10-Q
Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
FORM 10-Q 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 1-12107
 
ABERCROMBIE & FITCH CO.
(Exact name of Registrant as specified in its charter)
 
Delaware
31-1469076
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
6301 Fitch Path, New Albany, Ohio
43054
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (614) 283-6500
Not Applicable
(Former name, former address and former fiscal year, if changed since last report) 
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    x  Yes    ¨  No
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class A Common Stock
 
Outstanding at December 3, 2015
$.01 Par Value
 
67,204,664 Shares
 

Table of Contents


ABERCROMBIE & FITCH CO.
TABLE OF CONTENTS
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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Table of Contents


PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

ABERCROMBIE & FITCH CO.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Thousands, except per share amounts)
(Unaudited)



 
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Net sales
$
878,572

 
$
911,453

 
$
2,405,750

 
$
2,624,486

Cost of goods sold
318,785

 
344,383

 
924,552

 
992,801

Gross profit
559,787

 
567,070

 
1,481,198

 
1,631,685

Stores and distribution expense
392,942

 
413,551

 
1,173,773

 
1,257,422

Marketing, general and administrative expense
117,698

 
104,981

 
345,077

 
339,595

Restructuring (benefit) charge
—

 
—

 
(1,598
)
 
6,053

Asset impairment
12,076

 
16,706

 
18,209

 
16,706

Other operating income, net
(3,919
)
 
(1,534
)
 
(7,018
)
 
(9,444
)
Operating income (loss)
40,990

 
33,366

 
(47,245
)
 
21,353

Interest expense, net
4,586

 
5,572

 
13,792

 
9,589

Income (loss) before taxes
36,404

 
27,794

 
(61,037
)
 
11,764

Income tax (benefit) expense
(5,881
)
 
9,567

 
(40,688
)
 
4,331

Net income (loss)
42,285

 
18,227

 
(20,349
)
 
7,433

Less: Net income attributable to noncontrolling interests
394

 
—

 
1,816

 
—

Net income (loss) attributable to Abercrombie & Fitch Co.
$
41,891

 
$
18,227

 
$
(22,165
)
 
$
7,433

 
 
 
 
 
 
 
 
Net income (loss) per share attributable to Abercrombie & Fitch Co.
 
 
 
 
 
 
 
Basic
$
0.61

 
$
0.26

 
$
(0.32
)
 
$
0.10

Diluted
$
0.60

 
$
0.25

 
$
(0.32
)
 
$
0.10

 
 
 
 
 
 
 
 
Weighted-average shares outstanding
 
 
 
 
 
 
 
Basic
68,866

 
70,814

 
69,363

 
72,577

Diluted
69,265

 
72,128

 
69,363

 
73,870

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.20

 
$
0.20

 
$
0.60

 
$
0.60

 
 
 
 
 
 
 
 
Other comprehensive loss
 
 
 
 
 
 
 
Foreign currency translation
$
(1,491
)
 
$
(39,119
)
 
$
(11,362
)
 
$
(35,545
)
Derivative financial instruments, net of tax
(2,952
)
 
9,071

 
(11,288
)
 
11,345

Other comprehensive loss
(4,443
)
 
(30,048
)
 
(22,650
)
 
(24,200
)
Comprehensive income (loss)
37,842

 
(11,821
)
 
(42,999
)
 
(16,767
)
Less: Comprehensive income attributable to noncontrolling interests
394

 
—

 
1,816

 
—

Comprehensive income (loss) attributable to
Abercrombie & Fitch Co.
$
37,448

 
$
(11,821
)
 
$
(44,815
)
 
$
(16,767
)


The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
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ABERCROMBIE & FITCH CO.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Thousands, except par value amounts)
 


 
(unaudited)
 
 
 
October 31, 2015
 
January 31, 2015
Assets
 
 
 
Current assets:
 
 
 
