liquidity determined by the Company’s current ratio, working capital and free cash flow; |
• | Store metrics such as sales per gross square foot, average number of transactions per store and store contribution (defined as store sales less direct costs of operating the store); |
• | Transactional metrics such as traffic and conversion, average unit retail price, average unit cost, average units per transaction and average transaction values; and |
• | Return on invested capital and return on equity. |
While not all of these metrics are disclosed publicly by the Company due to the proprietary nature of the information, the Company publicly discloses and discusses many of these metrics within this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
RESULTS OF OPERATIONS
FISCAL 2015 COMPARED TO FISCAL 2014
Net Sales
Fiscal 2015 | Fiscal 2014 | ||||||||||||||||
(in thousands) | Net Sales | Change in Comparable Sales | Net Sales | Change in Comparable Sales | Net Sales $ Change | Net Sales % Change | |||||||||||
Abercrombie(1) | $ | 1,640,992 | (6)% | $ | 1,771,299 | (5)% | $ | (130,307 | ) | (7)% | |||||||
Hollister | 1,877,688 | —% | 1,947,869 | (10)% | (70,181 | ) | (4)% | ||||||||||
Other(2) | — | —% | 24,862 | —% | (24,862 | ) | - | ||||||||||
Total net sales | $ | 3,518,680 | (3)% | $ | 3,744,030 | (8)% | $ | (225,350 | ) | (6)% | |||||||
U.S. | $ | 2,282,040 | (3)% | $ | 2,408,427 | (6)% | $ | (126,387 | ) | (5)% | |||||||
International | 1,236,640 | (1)% | 1,335,603 | (12)% | (98,963 | ) | (7)% | ||||||||||
Total net sales | $ | 3,518,680 | (3)% | $ | 3,744,030 | (8)% | $ | (225,350 | ) | (6)% | |||||||
(1) | Includes Abercrombie & Fitch and abercrombie kids brands. |
(2) | Represents net sales from the Company's Gilly Hicks operations. See Note 16, "GILLY HICKS RESTRUCTURING," of the Notes to Consolidated Financial Statements included in "ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA," for additional information on the Company's exit from Gilly Hicks branded stores. |
Net sales for Fiscal 2015 decreased 6% compared to Fiscal 2014. The decrease in net sales was largely attributable to the adverse effect from changes in foreign currency exchange rates (based on converting prior year sales at current year foreign currency exchange rates) of approximately $153 million, or approximately 4%, and a 3% decrease in comparable sales, partially offset by the net impact of store openings, closings and remodels.
25
Cost of Sales, Exclusive of Depreciation and Amortization
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Cost of sales, exclusive of depreciation and amortization | $ | 1,361,137 | 38.7% | $ | 1,430,460 | 38.2% | |||||
Inventory write-down, net(1) | 20,647 | 0.6% | — | —% | |||||||
Adjusted non-GAAP cost of sales, exclusive of depreciation and amortization | $ | 1,340,490 | 38.1% | $ | 1,430,460 | 38.2% | |||||
Gross profit | $ | 2,157,543 | 61.3% | $ | 2,313,570 | 61.8% | |||||
Inventory write-down, net(1) | 20,647 | 0.6% | — | —% | |||||||
Adjusted non-GAAP gross profit | $ | 2,178,190 | 61.9% | $ | 2,313,570 | 61.8% | |||||
(1) | Includes net charges related to a write-down of the value of inventory to net realizable value as the Company elected to accelerate the disposition of certain aged merchandise that no longer supported the Company's brand positioning strategy. |
Cost of sales, exclusive of depreciation and amortization as a percentage of net sales increased by approximately 50 basis points for Fiscal 2015 compared to Fiscal 2014. The increase in rate was primarily due to the adverse effects from changes in foreign currency exchange rates and a net inventory write-down charge of $20.6 million, partially offset by an increase in average unit retail on a constant currency basis (based on converting prior year sales at current year foreign currency exchange rates, divided by number of units sold) and a decrease in average unit cost. Excluding the net inventory write-down charge, adjusted non-GAAP cost of sales, exclusive of depreciation and amortization as a percentage of net sales decreased by approximately 10 basis points for Fiscal 2015 compared to Fiscal 2014.
Stores and Distribution Expense
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Stores and distribution expense | $ | 1,604,214 | 45.6% | $ | 1,703,051 | 45.5% | |||||
Store fixture disposal(1) | (4,200 | ) | (0.1)% | — | —% | ||||||
Lease termination and store closure costs(2) | (1,756 | ) | —% | (5,612 | ) | (0.1)% | |||||
Profit improvement initiative(3) | (709 | ) | —% | (2,723 | ) | (0.1)% | |||||
Adjusted non-GAAP stores and distribution expense | $ | 1,597,549 | 45.4% | $ | 1,694,716 | 45.3% | |||||
(1) | Includes accelerated depreciation and disposal charges related to the discontinued use of certain store fixtures associated with changes to the Abercrombie and Hollister store experiences. |
(2) | Includes charges related to lease terminations and store closures. |
(3) | Includes charges related to the Company's profit improvement initiative. |
Stores and distribution expense as a percentage of net sales and adjusted non-GAAP stores and distribution expense as a percent of net sales increased by approximately 10 basis points for Fiscal 2015 compared to Fiscal 2014. The increase as a percentage of net sales was primarily due to the deleveraging effect from lower net sales and higher direct-to-consumer expense, partially offset by a benefit from expense reduction efforts.
Shipping and handling costs, including costs incurred to store, move and prepare the products for shipment and costs incurred to physically move the product to the customer, associated with direct-to-consumer operations were $115.0 million for Fiscal 2015 compared to $108.1 million for Fiscal 2014.
Handling costs, including costs incurred to store, move and prepare the products for shipment to stores, were $44.5 million for Fiscal 2015 compared to $52.2 million for Fiscal 2014.
Shipping and handling costs are included in stores and distribution expense on the Consolidated Statements of Operations and Comprehensive Income (Loss).
