Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read together with the Company’s Condensed Consolidated Financial Statements and notes thereto included in this Quarterly Report on Form 10-Q in “ ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) ,” to which all references to Notes in MD&A are made.
INTRODUCTION
MD&A is provided as a supplement to the accompanying Condensed Consolidated Financial Statements and notes thereto to help provide an understanding of the Company’s results of operations, financial condition, and liquidity. MD&A is organized as follows:
•
Overview . This section provides a general description of the Company’s business and certain segment information.
•
Current Trends and Outlook . This section provides a discussion related to COVID-19’s impact on the Company’s business and other certain risks and challenges, as well as a summary of the Company’s performance for the thirteen and twenty-six weeks ended August 1, 2020 and August 3, 2019 .
•
Results of Operations . This section provides an analysis of certain components of the Company’s Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the thirteen and twenty-six weeks ended August 1, 2020 and August 3, 2019 .
•
Liquidity and Capital Resources . This section provides a discussion of the Company’s financial condition, changes in financial condition and liquidity as of August 1, 2020 , which includes (i) an analysis of financial condition as compared to February 1, 2020 ; (ii) an analysis of changes in cash flows for the twenty-six weeks ended August 1, 2020 as compared to the twenty-six weeks ended August 3, 2019 ; and (iii) an analysis of liquidity, including a discussion related to preserving liquidity during COVID-19, remaining availability under the ABL Facility, the Company’s share repurchase and dividend programs, and outstanding debt and covenant compliance.
•
Recent Accounting Pronouncements . The recent accounting pronouncements the Company has adopted or is currently evaluating, including the dates of adoption and/or expected dates of adoption, and anticipated effects on the Company’s Condensed Consolidated Financial Statements, are discussed, as applicable.
•
Critical Accounting Policies and Estimates . This section discusses accounting policies considered to be important to the Company’s results of operations and financial condition, which typically require significant judgment and estimation on the part of management in their application.
•
Non-GAAP Financial Measures . MD&A provides a discussion of certain financial measures that have been determined to not be in accordance with GAAP. This section includes certain reconciliations for non-GAAP financial measures and additional details on these financial measures, including information as to why the Company believes the non-GAAP financial measures provided within MD&A are useful to investors.
The following risks, categorized by the primary nature of the associated risk, including the disclosures in “ITEM 1A. RISK FACTORS” of A&F’s Annual Report on Form 10-K for Fiscal 2019 , as well as those disclosed in the Current Report on Form 8-K filed with the Securities and Exchange Commission on June 17, 2020 and in “ITEM 1A. RISK FACTORS” of this Quarterly Report on Form 10-Q, in some cases have affected and in the future could affect the Company’s financial performance and cause actual results for Fiscal 2020 and beyond to differ materially from those expressed or implied in any of the forward-looking statements included in this Quarterly Report on Form 10-Q or otherwise made by management. The following risks, or a combination of risks, may be exacerbated by COVID-19 and could result in adverse impacts on the Company’s business, results of operations, financial condition and cash flows.
Macroeconomic and industry risks include:
•
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 impact on our business;
•
Failure to engage our customers, anticipate customer demand and changing fashion trends, and manage our inventory commensurately could have a material adverse impact on our business;
•
Our failure to operate in a highly competitive and constantly evolving industry could have a material adverse impact on our business;
•
Fluctuations in foreign currency exchange rates could have a material adverse impact on our business;
•
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;
24
Table of Contents
•
The impact of war, acts of terrorism, mass casualty events or civil unrest could have a material adverse impact on our business;
•
The impact of extreme weather, infectious disease outbreaks, including COVID-19, and other unexpected events could result in an interruption to our business, as well as to the operations of our third-party partners, and have a material adverse impact on our business; and
•
The current outbreak of the novel coronavirus, or COVID‐19, has materially adversely impacted and disrupted, and may continue to materially adversely impact and cause disruption to, our business, financial performance and condition, operating results, liquidity and cash flows. The spread of the COVID‐19 outbreak has caused significant disruptions in the United States and global economy, the extent of the impact and duration of which is not yet known. Any future outbreak of any other highly infectious or contagious disease could have a similar impact.
Strategic risks include:
•
Failure to successfully develop an omnichannel shopping experience, a significant component of our growth strategy, or failure to successfully invest in customer, digital and omnichannel initiatives could have a material adverse impact on our business;
•
Our failure to optimize our global store network could have a material adverse impact on our business; and
•
Our failure to execute our international growth strategy successfully and inability to conduct business in international markets as a result of legal, tax, regulatory, political and economic risks could have a material adverse impact on our business.
Operational risks include:
•
Failure to protect our reputation could have a material adverse impact on our business;
•
If our information technology systems are disrupted or cease to operate effectively it could have a material adverse impact on our business;
•
We may be exposed to risks and costs associated with cyber-attacks, data protection, credit card fraud and identity theft that could have a material adverse impact on our business;
•
Our reliance on our distribution centers makes us susceptible to disruptions or adverse conditions affecting our supply chain;
•
Changes in the cost, availability and quality of raw materials, labor, transportation, and trade relations could have a material adverse impact on our business;
•
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 have a material adverse impact on our business; and
•
We rely on the experience and skills of our executive officers and associates, and the failure to attract or retain this talent, or effectively manage succession could have a material adverse impact on our business.
Legal, tax, regulatory and compliance risks include:
•
Fluctuations in our tax obligations and effective tax rate may result in volatility in our results of operations and could have a material adverse impact on our business;
•
Our litigation exposure, or any securities litigation and shareholder activism, could have a material adverse impact on our business;
•
Failure to adequately protect our trademarks could have a negative impact on our brand image and limit our ability to penetrate new markets which could have a material adverse impact on our business;
•
Changes in the regulatory or compliance landscape could have a material adverse impact on our business; and
•
The agreements related to our senior secured asset-based revolving credit facility and our senior secured notes include restrictive covenants that limit our flexibility in operating our business and our inability to obtain credit on reasonable terms in the future could have an adverse impact on our business.
The factors listed above are not our only risks. Additional risks may arise, and current evaluations of risks may change, which could lead to material, adverse effects on our business, operating results and financial condition.
The Company cautions that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this Quarterly Report on Form 10-Q or made by the Company, its management or spokespeople involve risks and uncertainties and are subject to change based on various important factors, many of which may be beyond the Company’s control. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” and similar expressions may identify forward-looking statements. Future economic and industry trends that could potentially impact revenue and profitability are difficult to predict. Therefore, there can be no assurance that the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties in the forward-looking statements included herein, including the uncertainty surrounding COVID-19, the inclusion of such information should not be regarded as a representation by the Company, or any other person, that the objectives of the Company will be achieved. The forward-looking statements included herein are based on information presently available to the management of the Company. Except as may be required by applicable law, the Company assumes no obligation to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.
25
Table of Contents
OVERVIEW
Business summary
The Company is a global multi-brand omnichannel specialty retailer, whose products are sold primarily through its Company-owned store and digital channels, as well as through various third-party wholesale, franchise and licensing arrangements. The Company offers a broad assortment of apparel, personal care products and accessories for men, women and kids under the Hollister, Abercrombie & Fitch and abercrombie kids brands. The brands share a commitment to offering unique products of enduring quality and exceptional comfort that allow customers around the world to express their own individuality and style. The Company primarily has operations in North America, Europe and Asia, among other regions.