Cash and equivalents
$
405,611

 
$
520,708

Receivables
62,132

 
52,910

Inventories, net
601,541

 
460,794

Deferred income taxes, net
34,344

 
13,986

Other current assets
109,527

 
116,574

Total current assets
1,213,155

 
1,164,972

Property and equipment, net
918,926

 
967,001

Other assets
380,663

 
373,194

Total assets
$
2,512,744

 
$
2,505,167

Liabilities and stockholders' equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
303,992

 
$
141,685

Accrued expenses
309,209

 
282,736

Short-term portion of deferred lease credits
25,031

 
26,629

Income taxes payable
4,665

 
32,804

Short-term portion of borrowings, net
1,513

 
2,102

Total current liabilities
644,410

 
485,956

Long-term liabilities:
 
 
 
Long-term portion of deferred lease credits
96,993

 
106,393

Long-term portion of borrowings, net
288,091

 
291,310

Leasehold financing obligations
48,370

 
50,521

Other liabilities
166,002

 
181,286

Total long-term liabilities
599,456

 
629,510

Stockholders' equity
 
 
 
Class A Common Stock - $0.01 par value: 150,000 shares authorized and 103,300 shares issued at each of October 31, 2015 and January 31, 2015
1,033

 
1,033

Paid-in capital
428,651

 
434,137

Retained earnings
2,485,878

 
2,550,673

Accumulated other comprehensive loss, net of tax
(106,230
)
 
(83,580
)
Treasury stock, at average cost: 36,147 and 33,948 shares at October 31, 2015 and January 31, 2015, respectively
(1,544,168
)
 
(1,512,562
)
Total Abercrombie & Fitch Co. stockholders' equity
1,265,164

 
1,389,701

Noncontrolling interests
3,714

 
—

Total stockholders' equity
1,268,878

 
1,389,701

Total liabilities and stockholders' equity
$
2,512,744

 
$
2,505,167



The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
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ABERCROMBIE & FITCH CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands)
(Unaudited)
 


 
Thirty-nine Weeks Ended
 
October 31, 2015
 
November 1, 2014
Operating activities
 
 
 
Net (loss) income
$
(20,349
)
 
$
7,433

Adjustments to reconcile net (loss) income to net cash provided by operating activities
 
 
 
Depreciation and amortization
160,364

 
174,966

Asset impairment
18,209

 
16,706

Loss on disposal
6,312

 
3,580

Amortization of deferred lease credits
(21,482
)
 
(29,525
)
Benefit from deferred income taxes
(36,747
)
 
(1,408
)
Share-based compensation
21,681

 
17,396

Changes in assets and liabilities
 
 
 
Inventories, net
(141,725
)
 
(90,485
)
Accounts payable and accrued expenses
148,832

 
3,049

Lessor construction allowances
4,743

 
11,669

Income taxes
(34,249
)
 
(55,239
)
Other assets
(9,268
)
 
(15,739
)
Other liabilities
(29,781
)
 
(12,939
)
Net cash provided by operating activities
66,540

 
29,464

Investing activities
 
 
 
Purchases of property and equipment
(105,216
)
 
(132,183
)
Proceeds from sale of property and equipment
11,109

 
—

Other investing activities
9,544

 
—

Net cash used for investing activities
(84,563
)
 
(132,183
)
Financing activities
 
 
 
Purchase of treasury stock
(50,033
)
 
(285,038
)
Repayments of borrowings
(2,250
)
 
(195,000
)
Proceeds from borrowings
—

 
357,000

Other financing activities
147

 
579

Dividends paid
(41,704
)
 
(43,494
)
Net cash used for financing activities
(93,840
)
 
(165,953
)
Effect of exchange rates on cash
(3,234
)
 
(10,880
)
Net decrease in cash and equivalents
(115,097
)
 
(279,552
)
Cash and equivalents, beginning of period
520,708

 
600,116

Cash and equivalents, end of period
$
405,611

 
$
320,564

Significant non-cash investing activities
 
 
 
