Item 7. Management’s Discussion and Analysis
Item 7. 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 audited Consolidated Financial Statements and notes thereto included in this Annual Report on Form 10-K in “ ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ,” to which all references to Notes in MD&A are made.
INTRODUCTION
MD&A is provided as a supplement to the accompanying 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, and an overview of key performance indicators reviewed by various members of management to gauge the Company’s results.
• Current Trends and Outlook . This section provides a discussion related to COVID-19’s impact on the Company’s business and discussion of the Company’s long-term plans for growth. In addition, this section also provides a summary of the Company’s performance over recent years, primarily Fiscal 2020 and Fiscal 2019.
• Results of Operations . This section provides an analysis of certain components of the Company’s Consolidated Statements of Operations and Comprehensive (Loss) Income for Fiscal 2020 as compared to Fiscal 2019.
• Liquidity and Capital Resources . This section provides a discussion of the Company’s financial condition, changes in financial condition and liquidity as of January 30, 2021, which includes (i) an analysis of changes in cash flows for Fiscal 2020 as compared to Fiscal 2019, (ii) an analysis of liquidity, including the availability under credit facilities, payments of dividends, and outstanding debt and covenant compliance, (iii) a summary of contractual and other obligations as of January 30, 2021 and (iv) a discussion related to actions taken during Fiscal 2020 to preserve liquidity in light of COVID-19.
• Recent Accounting Pronouncements . The recent accounting pronouncements the Company has adopted or is currently evaluating, including the dates of adoption or expected dates of adoption, as applicable, and anticipated effects on the Company’s audited Consolidated Financial Statements, are included in Note 2 “ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES .”
• 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 the Company’s 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 accounting principles generally accepted in the U.S. (“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.
A discussion of the Company’s financial condition, changes in financial condition and results of operations for Fiscal 2019 as compared to Fiscal 2018, is incorporated by reference from “ ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ,” in PART II of A&F’s Annual Report on Form 10-K for Fiscal 2019, filed with the SEC on March 31, 2020.
Safe harbor statement under the Private Securities Litigation Reform Act of 1995
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 Annual Report on Form 10-K or made by the Company, its management or its 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 Annual Report on Form 10-K 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. A discussion of material risks that could affect the Company’s financial performance and cause actual results to differ materially from those expressed or implied in any of the forward-looking statements is included in “ ITEM 1A. RISK FACTORS ,” of this Annual Report on Form 10-K.
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OVERVIEW
Business summary
The Company is a global multi-brand omnichannel specialty retailer, whose products are sold primarily through its digital channels and Company-owned stores, as well as through various third-party arrangements. The Company offers a broad assortment of apparel, personal care products and accessories for men, women and kids under the Company’s two brand-based operating segments: Hollister, which includes the Company’s Hollister and Gilly Hicks brands, and Abercrombie, which includes the Company’s 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 operates primarily in North America, Europe and Asia.
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/ ending Number of weeks
Fiscal 2019 February 1, 2020 52
Fiscal 2020 January 30, 2021 52
Fiscal 2021 January 29, 2022 52
Due to the seasonal nature of the retail apparel industry, the results of operations for any interim period are not necessarily indicative of the results expected for the full fiscal year and the Company could experience significant fluctuations in certain asset and liability accounts. The Company experiences its greatest sales activity during Fall, due to Back-to-School and Holiday sales periods, respectively.
Key performance indicators
The following measurements are among the key performance indicators reviewed by various members of the Company’s management to gauge the Company’s results:
• Changes in net sales and comparable sales;
• Comparative results of operations on a constant currency basis with the prior year’s results converted at the current year’s foreign currency exchange rate to remove the impact of foreign currency exchange rate fluctuation;
• Gross profit and gross profit rate;
• Cost of sales, exclusive of depreciation and amortization, as a percentage of net sales;
• 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 (“operating margin”);
• Net income and net income attributable to A&F;
• Cash flow and liquidity measures, such as the Company’s current ratio, working capital and free cash flow;
• Inventory metrics, such as inventory turnover;
• Return on invested capital and return on equity;
• Store metrics, such as net sales per gross square foot, and store 4-wall operating margins;
• Digital and omnichannel metrics, such as total shipping expense as a percentage of digital sales, and certain metrics related to our purchase-online-pickup-in-store and order-in-store programs;
• Transactional metrics, such as traffic and conversion, performance across key product categories, average unit retail, average unit cost, average units per transaction and average transaction values; and
• Customer-centric metrics such as customer satisfaction, customer retention and acquisition, and certain metrics related to the loyalty programs.
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 MD&A.
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CURRENT TRENDS AND OUTLOOK
Impact of 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 Europe, Middle East and Africa (“EMEA”) 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 continue 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 COVID-19.
The extent of future impacts of COVID-19 on the Company’s business, including the duration and impact on overall customer demand, are uncertain as current circumstances are dynamic and depend on future developments, including, but not limited to, the duration and spread of COVID-19, the emergence of new variants of the coronavirus and the availability and acceptance of effective vaccines or medical treatments.
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. As of January 30, 2021 and March 24, 2021, approximately 88% and 91% of Company-operated stores were open for in-store service, respectively, with temporary store closures primarily in the EMEA region. The Company plans to follow the guidance of local governments to determine when it can reopen closed 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;
• Increasing its omnichannel capabilities by introducing 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.