The Company’s two operating segments are brand-based: Hollister and Abercrombie, the latter of which includes the Company’s Abercrombie & Fitch and abercrombie kids brands.
The Company’s fiscal year ends on the Saturday closest to January 31. All references herein to the Company’s fiscal years are as follows:
Fiscal year
Year ended
Number of weeks
Fiscal 2018
February 2, 2019
52
Fiscal 2019
February 1, 2020
52
Fiscal 2020
January 30, 2021
52
Due to the seasonal nature of the retail apparel industry, the results of operations for any current period are not necessarily indicative of the results expected for the full fiscal year and the Company could have significant fluctuations in certain asset and liability accounts. The Company historically experiences its greatest sales activity during the fall season, the third and fourth fiscal quarters, due to back-to-school and holiday sales periods, respectively.
CURRENT TRENDS AND OUTLOOK
COVID-19
In January 2020, the Company began to experience business disruptions in the Asia-Pacific (“APAC”) region as a result of COVID-19. In February 2020, the situation escalated as the scope of COVID-19 worsened beyond the APAC region, with the United States (the “U.S.”) and the Europe, Middle East and Africa (“EMEA”) region experiencing significant outbreaks. In March 2020, the COVID-19 outbreak was declared to be a global pandemic by the World Health Organization. In response to COVID-19, certain governments have imposed travel restrictions and local statutory quarantines and the Company has recommended associates who are able to perform their role remotely to do so. The Company is reacting to COVID-19 on a daily basis, including by conforming to local government guidance and monitoring developments in government legislation or other government actions in response to the COVID-19 outbreak.
As a result of COVID-19, in January 2020, the Company temporarily closed the majority of its stores in the APAC region and in March 2020, the Company temporarily closed its stores across brands in North America and the EMEA region. The majority of APAC stores were reopened during March 2020, and the Company began to reopen stores in North America and the EMEA region on a rolling basis in late April 2020. The Company had reopened approximately 90% of Company-operated stores for in-store service as of August 1, 2020, which has since increased to approximately 95% as of September 3, 2020, representing 100% of international stores and the majority of U.S. stores, although many with modified operating hours. The Company plans to follow the guidance of local governments to determine when it can reopen remaining stores and to evaluate whether further store closures will be necessary.
The Company has also implemented a range of precautionary health and safety measures with the well-being of the Company’s customers, associates and business partners in mind , including:
•
Requiring associates to use face coverings, depending on geographic region;
•
Encouraging or requiring customers to use face coverings, depending on geographic region;
•
Conducting associate wellness checks in accordance with local government direction;
•
Enhancing cleaning routines and installing plexiglass barriers in the majority of store locations;
•
Implementing various measures to encourage social distancing, including managing occupancy limits;
•
Encouraging contactless payment options, where available;
•
Opening fitting rooms where permissible, with additional cleaning procedures for clothing that has been tried on;
•
Removing returned merchandise from the sales floor for a period of time where mandated by local government;
•
Reducing store hours in select locations;
•
Continuing to offer Purchase-Online-Pickup-in-Store, including curbside pick-up at a majority of U.S. locations;
•
Following recommended cleaning and distancing measures in the Company's distribution centers; and
•
Maximizing work-from-home and digital collaboration alternatives to minimize in-person meetings whenever possible.
26
Table of Contents
The Company has seen, and may continue to see material reductions in sales across brands and regions as a result of COVID-19. Total net sales decreased approximately 17% and 25% for the thirteen and twenty-six weeks ended August 1, 2020 as compared to the comparable periods ended August 3, 2019, respectively, primarily driven by temporary store closures and a decline in traffic as compared to the previous year as a result of COVID-19. For the U.S. and the EMEA region, which collectively accounted for 89% of total net sales in Fiscal 2019, the Company experienced sales productivity for reopened stores of approximately 75% and 60% , respectively, as compared to last year’s levels during the thirteen weeks ended August 1, 2020 .
The Company’s digital operations across brands have continued to serve the Company’s customers during this unprecedented period of temporary store closures as the Company’s distribution centers implemented enhanced cleaning and social distancing measures in order to remain operational. Digital sales increased approximately 56% and 41% for the thirteen and twenty-six weeks ended August 1, 2020 as compared to the comparable periods ended August 3, 2019, respectively. Despite the recent strength in digital sales, the Company has historically generated the majority of its annual net sales through stores and there can be no assurance that the current performance in the digital channel will continue.
The Company has seen, and expects to continue to see, material adverse impacts as a result of COVID-19. As a result, for the third quarter of Fiscal 2020, the Company expects net sales to be down in the range of 15% to 20% as compared to last year. The current circumstances and the impacts of COVID-19 on the Company’s operations, including the duration and impact on overall customer demand, are dynamic, and this sales expectation assumes that the back-to-school selling season, which generally occurs in August, will extend through September and potentially October as school resumes throughout the U.S. and the weather becomes more seasonal.
The Company is also focused on managing inventories and the impacts COVID-19 has had, and continues to have, on its global supply chain, including potential disruptions of product deliveries. The Company sources the majority of its merchandise outside of the U.S. through arrangements with vendors primarily located in southeast Asia and, as of August 1, 2020, the vast majority of the factories the Company partners with were operating at full capacity. In order to complete production, these manufacturing factories are dependent on raw materials from fabric mills that are primarily located in the APAC region. The Company continues to collaborate with its third-party partners to mitigate significant delays in delivery of merchandise. During Fiscal 2020, the Company has reduced certain orders that were not already in production, delayed and recadenced deliveries and implemented various strategies to tightly manage inventories, including utilizing ship-from-store capabilities in select locations.
Despite these near-term challenges presented by COVID-19, the Company remains committed to, and confident in, its long-term vision. The Company continues to evaluate opportunities to make progress against its key transformation initiatives while balancing the near-term challenges and unprecedented uncertainty presented by COVID-19. The Company’s progress executing against the following key transformation initiatives has created the foundation to allow the Company to respond quickly to COVID-19:
•
Optimizing the global store network;
•
Enhancing digital and omnichannel capabilities;
•
Increasing the speed and efficiency of the concept-to-customer product life cycle by further investing in capabilities to position the supply chain for greater speed, agility and efficiency, while leveraging data and analytics to offer the right product at the right time and the right price; and
•
Improving customer engagement through loyalty programs and marketing optimization.
The Company entered this period of uncertainty with a healthy liquidity position and has taken and continues to take immediate, aggressive and prudent actions, including reevaluating all expenditures, to balance short and long-term liquidity needs, in order to best position the business for its key stakeholders. Actions to preserve liquidity and manage cash flows during Fiscal 2020, include, but are not limited to:
•
Partnering with merchandise and non-merchandise vendors in regards to payment terms;
•
Recadencing inventory receipts to better align inventory with expected market demand;
•
Reducing expenses to better align operating costs with sales;
•
Borrowing $210.0 million under the ABL Facility in March 2020 which was then repaid in July 2020 along with the Term Loan Facility, using proceeds from the issuance of the Senior Secured Notes and existing cash on hand;
•
Withdrawing $50.0 million from the overfunded Rabbi Trust assets, which represented the majority of excess funds;
•
Temporarily suspending the Company's share repurchase and dividend programs; and
•
Assessing government policy and economic stimulus responses to COVID-19 for both business and individuals.
