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 certain of the Company’s focus areas for the upcoming fiscal year and discussion of certain risks and challenges, such as COVID-19, as well as a summary of the Company’s performance for the thirteen weeks ended May 1, 2021 and May 2, 2020.
• 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 weeks ended May 1, 2021 and May 2, 2020.
• Liquidity and Capital Resources . This section provides a discussion of the Company’s expected primary sources and uses of cash, financial condition and liquidity as of May 1, 2021, which includes (i) an analysis of financial condition as compared to January 30, 2021; (ii) an analysis of changes in cash flows for the thirteen weeks ended May 1, 2021 as compared to the thirteen weeks ended May 2, 2020; and (iii) an analysis of liquidity, including discussion related to the Company’s Senior Secured Notes and 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 2020 in some cases have affected and in the future could affect the Company’s financial performance and cause actual results for Fiscal 2021 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:
• COVID‐19 has and may continue to materially adversely impact and cause disruption to our business;
• 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 effectively 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;
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• 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;
• The impact of war, acts of terrorism, mass casualty events, social unrest, civil disturbance or disobedience could have a material adverse impact on our business; and
• 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.
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;
• 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; and
• Our failure to appropriately address emerging environmental, social and governance matters could have a material adverse impact on our reputation and, as a result, 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;
• We rely on the experience and skills of our executive officers and associates, and the failure to attract or retain this talent, effectively manage succession, and establish a diverse workforce could have a material adverse impact on our business; and
• We identified a material weakness in our internal control over financial reporting and may identify additional material weaknesses in the future. If we fail to remediate our material weaknesses, or if we fail to establish and maintain effective internal control over financial reporting, our ability to accurately and timely report our financial results could be adversely affected.
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 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.
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OVERVIEW
Business summary
The Company is a global, digitally-led omnichannel retailer. The Company offers a broad assortment of apparel, personal care products and accessories for men, women and kids, which are sold primarily through its digital channels and Company-owned stores, as well as through various third-party arrangements. As of May 1, 2021, the Company’s two brand-based operating segments were Hollister, which includes the Company’s Hollister and Gilly Hicks brands, and Abercrombie, which includes the Company’s Abercrombie & Fitch and abercrombie kids brands. On May 20, 2021, the Company launched its newest brand, Social Tourist. These five 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 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 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
Focus areas for Fiscal 2021
The Company remains committed to, and confident in, its long-term vision of becoming a digitally-led global omnichannel apparel retailer and continues to evaluate opportunities to make progress against initiatives that support this vision.
The Company entered Fiscal 2021 on the offense, and has made progress towards recouping COVID-19 driven sales losses. Reflecting ongoing global uncertainty, the Company plans to continue to conservatively manage inventories, optimize its distribution center capacity for digital demand and tightly manage expenses while maintaining flexibility to make strategic investments in the business.
The following focus areas for Fiscal 2021 serve as a framework to the Company achieving its long-term vision of becoming a digitally-led global omnichannel apparel retailer and achieving sustainable long-term operating margin expansion:
• Accelerate digital, data and technology investments to increase agility and improve the customer experience;
• Increase marketing investments to build on momentum across brands and geographies;
• Invest in Gilly Hicks and the Company’s newest brand, Social Tourist, which launched on May 20, 2021;
• Optimize store square footage, while being opportunistic in global store expansion; and
• Integrate environmental, social and governance practices and standards throughout the organization.
Global Store Network Optimization
As part of its ongoing global store network optimization initiative and stated goal of repositioning from larger format, tourist-dependent flagship locations to smaller, omni-enabled stores that cater to local customers, the Company closed its Abercrombie & Fitch brand Orchard Road, Singapore flagship location during the first quarter of Fiscal 2021. This leaves the Company with six operating flagships at the end of the first quarter of Fiscal 2021, down from seven at the beginning of Fiscal 2021 and 15 at the beginning of Fiscal 2020.
In addition, the Company closed 129 non-flagship locations and eight flagship locations during Fiscal 2020. These actions, 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. Future closures could be completed through natural lease expirations, while certain 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.
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Additional details related to store count and gross square footage follow:
Hollister (1)
Abercrombie (2)
Total Company (3)
U.S. International U.S. International U.S. International Total
Number of stores:
January 30, 2021 347 150 190 48 537 198 735
New 2 1 — 1 2 2 4
Permanently closed — (1) (6) (1) (6) (2) (8)
May 1, 2021 349 150 184 48 533 198 731
Gross square footage (in thousands) :
May 1, 2021 2,324 1,212 1,275 378 3,599 1,590 5,189
(1) Hollister includes the Company’s Hollister and Gilly Hicks brands. Locations with Gilly Hicks carveouts within Hollister stores are represented as a single store count. Excludes 10 international franchise stores as of May 1, 2021 and nine international franchise stores as of January 30, 2021. Excludes 12 Company-operated temporary stores as of each of May 1, 2021 and January 30, 2021.