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 14% for Fiscal 2020 as compared to Fiscal 2019, primarily driven by temporary store closures and a decline in traffic as compared to the previous year as a result of COVID-19. During Fiscal 2020, sales for stores that had reopened were approximately 75% of Fiscal 2019 levels. The Company has experienced other material impacts as a result of COVID-19, including, but not limited to, deferred tax valuation allowances, long-lived asset impairment, adjustments of the carrying amount of inventory and changes in the effectiveness of its hedging instruments.
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. In response to elevated digital demand during this period, the Company has increased its omnichannel capabilities by continuing to offer Purchase-Online-Pickup-in-Store, including curbside pickup at a majority of U.S. locations, and by utilizing ship-from-store capabilities. In addition, to prepare for the Fiscal 2020 holiday season, the Company entered into a short-term lease for an additional distribution center and partnered with incremental carriers. Digital net sales increased approximately 39% for Fiscal 2020 as compared to Fiscal 2019, resulting in digital sales accounting for 54% of total revenues in Fiscal 2020 compared to 33% in Fiscal 2019. 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 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 January 30, 2021, 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
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to collaborate with its third-party partners to mitigate significant delays in delivery of merchandise, especially in light of disruptions across the supply chain, including port congestion and shipping container shortages. During Fiscal 2020, the Company reduced certain orders that were not already in production, delayed and altered the cadence of deliveries and implemented various strategies to tightly manage inventories, including utilizing ship-from-store capabilities in select locations.
The Company’s progress executing against the following key transformation initiatives created the foundation to allow the Company to respond quickly to COVID-19 in Fiscal 2020:
• 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 Fiscal 2020 with a healthy liquidity position, however in light of COVID-19 the Company took immediate, aggressive and prudent actions, including re-evaluating all expenditures, to balance short-term and long-term liquidity needs, in order to best position the business for the Company’s stakeholders during Fiscal 2020. Actions to preserve liquidity and manage cash flows during Fiscal 2020, included, but were not limited to the following:
• Partnered with merchandise and non-merchandise vendors in regards to payment terms;
• Managed inventory receipts tightly to align inventory with expected market demand;
• Reduced expenses to better align operating costs with sales;
• Assessed government policy and economic stimulus responses to COVID-19 for both business and individuals;
• Borrowed $210.0 million under the ABL Facility in March 2020, which was then repaid in July 2020 along with the Term Loan Facility;
• Withdrew $50.0 million from the overfunded Rabbi Trust assets, representing the majority of excess funds in March 2020;
• Announced the temporary suspension of the Company's share repurchase and dividend programs in March 2020 and May 2020, respectively; and
• Completed a private offering of $350.0 million aggregate principal amount of Senior Secured Notes in July 2020.
Reflecting ongoing global uncertainty and the near-term challenges that COVID-19 presents, such as continued temporary store closures, uncertainty surrounding the global economy and customer discretionary spending habits, the Company plans to conservatively manage cash and liquidity in the first half of Fiscal 2021, while prioritizing investments in the business and continuing to fund operating activities. Regarding returns to shareholders, although the dividend program remains suspended, the Company recently announced that it plans to resume share repurchases beginning on or after March 4, 2021, dependent on various factors, such as market and business conditions, including the Company’s ability to accelerate investments in the business.
As of January 30, 2021, the Company had liquidity of $1.3 billion as compared to $0.9 billion as of February 1, 2020, comprised of cash and equivalents and borrowing available to the Company under the ABL Facility.
Despite the Company's recent history of partnering with its vendors regarding payment terms, certain payment term extensions were temporary and certain previously deferred payments have since been made. 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.
For further information about how COVID-19 could impact our operations, refer to “ ITEM 1A. RISK FACTORS ,” of this Annual Report on Form 10-K.
Global Store Network Optimization
Reflecting a continued focus on its key transformation initiative ‘Global Store Network Optimization,’ the Company delivered new store experiences across brands during Fiscal 2020 and Fiscal 2019. Details related to these new store experiences follow:
Type of new store experience Fiscal 2020 Fiscal 2019
New stores 15 40
Remodels 4 24
Right-sizes 6 26
Total 25 90
A component of optimizing the Company’s global store network is pivoting away from large format tourist-dependent flagship stores and opening smaller, omni-enabled stores that cater to local customers. As a result, the Company closed twelve flagship locations during Fiscal 2019 and Fiscal 2020. This leaves the Company with seven operating flagships at the end of Fiscal 2020, down from 15 at the beginning of the year. Future closures could be completed through natural lease expirations, while certain
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other 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 related to these actions.
In addition, the Company closed 129 non-flagship locations, resulting in 137 total store closures during Fiscal 2020. Store optimization efforts in Fiscal 2020 reduced total Company store gross square footage by approximately 1.1 million gross square feet, or 17%, as compared to Fiscal 2019 year-end. The actions taken in Fiscal 2020, combined with ongoing digital sales growth, are expected to continue to transform the Company's operating model and reposition the Company for the future as the Company continues to focus on aligning store square footage with digital penetration.
Store count and gross square footage by brand and geography as of February 1, 2020 and January 30, 2021 were as follows:
Hollister (1)
Abercrombie (2)
Total Company (3)
United States International United States International United States International Total
Number of stores:
February 1, 2020 (4)
392 155 257 53 649 208 857
New 3 3 4 5 7 8 15
Closed (48) (8) (71) (10) (119) (18) (137)
January 30, 2021 347 150 190 48 537 198 735
Gross square footage (in thousands) :
February 1, 2020 (4)
2,605 1,263 1,829 617 4,434 1,880 6,314
January 30, 2021 2,309 1,219 1,311 393 3,620 1,612 5,232
(1) Hollister includes the Hollister and Gilly Hicks brands. Locations with Gilly Hicks carveouts within Hollister stores are represented as a single store count. Excludes nine international franchise stores as of each of January 30, 2021 and February 1, 2020. Excludes 12 Company-operated temporary stores as of January 30, 2021 and 15 as of February 1, 2020.