In addition, despite the Company’s recent history of partnering with its vendors regarding payment terms, there can be no assurance that the Company will be able to maintain extended payment terms or continue to defer payments, which may result in incremental operating cash outflows in future periods.
As of August 1, 2020 , the Company had liquidity of $1.061 billion as compared to $913.8 million as of February 1, 2020, comprising cash and equivalents and actual incremental borrowing available to the Company under the ABL Facility.
It is possible that our preparations for the events listed above are not adequate to mitigate their impact, and that these events could further adversely affect our business and results of operations. For a discussion of significant risks that have the potential to cause our actual results to differ materially from our expectations, refer to the disclosures under the heading “FORWARD-LOOKING STATEMENTS AND RISK FACTORS” in “ITEM 1A. RISK FACTORS” of A&F’s Annual Report on Form 10-K for Fiscal 2019 .
27
Table of Contents
United Kingdom’s withdrawal from the European Union (“Brexit”)
In June 2016, the United Kingdom passed a referendum to recommend withdrawing from the European Union. Although the United Kingdom left the European Union in January 2020, the final terms of the United Kingdom’s withdrawal remain unclear. The Company believes that this referendum and the uncertainty surrounding the terms of the United Kingdom’s withdrawal adversely impacted international sales results in Fiscal 2019, with decreased traffic and declining values of the Euro and British Pound as compared to the U.S. Dollar over Fiscal 2018.
Upon withdrawal from the European Union in January 2020, the United Kingdom entered a transition period during which there will be on-going negotiations. During this transition period, the United Kingdom’s existing trading relationship with the European Union will remain in place and it will continue to follow the European Union's rules. It is not clear at this time what, if any, agreements will be reached by the current December 31, 2020 transition period deadline, or the impact that COVID-19 may have on the negotiation timeline .
There is continued uncertainty related to the impact on consumer behavior, trade relations, economic conditions, foreign currency exchange rates and the free movement of goods, services, people and capital between the United Kingdom and the European Union during this time of transition. The United Kingdom’s withdrawal from the European Union could also adversely impact other areas of the business, including, but not limited to, an increase in duties and delays in the delivery of merchandise from the Company’s Netherlands distribution center to its customers in the United Kingdom if trade barriers materialize. The United Kingdom’s withdrawal from the European Union could also adversely impact the operations of the Company’s vendors and of our other third-party partners.
In order to mitigate the risks associated with the United Kingdom’s withdrawal from the European Union, the Company is: collaborating across the organization and testing systems; working with external partners to develop contingency plans for potential adverse impacts; and taking actions to reduce, to the extent possible, the potential impact of any incremental duty exposure. It is possible that preparations for the events listed above are not adequate to mitigate their impact, and that these events could further adversely affect the business and results of operations.
Global Store Network Optimization
A component of optimizing the Company’s global store fleet is pivoting away from large format flagship stores and striving towards opening smaller, more productive omnichannel focused brand experiences. As a result, the Company has closed certain of its flagship stores and may have additional closures as the Company executes against this strategy. Although some of these closures may be completed through natural lease expirations, certain other of the Company’s leases include early termination options that can be exercised under specific conditions. The Company may also elect to exit or modify other leases, and could incur charges or realize benefits related to these actions.
For context, at the beginning of Fiscal 2019 , the Company had 19 flagship stores, and as of the end of the second quarter of Fiscal 2020 , the Company had 15 flagship stores. Details related to recently closed flagship stores follow:
Brand (1)
Flagship location
Timing of store closure
Abercrombie & Fitch
Pedder Street, Hong Kong Special Administrative Region, China
First quarter of Fiscal 2017
Abercrombie & Fitch
Copenhagen, Denmark
First quarter of Fiscal 2019
Hollister
SoHo, New York City, U.S.
Second quarter of Fiscal 2019
Abercrombie
Milan, Italy
Fourth quarter of Fiscal 2019
abercrombie kids (2)
London, United Kingdom
Fourth quarter of Fiscal 2019
(1)
Abercrombie includes the Abercrombie & Fitch and abercrombie kids brands and, when used in the table above, signifies a location with an abercrombie kids carveout within an Abercrombie & Fitch store that would be represented as a single store count.
(2)
The abercrombie kids store in London will be converted to corporate office space and the location will be utilized as the Company’s EMEA regional headquarters.
28
Table of Contents
Additional details related to store count and gross square footage follow:
Hollister (1)
Abercrombie (2)
Total Company
U.S.
International
U.S.
International
U.S.
International
Total
Number of stores:
February 1, 2020
391
155
256
52
647
207
854
New
1
2
2
4
3
6
9
Permanently closed
(6)
(2)
(5)
—
(11)
(2)
(13)
August 1, 2020
386
155
253
56
639
211
850
Gross square footage (in thousands) :
August 1, 2020
2,568
1,265
1,811
633
4,379
1,898
6,277
(1)
Locations with Gilly Hicks carveouts within Hollister stores are represented as a single store count. Excludes nine international franchise stores as of each of August 1, 2020 and February 1, 2020 . Excludes 15 Company-operated temporary stores as of August 1, 2020 and 16 as of February 1, 2020 .
(2)
Abercrombie includes the Company's Abercrombie & Fitch and abercrombie kids brands. Locations with abercrombie kids carveouts within Abercrombie & Fitch stores are represented as a single store count. Excludes eight international franchise stores as of each of August 1, 2020 and seven as of February 1, 2020 . Excludes six Company-operated temporary stores as of August 1, 2020 and eight as of February 1, 2020 .
Summary of results
A summary of results for the thirteen and twenty-six weeks ended August 1, 2020 and August 3, 2019 follows:
GAAP
Non-GAAP (1)
(in thousands, except change in net sales, gross profit rate, operating margin and per share amounts)
August 1, 2020 (2)
August 3, 2019 (3)
August 1, 2020 (2)
August 3, 2019 (3)
Thirteen Weeks Ended
Net sales
$
698,328
$
841,078
Change in net sales
(17.0
)%
(0.2
)%
Gross profit rate
60.7
%
59.3
%
Operating income (loss)
$
14,143
$
(39,484
)
$
22,226
$
(39,484
)
Operating income (loss) margin
2.0
%
(4.7
)%
3.2
%
(4.7
)%
Net income (loss) attributable to A&F
$
5,464
$
(31,142
)
$
14,713
$
(31,142
)
Net income (loss) per diluted share attributable to A&F
$
0.09
$
(0.48
)
$
0.23
$
(0.48
)
Twenty-six Weeks Ended
Net sales
$
1,183,687
$
1,575,050
Change in net sales
(24.8
)%
0.1
%
Gross profit rate
58.1
%
59.9
%
Operating loss
$
(194,984
)
$
(66,742
)
$
(143,973
)
$
(66,742
)
Operating loss margin
(16.5
)%
(4.2
)%
(12.2
)%
(4.2
)%
Net loss attributable to A&F
$
(238,684
)
$
(50,297
)
$
(190,939
)
$
(50,297
)
Net loss per diluted share attributable to A&F
$
(3.82
)
$
(0.76
)
$
(3.05
)
$
(0.76
)
(1)
Discussion as to why the Company believes that these non-GAAP financial measures are useful to investors is provided below under “ NON-GAAP FINANCIAL MEASURES .”
(2)
Results for Fiscal 2020 reflect significant adverse tax impacts related to valuation allowances on deferred tax assets and other tax charges. Refer to Note 11, “ INCOME TAXES .”