Change in accrual for construction in progress
$
22,882

 
$
1,054

Supplemental information
 
 
 
Cash paid for interest
$
12,220

 
$
12,554

Cash paid for income taxes, net of refunds
$
45,100

 
$
68,357



The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements.
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ABERCROMBIE & FITCH CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION

Nature of Business

Abercrombie & Fitch Co. (“A&F”), through its subsidiaries (collectively, A&F and its subsidiaries are referred to as “Abercrombie & Fitch” or the “Company”), is a specialty retailer of branded apparel and accessories. The Company operates stores in North America, Europe, Asia and the Middle East and direct-to-consumer operations in North America, Europe and Asia that serve its customers throughout the world.

Principles of Consolidation

The accompanying Condensed Consolidated Financial Statements include historical financial statements of, and transactions applicable to, the Company and reflect its assets, liabilities, results of operations and cash flows.

The Company has interests in a United Arab Emirates business venture and in a Kuwait business venture with Majid al Futtaim Fashion L.L.C. ("MAF"), each of which meets the definition of a variable interest entity (“VIE”). The Company is deemed to be the primary beneficiary of these VIEs; therefore, the Company has consolidated the operating results, assets and liabilities of these VIEs, with MAF's portion of net income presented as net income attributable to noncontrolling interests ("NCI") in the Company's Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) and MAF's portion of equity presented as NCI in the Condensed Consolidated Balance Sheets. The Company began presenting income attributable to NCI in the second quarter of Fiscal 2015. Income attributable to NCI of $1.8 million for the thirty-nine weeks ended October 31, 2015 included $0.8 million related to Fiscal 2014.

Fiscal Year

The Company’s fiscal year ends on the Saturday closest to January 31. All references herein to “Fiscal 2015” and “Fiscal 2014” represent the 52-week fiscal years ending on January 30, 2016 and January 31, 2015, respectively.

Interim Financial Statements

The Condensed Consolidated Financial Statements as of October 31, 2015, and for the thirteen and thirty-nine week periods ended October 31, 2015 and November 1, 2014, are unaudited and are presented pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, these Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto contained in A&F’s Annual Report on Form 10-K for Fiscal 2014 filed with the SEC on March 30, 2015. The January 31, 2015 consolidated balance sheet data were derived from audited consolidated financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”).

In the opinion of management, the accompanying Condensed Consolidated Financial Statements reflect all adjustments (which are of a normal recurring nature) necessary to state fairly, in all material respects, the financial position and results of operations and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for Fiscal 2015.

Net income attributable to A&F for the thirteen and thirty-nine weeks ended October 31, 2015 included a benefit of $1.2 million and a charge of $0.1 million, respectively, related to the correction of certain errors from prior periods. Net income attributable to A&F for the thirteen and thirty-nine weeks ended November 1, 2014 included a charge of $0.8 million and $2.4 million, respectively, related to the correction of certain errors from prior periods. The Company does not believe these corrections were material to any current or prior interim or annual periods that were affected.

The Condensed Consolidated Financial Statements as of October 31, 2015 and for the thirteen and thirty-nine week periods ended October 31, 2015 and November 1, 2014 included herein have been reviewed by PricewaterhouseCoopers LLP, an independent registered public accounting firm, and the report of such firm follows the Notes to Condensed Consolidated Financial Statements.


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PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 (the “Act”) for their report on the Condensed Consolidated Financial Statements because their report is not a “report” or a “part” of a registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

Recent Accounting Pronouncements

The following table provides a brief description of recent accounting pronouncements that could affect the Company's financial statements:
Standard
 
Description
 
Date of
Adoption
 
Effect on the Financial Statements or Other Significant Matters
Standard adopted
ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs
 
This standard amends ASC 835, Interest—Imputation of Interest. The amendment provides guidance on the financial statement presentation of debt issuance costs as a direct reduction of a liability when associated with a liability.
 