(2) Abercrombie includes the Abercrombie & Fitch and abercrombie kids brands. Locations with abercrombie kids carveouts within Abercrombie & Fitch stores are represented as a single store count. Excludes 10 international franchise stores as of January 30, 2021 and seven as of February 1, 2020. Excludes two Company-operated temporary stores as of January 30, 2021 and six as of February 1, 2020.
(3) This store count excludes one international third-party operated multi-brand outlet store as of January 30, 2021.
(4) Prior period numbers have been revised due to a change in the temporary store definition to only include store leases with original terms of 18 months or less.
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. Upon withdrawal from the European Union in January 2020 (“Brexit"), the United Kingdom entered into a formal transition period that expired on December 31, 2020, during which the United Kingdom and the European Union negotiated a post-Brexit trade agreement. The ultimate impact of Brexit on the Company will depend on the effects of this agreement, which went into effect on January 1, 2021.
There is continued uncertainty related to the ultimate 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: collaborated across the organization and tested systems; worked with external partners to develop contingency plans for potential adverse impacts; and took 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 adversely affect the business and results of operations.
Impact of global events and uncertainty
As a global multi-brand omnichannel specialty retailer, with operations in North America, Europe and Asia, among other regions and, as a result, management is are mindful of macroeconomic risks and global challenges that could adversely impact certain areas of the business. As a result, in addition to the events listed within MD&A, management continues to monitor certain other global events. The Company continues to assess the potential impacts these events and similar events may have on the business in future periods and continues to develop contingency plans to assist in mitigating potential impacts. It is possible that the Company’s preparations for the events discussed within MD&A are not adequate to mitigate their impact, and that these events could further adversely affect its business and results of operations. For a discussion of material risks that have the potential to cause actual results to differ materially from expectations, refer to “ ITEM 1A. RISK FACTORS ,” included in this Annual Report on Form 10-K.
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Focus areas for Fiscal 2021
Reflecting ongoing global uncertainty and the near-term challenges COVID-19 presents, in Fiscal 2021, the Company plans to continue to conservatively manage inventories, position its supply chain to optimize its capacity to fulfill digital orders and tightly manage expenses.
For Fiscal 2021, the Company plans to make progress recovering sales losses experienced in Fiscal 2020 as a result of COVID-19, while maintaining or improving on gross profit rate from Fiscal 2020 levels. While the Company expects to see certain savings in operating expenses in Fiscal 2021, reflecting Fiscal 2020 permanent store closures and rent negotiations, certain operating expenses related to stores that were temporarily closed in Fiscal 2020 due to COVID-19 are expected to return in Fiscal 2021. The Company plans to reposition expense savings towards customer-facing areas, specifically targeting the acceleration of marketing, digital and data investments.
The Company continues to evaluate opportunities to invest in and make progress on initiatives that position the business for sustainable long-term growth that align with the strategic pillars as described within “ ITEM 1. BUSINESS - STRATEGY AND KEY BUSINESS PRIORITIES ,” included in this Annual Report on Form 10-K.
Summary of results
A summary of results for Fiscal 2020 and Fiscal 2019 follows:
GAAP Non-GAAP (1)
(in thousands, except change in net sales, gross profit rate, operating margin and per share amounts) Fiscal 2020 Fiscal 2019 Fiscal 2020 Fiscal 2019
Net sales $ 3,125,384 $ 3,623,073
Change in net sales from the prior fiscal year (14) % 1 %
Gross profit rate (2)
60.5 % 59.4 %
Operating (loss) income (3)
$ (20,469) $ 70,068 $ 52,468 $ 82,820
Operating (loss) income margin (0.7) % 1.9 % 1.7 % 2.3 %
Net (loss) income attributable to A&F (3) (4)
$ (114,021) $ 39,358 $ (45,383) $ 48,097
Net (loss) income per diluted share attributable to A&F (3) (4)
$ (1.82) $ 0.60 $ (0.73) $ 0.73
(1) Refer to “ RESULTS OF OPERATIONS ” for details on excluded items. 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) Gross profit is derived from cost of sales, exclusive of depreciation and amortization.
(3) Fiscal 2019 results included $47 million of flagship store exit charges, which adversely impacted net income per diluted share attributable to A&F by approximately $0.53 per share, net of estimated tax effect. Refer to Note 19, “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES .”
(4) Fiscal 2020 results included $101 million of adverse tax impacts related to valuation allowances on deferred tax assets and other tax charges as a result of the COVID-19 pandemic, which adversely impacted net loss per diluted share by or $1.61 per share. Refer to Note 12, “ INCOME TAXES .”