26
Marketing, General and Administrative Expense
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Marketing, general and administrative expense | $ | 470,321 | 13.4% | $ | 458,820 | 12.3% | |||||
Legal settlement charges(1) | (15,753 | ) | (0.4)% | — | —% | ||||||
Profit improvement initiative(2) | (1,770 | ) | (0.1)% | (3,776 | ) | (0.1)% | |||||
Corporate governance matters(3) | — | —% | (12,644 | ) | (0.3)% | ||||||
Adjusted non-GAAP marketing, general and administrative expense | $ | 452,798 | 12.9% | $ | 442,400 | 11.8% | |||||
(1) | Includes charges related to certain proposed legal settlements. |
(2) | Includes charges related to the Company's profit improvement initiative. |
(3) | Includes legal, advisory and other charges related to certain corporate governance matters. |
Marketing, general and administrative expense as a percentage of net sales and adjusted non-GAAP marketing, general and administrative expense as a percentage of net sales increased by approximately 110 basis points for Fiscal 2015 compared to Fiscal 2014. The increase in rate was primarily due to the deleveraging effect from lower net sales, higher compensation related expense and certain proposed legal settlement charges of $15.8 million, partially offset by the year-over-year impact of corporate governance matters related charges and expense reduction efforts.
Restructuring (Benefit) Charge
The Company recognized a restructuring benefit of $1.6 million for Fiscal 2015 from better than expected lease exit terms associated with the restructuring of the Gilly Hicks brand. Restructuring charges associated with the closure of the Gilly Hicks stand-alone stores for Fiscal 2014 were $8.4 million.
Asset Impairment
The Company incurred non-cash asset impairment charges of $18.2 million for Fiscal 2015, compared to $45.0 million for Fiscal 2014 primarily related to stores whose asset carrying values were determined not to be recoverable and exceeded fair value. For Fiscal 2015, the non-cash asset impairment charges primarily related to the Company's Abercrombie & Fitch flagship store in Hong Kong as well as certain fixtures that were removed in connection with changes to the Abercrombie and Hollister store experiences. For Fiscal 2014, store-related asset impairment charges primarily related to the Company's Abercrombie & Fitch flagship store locations in Tokyo, Japan and Seoul, Korea, as well as nine Hollister stores and nine abercrombie kids stores. Additionally, the Company incurred charges of approximately $11.3 million in Fiscal 2014 to record the expected loss on the sale of the Company-owned aircraft.
Other Operating Income, Net
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Other operating income, net | $ | 6,441 | 0.2% | $ | 15,239 | 0.4% | |||||
Lease termination and store closure costs(1) | 2,211 | 0.1% | — | —% | |||||||
Adjusted non-GAAP other operating income, net | $ | 8,652 | 0.2% | $ | 15,239 | 0.4% | |||||
(6) | Includes charges related to a release of cumulative translation adjustment as the Company substantially completed the liquidation of its Australian operations. |
Other operating income, net was $6.4 million for Fiscal 2015 compared to $15.2 million for Fiscal 2014. For Fiscal 2015, other operating income, net included income of $2.2 million related to insurance recoveries and $4.7 million related to gift card breakage, partially offset by losses of $1.5 million related to foreign currency transactions. For Fiscal 2014, other operating income, net included income of $10.2 million related to insurance recoveries and $5.8 million related to gift card breakage, and losses of $2.0 million related to foreign currency transactions.
27
Operating Income
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Operating income | $ | 72,838 | 2.1% | $ | 113,519 | 3.0% | |||||
Inventory write-down, net(1) | 20,647 | 0.6% | — | —% | |||||||
Asset impairment(2) | 18,209 | 0.5% | 44,988 | 1.2% | |||||||
Legal settlement charges(3) | 15,753 | 0.4% | — | —% | |||||||
Store fixture disposal(4) | 4,200 | 0.1% | — | —% | |||||||
Profit improvement initiative(5) | 2,479 | 0.1% | 6,499 | 0.2% | |||||||
Lease termination and store closure costs(6) | 3,967 | 0.1% | 5,612 | 0.1% | |||||||
Restructuring (benefit) charges(7) | (1,598 | ) | —% | 8,431 | 0.2% | ||||||
Corporate governance matters(8) | — | —% | 12,644 | 0.3% | |||||||
Adjusted non-GAAP operating income | $ | 136,495 | 3.9% | $ | 191,693 | 5.1% | |||||
(1) | Includes net inventory write-down charges related to a decision to accelerate the disposition of certain aged merchandise. |
(2) | Includes impairment charges related to stores whose asset carrying values were determined not to be recoverable and exceeded fair value, for Fiscal 2014, a fair value adjustment to the Company-owned aircraft, and for Fiscal 2015, certain store fixtures in connection with changes to the Abercrombie and Hollister store experiences. |
(3) | Includes charges related to certain proposed legal settlements. |
(4) | Includes accelerated depreciation and disposal charges related to the discontinued use of certain store fixtures. |
(5) | Includes charges related to the Company's profit improvement initiative. |
(6) | Includes charges related to lease terminations and store closures, including charges related to a release of cumulative translation adjustment as the Company substantially completed the liquidation of its Australian operations. |
(7) | Includes restructuring (benefit) charges associated with the closure of the Gilly Hicks stand-alone stores, net of better than expected lease exit terms. |
(8) | Includes legal, advisory and other charges related to certain corporate governance matters. |
Operating income as a percentage of net sales decreased by approximately 100 basis points for Fiscal 2015 compared to Fiscal 2014. The decrease in rate was primarily due to the deleveraging effect of lower net sales, higher direct-to-consumer costs and higher compensation related expense, partially offset by expense reduction efforts, an increase in average unit retail on a constant currency basis (based on converting prior year sales at current year foreign currency exchange rates, divided by number of units sold), a decrease in average unit cost and the net year-over-year impact of certain items presented in the above table. Excluding certain items, as presented above, adjusted non-GAAP operating income as a percentage of net sales decreased approximately 120 basis points for Fiscal 2015 compared to Fiscal 2014.
Interest Expense, Net
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Interest expense | $ | 22,601 | 0.6% | $ | 18,305 | 0.5% | |||||
Interest income | (4,353 | ) | (0.1)% | (3,940 | ) | (0.1)% | |||||
Interest expense, net | $ | 18,248 | 0.5% | $ | 14,365 | 0.4% | |||||
The increase in interest expense, net for Fiscal 2015 compared to Fiscal 2014 was primarily due to an increase in the average principal balance and a higher interest rate on debt outstanding.
Tax Expense
Fiscal 2015 | Fiscal 2014 | ||||||||||
(in thousands, except ratios) | Effective Tax Rate | Effective Tax Rate | |||||||||
Tax expense | $ | 16,031 | 29.4% | $ | 47,333 | 47.7% | |||||
Tax effect of excluded items(1) | 21,186 | 17,686 | |||||||||
Adjusted non-GAAP tax expense | $ | 37,217 | 31.5% | $ | 65,019 | 36.7% | |||||
(1) | Refer to "Operating Income" for details of excluded items. The Company computed the tax effect of excluded items based on non-GAAP pre-tax income. |
28
With respect to the Company’s annual effective tax rate, undistributed net income generated by foreign subsidiaries after October 31, 2015 is no longer considered to be indefinitely invested outside of the U.S. Accordingly, the Company recognized deferred U.S. income taxes on net income generated after October 31, 2015. This change is reflected in the Company’s income tax expense recognized for Fiscal 2015.