February 1, 2015
 
The adoption of this guidance impacted the Company's consolidated financial statements by approximately $0.6M.
ASU 2015-15, Simplifying the Presentation of Debt Issuance Costs
 
This standard amends ASC 835, Interest—Imputation of Interest. The amendment provides guidance on the financial statement presentation of debt issuance costs associated with line-of-credit arrangements as an asset regardless of whether there are any outstanding borrowings on the line-of-credit arrangement.
 
August 2, 2015
 
The adoption of this guidance did not have any impact on the Company's consolidated financial statements.
Standards not yet adopted
ASU 2014-09, Revenue from Contracts with Customers
 
This standard supersedes the revenue recognition requirements in "Revenue Recognition (Topic 605)." The new ASC guidance requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration which the entity expects to be entitled to in exchange for those goods or services.
 
February 4, 2018
 
The Company is currently evaluating the potential impact of this standard.
ASU 2015-11, Simplifying the Measurement of Inventory
 
This standard amends ASC 330, Inventory. This amendment applies to inventory measured using first-in, first-out (FIFO) or average cost. Under this amendment, inventory should be measured at the lower of cost and net realizable value, which is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
 
January 29, 2017*
 
The adoption of this amendment is not expected to have a material impact on the Company's consolidated financial statements.

ASU 2015-17, Income Taxes: Balance Sheet Classification of Deferred Taxes

 
This standard requires that deferred tax assets and liabilities be classified as noncurrent in a classified statement of financial position.
 
January 29, 2017*
 
The adoption of this standard will result in the reclassification of all current deferred tax assets and liabilities to noncurrent in the Company's consolidated balance sheets.

* Early adoption is permitted.

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2. NET INCOME (LOSS) PER SHARE

Net income (loss) per basic and diluted share is computed based on the weighted-average number of outstanding shares of common stock.

The following table presents weighted-average shares outstanding and anti-dilutive shares:
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
(in thousands)
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Shares of common stock issued
103,300

 
103,300

 
103,300

 
103,300

Weighted-average treasury shares
(34,434
)
 
(32,486
)
 
(33,937
)
 
(30,723
)
Weighted-average — basic shares
68,866

 
70,814

 
69,363

 
72,577

Dilutive effect of share-based compensation awards
399

 
1,314

 
—

 
1,293

Weighted-average — diluted shares
69,265

 
72,128

 
69,363

 
73,870

Anti-dilutive shares (1)
10,205

 
5,566

 
12,154

 
5,621


(1) 
Reflects the total number of shares related to outstanding share-based compensation awards that have been excluded from the computation of net income (loss) per diluted share because the impact would have been anti-dilutive.

During the third quarter of Fiscal 2015, A&F repurchased approximately 2.5 million additional shares of A&F's Common Stock in the open market at a market value of approximately $50 million.


3. FAIR VALUE

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value are prioritized based on a three-level hierarchy. The three levels of inputs to measure fair value are as follows:

•
Level 1—inputs are unadjusted quoted prices for identical assets or liabilities that are available in active markets that the Company can access at the measurement date.
•
Level 2—inputs are other than quoted market prices included within Level 1 that are observable for assets or liabilities, directly or indirectly.
•
Level 3—inputs to the valuation methodology are unobservable.


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The lowest level of significant input determines the placement of the entire fair value measurement in the hierarchy. The three levels of the hierarchy and the distribution within it of the Company’s assets and liabilities, measured at fair value on a recurring basis, were as follows:
 
Assets and Liabilities at Fair Value as of October 31, 2015
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds
$
79,212

 
$
—

 
$
—

 
$
79,212

Derivative financial instruments
—

 
1,769

 
—

 
1,769

Total assets measured at fair value
$
79,212

 
$
1,769

 
$
—

 
$
80,981

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
—

 
396

 
—

 
396

Total liabilities measured at fair value
$
—

 
$
396

 
$
—

 
$
396

 
Assets and Liabilities at Fair Value as of January 31, 2015
(in thousands)
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds
$
122,047