Certain components of the Company’s Consolidated Balance Sheets as of February 1, 2020 and January 30, 2021 and Consolidated Statements of Cash Flows for Fiscal 2020 and Fiscal 2019 were as follows:
(in thousands)
Balance Sheets data January 30, 2021 February 1, 2020
Cash and equivalents $ 1,104,862 $ 671,267
Gross borrowings outstanding, carrying amount $ 350,000 $ 233,250
Inventories $ 404,053 $ 434,326
Statement of Cash Flows data Fiscal 2020 Fiscal 2019
Net cash provided by operating activities $ 404,918 $ 300,685
Net cash used for investing activities $ (51,910) $ (202,784)
Net cash provided by (used for) financing activities $ 69,717 $ (147,873)
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RESULTS OF OPERATIONS
The estimated basis point (“BPS”) change disclosed throughout this Results of Operations has been rounded based on the change in the percentage of net sales.
Net sales
(in thousands) Fiscal 2020 Fiscal 2019 $ Change % Change
Hollister $ 1,834,349 $ 2,158,514 $ (324,165) (15)%
Abercrombie 1,291,035 1,464,559 (173,524) (12)%
Total Company $ 3,125,384 $ 3,623,073 $ (497,689) (14)%
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 Fiscal 2020 and Fiscal 2019 were as follows:
(in thousands) Fiscal 2020 Fiscal 2019 $ Change % Change
United States $ 2,127,403 $ 2,410,802 $ (283,399) (12)%
EMEA 709,451 822,202 $ (112,751) (14)%
APAC 176,636 264,895 $ (88,259) (33)%
Other 111,894 125,174 $ (13,280) (11)%
International $ 997,981 $ 1,212,271 $ (214,290) (18)%
Total Company $ 3,125,384 $ 3,623,073 $ (497,689) (14)%
For Fiscal 2020, net sales decreased 14% as compared to Fiscal 2019, primarily due to a decrease in units sold driven by reduced store traffic, including as it related to temporary store closures as a result of COVID-19, partially offset by 39% digital sales growth. Average unit retail increased year-over-year, driven by lower promotions, with benefits from changes in foreign currency exchange rates of approximately $22 million.
Cost of sales, exclusive of depreciation and amortization
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Cost of sales, exclusive of depreciation and amortization $ 1,234,179 39.5% $ 1,472,155 40.6% (110)
For Fiscal 2020, cost of sales, exclusive of depreciation and amortization, as a percentage of net sales decreased approximately 110 basis points as compared to Fiscal 2019, reflecting benefits of approximately 30 basis points from changes in foreign currency exchange rates. The year-over-year decrease was primarily attributable to increased average unit retail driven by lower promotions. Average unit cost remained relatively flat, reflecting, among other items, adverse impacts of approximately 50 basis points related to charges to reduce the carrying value of inventory during the thirteen weeks ended May 2, 2020, primarily as a result of COVID-19 and the temporary closure of the Company’s stores and benefits of approximately 30 basis points from inventory shrink favorability.
Gross profit, exclusive of depreciation and amortization
Fiscal 2020 Fiscal 2019
% of Net Sales % of Net Sales BPS Change
Gross profit, exclusive of depreciation and amortization $ 1,891,205 60.5% $ 2,150,918 59.4% 110
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Stores and distribution expense
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Stores and distribution expense $ 1,391,584 44.5% $ 1,551,243 42.8% 170
For Fiscal 2020, stores and distribution expense decreased 10% as compared to Fiscal 2019, primarily driven by a $117 million reduction in store occupancy expense, reflecting the impact of COVID-19 on operations including temporary store closures and benefits from rent abatements recognized as variable lease cost and a $92 million reduction in payroll expense, which was inclusive of a benefit of $18 million related to government subsidies in certain jurisdictions where the Company qualifies. These reductions in expense were partially offset by a $67 million increase in shipping and handling expense related to the 39% year-over-year digital sales growth.
Marketing, general and administrative expense
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Marketing, general and administrative expense $ 463,843 14.8% $ 464,615 12.8% 200
For Fiscal 2020, marketing, general and administrative expense was approximately flat as compared to Fiscal 2019, reflecting reductions in marketing and other controllable expenses, and an increase in payroll expense as a result of higher performance-based compensation.
Flagship store exit (benefits) charges
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Flagship store exit (benefits) charges $ (11,636) (0.4)% $ 47,257 1.3% (170)
For Fiscal 2020, flagship store exit benefits primarily related to the closure of several international Abercrombie & Fitch flagship stores. Flagship store exit charges for Fiscal 2019 primarily related to the closure of the Company’s SoHo Hollister flagship in New York City. Refer to Note 19, “ FLAGSHIP STORE EXIT (BENEFITS) CHARGES . ”
Asset impairment, exclusive of flagship store exit charges
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Asset impairment, exclusive of flagship store exit charges $ 72,937 2.3% $ 19,135 0.5% 180
Excluded items:
Asset impairment charges (1)
(72,937) (2.3)% (12,752) (0.4)% (190)
Adjusted non-GAAP asset impairment, exclusive of flagship store exit charges
$ — 0.0% $ 6,383 0.2% (20)
(1) Refer to “ NON-GAAP FINANCIAL MEASURES ,” for further details.
Refer to Note 9, “ ASSET IMPAIRMENT ,” for further discussion.
Other operating income, net
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Other operating income, net $ 5,054 0.2% $ 1,400 0.0% 20
For Fiscal 2020, other operating income, net, increased as compared to Fiscal 2019, primarily due to foreign currency exchange related gains in Fiscal 2020.
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Operating (loss) income
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Operating (loss) income $ (20,469) (0.7)% $ 70,068 1.9% (260)
Excluded items:
Asset impairment charges (1)
72,937 2.3% 12,752 0.4% 190
Adjusted non-GAAP operating income $ 52,468 1.7% $ 82,820 2.3% (60)
(1) Refer to “ NON-GAAP FINANCIAL MEASURES ,” for further details.