The effective tax rate was 29.4% for Fiscal 2015 compared to 47.7% for Fiscal 2014. Excluding certain items, as presented above in the table under "Operating Income," the adjusted non-GAAP effective tax rate was 31.5% for Fiscal 2015 compared to 36.7% for Fiscal 2014. The effective tax rate and the adjusted non-GAAP effective tax rate for Fiscal 2015 reflect discrete benefits of $7.4 million and $5.4 million, respectively, related to a release of a valuation allowance and other discrete tax items.
As of January 30, 2016, the Company had approximately $89.7 million in net deferred tax assets, which included approximately $14.2 million of net deferred tax assets in Japan. The realization of the Company's Japanese net deferred tax assets will depend upon the future generation of sufficient taxable profits Japan. While the Company believes it is more likely than not that these net deferred tax assets will be realized, it is not certain. Should circumstances change, these net deferred tax assets may become subject to a valuation allowance in the future. Additional valuation allowances would result in additional tax expense.
Net Income and Net Income per Share Attributable to A&F
Net income and net income per diluted share attributable to A&F were $35.6 million and $0.51, respectively, for Fiscal 2015 compared to net income and net income per diluted share attributable to A&F of $51.8 million and $0.71, respectively, for Fiscal 2014. Excluding certain items and their tax effects, as presented above under "Operating Income" and "Tax Expense," adjusted non-GAAP net income and net income per diluted share attributable to A&F were $78.0 million and $1.12, respectively, for Fiscal 2015 compared to adjusted non-GAAP net income and net income per diluted share attributable to A&F of $112.3 million and $1.54, respectively, for Fiscal 2014.
FISCAL 2014 COMPARED TO FISCAL 2013
Net Sales
Fiscal 2014 | Fiscal 2013 | ||||||||||||||||
(in thousands) | Net Sales | Change in Comparable Sales | Net Sales | Change in Comparable Sales | Net Sales $ Change | Net Sales % Change | |||||||||||
Abercrombie(1) | $ | 1,771,299 | (5)% | $ | 1,893,955 | (9)% | $ | (122,656 | ) | (6)% | |||||||
Hollister | 1,947,869 | (10)% | 2,127,816 | (14)% | (179,947 | ) | (8)% | ||||||||||
Other(2) | 24,862 | —% | 95,126 | —% | (70,264 | ) | (74)% | ||||||||||
Total net sales | $ | 3,744,030 | (8)% | $ | 4,116,897 | (11)% | $ | (372,867 | ) | (9)% | |||||||
U.S. | $ | 2,408,427 | (6)% | $ | 2,659,089 | (11)% | $ | (250,662 | ) | (9)% | |||||||
International | 1,335,603 | (12)% | 1,457,808 | (11)% | (122,205 | ) | (8)% | ||||||||||
Total net sales | $ | 3,744,030 | (8)% | $ | 4,116,897 | (11)% | $ | (372,867 | ) | (9)% | |||||||
(1) | Includes Abercrombie & Fitch and abercrombie kids brands. |
(2) | Represents net sales from the Company's Gilly Hicks operations. See Note 16, "GILLY HICKS RESTRUCTURING," of the Notes to Consolidated Financial Statements included in "ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA," for additional information on the Company's exit from Gilly Hicks branded stores. |
Net sales for Fiscal 2014 decreased 9% compared to Fiscal 2013. The decrease in net sales was attributable to an 8% decrease in comparable sales, the net impact of store openings, closings and remodels, and the adverse effects of changes in foreign currency exchange rates (based on converting prior year sales at current year foreign currency exchange rates) of approximately $19.2 million.
29
Cost of Sales, Exclusive of Depreciation and Amortization
Fiscal 2014 | Fiscal 2013 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Net sales | $ | 3,744,030 | 100.0% | $ | 4,116,897 | 100.0% | |||||
Cost of sales, exclusive of depreciation and amortization | 1,430,460 | 38.2% | 1,541,462 | 37.4% | |||||||
Gross profit | $ | 2,313,570 | 61.8% | $ | 2,575,435 | 62.6% | |||||
Cost of sales, exclusive of depreciation and amortization as a percentage of net sales increased by approximately 80 basis points for Fiscal 2014 compared to Fiscal 2013. The increase in rate was primarily due to increased promotional activity, including shipping promotions in the direct-to-consumer business, partially offset by lower average unit cost.
Stores and Distribution Expense
Fiscal 2014 | Fiscal 2013 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Stores and distribution expense | $ | 1,703,051 | 45.5% | $ | 1,907,687 | 46.3% | |||||
Lease termination and store closure costs(1) | (5,612 | ) | (0.1)% | — | —% | ||||||
Profit improvement initiative(2) | (2,723 | ) | (0.1)% | (1,131 | ) | —% | |||||
Adjusted non-GAAP stores and distribution expense | $ | 1,694,716 | 45.3% | $ | 1,906,556 | 46.3% | |||||
(1) | Includes charges related to lease terminations and store closures. |
(2) | Includes charges related to the Company's profit improvement initiative. |
Stores and distribution expense as a percentage of net sales decreased by approximately 90 basis points for Fiscal 2014 compared to Fiscal 2013. The decrease in rate was primarily due to savings from the profit improvement initiative primarily related to in-store payroll and other controllable stores expenses, partially offset by the deleveraging effect of negative comparable sales and higher direct-to-consumer expense. Excluding certain items, as presented in the above table, adjusted non-GAAP stores and distribution expense as a percent of net sales decreased by approximately 100 basis points for Fiscal 2014 compared to Fiscal 2013.
Shipping and handling costs, including costs incurred to store, move and prepare the products for shipment and costs incurred to physically move the product to the customer, associated with direct-to-consumer operations were $108.1 million for Fiscal 2014 compared to $93.4 million for Fiscal 2013.
Handling costs, including costs incurred to store, move and prepare the products for shipment to stores, were $52.2 million for Fiscal 2014 compared to $53.9 million for Fiscal 2013.
Shipping and handling costs are included in stores and distribution expense on the Consolidated Statements of Operations and Comprehensive Income (Loss).