(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 12 international franchise stores as of May 1, 2021 and 10 international franchise stores as of January 30, 2021. Excludes four and two Company-operated temporary stores as of May 1, 2021 and January 30, 2021, respectively.
(3) This store count excludes one international third-party operated multi-brand outlet store as of each of May 1, 2021 and January 30, 2021.
COVID-19
In March 2020, the COVID-19 outbreak was declared to be a global pandemic by the World Health Organization. The Company continues to navigate COVID-19, including by conforming to local government guidance and monitoring health and safety measures with the well-being of the Company’s customers, associates and business partners remaining a top priority.
In response to COVID-19, certain governments imposed travel restrictions and local statutory quarantines and the Company experienced widespread temporary store closures. As of May 1, 2021, the vast majority of Company-operated stores were fully open for in-store service 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.
Total net sales increased approximately 61% for the thirteen weeks ended May 1, 2021 as compared to the thirteen weeks ended May 2, 2020 driven by increased store foot traffic relative to last year which was impacted by widespread temporary store closures due to COVID-19, and year-over-year digital sales growth of approximately 45%.
The Company’s digital operations across brands have continued to serve the Company’s customers during periods 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 leaned into its omnichannel capabilities by continuing to offer Purchase-Online-Pickup-in-Store, rolling out curbside pick-up at a majority of U.S. locations, and by utilizing ship-from-store capabilities. 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 may continue to see, material adverse impacts as a result of COVID-19. The extent of future impacts of COVID-19 on the Company’s business, including the 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, potential future outbreaks, the emergence of new variants of the coronavirus and the acceptance of effective vaccines or medical treatments.
For a discussion of material 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 2020.
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Summary of results
A summary of results for the thirteen weeks ended May 1, 2021 and May 2, 2020 follows:
GAAP Non-GAAP (1)
(in thousands, except change in net sales, gross profit rate, operating margin and per share amounts) May 1, 2021 May 2, 2020 (2)
May 1, 2021 May 2, 2020 (2)
Thirteen Weeks Ended
Net sales $ 781,405 $ 485,359
Change in net sales 61.0 % (33.9) %
Gross profit rate 63.4 % 54.4 %
Operating income (loss) $ 57,433 $ (209,127) $ 60,097 $ (166,199)
Operating income (loss) margin 7.3 % (43.1) % 7.7 % (34.2) %
Net income (loss) attributable to A&F $ 41,768 $ (244,148) $ 43,983 $ (205,652)
Net income (loss) per diluted share attributable to A&F $ 0.64 $ (3.90) $ 0.67 $ (3.29)
(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 10, “ INCOME TAXES .”
Certain components of the Company’s Condensed Consolidated Balance Sheets as of May 1, 2021 and January 30, 2021 were as follows:
(in thousands) May 1, 2021 January 30, 2021
Cash and equivalents $ 909,008 $ 1,104,862
Gross long-term borrowings outstanding, carrying amount $ 350,000 $ 350,000
Inventories $ 388,633 $ 404,053
Certain components of the Company’s Condensed Consolidated Statements of Cash Flows for the thirteen week periods ended May 1, 2021 and May 2, 2020 were as follows:
(in thousands) May 1, 2021 May 2, 2020
Net cash used for operating activities $ (131,350) $ (140,776)
Net cash (used for) provided by investing activities $ (14,404) $ 3,010
Net cash (used for) provided by financing activities $ (53,191) $ 171,668
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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
The Company’s net sales by operating segment for the thirteen weeks ended May 1, 2021 and May 2, 2020 were as follows:
Thirteen Weeks Ended
(in thousands) May 1, 2021 May 2, 2020 $ Change % Change
Hollister (1)
$ 442,408 $ 273,012 $ 169,396 62%
Abercrombie (2)
338,997 212,347 126,650 60%
Total $ 781,405 $ 485,359 $ 296,046 61%
(1) Includes Hollister and Gilly Hicks brands.