(3)
Results for Fiscal 2019 reflect significant adverse impacts related to flagship store exit charges. Refer to Note 17, “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES .”
Certain components of the Company’s Condensed Consolidated Balance Sheets as of August 1, 2020 and February 1, 2020 were as follows:
(in thousands)
August 1, 2020
February 1, 2020
Cash and equivalents
$
766,721
$
671,267
Gross long-term borrowings outstanding, carrying amount
$
350,000
$
233,250
Inventories
$
453,239
$
434,326
Certain components of the Company’s Condensed Consolidated Statements of Cash Flows for the twenty-six week periods ended August 1, 2020 and August 3, 2019 were as follows:
(in thousands)
August 1, 2020
August 3, 2019
Net cash provided by (used) for operating activities
$
96,233
$
(36,055
)
Net cash used for investing activities
$
(75,621
)
$
(94,224
)
Net cash provided by (used) for financing activities
$
71,329
$
(91,924
)
29
Table of Contents
RESULTS OF OPERATIONS
Net sales
The Company’s net sales by operating segment for the thirteen and twenty-six weeks ended August 1, 2020 and August 3, 2019 were as follows:
Thirteen Weeks Ended
(in thousands)
August 1, 2020
August 3, 2019
$ Change
% Change
Hollister
$
429,248
$
504,758
$
(75,510
)
(15)%
Abercrombie (1)
269,080
336,320
(67,240
)
(20)%
Total
$
698,328
$
841,078
$
(142,750
)
(17)%
Twenty-six Weeks Ended
(in thousands)
August 1, 2020
August 3, 2019
$ Change
% Change
Hollister
$
702,260
$
933,203
$
(230,943
)
(25)%
Abercrombie (1)
481,427
641,847
(160,420
)
(25)%
Total
$
1,183,687
$
1,575,050
$
(391,363
)
(25)%
(1)
Includes Abercrombie & Fitch and abercrombie kids brands.
Net sales by geographic area are presented by attributing revenues to an individual country on the basis of the country in which the merchandise was sold for in-store purchases and the shipping location provided by customers for digital orders. The Company’s net sales by geographic area for the thirteen and twenty-six weeks ended August 1, 2020 and August 3, 2019 were as follows:
Thirteen Weeks Ended
(in thousands)
August 1, 2020
August 3, 2019
$ Change
% Change
U.S.
$
458,671
$
543,472
$
(84,801
)
(16)%
EMEA
171,297
200,642
(29,345
)
(15)%
APAC
41,814
67,350
(25,536
)
(38)%
Other
26,546
29,614
(3,068
)
(10)%
International
$
239,657
$
297,606
$
(57,949
)
(19)%
Total
$
698,328
$
841,078
$
(142,750
)
(17)%
Twenty-six Weeks Ended
(in thousands)
August 1, 2020
August 3, 2019
$ Change
% Change
U.S.
$
781,533
$
1,013,130
$
(231,597
)
(23)%
EMEA
283,951
374,586
(90,635
)
(24)%
APAC
74,150
132,926
(58,776
)
(44)%
Other
44,053
54,408
(10,355
)
(19)%
International
$
402,154
$
561,920
$
(159,766
)
(28)%
Total
$
1,183,687
$
1,575,050
$
(391,363
)
(25)%
For the second quarter of Fiscal 2020 , net sales decreased 17% as compared to the second quarter of Fiscal 2019 , primarily due to a decrease in units sold driven by temporary store closures and a decline in store traffic across brands as a result of COVID-19, partially offset by 56% digital sales growth. Average unit retail increased year-over-year, driven by less promotions and lower clearance levels, with changes in foreign currency exchange rates adversely impacted net sales by $2 million .
For the year-to-date period of Fiscal 2020 , net sales decreased 25% as compared to the year-to-date period of Fiscal 2019 , primarily due to a decrease in units sold driven by temporary store closures and a decline in store traffic across brands as a result of COVID-19, partially offset by 41% digital sales growth. Average unit retail decreased year-over-year, driven by strategic and targeted promotions in response to the retail environment, with changes in foreign currency exchange rates adversely impacting net sales by $9 million . Excluding the adverse impact of changes in foreign currency exchange rates, net sales for the year-to-date period of Fiscal 2020 decreased 24% as compared to the year-to-date period of Fiscal 2019 .
30
Table of Contents
Cost of sales, exclusive of depreciation and amortization
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Cost of sales, exclusive of depreciation and amortization
$
274,720
39.3%
$
342,445
40.7%
(140)
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Cost of sales, exclusive of depreciation and amortization
$
495,934
41.9%
$
632,327
40.1%
180
(1)
The estimated basis point (“BPS”) change has been rounded based on the change in the percentage of net sales.
For the second quarter of Fiscal 2020 , cost of sales, exclusive of depreciation and amortization, as a percentage of net sales decreased by approximately 140 basis points as compared to the second quarter of Fiscal 2019 . The year-over-year decline was primarily attributable to increased average unit retail without a corresponding increase in average unit cost, which was flat year-over-year.
For the year-to-date period of Fiscal 2020 , cost of sales, exclusive of depreciation and amortization, as a percentage of net sales increased by approximately 180 basis points as compared to the year-to-date period of Fiscal 2019 , primarily driven by adverse impacts of approximately $15 million related to charges reducing the carrying value of inventory during the first quarter of Fiscal 2020.
Gross profit, exclusive of depreciation and amortization
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Gross profit, exclusive of depreciation and amortization
$
423,608
60.7%
$
498,633
59.3%
140
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Gross profit, exclusive of depreciation and amortization
$
687,753
58.1%
$
942,723
59.9%
(180)
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
31
Table of Contents
Stores and distribution expense
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Stores and distribution expense
$
310,370
44.4%
$
376,347
44.7%
(30)
Twenty-six Weeks Ended
November 2, 2019
November 3, 2018
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Stores and distribution expense
$
632,494
53.4%
$
732,959
46.5%
690
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
For the second quarter of Fiscal 2020 , stores and distribution expense decreased 18% as compared to the second quarter of Fiscal 2019 , primarily driven by a $38 million reduction in payroll expense driven by temporary store closures in response to COVID-19, net of a benefit of $3 million related to expected government subsidies in certain jurisdictions where the Company qualifies. The Company also experienced a $26 million reduction in store occupancy expense driven by temporary store closures in response to COVID-19. These reductions in expense were partially offset by a $10 million increase in shipping and handling expense related to 56% year-over-year digital sales growth.
For the second quarter of Fiscal 2020 , stores and distribution expense as a percentage of net sales decreased by approximately 30 basis points as compared to the second quarter of Fiscal 2019 .
For the year-to-date period of Fiscal 2020 , stores and distribution expense decreased 14% as compared to the year-to-date period of Fiscal 2019 , primarily driven by a $66 million reduction in payroll expense driven by temporary store closures in response to COVID-19, net of a benefit of $12 million related to expected government subsidies in certain jurisdictions where the Company qualifies. The Company also experienced a $40 million reduction in store occupancy expense driven by temporary store closures in response to COVID-19. These reductions in expense were partially offset by a $19 million increase in shipping and handling expense related to 41% year-over-year digital sales growth.