Marketing, General and Administrative Expense
Fiscal 2014 | Fiscal 2013 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Marketing, general and administrative expense | $ | 458,820 | 12.3% | $ | 481,784 | 11.7% | |||||
Profit improvement initiative(1) | (3,776 | ) | (0.1)% | (12,708 | ) | (0.3)% | |||||
Corporate governance matters(2) | (12,644 | ) | (0.3)% | — | —% | ||||||
Adjusted non-GAAP marketing, general and administrative expense | $ | 442,400 | 11.8% | $ | 469,076 | 11.4% | |||||
(1) | Includes charges related to the Company's profit improvement initiative. |
(2) | Includes legal, advisory and other charges related to certain corporate governance matters. |
Marketing, general and administrative expense as a percentage of net sales increased by approximately 60 basis points for Fiscal 2014 compared to Fiscal 2013. The increase in rate was driven primarily by the deleveraging effect of negative comparable sales and an increase in marketing expense, partially offset by a decrease in compensation expense. Excluding certain items, presented in the above table, adjusted non-GAAP marketing, general and administrative expense increased as a percent of net sales by approximately 40 basis points for Fiscal 2014 compared to Fiscal 2013.
30
Restructuring Charge
Charges associated with the restructuring of the Gilly Hicks brand were $8.4 million for Fiscal 2014, of which $6.0 million related to lease terminations and $2.1 million related to asset impairment. Charges associated with the restructuring of the Gilly Hicks brand were $81.5 million for Fiscal 2013, of which $42.7 million related to lease terminations and $37.9 million related to asset impairment.
Asset Impairment
The Company incurred non-cash asset impairment charges of $45.0 million for Fiscal 2014, compared to $46.7 million for Fiscal 2013 related primarily to stores whose asset carrying values were determined not to be recoverable and exceeded fair value. For Fiscal 2014, store-related asset impairment charges are primarily related to the Company's Abercrombie & Fitch flagship store locations in Tokyo, Japan and Seoul, Korea, as well as nine Hollister stores and nine abercrombie kids stores. Additionally, the Company incurred charges of approximately $11.3 million for Fiscal 2014 to record the expected loss on disposal of the plan to sell the Company-owned aircraft.
Other Operating Income, Net
Other operating income, net was $15.2 million for Fiscal 2014 compared to other operating income, net of $23.1 million for Fiscal 2013. Other operating income, net included income of $10.2 million related to insurance recoveries and $5.8 million related to gift card breakage, partially offset by losses of $2.0 million related to foreign currency transactions for Fiscal 2014, compared to income of $9.0 million related to insurance recoveries, $8.8 million related to gift card breakage and $2.9 million related to foreign currency transactions for Fiscal 2013.
Operating Income
Fiscal 2014 | Fiscal 2013 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Operating income | $ | 113,519 | 3.0% | $ | 80,823 | 2.0% | |||||
Asset impairment(1) | 44,988 | 1.2% | 46,715 | 1.1% | |||||||
Corporate governance matters(2) | 12,644 | 0.3% | — | —% | |||||||
Restructuring charges(3) | 8,431 | 0.2% | 81,500 | 2.0% | |||||||
Profit improvement initiative(4) | 6,499 | 0.2% | 13,839 | 0.3% | |||||||
Lease termination and store closure costs(5) | 5,612 | 0.1% | — | —% | |||||||
Adjusted non-GAAP operating income | $ | 191,693 | 5.1% | $ | 222,877 | 5.4% | |||||
(1) | Includes impairment charges related to stores whose asset carrying values were determined not to be recoverable and exceeded fair value, and for Fiscal 2014, a fair value adjustment to the Company-owned aircraft. |
(2) | Includes legal, advisory and other charges related to certain corporate governance matters. |
(3) | Includes restructuring charges associated with the closure of the Gilly Hicks stand-alone stores. |
(4) | Includes charges related to the Company's profit improvement initiative. |
(5) | Includes charges related to lease terminations and store closures. |
Operating income as a percentage of net sales increased by approximately 110 basis points for Fiscal 2014 compared to Fiscal 2013. The year-over-year change in rate was primarily due to the the net year-over-year impact of certain items, as presented above, and expense reduction related to the Company's profit improvement initiative, partially offset by the deleveraging effect of negative comparable sales and investment in direct-to-consumer operations. Excluding certain items, as presented above, adjusted non-GAAP income as a percentage of net sales decreased approximately 30 basis points for Fiscal 2014 compared to Fiscal 2013.
Interest Expense, Net
Fiscal 2014 | Fiscal 2013 | ||||||||||
(in thousands) | % of Net Sales | % of Net Sales | |||||||||
Interest expense | $ | 18,305 | 0.5% | $ | 11,183 | 0.3% | |||||
Interest income | (3,940 | ) | (0.1)% | (3,637 | ) | (0.1)% | |||||
Interest expense, net | $ | 14,365 | 0.4% | $ | 7,546 | 0.2% | |||||
31
The increase in interest expense for Fiscal 2014 compared to Fiscal 2013 was primarily due to an increase in the average principal balance and interest rate on debt outstanding.
Tax Expense
Fiscal 2014 | Fiscal 2013 | ||||||||||
(in thousands, except ratios) | Effective Tax Rate | Effective Tax Rate | |||||||||
Tax expense | $ | 47,333 | 47.7% | $ | 18,649 | 25.5% | |||||
Tax effect of excluded items(1) | 17,686 | 46,063 | |||||||||
Adjusted non-GAAP tax expense | $ | 65,019 | 36.7% | $ | 64,712 | 30.1% | |||||
(1) | Refer to "OPERATING INCOME" for details of excluded items. The Company computed the tax effect of excluded items based on non-GAAP pre-tax income. |
The effective tax rate was 47.7% for Fiscal 2014 compared to 25.5% for Fiscal 2013. Excluding certain items, as presented above, the adjusted non-GAAP effective tax rate was 36.7% for Fiscal 2014 compared to 30.1% for Fiscal 2013.
The change in the effective tax rate for Fiscal 2014 as compared to Fiscal 2013 was primarily due to an unfavorable change in the mix of earnings on a jurisdictional basis, a $6.1 million valuation allowance established in 2014 for net operating loss carryforwards for which the Company determined based on evidence it was more likely than not that the associated deferred tax asset would not be realized, as well as a benefit of $6.7 million in Fiscal 2013 resulting from the settlement of certain state tax audits and other discrete matters.
As of January 31, 2015, the Company had approximately $111.0 million in net deferred tax assets, which included approximately $15.9 million of net deferred tax assets related to Japan. The realization of the Company's Japanese net deferred tax assets is dependent upon the future generation of sufficient taxable profits in Japan. While the Company believes it is more likely than not that these net deferred tax assets will be realized, it is not certain. Should circumstances change, these net deferred tax assets may become subject to a valuation allowance in the future. Additional valuation allowances would results in additional tax expense.