(2) 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 weeks ended May 1, 2021 and May 2, 2020 were as follows:
Thirteen Weeks Ended
(in thousands) May 1, 2021 May 2, 2020 $ Change % Change
U.S. $ 553,846 $ 322,862 $ 230,984 72%
EMEA 159,002 112,654 46,348 41%
APAC 46,046 32,335 13,711 42%
Other 22,511 17,508 5,003 29%
International $ 227,559 $ 162,497 $ 65,062 40%
Total $ 781,405 $ 485,359 $ 296,046 61%
For the first quarter of Fiscal 2021, net sales increased 61% as compared to the first quarter of Fiscal 2020, primarily due to an increase in units sold as a result of increased store foot traffic relative to last year, which was impacted by widespread temporary store closures due to COVID-19, and 45% digital sales growth. Average unit retail increased year-over-year, driven by lower promotions and markdowns, with benefits from changes in foreign currency exchange rates of approximately $12 million.
Cost of sales, exclusive of depreciation and amortization
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Cost of sales, exclusive of depreciation and amortization $ 286,271 36.6% $ 221,214 45.6% (900)
For the first quarter of Fiscal 2021, cost of sales, exclusive of depreciation and amortization, as a percentage of net sales decreased by approximately 900 basis points as compared to the first quarter of Fiscal 2020. The year-over-year decline was primarily attributable to increased average unit retail on reduced promotions and markdowns.
Gross profit, exclusive of depreciation and amortization
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Gross profit, exclusive of depreciation and amortization $ 495,134 63.4% $ 264,145 54.4% 900
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Stores and distribution expense
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Stores and distribution expense $ 316,608 40.5% $ 322,124 66.4% (2,590)
For the first quarter of Fiscal 2021, stores and distribution expense decreased 2% as compared to the first quarter of Fiscal 2020, primarily driven by a $32 million reduction in store occupancy expense reflecting a decrease in store count and favorable rent negotiations. The decrease in store occupancy expense was partially offset by a $13 million increase in store payroll expense, reflecting the return of certain expenses saved last year from COVID-19 temporary store closures, and a $9 million increase in digital shipping and handling expense reflecting 45% year-over-year digital sales growth.
Marketing, general and administrative expense
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Marketing, general and administrative expense $ 120,947 15.5% $ 108,257 22.3% (680)
For the first quarter of Fiscal 2021, marketing, general and administrative expense increased 12% as compared to the first quarter of Fiscal 2020, primarily driven by increased performance-based compensation and digital media spend, partially offset by lower non-customer-facing controllable expenses and in-store marketing costs.
Flagship store exit benefits
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Flagship store exit benefits $ (1,100) (0.1)% $ (543) (0.1)% —
Refer to Note 16, “ FLAGSHIP STORE EXIT BENEFITS .”
Asset impairment, exclusive of flagship store exit charges
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Asset impairment, exclusive of flagship store exit charges $ 2,664 0.3% $ 42,928 8.8% (850)
Excluded items:
Asset impairment charges (1)
(2,664) (0.3)% (42,928) (8.8)% 850
Adjusted non-GAAP asset impairment, exclusive of flagship store exit charges $ — 0.0% $ — —% —
(1) Refer to “ NON-GAAP FINANCIAL MEASURES , ” for further details.
Refer to Note 9, “ ASSET IMPAIRMENT .”
Other operating income (loss), net
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Other operating income (loss), net $ 1,418 0.2% $ (506) (0.1)% (30)
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Operating income (loss)
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Operating income (loss) $ 57,433 7.3% $ (209,127) (43.1)% 5,040
Excluded items:
Asset impairment charges (1)
2,664 0.3% 42,928 8.8% (850)
Adjusted non-GAAP operating income (loss) $ 60,097 7.7% $ (166,199) (34.2)% 4,190
(1) Refer to “ NON-GAAP FINANCIAL MEASURES , ” for further details.
Interest expense, net
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Interest expense $ 9,143 1.2% $ 5,073 1.0% 20
Interest income (537) (0.1)% (1,702) (0.4)% 30
Interest expense, net $ 8,606 1.1% $ 3,371 0.7% 40
For the first quarter of Fiscal 2021, interest expense, net increased $5.2 million as compared to the first quarter of Fiscal 2020. The increase in interest expense, net, is primarily driven by higher interest expense in the current year, reflecting higher average borrowings outstanding at a higher interest rate, as well as lower interest income earned on the Company’s investments and cash holdings.
Income tax expense
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands, except ratios) Effective Tax Rate Effective Tax Rate
Income tax expense $ 6,121 12.5% $ 31,533 (14.8)%
Excluded items:
Tax effect of pre-tax excluded items (1)
449 4,432
Adjusted non-GAAP income tax expense $ 6,570 12.8% $ 35,965 (21.2)%
(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.