For the year-to-date period of Fiscal 2020 , stores and distribution expense as a percentage of net sales increased by approximately 690 basis points as compared to the year-to-date period of Fiscal 2019 , primarily due to the deleverage associated with lost sales from temporary store closures in response to COVID-19.
Marketing, general and administrative expense
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Marketing, general and administrative expense
$
97,252
13.9%
$
115,694
13.8%
10
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Marketing, general and administrative expense
$
205,509
17.4%
$
227,641
14.5%
290
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
For the second quarter of Fiscal 2020 , marketing, general and administrative expense decreased 16% as compared to the second quarter of Fiscal 2019 , primarily driven by reductions in marketing, payroll and other controllable expenses.
For the year-to-date period of Fiscal 2020 , marketing, general and administrative expense decreased 10% as compared to the year-to-date period of Fiscal 2019 , primarily driven by marketing and other controllable expenses. For the year-to-date period of Fiscal 2020 , marketing, general and administrative expense as a percentage of net sales increased by approximately 290 basis points as compared to the year-to-date period of Fiscal 2019 , primarily due to the deleverage associated with lost sales from temporary store closures in response to COVID-19.
32
Table of Contents
Flagship store exit (benefits) charges
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Flagship store exit (benefits) charges
$
(3,884
)
(0.6)%
$
44,994
5.3%
(590)
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Flagship store exit (benefits) charges
$
(4,427
)
(0.4)%
$
46,738
3.0%
(340)
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
Flagship store exit charges for the second quarter and year-to-date period of Fiscal 2019 , primarily relate to the closure of the Company’s SoHo, New York City Hollister flagship store. Refer to Note 17 , “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES .”
Asset impairment, exclusive of flagship store exit charges
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Asset impairment, exclusive of flagship store exit charges
$
8,083
1.2%
$
715
0.1%
110
Excluded items:
Asset impairment charges (2)
(8,083
)
(1.2)%
—
0.0%
(120)
Adjusted non-GAAP asset impairment, exclusive of flagship store exit charges
$
—
0.0%
$
715
0.1%
(10)
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Asset impairment, exclusive of flagship store exit charges
$
51,011
4.3%
$
2,377
0.2%
410
Excluded items:
Asset impairment charges (2)
(51,011
)
(4.3)%
—
0.0%
(430)
Adjusted non-GAAP asset impairment, exclusive of flagship store exit charges
$
—
0.0%
$
2,377
0.2%
(20)
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
(2)
Refer to “ NON-GAAP FINANCIAL MEASURES , ” for further details.
Refer to Note 9 , “ ASSET IMPAIRMENT .”
Other operating income (loss), net
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Other operating income (loss), net
$
2,356
0.3%
$
(367
)
—%
(30)
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Other operating income, net
$
1,850
0.2%
$
250
—%
(20)
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
33
Table of Contents
Operating income (loss)
Thirteen Weeks Ended
August 1, 2020
August 3, 2019 (1)
(in thousands)
% of Net sales
% of Net sales
BPS Change (2)
Operating income (loss)
$
14,143
2.0%
$
(39,484
)
(4.7)%
670
Excluded items:
Asset impairment charges (3)
8,083
1.2%
—
0.0%
120
Adjusted non-GAAP operating income (loss)
$
22,226
3.2%
$
(39,484
)
(4.7)%
790
Impact from changes in foreign currency exchange rates
—
0.0%
926
0.1%
(10)
Adjusted non-GAAP operating income (loss) on a constant currency basis (3)
$
22,226
3.2%
$
(38,558
)
(4.6)%
780
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (2)
Operating loss
$
(194,984
)
(16.5)%
$
(66,742
)
(4.2)%
(1,230)
Excluded items:
Asset impairment charges (3)
51,011
4.3%
—
0.0%
430
Adjusted non-GAAP operating loss
$
(143,973
)
(12.2)%
$
(66,742
)
(4.2)%
(800)
Impact from changes in foreign currency exchange rates
—
0.0%
(2,189
)
(0.1)%
10
Adjusted non-GAAP operating loss on a constant currency basis (3)
$
(143,973
)
(12.2)%
$
(68,931
)
(4.4)%
(780)
(1)
Fiscal 2019 results include $45.0 million of flagship store exit charges for the thirteen weeks ended August 3, 2019 . Refer to Note 17, “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES .”
(2)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
(3)
Refer to “ NON-GAAP FINANCIAL MEASURES , ” for further details.
Interest expense, net
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net sales
% of Net sales
BPS Change (1)
Interest expense
$
7,761
1.1%
$
4,479
0.5%
60
Interest income
(663
)
(0.1)%
(3,109
)
(0.4)%
30
Interest expense, net
$
7,098
1.0%
$
1,370
0.2%
80
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (1)
Interest expense
$
12,834
1.1%
$
9,011
0.6%
50
Interest income
(2,365
)
(0.2)%
(7,025
)
(0.4)%
20
Interest expense, net
$
10,469
0.9%
$
1,986
0.1%
80
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
For the second quarter of Fiscal 2020 , interest expense, net increased $5.7 million as compared to the second quarter of Fiscal 2019 . For the year-to-date period of Fiscal 2020 , interest expense, net increased $8.5 million as compared to the year-to-date period of Fiscal 2019 .
The increase in interest expense, net, for the aforementioned periods is primarily driven by lower interest income earned on the company’s investments and cash holdings and higher interest expense in the current year, reflecting an increase in interest expense related to certain of the Company’s long-term obligations and incremental expense in connection with the issuance of the Senior Secured Notes, the proceeds of which were primarily used to repay the then outstanding borrowings under the Company’s credit facilities.
34
Table of Contents
Income tax expense (benefit)
Thirteen Weeks Ended
August 1, 2020
August 3, 2019
(in thousands, except ratios)
Effective Tax Rate
Effective Tax Rate
Income tax expense (benefit)
$
1,253
17.8%
$
(11,330
)
27.7%
Excluded items:
Tax effect of pre-tax excluded items (1)
(1,166
)
—
Adjusted non-GAAP income tax expense (benefit)
$
87
0.6%
$
(11,330
)
27.7%
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands, except ratios)
Effective Tax Rate
Effective Tax Rate
Income tax expense (benefit)
$
32,786
(16.0)%
$
(20,918
)
30.4%
Deduct:
Tax effect of pre-tax excluded items (1)
3,266
Adjusted non-GAAP income tax (benefit) expense
$
36,052
(23.3)%
$
(20,918
)
30.4%
(1)
The tax effect of pre-tax excluded items is the difference between the tax provision calculation on a GAAP basis and on an adjusted non-GAAP basis. Refer to “ Operating income (loss) ” for details of pre-tax excluded items.
The Company’s effective tax rate for the year-to-date period of Fiscal 2020 was adversely impacted by $84.1 million of adverse tax impacts, ultimately giving rise to income tax expense on a consolidated pre-tax loss. These adverse tax impacts are as follows:
•
The Company did not recognize income tax benefits on $204.1 million of pre-tax losses generated in the twenty-six weeks ended August 1, 2020 in certain jurisdictions as the Company currently anticipates pre-tax losses in these jurisdictions for the fiscal year, resulting in adverse tax impacts of $47.6 million .
•
The Company recognized discrete charges of $36.5 million related to the establishment of valuation allowances and other tax charges in certain jurisdictions, including, but not limited to Switzerland, Germany and the U.S. principally as a result of the significant adverse impacts of COVID-19.