Net Income and Net Income per Share Attributable to A&F
Net income and net income per diluted share attributable to A&F was $51.8 million and $0.71, respectively, for Fiscal 2014 compared to net income and net income per diluted share attributable to A&F of $54.6 million and $0.69, respectively, for Fiscal 2013. Excluding certain items and their tax effects, as presented above under "OPERATING INCOME" and "TAX EXPENSE," adjusted non-GAAP net income and net income per diluted share attributable to A&F was $112.3 million and $1.54, respectively, for Fiscal 2014 compared to adjusted non-GAAP net income and net income per diluted share attributable to A&F of $150.6 million and $1.91, respectively, for Fiscal 2013.
LIQUIDITY AND CAPITAL RESOURCES
HISTORICAL SOURCES AND USES OF CASH
Seasonality of Cash Flows
The Company’s business has two principal selling seasons: the Spring season which includes the first and second fiscal quarters (“Spring”) and the Fall season which includes the third and fourth fiscal quarters ("Fall"). As is typical in the apparel industry, the Company experiences its greatest sales activity during the Fall season due to Back-to-School and Holiday sales periods, particularly in the U.S. The Company relies on excess operating cash flows, which are largely generated in the Fall season, to fund operating expenses throughout the year and to reinvest in the business to support future growth. The Company also has a revolving credit facility available as a source of additional funding.
Asset-Based Revolving Credit Facility
The Company has a senior secured revolving credit facility with availability of up to $400 million (the “ABL Facility”), subject to a borrowing base. The ABL Facility is available for working capital, capital expenditures and other general corporate purposes. The ABL Facility will mature on August 7, 2019. No borrowings were outstanding under the ABL Facility as of January 30, 2016.
32
Amounts borrowed under the ABL Facility bear interest, at the Company’s option, at either an adjusted LIBOR rate plus a margin of 1.25% to 1.75% per annum, or an alternate base rate plus a margin of 0.25% to 0.75% per annum based on average historical excess availability during the preceding quarter. The Company is also required to pay a fee of 0.25% per annum on undrawn commitments under the ABL Facility. Customary agency fees and letter of credit fees are also payable in respect of the ABL Facility.
As of January 30, 2016, the borrowing base on the ABL Facility was $265.3 million. As of March 24, 2016, the Company had not drawn on the ABL Facility, but had approximately $1.9 million in outstanding stand-by letters of credit under the ABL Facility.
Term Loan Facility
The Company is also party to a term loan agreement, which provides for a term loan facility of $300 million (the “Term Loan Facility” and, together with the ABL Facility, the “2014 Credit Facilities”). The Term Loan Facility was issued at a $3 million or 1.0% discount. In addition, the Company recorded deferred financing fees associated with the issuance of the 2014 Credit Facilities of $5.8 million in aggregate, of which $3.2 million was paid to lenders. The Company is amortizing the debt discount and deferred financing fees over the respective contractual terms of the 2014 Credit Facilities.
The Company's Term Loan debt is presented in the Consolidated Balance Sheets, net of the unamortized discount and fees paid to lenders. Net borrowings as of January 30, 2016 were as follows:
(in thousands) | January 30, 2016 | January 31, 2015 | |||||
Borrowings, gross at carrying amount | $ | 293,250 | $ | 299,250 | |||
Unamortized discount | (1,929 | ) | (2,786 | ) | |||
Unamortized fees paid to lenders | (5,086 | ) | (3,052 | ) | |||
Borrowings, net | 286,235 | 293,412 | |||||
Less: short-term portion of borrowings, net of discount and fees | — | (2,102 | ) | ||||
Long-term portion of borrowings, net | $ | 286,235 | $ | 291,310 | |||
The Term Loan Facility will mature on August 7, 2021 and amortizes at a rate equal to 0.25% of the original principal amount per quarter, beginning with the fourth quarter of Fiscal 2014. The Company prepaid its' scheduled Fiscal 2016 amortization in January 2016. The Term Loan Facility is subject to (a) beginning in 2016, an annual mandatory prepayment in an amount equal to 0% to 50% of the Company's excess cash flows in the preceding fiscal year, depending on the Company's leverage ratio and (b) certain other mandatory prepayments upon receipt by the Company of proceeds of certain debt issuances, asset sales and casualty events, subject to certain exceptions specified therein, including reinvestment rights. The Company was not required to make any mandatory prepayments under the Term Loan Facility in Fiscal 2016.
At the Company's option, borrowings under the Term Loan Facility will bear interest at either (a) an adjusted LIBOR rate no lower than 1.00% plus a margin of 3.75% per annum or (b) an alternate base rate plus a margin of 2.75% per annum. Customary agency fees are also payable in respect of the Term Loan Facility. The interest rate on borrowings under the Term Loan Facility was 4.75% as of January 30, 2016.
The Company's credit facilities are described in Note 11, "BORROWINGS" of the Notes to the Consolidated Financial Statements included in "ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA," of this Annual Report on Form 10-K.
Operating Activities
Net cash provided by operating activities was $309.9 million for Fiscal 2015 compared to $312.5 million for Fiscal 2014 and $175.5 million for Fiscal 2013. Significant changes in the underlying drivers of net cash provided by operating activities for Fiscal 2015 as compared to Fiscal 2014 related primarily to changes in accounts payable and accrued expenses and inventories, net. For Fiscal 2015, the Company had a $51.1 million net cash inflow associated with an increase in accounts payable and accrued expenses resulting from the Company's extension of vendor payment terms, as compared to a $37.4 million net cash outflow for Fiscal 2014 associated with a decrease in accounts payable and accrued expenses driven by cash payments related to Gilly Hicks restructuring for Fiscal 2014. The Company also experienced $41.6 million less of a cash inflow from the year-over-year reduction in inventory balances for Fiscal 2015 as compared to Fiscal 2014. The increase in net cash provided by operating activities in Fiscal 2014 from Fiscal 2013 was primarily driven by changes in inventory and accounts payable and accrued expenses.
33
Investing Activities
Cash outflows for investing activities in Fiscal 2015, Fiscal 2014 and Fiscal 2013 were used primarily for new store construction, store remodels, information technology, and direct-to-consumer and omnichannel capabilities. Fiscal 2015 cash investing activities also included proceeds from the sale of a Company-owned aircraft.