Interest expense, net
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Interest expense $ 31,726 1.0% $ 19,908 0.5% 50
Interest income (3,452) (0.1)% (12,171) (0.3)% 20
Interest expense, net $ 28,274 0.9% $ 7,737 0.2% 70
For Fiscal 2020, interest expense, net, increased primarily driven by higher interest expense in the current year related to the issuance of the Senior Secured Notes, as well as lower interest income earned on the Company’s investments and cash holdings.
Income tax expense
Fiscal 2020 Fiscal 2019
(in thousands, except ratios) Effective Tax Rate Effective Tax Rate
Income tax expense $ 60,211 (123.5)% $ 17,371 27.9%
Excluded items:
Tax effect of pre-tax excluded items (1)
4,299 4,013
Adjusted non-GAAP income tax expense $ 64,510 266.6% $ 21,384 28.5%
(1) Refer to “ Operating (loss) income ” for details of pre-tax excluded items. The tax effect of pre-tax excluded items is the difference between the tax provision calculation on a GAAP basis and an adjusted non-GAAP basis.
The Company’s effective tax rate for Fiscal 2020 was impacted by $101.4 million of adverse tax impacts, ultimately giving rise to income tax expense on a consolidated pre-tax loss. These adverse tax impacts were as follows:
• The Company did not recognize income tax benefits on $203.4 million of pre-tax losses generated in Fiscal 2020 in certain jurisdictions, resulting in adverse tax impacts of $39.5 million.
• The Company recognized charges of $61.9 million related to the establishment of valuation allowances and other tax charges in certain jurisdictions, including, but not limited to, the U.S., Switzerland, Germany and Japan principally as a result of the significant adverse impacts of COVID-19.
Refer to Note 12, “ INCOME TAXES ,” for further discussion on factors that impacted the effective tax rate in Fiscal 2020 and Fiscal 2019.
Net (loss) income attributable to A&F
Fiscal 2020 Fiscal 2019
(in thousands) % of Net Sales % of Net Sales BPS Change
Net (loss) income attributable to A&F $ (114,021) (3.6)% $ 39,358 1.1% (470)
Excluded items, net of tax (1)
68,638 2.2% 8,739 0.2% 200
Adjusted non-GAAP net income attributable to A&F (2)
$ (45,383) (1.5)% $ 48,097 1.3% (280)
(1) Excludes items presented above under “ Operating (loss) income , ” and “ Income tax expense . ”
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Net (loss) income per diluted share attributable to A&F
Fiscal 2020 Fiscal 2019 $ Change
Net (loss) income per diluted share attributable to A&F $ (1.82) $ 0.60 $(2.42)
Excluded items, net of tax (1)
1.10 0.13 0.97
Adjusted non-GAAP net (loss) income per diluted share attributable to A&F $ (0.73) $ 0.73 $(1.46)
Impact from changes in foreign currency exchange rates — 0.29 (0.29)
Adjusted non-GAAP net (loss) income per diluted share attributable to A&F on a constant currency basis (2)
$ (0.73) $ 1.02 $(1.75)
(1) Excludes items presented above under “ Operating (loss) income , ” and “ Income tax expense . ”
(2) Refer to “ NON-GAAP FINANCIAL MEASURES ,” for further details.
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LIQUIDITY AND CAPITAL RESOURCES
Overview
The Company’s capital allocation strategy, priorities and investments are reviewed by A&F’s Board of Directors considering both liquidity and valuation factors. Reflecting ongoing global uncertainty and the near-term challenges that COVID-19 presents, such as continued temporary store closures, uncertainty surrounding the global economy and customer discretionary spending habits, the Company plans to conservatively manage cash and liquidity in the first half of Fiscal 2021, while prioritizing investments in the business and continuing to fund operating activities. Regarding returns to shareholders, although the dividend program remains suspended, the Company recently announced that it plans to resume share repurchases on or after March 4, 2021, dependent on various factors, such as market and business conditions, including the Company’s ability to accelerate investments in the business. 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: Spring and Fall. The Company experiences its greatest sales activity during Fall, due to 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 ”.
The Company entered Fiscal 2020 with a healthy liquidity position, however in light of COVID-19 the Company took immediate, aggressive and prudent actions, including re-evaluating all expenditures, to balance short-term and long-term liquidity needs, in order to best position the business for the Company’s key stakeholders during Fiscal 2020. In an effort to improve the Company’s near-term cash position, 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 $50.0 million from the overfunded Rabbi Trust assets, which represented the majority of excess funds. 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 directed towards funding operating activities, including the acquisition of inventory, and obligations related to compensation, marketing, leases and any lease buyouts or modifications it may exercise, taxes and other operating activities. Reflecting ongoing global uncertainty and the near-term challenges that COVID-19 presents, such as continued temporary store closures, uncertainty surrounding the global economy and customer discretionary spending habits, the Company plans to conservatively manage cash and liquidity in the first half of Fiscal 2021, while prioritizing investments in the business and continuing to fund operating activities.