Refer to Note 11 , “ INCOME TAXES .”
Net income (loss) attributable to A&F
Thirteen Weeks Ended
August 1, 2020
August 3, 2019 (1)
(in thousands)
% of Net sales
% of Net sales
BPS Change (2)
Net income (loss) attributable to A&F
$
5,464
0.8%
$
(31,142
)
(3.7)%
450
Excluded items, net of tax (3)
9,249
1.3%
—
0.0%
130
Adjusted non-GAAP net income (loss) attributable to A&F
$
14,713
2.1%
$
(31,142
)
(3.7)%
580
Twenty-six Weeks Ended
August 1, 2020 (4)
August 3, 2019 (1)
(in thousands)
% of Net Sales
% of Net Sales
BPS Change (3)
Net loss attributable to A&F
$
(238,684
)
(20.2)%
$
(50,297
)
(3.2)%
(1,700)
Excluded items, net of tax (3)
47,745
4.0%
—
0.0%
400
Adjusted non-GAAP net loss attributable to A&F
$
(190,939
)
(16.1)%
$
(50,297
)
(3.2)%
(1,290)
(1)
Results for Fiscal 2019 reflect significant adverse impacts related to flagship store exit charges. Refer to Note 17, “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES .”
(2)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
(3)
Excluded items presented above under “ Operating income (loss) ,” and “ Income tax expense (benefit). ”
(4)
Results for Fiscal 2020 reflect significant adverse tax impacts related to valuation allowances on deferred tax assets and other tax charges. Refer to Note 11, “ INCOME TAXES .”
35
Table of Contents
Net income (loss) per diluted share attributable to A&F
Thirteen Weeks Ended
August 1, 2020 (1)
August 3, 2019 (2)
$ Change
Net income (loss) per diluted share attributable to A&F
$
0.09
$
(0.48
)
$0.57
Excluded items, net of tax (3)
0.15
—
0.15
Adjusted non-GAAP net income (loss) per diluted share attributable to A&F
$
0.23
$
(0.48
)
$0.71
Impact from changes in foreign currency exchange rates
—
0.02
(0.02)
Adjusted non-GAAP net income (loss) per diluted share attributable to A&F on a constant currency basis
$
0.23
$
(0.46
)
$0.69
Twenty-six Weeks Ended
August 1, 2020 (1)
August 3, 2019 (2)
$ Change
Net loss per diluted share attributable to A&F
$
(3.82
)
$
(0.76
)
(3.06)
Excluded items, net of tax (3)
0.76
—
0.76
Adjusted non-GAAP net loss per diluted share attributable to A&F
$
(3.05
)
$
(0.76
)
(2.29)
Impact from changes in foreign currency exchange rates
—
(0.02
)
0.02
Adjusted non-GAAP net loss per diluted share attributable to A&F on a constant currency basis
$
(3.05
)
$
(0.79
)
(2.26)
(1)
Results for Fiscal 2020 reflect significant adverse tax impacts related to valuation allowances on deferred tax assets and other tax charges. Refer to Note 11, “ INCOME TAXES .”
(2)
Results for Fiscal 2019 reflect significant adverse impacts related to flagship store exit charges. Refer to Note 17, “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES .”
(3)
Excluded items presented above under “ Operating income (loss) ,” and “ Income tax expense (benefit). ”
36
Table of Contents
LIQUIDITY AND CAPITAL RESOURCES
Overview
The Company’s capital allocation strategy, priorities and investments are reviewed by the Company’s Board of Directors considering both liquidity and valuation factors. The Company’s current capital allocation strategy is to prioritize navigating the near-term challenges that COVID-19 presents and continuing to fund operating activities. The Company believes that it will have adequate liquidity to fund operating activities over the next 12 months.
Primary sources and uses of cash
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”). The Company generally experiences its greatest sales activity during the Fall season, due to the back-to-school and holiday sales periods. The Company relies on excess operating cash flows, which are largely generated in Fall, to fund operations throughout the year and to reinvest in the business to support future growth. The Company also has the ABL Facility available as a source of additional funding, which is described further below under “ Credit facilities and Senior Secured Notes ”.
As a precautionary measure in response to COVID-19, in March 2020, the Company borrowed $210.0 million under the ABL Facility to improve its near-term cash position and withdrew the majority of excess funds from the overfunded Rabbi Trust assets, providing the Company with $50.0 million of additional cash. In July 2020, the Company completed the issuance of the Senior Secured Notes and received gross proceeds of $350.0 million. The Company used the net proceeds from the offering of the Senior Secured Notes, along with existing cash on hand, to repay outstanding borrowings and accrued interest under the Term Loan Facility and the ABL Facility, with the remaining net proceeds used towards fees and expenses in connection with such repayments and the offering of the Senior Secured Notes.
Over the next twelve months, the Company expects its primary cash requirements to be towards funding operating activities, including the acquisition of inventory, and obligations related to compensation, leases and any lease buyouts or modifications it may exercise, taxes and other operating activities. The Company entered this period of uncertainty with a healthy liquidity position and has taken and continues to take immediate, aggressive and prudent actions, including reevaluating all expenditures, in order to balance the Company’s short and long-term liquidity needs and best position the business for key stakeholders.
The Company also evaluates opportunities for investments in line with its key transformation initiatives that have positioned the business to quickly respond to the COVID-19 pandemic and strives to invest in projects that have high expected returns. These improvements may include new store experiences or investments in its omnichannel initiatives or loyalty programs. In addition, the Company evaluates store closures, including flagship lease buyouts and options to early terminate store leases. Historically, the Company has utilized free cash flow generated from operations to fund any discretionary capital expenditures, which have been prioritized towards new store experiences, as well as digital and omnichannel investments, information technology, and other projects. For the year-to-date period ended August 1, 2020 , the Company used $75.6 million towards capital expenditures. Total capital expenditures for Fiscal 2020 are expected to be approximately $100 million , down from $202.8 million of capital expenditures in Fiscal 2019.
Share repurchases and dividends
In order to preserve liquidity and maintain financial flexibility in light COVID-19, in March 2020, the Company announced that it had temporarily suspended its share repurchase program and in May 2020, the Company announced that it had temporarily suspended its dividend program. The Company will review these temporary suspensions throughout the year to determine, in light of facts and circumstances at that time, whether and when to reinstate these programs.
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 February for Fiscal 2020 and in each of February, May, August and November in Fiscal 2019 and Fiscal 2018. Dividends were paid in March for Fiscal 2020, and each of March, June, September and December in Fiscal 2019 and Fiscal 2018. A&F’s Board of Directors reviews the dividend on a quarterly basis and establishes the dividend amount based on A&F’s financial condition, results of operations, capital requirements, current and projected cash flows, business prospects and other factors, including the potential severity of impacts to the business resulting from COVID-19 and any restrictions related to the company’s agreements related to the Senior Secured Notes and ABL Facility. There can be no assurance that the Company will reinstate its dividend program in the future or, if dividends are paid, that they will be in amounts similar to past dividends.
Historically, the Company has repurchased shares of its Common Stock from time to time, dependent on market and business conditions, with the primary objective to offset dilution from issuances of Common Stock associated with the exercise of employee stock appreciation rights and the vesting of restricted stock units. Shares repurchased may be in the open market, including pursuant to any trading plans established in accordance with Rule 10b5-1 of the Exchange Act, through privately negotiated transactions or other transactions or by a combination of such methods. Refer to “ ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS ” for the number of shares remaining available for purchase under the Company’s June 2019 publicly announced stock repurchase authorization.