Financing Activities
For Fiscal 2015, cash outflows for financing activities consisted primarily of the payment of dividends of $55.1 million and the repurchase of A&F's Common Stock of $50.0 million. For Fiscal 2014, cash outflows for financing activities consisted primarily of the repurchase of A&F's Common Stock of $285.0 million, the payment of dividends of $57.4 million and the repayment of borrowings of $195.8 million. For Fiscal 2013, cash outflows for financing activities consisted primarily of the repurchase of A&F’s Common Stock of $115.8 million, the repayment of borrowings of $15.0 million and the payment of dividends of $61.9 million. For Fiscal 2014 and Fiscal 2013, cash inflows from financing activities consisted primarily of proceeds from borrowings of $357.0 million and $150.0 million, respectively.
During Fiscal 2015, A&F repurchased approximately 2.5 million shares of A&F’s Common Stock in the open market with a market value of approximately $50.0 million. During Fiscal 2014, A&F repurchased approximately 7.3 million shares of A&F’s Common Stock, of which approximately 3.5 million shares with a market value of approximately $135.0 million were purchased in the open market and approximately 3.8 million shares with an aggregate cost of $150.0 million were purchased pursuant to an accelerated share repurchase agreement. During Fiscal 2013, A&F repurchased approximately 2.4 million shares of A&F's Common Stock in the open market with a market value of $115.8 million. Repurchase of A&F's Common Stock were made pursuant to the A&F Board of Directors' authorizations.
As of January 30, 2016, A&F had approximately 6.5 million remaining shares available for repurchase as part of the A&F Board of Directors’ previously approved authorizations.
FUTURE CASH REQUIREMENTS AND SOURCES OF CASH
Over the next twelve months, the Company’s primary cash requirements will be to fund operating activities, including the acquisition of inventory, and obligations related to compensation, leases, taxes and other operating activities, as well as to fund capital expenditures and quarterly dividends to stockholders subject to approval by A&F's Board of Directors. The Company has availability under the ABL Facility as a source of additional funding.
The Company may continue to repurchase shares of its Common Stock and would anticipate funding these cash requirements utilizing free cash flow generated from operations or proceeds from its existing credit facilities.
As of January 30, 2016, $239.4 million of the Company's $588.6 million of cash and equivalents was held by foreign affiliates. The Company is not dependent on dividends from its foreign affiliates to fund its U.S. operations or make distributions to A&F’s stockholders. Unremitted earnings from foreign affiliates generally would become subject to U.S. income tax if remitted as dividends or lent to A&F or a U.S. affiliate. As of January 30, 2016, a provision for U.S. income tax has not been recorded on $164.5 million of the cash and equivalents held by foreign affiliates.
OFF-BALANCE SHEET ARRANGEMENTS
The Company uses in the ordinary course of business stand-by letters of credit under the existing ABL Facility. The Company had $2.3 million in stand-by letters of credit outstanding as of January 30, 2016. The Company has no other off-balance sheet arrangements.
34
CONTRACTUAL OBLIGATIONS
Payments due by period | ||||||||||||||||||||
(in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
Operating lease obligations (1) | $ | 1,734,171 | $ | 390,166 | $ | 570,920 | $ | 349,782 | $ | 423,303 | ||||||||||
Long-term debt obligations | 293,250 | — | 6,000 | 6,000 | 281,250 | |||||||||||||||
Purchase obligations | 324,538 | 255,600 | 40,094 | 20,145 | 8,699 | |||||||||||||||
Other obligations (2) | 131,522 | 15,823 | 31,125 | 38,462 | 46,112 | |||||||||||||||
Capital lease obligations | 2,118 | 634 | 1,407 | 77 | — | |||||||||||||||
Totals | $ | 2,485,599 | $ | 662,223 | $ | 649,546 | $ | 414,466 | $ | 759,364 | ||||||||||
(1) | Includes leasehold financing obligations of $47.4 million. Refer to Note 2, "SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES," of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K for additional information. |
(2) | Includes estimated interest payments based on the interest rate as of January 30, 2016 and assuming normally scheduled principal payments. |
Long-term debt obligations consist of principal payments under the Term Loan Agreement. Refer to Note 11, "BORROWINGS," of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K for additional information.
Operating lease obligations consist primarily of non-cancelable future minimum lease commitments related to store operating leases. See Note 2, “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Leased facilities,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K, for further discussion. Excluded from the obligations above are amounts related to portions of lease terms that are currently cancelable at the Company's discretion. While included in the obligations above, in many instances, the Company has options to terminate certain leases if stated sales volume levels are not met or the Company ceases operations in a given country. Operating lease obligations do not include common area maintenance (“CAM”), insurance, marketing or tax payments for which the Company is also obligated. Total expense related to CAM, insurance, marketing and taxes was $171.7 million in Fiscal 2015.
The purchase obligations category represents purchase orders for merchandise to be delivered during Fiscal 2016 and commitments for fabric expected to be used during upcoming seasons. In addition, purchase obligations include agreements to purchase goods or services including information technology contracts and third-party distribution center service contracts.
Other obligations consist primarily of asset retirement obligations and the Supplemental Executive Retirement Plan. See Note 17, “SAVINGS AND RETIREMENT PLANS,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K, for further discussion.
Due to uncertainty as to the amounts and timing of future payments, the contractual obligations table above does not include tax (including accrued interest and penalties) of $2.9 million related to uncertain tax positions at January 30, 2016. Deferred taxes are also not included in the preceding table. For further discussion, see Note 10, “INCOME TAXES,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K.
A&F has historically paid quarterly dividends on its Common Stock. There are no amounts included in the above table related to dividends due to the fact that dividends are subject to determination and approval by A&F's Board of Directors.
35
STORE ACTIVITY
During the year, the Company opened fifteen international full-price stores, including its first Abercrombie & Fitch store in the United Arab Emirates (UAE), 6 U.S. full-price stores and 9 U.S. outlet stores. In addition, the Company closed 55 U.S. stores and four international stores.