The Company evaluates opportunities for investments in the business that are in line with initiatives that position the business for sustainable long-term growth that align with its strategic pillars as described within “ I TEM 1. BUSINESS - STRATEGY AND KEY BUSINESS PRIORITIES ”. Examples of potential investment opportunities include, but are not limited to, new store experiences and options to early terminate store leases, investments in its omnichannel initiatives and investments to increase the Company’s capacity to fulfill digital orders. 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 Fiscal 2020, the Company used $101.9 million towards capital expenditures, down from $202.8 million of capital expenditures in Fiscal 2019. Total capital expenditures for Fiscal 2021 are expected to be approximately $100 million.
Share repurchases and dividends
In order to preserve liquidity and maintain financial flexibility in light of 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 has since announced it plans to resume share repurchase activity beginning on or after March 4, 2021. The timing and amount of any future share repurchases will depend on various factors, including market and business conditions. The Company’s dividend program remains suspended. The Company may in the future review its dividend program to determine, in light of facts and circumstances at that time, whether and when to reinstate.
Historically, the Company has repurchased shares of its Common Stock from time to time, dependent on market and business conditions, with the objectives of offsetting dilution from issuances of Common Stock associated with the exercise of employee stock appreciation rights and the vesting of restricted stock units and returning excess cash to shareholders. Shares may be repurchased 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 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
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PURCHASES OF EQUITY SECURITIES ” for additional information regarding the Company’s share repurchases during the fourth quarter of Fiscal 2020 and the number of shares remaining available for purchase under the Company’s publicly announced stock repurchase authorization.
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. Dividends were paid in March for Fiscal 2020, and in each of March, June, September and December in Fiscal 2019. A&F’s Board of Directors reviews and establishes a dividend amount, if any, 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 under the Company’s agreements related to the Senior Secured Notes and the ABL Facility. There can be no assurance that the Company will pay dividends in the future or, if dividends are paid, that they will be in amounts similar to past dividends.
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 which began in January 2021. The Company’s debt related to the Senior Secured Notes is presented on the Consolidated Balance Sheet, net of the unamortized fees. As of January 30, 2021, 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 asset-based revolving credit facility of up to $400 million. As of January 30, 2021, the Company did not have any borrowings outstanding under the ABL Facility. The ABL Facility matures on October 19, 2022.
Details regarding borrowing available to the Company under the ABL Facility as of January 30, 2021 follow:
(in thousands) January 30, 2021
Borrowing base $ 245,951
Less: Outstanding stand-by letters of credit (871)
Borrowing capacity 245,080
Less: Minimum excess availability (1)
(30,000)
Borrowing available under the ABL Facility $ 215,080
(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 13, “ BORROWINGS ,” for additional information.
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 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 tax expense.
As of January 30, 2021, $410.1 million of the Company’s $1.1 billion 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 to fund investing and financing activities.
Refer to Note 12, “ INCOME TAXES ,” for additional details regarding the impact certain events related to the Company’s income taxes had on the Company’s Consolidated Financial Statements.
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Analysis of cash flows
The table below provides certain components of the Company’s Consolidated Statements of Cash Flows for Fiscal 2020 and Fiscal 2019:
(in thousands) Fiscal 2020 Fiscal 2019
Cash and equivalents, and restricted cash and equivalents, beginning of period $ 692,264 $ 745,829
Net cash provided by operating activities 404,918 300,685
Net cash used for investing activities (51,910) (202,784)
Net cash provided by (used for) financing activities 69,717 (147,873)
Effects of foreign currency exchange rate changes on cash 9,168 (3,593)
Net increase (decrease) in cash and equivalents, and restricted cash and equivalents 431,893 (53,565)
Cash and equivalents, and restricted cash and equivalents, end of period $ 1,124,157 $ 692,264
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 altering the cadence of inventory receipts to align inventory with expected market demand;
• Reducing expenses to align operating costs with sales; and
• Suspending rent payments for a significant number of stores that were closed for a period of time 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.
These benefits to operating cash flows were partially offset by lower cash receipts as a result of the 14% 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.
While the Company has been successful in obtaining certain rent abatements and landlord concessions of rent payable during Fiscal 2020 as a result of COVID-19 store closures, the Company continues to engage with its landlords to find a mutually beneficial and agreeable path forward for certain of its other leases. In addition, despite the Company's recent history of partnering with its vendors regarding payment terms, certain payment term extensions were temporary and certain previously deferred payments have since been made. 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 Fiscal 2020, net cash outflows for investing activities were used for capital expenditures of $101.9 million as compared to $202.8 million in Fiscal 2019, reflecting actions taken in Fiscal 2020 to preserve liquidity and manage cash flows in light of the COVID-19 pandemic. Fiscal 2020 net cash used for investing activities also reflects the withdrawal of $50.0 million from the overfunded Rabbi Trust assets, which represented the majority of excess funds.
Financing activities - For Fiscal 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 the ABL Facility, with the remaining net proceeds used towards fees and expenses in connection with such repayments and the offering. In addition, the Company repurchased approximately 1.4 million shares of A&F’s Common Stock with a market value of approximately $15.2 million and paid dividends of $12.6 million during Fiscal 2020, prior to the Company’s decision to temporarily suspend its share repurchase and dividend programs in light of COVID-19. For Fiscal 2019, net cash used for financing activities consisted primarily of the repurchase of approximately 4.0 million shares of A&F’s Common Stock in the open market with a market value of approximately $63.5 million, dividend payments of $51.5 million and voluntary debt repayments of $20.0 million.