37
Table of Contents
Credit facilities and Senior Secured Notes
In July 2020, the Company completed the private offering of the Senior Secured Notes, and received gross proceeds of $350.0 million . The Senior Secured Notes will mature on July 15, 2025 and bear interest at a rate of 8.75% per annum, with semi-annual interest payments beginning in January 2021. The Company’s debt related to the Senior Secured Notes is presented on the Condensed Consolidated Balance Sheet, net of the unamortized fees. As of August 1, 2020 , the Company had $350.0 million of gross borrowings outstanding under the Senior Secured Notes.
In addition, the ABL Facility provides for a senior secured credit facility of up to $400 million. As of August 1, 2020 , the Company did not have any borrowings outstanding under the ABL Facility. The ABL Facility matures on October 19, 2022.
Details regarding the remaining borrowing capacity under the ABL Facility as of August 1, 2020 are as follows:
(in thousands)
August 1, 2020
Borrowing base
$
328,249
Less: Outstanding stand-by letters of credit
(789
)
Borrowing capacity
327,460
Less: Minimum excess availability (1)
(32,825
)
Actual incremental borrowing available
$
294,635
(1)
The Company must maintain excess availability equal to the greater of 10% of the loan cap or $30 million under the ABL Facility.
Refer to Note 12 , “ BORROWINGS .”
Income taxes
The Company’s earnings and profits from its foreign subsidiaries could be repatriated to the U.S., without incurring additional federal income tax. The Company has determined that the balance of the Company’s undistributed earnings and profits from its foreign subsidiaries as of February 2, 2019 are considered indefinitely reinvested outside of the U.S., and if these funds were to be repatriated to the U.S., the Company would expect to incur an insignificant amount of state income taxes and foreign withholding taxes. The Company accrues for both state income taxes and foreign withholding taxes with respect to earnings and profits earned after February 2, 2019, in such a manner that these funds could be repatriated without incurring additional taxes.
As of August 1, 2020 , $350.3 million of the Company’s $766.7 million of cash and equivalents were held by foreign affiliates. The Company is not dependent on dividends from its foreign affiliates to fund its U.S. operations or pay dividends, if any, to A&F’s stockholders.
Refer to Note 11 , “ INCOME TAXES .”
Analysis of cash flows
The table below provides certain components of the Company’s Condensed Consolidated Statements of Cash Flows for the twenty-six weeks ended August 1, 2020 and August 3, 2019 :
Twenty-six Weeks Ended
August 1, 2020
August 3, 2019
(in thousands)
Cash and equivalents, and restricted cash and equivalents, beginning of period
$
692,264
$
745,829
Net cash provided by (used for) operating activities
96,233
(36,055
)
Net cash used for investing activities
(75,621
)
(94,224
)
Net cash provided by (used for) financing activities
71,329
(91,924
)
Effect of foreign currency exchange rates on cash
1,785
(2,455
)
Net increase (decrease) in cash and equivalents, and restricted cash and equivalents
93,726
(224,658
)
Cash and equivalents, and restricted cash and equivalents, end of period
$
785,990
$
521,171
Operating activities - The year-over-year change in operating cash flows was primarily due to actions taken by the Company during Fiscal 2020 to preserve liquidity and manage cash flows in light of COVID-19, including, but not limited to:
•
Partnering with merchandise and non-merchandise vendors regarding payment terms;
•
Reducing and recadencing inventory receipts to better align inventory with expected market demand;
•
Reducing expenses to better align operating costs with sales;
•
Withdrawing $50.0 million from the overfunded Rabbi Trust assets, the majority of excess funds; and
•
Suspending rent payments for a significant number of stores that were closed during Fiscal 2020 as a result of COVID-19, which, coupled with rent abatements and changes in payment cadence, attributed to a year-over-year decrease in cash paid for operating lease liabilities.
38
Table of Contents
These benefits to operating cash flows were partially offset by lower cash receipts as a result of a 25% decrease in net sales from last year driven by temporary store closures and a decline in store traffic in response to COVID-19 during Fiscal 2020.
The Company continues to engage with its landlords to find a mutually beneficial and agreeable path forward. To the extent that the Company is successful in negotiating further rent abatements, these benefits will be recognized as a component of variable lease cost. In addition, despite the Company’s recent history of partnering with its vendors regarding payment terms, there can be no assurance that the Company will be able to maintain extended payment terms or continue to defer payments, which may result in incremental operating cash outflows in future periods.
Investing activities - For the twenty-six weeks ended August 1, 2020 , net cash outflows for investing activities were used for capital expenditures of $75.6 million as compared to $94.2 million for the twenty-six weeks ended August 3, 2019 , reflecting actions taken in Fiscal 2020 to preserve liquidity and manage cash flows in light of the COVID-19 pandemic.
Financing activities - For the twenty-six weeks ended August 1, 2020 , net cash provided by financing activities primarily consisted of the issuance of the Senior Secured Notes and receipt of related gross proceeds of $350.0 million and borrowings under the ABL Facility of $210.0 million. The gross proceeds from the Senior Secured Notes offering were used along with existing cash on hand, to repay all then outstanding borrowings and accrued interest under the Term Loan Facility and ABL Facility, with the remaining net proceeds used towards fees and expenses in connection with such repayments and the offering. In addition, the Company returned $27.7 million to shareholders during the twenty-six weeks ended August 1, 2020, prior to the Company’s decision to temporarily suspend its share repurchase and dividend programs in light of COVID-19, as compared to $84.2 million during the twenty-six weeks ended August 3, 2019 .
Off-balance sheet arrangements
As of August 1, 2020 , the Company did not have any material off-balance sheet arrangements.
Contractual obligations
The Company’s contractual obligations consist primarily of operating leases, purchase orders for merchandise inventory, unrecognized tax benefits, certain retirement obligations, lease deposits and other agreements to purchase goods and services that are legally binding and that require minimum quantities to be purchased. These contractual obligations impact the Company’s short-term and long-term liquidity and capital resource needs.
During the thirteen weeks ended August 1, 2020, the Company issued the Senior Secured Notes, which mature in July 2025. The Company received $350.0 million in proceeds from this transaction and repaid all outstanding borrowings under the ABL Facility and Term Loan Facility. Based on the aggregate principal amount of the Senior Secured Notes outstanding as of August 1, 2020 , estimated interest payments related to the Senior Secured Notes are as follows:
(in thousands)
Total
Fiscal 2020
Fiscal 2021-Fiscal 2023
Fiscal 2024-Fiscal 2025
Fiscal 2026 and thereafter
Interest payments due by period
$
154,231
$
16,418
$
91,875
$
45,938
$
—
Other than the items described above, there have been no material changes during the thirteen weeks ended August 1, 2020 , in the contractual obligations as of February 1, 2020 , with the exception of those obligations which occurred in the normal course of business (primarily changes in the Company’s merchandise inventory-related purchases and lease obligations, which fluctuate throughout the year as a result of the seasonal nature of the Company’s operations).