Store count and gross square footage by brand and geography are presented below:
Abercrombie (1) | Hollister (2) | Total | |||||||||||||||
United States | International | United States | International | United States | International | ||||||||||||
February 1, 2014 | 381 | 24 | 458 | 129 | 839 | 153 | |||||||||||
New | 6 | 8 | 2 | 7 | 8 | 15 | |||||||||||
Closed | (26 | ) | — | (27 | ) | (1 | ) | (53 | ) | (1 | ) | ||||||
January 31, 2015 | 361 | 32 | 433 | 135 | 794 | 167 | |||||||||||
New | 13 | 7 | 2 | 8 | 15 | 15 | |||||||||||
Closed | (34 | ) | — | (21 | ) | (4 | ) | (55 | ) | (4 | ) | ||||||
January 30, 2016 | 340 | 39 | 414 | 139 | 754 | 178 | |||||||||||
Gross square feet (in thousands): | |||||||||||||||||
January 31, 2015 | 2,798 | 560 | 2,988 | 1,171 | 5,786 | 1,731 | |||||||||||
January 30, 2016 | 2,634 | 619 | 2,856 | 1,183 | 5,490 | 1,802 | |||||||||||
(1) | Abercrombie includes the Company's Abercrombie & Fitch and abercrombie kids brands. Prior period store counts have been restated to combine Abercrombie & Fitch stores with abercrombie kids carveouts into one store. The change reduced total stores by eight stores as of January 31, 2015 and by six stores as of February 1, 2014. Excludes one international franchise store as of January 30, 2016. |
(2) | Includes seven international Gilly Hicks store closures and one U.S Gilly Hicks store closure during Fiscal 2014. Excludes two international franchise stores as of January 30, 2016. |
CAPITAL EXPENDITURES
Capital expenditures totaled $143.2 million, $174.6 million and $163.9 million for Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively. A summary of capital expenditures is as follows:
(in thousands) | Fiscal 2015 | Fiscal 2014 | Fiscal 2013 | |||||||||
New store construction, store refreshes and remodels | $ | 71,675 | $ | 86,316 | $ | 101,404 | ||||||
Home office, distribution centers and information technology | 71,524 | 88,291 | 62,521 | |||||||||
Total capital expenditures | $ | 143,199 | $ | 174,607 | $ | 163,925 | ||||||
The Company expects capital expenditures in the range of $150 million to $175 million for Fiscal 2016, which will be prioritized toward new stores and store updates, as well as direct-to-consumer and information technology investments to support growth initiatives.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2, "SUMMARY OF SIGNIFICANT ACCOUTING POLICIES - Recent accounting pronouncements" of the Notes to the Consolidated Financial Statements included in "ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA," of this Annual Report on Form 10-K for recent accounting pronouncements, including the expected dates of adoption and anticipated effects on our Consolidated Financial Statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Since actual results may differ from those estimates, the Company revises its estimates and assumptions as new information becomes available.
36
The Company believes the following policies are the most critical to the portrayal of the Company’s financial condition and results of operations.
Policy | Effect if Actual Results Differ from Assumptions | |
Revenue Recognition | ||
The Company reserves for sales returns through estimates based on historical returns experience, recent sales activity and various other assumptions that management believes to be reasonable. | The Company has not made any material changes in the accounting methodology used to determine the sales return reserve over the past three fiscal years. | |
The Company does not expect material changes to the underlying assumptions used to measure the sales return reserve as of January 30, 2016. However, actual results could vary from estimates and could result in material gains or losses. | ||
Inventory Valuation | ||
The Company reviews inventories on a quarterly basis. The Company reduces the inventory valuation when the carrying cost of specific inventory items on hand exceeds the amount expected to be realized from the ultimate sale or disposal of the goods, through a lower of cost or market ("LCM") adjustment. The valuation reserve is established to reduce inventory to its net realizable value based on the Company's consideration of multiple factors and assumptions including demand forecasts, current sales volumes, expected sell-off activity, composition and aging of inventory, historical recoverability experience and risk of obsolescence from changes in economic conditions or customer preferences. | The Company does not expect material changes to the underlying assumptions used to measure the shrink reserve or the LCM reserve as of January 30, 2016. However, actual results could vary from estimates and could significantly impact the ending inventory valuation at cost, as well as gross margin. An increase or decrease in the LCM reserve of 10% would have affected pre-tax income by approximately $2.0 million for Fiscal 2015. | |
Additionally, as part of inventory valuation, an inventory shrink estimate is made each quarter that reduces the value of inventory for lost or stolen items, based on sales volumes, average unit costs, historical losses and actual shrink results from previous physical inventories. | An increase or decrease in the inventory shrink accrual of 10% would have affected pre-tax income by approximately $1.1 million for Fiscal 2015. | |
Long-lived Assets | ||
Long-lived assets, primarily comprised of leasehold improvements, furniture, fixtures and equipment, are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of the long-lived asset might not be recoverable. These include, but are not limited to, material declines in operational performance, a history of losses, an expectation of future losses, other than temporary adverse market conditions and store closure or relocation decisions. On at least a quarterly basis, the Company reviews for indicators of impairment at the individual store level, the lowest level for which cash flows are identifiable. | Impairment loss calculations involve uncertainty due to the nature of the assumptions that management is required to make, including estimating projected cash flows and selecting the discount rate that best reflects the risk inherent in future cash flows. If actual results are not consistent with the estimates and assumptions used, there may be a material impact on the Company's financial condition or results of operation. As of January 30, 2016, stores that were tested for impairment and not impaired had a net book value of $7.6 million and had undiscounted cash flows which were in the range of 100% to 150% of their respective net asset values. | |
Stores that display an indicator of impairment are subjected to an impairment assessment. The Company’s impairment assessment requires management to make assumptions and judgments related, but not limited, to management's expectations for future operations and projected cash flows. The key assumptions used in the Company's undiscounted future cash flow models include sales, gross margin and, to a lesser extent, operating expenses. An impairment loss would be recognized when these undiscounted future cash flows are less than carrying amount of the asset group. In the circumstance of impairment, the loss would be measured as the excess of the carrying amount of the asset group over its fair value. The key assumptions used in estimating the fair value of impaired assets may include projected cash flows and discount rate. | For stores assessed by management as having indicators of impairment, a 10% decrease in the sales assumption used to project future cash flows in the impairment testing performed as of January 30, 2016 would have increased the Fiscal 2015 impairment charge by an insignificant amount. | |
37
Policy | Effect if Actual Results Differ from Assumptions | |
Income Taxes | ||
The provision for income taxes is determined using the asset and liability approach. Tax laws often require items to be included in tax filings at different times than the items are being reflected in the financial statements. A current liability is recognized for the estimated taxes payable for the current year. Deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. Deferred taxes are adjusted for enacted changes in tax rates and tax laws. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. | The Company does not expect material changes in the judgments, assumptions or interpretations used to calculate the tax provision for Fiscal 2015. However, changes in these judgments, assumptions or interpretations may occur and could have a material impact on the Company’s income tax provision. As of the end of Fiscal 2015, the Company had recorded valuation allowances of $1.6 million. | |
A provision for U.S. income tax has not been recorded on undistributed net income of our non-U.S. subsidiaries earned through October 31, 2015, which the Company has determined to be indefinitely reinvested outside the U.S. Following a corporate restructuring to support omnichannel growth, the Company has provided deferred U.S. income taxes for net income generated after October 31, 2015 from its non-U.S. subsidiaries. | If the Company’s intention or U.S. and/or international tax law changes in the future, there may be a material impact on the provision for income taxes in the period the change occurs. The amount of indefinitely reinvested net income that would be subject to U.S. income tax upon repatriation and for which no U.S. income taxes have been provided is $126.6 million as of January 30, 2016. | |
The Company records uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. Uncertain tax positions are adjusted periodically based on currently available evidence. Changes will impact the income tax provision and the effective tax rate in the period in which an adjustment is made. The Company recognizes accrued interest and penalties related to uncertain tax positions as a component of tax expense. | Of the total amount accrued for uncertain tax positions, it is reasonably possible that $1.25 million to $1.75 million could change in the next 12 months due to audit settlements, expiration of statutes of limitations or other resolution of uncertainties. Due to the uncertain and complex application of tax laws and/or regulations, it is possible that the ultimate resolution of audits may result in amounts which could be different from the amount estimated. In such case, the Company will record an adjustment in the period in which such matters are effectively settled. | |
Legal Contingencies | ||
The Company is a defendant in lawsuits and other adversarial proceedings arising in the ordinary course of business. Legal costs incurred in connection with the resolution of claims and lawsuits are expensed as incurred, and the Company establishes reserves for the outcome of litigation where it is probable that a loss has been incurred and such loss is estimable. Significant judgment may be applied in assessing the probability of loss and in estimating the amount of such losses. | Actual liabilities may exceed or be less than the amounts reserved, and there can be no assurance that the final resolution of these matters will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows. | |
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Investment Securities
The Company maintains its cash equivalents in financial instruments, primarily money market funds and U.S. treasury bills, with original maturities of three months or less.