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Contractual obligations
As of January 30, 2021, the Company’s contractual obligations were as follows:
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)
$ 1,410,687 $ 307,174 $ 498,827 $ 304,323 $ 300,363
Purchase obligations (2)
249,761 208,153 25,001 5,718 10,889
Long-term debt obligations (3)
350,000 — — 350,000 —
Other obligations (4)
259,524 87,489 86,352 60,073 25,610
Total $ 2,269,972 $ 602,816 $ 610,180 $ 720,114 $ 336,862
(1) Operating lease obligations consist of the Company’s future undiscounted operating lease payments, including future fixed lease payments associated with closed flagship stores. Operating lease obligations do not include variable payments related to both lease and nonlease components, such as contingent rent payments made by the Company based on performance, and payments related to taxes, insurance, and maintenance costs. Total variable lease cost was $65.3 million in Fiscal 2020. Refer to Note 2, “ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Leases , ” and Note 8, “ LEASES ,” for further discussion.
(2) Purchase obligations primarily consist of non-cancelable purchase orders for merchandise to be delivered during Fiscal 2021 and commitments for fabric expected to be used during upcoming seasons. In addition, purchase obligations include agreements to purchase goods or services, including, but not limited to, information technology, digital and marketing contracts, as well as estimated obligations related to the Company’s 13-year, 100% renewable energy supply agreement for its global home office and Company-owned distribution centers which is expected to begin in the Company’s fiscal year ending January 28, 2023.
(3) Long-term debt obligations consist of principal payments under the Senior Secured Notes. Refer to Note 13, “ BORROWINGS ,” for further discussion.
(4) Other obligations consists of: interest payments related to the Senior Secured Notes assuming normally scheduled principal payments; estimated asset retirement obligations; accrued rent related to stores where the Company suspended payments in light of COVID-19 temporary store closures and continues to engage with its landlords on a agreeable path forward; the amount of the employer-paid portion of social security taxes deferred in light of COVID-19; payments from the Supplemental Executive Retirement Plan; known and scheduled payments related to the Company’s deferred compensation and supplemental retirement plans; tax payments associated with the provisional, mandatory one-time deemed repatriation tax on accumulated foreign earnings, net payable over eight years pursuant to the Act; and minimum contractual obligations related to leases signed but not yet commenced, primarily related to the Company’s stores. Refer to Note 8, “ LEASES ,” Note 12, “ INCOME TAXES ,” Note 13, “ BORROWINGS ,” and Note 17, “ SAVINGS AND RETIREMENT PLANS ,” for further discussion.
In Fiscal 2019, the Company entered into a nine-year service and distribution agreement for a facility to be located in the Phoenix, Arizona area, with services expected to commence in Fiscal 2021. Due to uncertainty as to the ultimate minimum commitments related to this agreement, these expected obligations are excluded from the contractual obligations table.
Due to uncertainty as to the amounts and timing of future payments, tax related to uncertain tax positions, including accrued interest and penalties, of $1.1 million as of January 30, 2021 is excluded from the contractual obligations table. Deferred taxes are also excluded in the contractual obligations table. For further discussion, refer to Note 12, “ INCOME TAXES .”
As of January 30, 2021, the Company had recorded $6.1 million and $42.5 million of obligations related to its deferred compensation and supplemental retirement plans in accrued expenses and other liabilities on the Consolidated Balance Sheet, respectively. Amounts payable with known payment dates of $19.2 million have been classified in the contractual obligations table based on those scheduled payment dates. However, it is not reasonably practicable to estimate the timing and amounts for the remainder of these obligations, therefore, those amounts have been excluded in the contractual obligations table.
A&F had historically paid quarterly dividends on its Common Stock. Due to the fact that the dividend program is currently suspended and given the payment of future dividends are subject to determination and approval by A&F’s Board of Directors, there are no amounts included in the contractual obligations table related to dividends.
Off-balance sheet arrangements
As of January 30, 2021, the Company did not have any material off-balance sheet arrangements.
RECENT ACCOUNTING PRONOUNCEMENTS
The Company describes its significant accounting policies in Note 2, “ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES .” 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.
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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 GAAP. The preparation of these consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts. Since actual results may differ from those estimates, the Company revises its estimates and assumptions as new information becomes available. 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 maintains loyalty programs, which primarily provide customers with the opportunity to earn points toward future merchandise discount rewards with qualifying purchases. The Company accounts for expected future merchandise discount reward redemptions by recognizing an unearned revenue liability as customers accumulate points, taking into account expected future redemptions, which remains until revenue is recognized at the earlier of redemption or expiration, as a component of net sales.
This assessment requires management to make assumptions and judgments related to the probability that accumulated points will be converted into merchandise discount rewards, the probability that merchandise discount rewards will be redeemed by customers and the pattern of redemption activity. The Company determines its estimates of these factors based on historical redemption patterns.
The Company does not expect material changes to the underlying assumptions used to estimate deferred revenue associated with loyalty programs as of January 30, 2021. However, actual results could vary from estimates and could result in material gains or losses.
An increase of 10% in the Company’s point expiration and reward redemption estimates as of January 30, 2021 would have affected pre-tax loss by approximately $3.4 million for Fiscal 2020.
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 and net realizable value (“LCNRV”) adjustment.
The LCNRV adjustment reduces 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 LCNRV estimate as of January 30, 2021. However, actual results could vary from estimates and could significantly impact the ending inventory valuation at cost, as well as gross profit.
An increase or decrease in the LCNRV adjustment of 10% would have affected pre-tax loss by approximately $2.1 million for Fiscal 2020.