39
Table of Contents
RECENT ACCOUNTING PRONOUNCEMENTS
The Company describes its significant accounting policies in Note 2, “SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES , ” of the Notes to Consolidated Financial Statements contained in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of A&F’s Annual Report on Form 10-K for Fiscal 2019 . The Company reviews recent accounting pronouncements on a quarterly basis and has excluded discussion of those not applicable to the Company and those that did not have, or are not expected to have, a material impact on the Company’s consolidated financial statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company describes its critical accounting policies and estimates in “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” of A&F’s Annual Report on Form 10-K for Fiscal 2019 . There have been no significant changes in critical accounting policies and estimates since the end of Fiscal 2019 .
Policy
Effect if Actual Results Differ from Assumptions
Long-lived Assets
Long-lived assets, primarily operating lease right-of-use assets, 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 group 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, 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.
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 store cash flow models include sales, gross profit and, to a lesser extent, operating expenses.
An impairment loss may be recognized when these undiscounted future cash flows are less than the carrying amount of the asset group. In the circumstance of impairment, any loss would be measured as the excess of the carrying amount of the asset group over its fair value. Fair value of the Company’s store-related assets is determined at the individual store level based on the highest and best use of the asset group. The key assumptions used in the Company’s fair value analysis may include discounted future store cash flows and comparable market rents.
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.
Store assets that were tested for impairment as of August 1, 2020 and not impaired, had long-lived assets with a net book value of $146.0 million, which included $133.0 million of operating lease right-of-use assets, as of August 1, 2020.
Store assets that were previously-impaired as of August 1, 2020, had a remaining net book value of $162.2 million, which included $146.9 million of operating lease right-of-use assets, as of August 1, 2020.
40
Table of Contents
NON-GAAP FINANCIAL MEASURES
This Quarterly Report on Form 10-Q includes discussion of certain financial measures on both a GAAP and a non-GAAP basis. The Company believes that each of the non-GAAP financial measures presented in this “ ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ” is useful to investors as it provides a meaningful basis to evaluate the Company’s operating performance excluding the effect of certain items that the Company believes do not reflect its future operating outlook, such as certain asset impairment charges related to the Company’s flagship stores and significant impairments primarily attributable to the COVID-19 pandemic, therefore supplementing investors’ understanding of comparability of operations across periods. 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. These non-GAAP financial measures should be used as a supplement to, and not as an alternative to, the Company’s GAAP financial results, and may not be calculated in the same manner as similar measures presented by other companies.
Comparable sales
At times, the Company provides comparable sales, defined as the year-over-year percentage change in the aggregate of (1) 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 the prior year’s net sales converted at the current year’s foreign currency exchange rates to remove the impact of foreign currency exchange rate fluctuations, and (2) digital sales with the prior year’s net sales converted at the current year’s foreign currency exchange rates to remove the impact of foreign currency exchange rate fluctuations. Comparable sales exclude revenue other than store and digital sales. Management uses comparable sales to understand the drivers of year-over-year changes in net sales and believes comparable sales is a useful metric as it can assist investors in distinguishing the portion of the Company’s revenue attributable to existing locations from the portion attributable to the opening or closing of stores. The most directly comparable GAAP financial measure is change in net sales. In light of store closures related to COVID-19, the Company has not disclosed comparable sales for Fiscal 2020.
Excluded items
The following financial measures are disclosed on a GAAP and on an adjusted non-GAAP basis excluding the following items, as applicable:
Financial measures (1)
Excluded items
Asset impairment, exclusive of flagship store exit charges
Certain asset impairment charges
Operating income (loss)
Certain asset impairment charges
Income tax expense (benefit) (2)
Tax effect of pre-tax excluded items
Net income (loss) and net income (loss) per share attributable to A&F (2)
Pre-tax excluded items and the tax effect of pre-tax excluded items
(1)
Certain of these financial measures are also expressed as a percentage of net sales.
(2)
The tax effect of excluded items is the difference between the tax provision calculation on a GAAP basis and on an adjusted non-GAAP basis.
41
Table of Contents
Financial information on a constant currency basis
The Company provides certain financial information on a constant currency basis to enhance investors’ understanding of underlying business trends and operating performance by removing the impact of foreign currency exchange rate fluctuations. Management also uses financial information on a constant currency basis to award employee performance-based compensation. The effect from foreign currency exchange rates, calculated on a constant currency basis, is determined by applying the current period’s foreign currency exchange rates to the prior year’s results and is net of the year-over-year impact from hedging. The per diluted share effect from foreign currency exchange rates is calculated using a 26% effective tax rate.
A reconciliation of financial metrics on a constant currency basis to GAAP for the thirteen and twenty-six weeks ended August 1, 2020 and August 3, 2019 follows:
(in thousands, except change in net sales, gross profit rate, operating margin and per share data)
Thirteen Weeks Ended
Twenty-six Weeks Ended
Net sales
August 1, 2020
August 3, 2019
% Change
August 1, 2020
August 3, 2019
% Change
GAAP
$
698,328
$
841,078
(17)%
$
1,183,687
$
1,575,050
(25)%
Impact from changes in foreign currency exchange rates
—
(2,125
)
—%
—
(8,948
)
1%
Non-GAAP on a constant currency basis
$
698,328
$
838,953
(17)%
$
1,183,687
$
1,566,102
(24)%
Gross profit, exclusive of depreciation and amortization expense
August 1, 2020
August 3, 2019
BPS Change (1)
August 1, 2020
August 3, 2019
BPS Change (1)
GAAP
$
423,608
$
498,633
140
$
687,753
$
942,723
(180)
Impact from changes in foreign currency exchange rates
—
(1,408
)
—
—
(7,456
)
20
Non-GAAP on a constant currency basis
$
423,608
$
497,225
140
$
687,753
$
935,267
(160)
Operating income (loss)
August 1, 2020
August 3, 2019
BPS Change (1)
August 1, 2020
August 3, 2019
BPS Change (1)
GAAP
$
14,143
$
(39,484
)
670
$
(194,984
)
$
(66,742
)
(1,230)
Excluded items (2)
(8,083
)
—
(120)
(51,011
)
—
(430)
Adjusted non-GAAP
$
22,226
$
(39,484
)
790
$
(143,973
)
$
(66,742
)
(800)
Impact from changes in foreign currency exchange rates
—
926
(10)
—
(2,189
)
10
Adjusted non-GAAP on a constant currency basis
$
22,226
$
(38,558
)
780
$
(143,973
)
$
(68,931
)
(780)
Net income (loss) per diluted share attributable to A&F (3)
August 1, 2020
August 3, 2019
$ Change
August 1, 2020
August 3, 2019
$ Change
GAAP
$
0.09
$
(0.48
)
$0.57
$
(3.82
)
$
(0.76
)
$(3.06)
Excluded items, net of tax (2)
(0.15
)
—
(0.15)
(0.76
)
—
(0.76)
Adjusted non-GAAP
$
0.23
$
(0.48
)
$0.71
$
(3.05
)
$
(0.76
)
$(2.29)
Impact from changes in foreign currency exchange rates
—
0.02
(0.02)
—
(0.02
)
0.02
Adjusted non-GAAP on a constant currency basis
$
0.23
$
(0.46
)
$0.69
$
(3.05
)
$
(0.79
)
$(2.26)
(1)
The estimated basis point change has been rounded based on the change in the percentage of net sales.
(2)
Excluded items for the thirteen and twenty-six weeks ended August 1, 2020 consist of pre-tax store asset impairment charges and the tax effect of pre-tax excluded items.
42
Table of Contents
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.