Refer to Note 10, “ INCOME TAXES .”
Net income (loss) attributable to A&F
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands) % of Net sales % of Net sales BPS Change
Net income (loss) attributable to A&F $ 41,768 5.3% $ (244,148) (50.3)% 5,560
Excluded items, net of tax (1)
2,215 0.3% 38,496 7.9% (760)
Adjusted non-GAAP net income (loss) attributable to A&F $ 43,983 5.6% $ (205,652) (42.4)% 4,800
(1) Excluded items presented above under “ Operating income (loss) ,” and “ Income tax expense. ”
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Net income (loss) per diluted share attributable to A&F
Thirteen Weeks Ended
May 1, 2021 May 2, 2020 $ Change
Net income (loss) per diluted share attributable to A&F $ 0.64 $ (3.90) $4.54
Excluded items, net of tax (1)
$ 0.03 $ 0.62 $(0.59)
Adjusted non-GAAP net income (loss) per diluted share attributable to A&F $ 0.67 $ (3.29) $3.96
Impact from changes in foreign currency exchange rates
$ — $ (0.01) $0.01
Adjusted non-GAAP net income (loss) per diluted share attributable to A&F on a constant currency basis (2)
$ 0.67 $ (3.30) $3.97
(1) Excluded items presented above under “ Operating income (loss) ,” 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. 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 ”.
Over the next twelve months, the Company expects its primary cash requirements to be directed towards prioritizing investments in the business and continuing to fund 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.
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 “ITEM 1. BUSINESS - STRATEGY AND KEY BUSINESS PRIORITIES” of A&F’s Annual Report on Form 10-K for Fiscal 2020, including being opportunistic regarding growth opportunities, such as launching Social Tourist. 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 the year-to-date period ended May 1, 2021, the Company used $14.4 million towards capital expenditures. Total capital expenditures for Fiscal 2021 are expected to be approximately $100 million as compared to $101.9 million of capital expenditures in Fiscal 2020.
The Company entered Fiscal 2021 in a strong financial position, with cash and cash equivalents of $1.1 billion and total liquidity of approximately $1.3 billion. This allows the Company to evaluate potential opportunities to strategically deploy excess cash and delever the balance sheet, depending on various factors, such as market and business conditions. In Fiscal 2021, the Company has and continues to focus on such opportunities including, but not limited to, accelerating investments in the business, returning cash to shareholders through share repurchases, and repurchasing outstanding senior secured notes.
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. Although the dividend program remains suspended, the Company has since resumed share repurchases and may repurchase shares in the future, dependent on various factors, such as market and business conditions, including the Company’s ability to accelerate investments in the business. 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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS ” of Part II of this Quarterly Report on Form 10-Q for 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 and paid in March for Fiscal 2020. 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.
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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 Condensed Consolidated Balance Sheets, net of the unamortized fees. As of May 1, 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 May 1, 2021, the Company did not have any borrowings outstanding under the ABL Facility. The ABL Facility matures on April 29, 2026.
Details regarding the remaining borrowing capacity under the ABL Facility as of May 1, 2021 are as follows:
(in thousands) May 1, 2021
Borrowing base $ 253,370
Less: Outstanding stand-by letters of credit (837)
Borrowing capacity 252,533
Less: Minimum excess availability (1)
(30,000)
Borrowing available $ 222,533
(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 11, “ 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 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 May 1, 2021, $374.9 million of the Company’s $909.0 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 10, “ INCOME TAXES .”
Analysis of cash flows
The table below provides certain components of the Company’s Condensed Consolidated Statements of Cash Flows for the thirteen weeks ended May 1, 2021 and May 2, 2020:
Thirteen Weeks Ended
May 1, 2021 May 2, 2020
(in thousands)
Cash and equivalents, and restricted cash and equivalents, beginning of period $ 1,124,157 $ 692,264
Net cash used for operating activities (131,350) (140,776)
Net cash (used for) provided by investing activities (14,404) 3,010
Net cash (used for) provided by financing activities (53,191) 171,668
Effect of foreign currency exchange rates on cash (1,021) (3,891)
Net (decrease) increase in cash and equivalents, and restricted cash and equivalents (199,966) 30,011
Cash and equivalents, and restricted cash and equivalents, end of period $ 924,191 $ 722,275
Operating activities - During the year-to-date period ended May 1, 2021, the Company recognized higher cash receipts as compared to the year-to-date period ended May 2, 2020 as a result of the 61% year-over-year increase in net sales as the Company experienced widespread temporary store closures in response to COVID-19 during Fiscal 2020.