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 continues to review the need for valuation allowances on a quarterly basis. It is reasonably possible, if business conditions improve, that there could be material adjustments over the next 12 months to the total amount of valuation allowances as circumstances may be such that sufficient evidence would exist to indicate that some or all of the deferred taxes currently subject to a valuation allowance will be utilized. The Company does not expect that sufficient evidence to release the valuation allowance is likely to exist at any time prior to the fourth quarter of Fiscal 2021, and there is no guarantee that such evidence will exist or that deferred taxes will be utilized.
Changes in these judgments, assumptions or interpretations may occur and should those changes be significant, they could have a material impact on the Company’s income tax provision. As January 30, 2021, the Company had recorded valuation allowances of $174.3 million.
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 estimated liabilities for the outcome of litigation where it is probable that a loss has been incurred and the amount of loss, or range of loss, is reasonably estimable. For probable losses, the Company accrues to the low end of an estimated range of loss, unless another amount within the range is determined to be more likely. Significant judgment may be applied in assessing the probability of loss and in estimating the amount of such loss.
Actual liabilities may differ from the amounts recorded, and there can be no assurance that the final resolution of legal contingencies will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
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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.
Store assets that were tested for impairment as of January 30, 2021 and not impaired, had long-lived assets with a net book value of $82.5 million, which included $72.1 million of operating lease right-of-use assets as of January 30, 2021.
Store assets that were previously impaired as of January 30, 2021, had a remaining net book value of $115.3 million, which included $106.7 million of operating lease right-of-use assets, as of January 30, 2021.
If actual results are not consistent with the estimates and assumptions used in assessing impairment or measuring impairment losses, there may be a material impact on the Company’s financial condition or results of operation.
Leases
The Company’s lease right-of-use assets represent the Company’s right to use an underlying asset for the lease term. The Company’s lease liabilities represent the Company’s obligation to make lease payments arising from the lease. On the lease commencement date, the Company recognizes an asset for the right to use a leased asset and a liability based on the present value of remaining lease payments over the lease term on the Consolidated Balance Sheets.
In measuring the Company’s lease liabilities, the remaining lease payments are discounted to present value using a discount rate. As the rates implicit in the Company’s leases are not readily determinable, the Company uses its incremental borrowing rate based on the transactional currency of the lease and the lease term for the initial measurement of the lease right-of-use asset and the lease liability. For leases existing before the adoption of the new lease accounting standard, the Company used its incremental borrowing rate as of the date of adoption, determined using the remaining lease term as of the date of adoption. For leases commencing on or after the adoption of the new lease accounting standard, the incremental borrowing rate is determined using the remaining lease term as of the lease commencement date.
The Company estimates its incremental borrowing rate on a quarterly basis, based on the rate of interest that the Company would have to pay to borrow, on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment.
The Company does not expect material changes to the underlying assumptions used to measure its lease liabilities as of January 30, 2021.
An increase or decrease of 10% in the Company’s weighted-average discount rate as of January 30, 2021, would impact both the Company’s total assets and total liabilities by less than 1% and would not have a material impact on the Company’s pre-tax loss for Fiscal 2020.
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NON-GAAP FINANCIAL MEASURES
This Annual Report on Form 10-K 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 7. 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. Historically, management had used comparable sales to understand the drivers of year-over-year changes in net sales as well as a performance metric for certain performance-based restricted stock units. The Company believes comparable sales can be 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 (loss) income Certain asset impairment charges
Income tax expense (2)
Tax effect of pre-tax excluded items
Net (loss) income and net (loss) income 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.
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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 Fiscal 2020 and Fiscal 2019 is as follows:
(in thousands, except change in net sales, gross profit rate, operating margin and per share data)
Net sales Fiscal 2020 Fiscal 2019 % Change
GAAP $ 3,125,384 $ 3,623,073 (14)%
Impact from changes in foreign currency exchange rates — 22,459 (1)%
Net sales on a constant currency basis $ 3,125,384 $ 3,645,532 (14)%
Gross profit Fiscal 2020 Fiscal 2019 BPS Change (1)
GAAP $ 1,891,205 $ 2,150,918 110
Impact from changes in foreign currency exchange rates — 26,522 (30)
Gross profit on a constant currency basis $ 1,891,205 $ 2,177,440 80
Operating (loss) income Fiscal 2020 Fiscal 2019 BPS Change (1)
GAAP $ (20,469) $ 70,068 (260)
Excluded items (2)
(72,937) (12,752) (190)
Adjusted non-GAAP $ 52,468 $ 82,820 (60)
Impact from changes in foreign currency exchange rates — 20,325 (50)
Adjusted non-GAAP on a constant currency basis $ 52,468 $ 103,145 (110)
Net (loss) income per diluted share attributable to A&F Fiscal 2020 Fiscal 2019 $ Change
GAAP $ (1.82) $ 0.60 $(2.42)
Excluded items, net of tax (2)
(1.10) (0.13) (0.97)
Adjusted non-GAAP $ (0.73) $ 0.73 $(1.46)
Impact from changes in foreign currency exchange rates — 0.29 (0.29)
Adjusted non-GAAP on a constant currency basis $ (0.73) $ 1.02 $(1.75)
(1) The estimated basis point change has been rounded based on the percentage of net sales change.
(2) Refer to “ RESULTS OF OPERATIONS ,” for details on excluded items. The tax effect of excluded items is calculated as the difference between the tax provision on a GAAP basis and an adjusted non-GAAP basis.
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