The irrevocable rabbi trust (the “Rabbi Trust”) is intended to be used as a source of funds to match respective funding obligations to participants in the Abercrombie & Fitch Co. Nonqualified Savings and Supplemental Retirement Plan I, the Abercrombie & Fitch Co. Nonqualified Savings and Supplemental Retirement Plan II and the Supplemental Executive Retirement Plan. The Rabbi Trust assets primarily consist of trust-owned life insurance policies which are recorded at cash surrender value. The change in cash surrender value of the trust-owned life insurance policies held in the Rabbi Trust resulted in realized gains of $3.1 million, $3.2 million and $2.6 million for Fiscal 2015, Fiscal 2014 and Fiscal 2013, respectively, recorded in interest expense, net on the Consolidated Statements of Operations and Comprehensive Income (Loss).
38
The Rabbi Trust assets are included in other assets on the Consolidated Balance Sheets as of January 30, 2016 and January 31, 2015, and are restricted in their use as noted above.
Interest Rate Risks
The Company has approximately $293.3 million in gross borrowings outstanding under its term loan facility (the "Term Loan Facility") and no borrowings outstanding under its senior secured revolving credit facility (the "ABL Facility" and, together with the Term Loan Facility, the "2014 Credit Facilities"). The 2014 Credit Facilities carry interest rates that are tied to LIBOR, or an alternate base rate, plus a margin. The interest rate on the Term Loan Facility has a 100 basis point LIBOR floor, and assuming no changes in the Company’s financial structure as it stands, an increase in market interest rates of 100 basis points would have an effect on annual interest expense of approximately $1.9 million. This hypothetical analysis for Fiscal 2015 may differ from the actual change in interest expense due to various conditions which may result in changes in interest rates under the Company’s 2014 Credit Facilities.
Foreign Exchange Rate Risk
A&F’s international subsidiaries generally operate with functional currencies other than the U.S. Dollar. Since the Company’s Consolidated Financial Statements are presented in U.S. Dollars, the Company must translate revenues, expenses, assets and liabilities from functional currencies into U.S. Dollars at exchange rates in effect during or at the end of the reporting period. The fluctuation in the value of the U.S. Dollar against other currencies affects the reported amounts of revenues, expenses, assets and liabilities. The potential impact of currency fluctuation increases as international expansion increases.
A&F and its subsidiaries have exposure to changes in foreign currency exchange rates associated with foreign currency transactions and forecasted foreign currency transactions, including the sale of inventory between subsidiaries and foreign currency denominated assets and liabilities. The Company has established a program that primarily utilizes foreign currency forward contracts to partially offset the risks associated with the effects of certain foreign currency transactions and forecasted transactions. Under this program, increases or decreases in foreign currency exposures are partially offset by gains or losses on forward contracts, to mitigate the impact of foreign currency gains or losses. The Company does not use forward contracts to engage in currency speculation. All outstanding foreign currency forward contracts are recorded at fair value at the end of each fiscal period.
The fair value of outstanding foreign currency exchange forward contracts included in other current assets was $4.2 million and $10.3 million as of January 30, 2016 and January 31, 2015, respectively. The fair value of outstanding foreign currency exchange forward contracts included in other liabilities was insignificant as of January 30, 2016 and January 31, 2015. Foreign currency exchange forward contracts are sensitive to changes in foreign currency exchange rates. The Company assessed the risk of loss in fair values from the effect of a hypothetical 10% devaluation of the U.S. Dollar against the exchange rates for foreign currencies under contract. The results would decrease derivative contract fair values by approximately $13.0 million. As the Company's foreign currency exchange forward contracts are primarily designated as cash flow hedges of forecasted transactions, the hypothetical change in fair value would be largely offset by the net change in fair values of the underlying hedged items.
39
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
ABERCROMBIE & FITCH CO.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Thousands, except per share amounts)
2015 | 2014 | 2013 | |||||||||
Net sales | $ | 3,518,680 | $ | 3,744,030 | $ | 4,116,897 | |||||
Cost of sales, exclusive of depreciation and amortization | 1,361,137 | 1,430,460 | 1,541,462 | ||||||||
Gross profit | 2,157,543 | 2,313,570 | 2,575,435 | ||||||||
Stores and distribution expense | 1,604,214 | 1,703,051 | 1,907,687 | ||||||||
Marketing, general and administrative expense | 470,321 | 458,820 | 481,784 | ||||||||
Restructuring (benefit) charge | (1,598 | ) | 8,431 | 81,500 | |||||||
Asset impairment | 18,209 | 44,988 | 46,715 | ||||||||
Other operating income, net | (6,441 | ) | (15,239 | ) | (23,074 | ) | |||||
Operating income | 72,838 | 113,519 | 80,823 | ||||||||
Interest expense, net | 18,248 | 14,365 | 7,546 | ||||||||
Income before taxes | 54,590 | 99,154 | |||||||||