The Company also took various immediate, aggressive actions during Fiscal 2020 to preserve liquidity and manage cash flows in light of COVID-19 in order to best position the business for key stakeholders, including, but not limited to (i) partnering with merchandise and non-merchandise vendors in regards to payment terms; (ii) tightly managing inventory receipts to align inventory with expected market demand; and (iii) significantly reducing expenses to better align operating costs with sales. The Company also suspended rent payments for a larger proportion of its stores in Fiscal 2020 than it has in Fiscal 2021 related to
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stores that were closed for a period of time as a result of COVID-19. 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.
In addition, during the year-to-date period ended May 1, 2021, the Company finalized an agreement with and paid its landlord partner to settle all remaining obligations related to the SoHo Hollister flagship store in New York City, which closed during the second quarter of Fiscal 2019. Prior to this new agreement, the Company was required to make payments in aggregate of $80.1 million pursuant to the lease agreements through Fiscal 2028. The new agreement resulted in an acceleration of payments and provided for a discount resulting in an operating cash outflow of $63.8 million during the year-to-date period ended May 1, 2021.
Investing activities - During the year-to-date period ended May 1, 2021, net cash outflows for investing activities were used for capital expenditures of $14.4 million as compared to $47.0 million for the year-to-date period ended May 2, 2020. In addition, the year-to-date period ended May 2, 2020, reflects the withdrawal of $50.0 million from the overfunded Rabbi Trust assets, which represented the majority of excess funds, improving the Company’s near-term cash position in light of COVID-19.
Financing activities - During the year-to-date period ended May 2, 2020, in an effort to further improve the Company’s near-term cash position as a precautionary measure in response to COVID-19, the Company borrowed $210.0 million under the ABL Facility. The Company repaid all outstanding borrowings under the ABL Facility in July 2020, using a portion of the net proceeds from the offering of the Senior Secured Notes and cash on hand. In addition, during the year-to-date period ended May 2, 2020, 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, prior to the Company’s decision to temporarily suspend its share repurchase and dividend programs in light of COVID-19. The Company resumed share repurchase activity beginning March 2021 and repurchased approximately 1.1 million shares of A&F’s Common Stock with a market value of approximately $35.2 million during the year-to-date period ended May 1, 2021.
Off-balance sheet arrangements
As of May 1, 2021, 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.
There have been no material changes during the thirteen weeks ended May 1, 2021 in the contractual obligations as of January 30, 2021, 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).
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 2020. 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 2020. There have been no significant changes in critical accounting policies and estimates since the end of Fiscal 2020.
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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, thereby 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 or Fiscal 2021.
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 Asset impairment charges
Operating income (loss) Asset impairment charges
Income tax expense (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.
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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 the thirteen weeks ended May 1, 2021 and May 2, 2020 follows:
(in thousands, except change in net sales, gross profit rate, operating margin and per share data) Thirteen Weeks Ended
Net sales May 1, 2021 May 2, 2020 % Change
GAAP $ 781,405 $ 485,359 61%
Impact from changes in foreign currency exchange rates — 12,273 (4)%
Non-GAAP on a constant currency basis $ 781,405 $ 497,632 57%
Gross profit, exclusive of depreciation and amortization expense May 1, 2021 May 2, 2020 BPS Change (1)
GAAP $ 495,134 $ 264,145 900
Impact from changes in foreign currency exchange rates — 7,384 (20)
Non-GAAP on a constant currency basis $ 495,134 $ 271,529 880
Operating income (loss) May 1, 2021 May 2, 2020 BPS Change (1)
GAAP $ 57,433 $ (209,127) 5,040
Excluded items (2)
(2,664) (42,928) 850
Adjusted non-GAAP $ 60,097 $ (166,199) 4,190
Impact from changes in foreign currency exchange rates — (900) (60)
Adjusted non-GAAP on a constant currency basis $ 60,097 $ (167,099) 4,130
Net income (loss) per diluted share attributable to A&F May 1, 2021 May 2, 2020 $ Change
GAAP $ 0.64 $ (3.90) $4.54
Excluded items, net of tax (2)
(0.03) (0.62) 0.59
Adjusted non-GAAP $ 0.67 $ (3.29) $3.96
Impact from changes in foreign currency exchange rates — (0.01) 0.01
Adjusted non-GAAP on a constant currency basis $ 0.67 $ (3.30) $3.97
(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 weeks ended May 1, 2021 and May 2, 2020 consisted of pre-tax store asset impairment charges and the tax effect of pre-tax excluded items.
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