 
$
—

 
$
—

 
$
122,047

Derivative financial instruments
—

 
10,293

 
—

 
10,293

Total assets measured at fair value
$
122,047

 
$
10,293

 
$
—

 
$
132,340

Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments
—

 
—

 
—

 
—

Total liabilities measured at fair value
$
—

 
$
—

 
$
—

 
$
—


The level 2 assets and liabilities consist of derivative financial instruments, primarily forward foreign currency exchange contracts. The fair value of forward foreign currency exchange contracts is determined by using quoted market prices of the same or similar instruments, adjusted for counterparty risk.

Disclosures of Fair Value of Other Assets and Liabilities:

The Company’s borrowings under the Company's credit facilities are carried at historical cost in the accompanying Condensed Consolidated Balance Sheets. For disclosure purposes, the Company estimated the fair value of borrowings outstanding using a discounted cash flow analysis based on market rates obtained from independent third parties for similar types of debt. The inputs used to value the borrowings outstanding are considered to be Level 2 instruments.

The carrying amount and fair value of the Company's term loan facility were as follows:
(in thousands)
October 31, 2015
 
January 31, 2015
Gross borrowings outstanding, carrying amount
$
297,000

 
$
299,250

Gross borrowings outstanding, fair value
$
289,575

 
$
295,135


No borrowings were outstanding under the Company's senior secured revolving credit facility as of October 31, 2015 or January 31, 2015.


4. INVENTORIES, NET

Inventories, net consisted of:
(in thousands)
October 31, 2015
 
January 31, 2015
Inventories
$
635,967

 
$
484,865

Less: Lower of cost or market reserve
(29,303
)
 
(12,707
)
Less: Shrink reserve
(5,123
)
 
(11,364
)
Inventories, net
$
601,541

 
$
460,794


Inventories are valued at the lower of cost or market on a weighted-average cost basis. The Company reduces the carrying value of inventory through a lower of cost or market adjustment, the impact of which is reflected in cost of goods sold on the Condensed

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Consolidated Statements of Operations and Comprehensive Income (Loss). The lower of cost or market reserve is based on an analysis of historical experience, composition and aging of the inventory and management's judgment regarding future demand and market conditions.

Additionally, as part of inventory valuation, inventory shrinkage estimates based on historical trends from actual physical inventories are made each period that reduce the inventory value for lost or stolen items. The Company performs physical inventories on a periodic basis and adjusts the shrink reserve accordingly.


5. PROPERTY AND EQUIPMENT, NET

Property and equipment, net consisted of:
(in thousands)
October 31, 2015
 
January 31, 2015
Property and equipment, at cost
$
2,830,013

 
$
2,797,250

Less: Accumulated depreciation and amortization
(1,911,087
)
 
(1,830,249
)
Property and equipment, net
$
918,926

 
$
967,001


Long-lived assets, primarily comprised of property and equipment, are tested for impairment periodically or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Factors used in the evaluation include, but are not limited to, management’s plans for future operations, recent operating results, and undiscounted projected cash flows.

Fair value of the Company's store-related assets is determined at the individual store level, primarily using a discounted cash flow model that utilizes Level 3 inputs. The estimation of future cash flows from operating activities requires significant estimates of factors that include future sales, gross margin performance and operating expenses. In instances where the discounted cash flow analysis indicates a negative value at the store level, the market exit price based on historical experience, and other comparable market data where applicable, is used to determine the fair value by asset type.

Store-related assets are considered level 3 assets in the fair value hierarchy and the fair values were determined at the individual store level, primarily using a discounted cash flow model. The estimation of future cash flows from operating activities requires significant estimates of factors that include future sales, gross margin performance and operating expenses. In instances where the discounted cash flow analysis indicated an impairment at the store level, the market exit price based on historical experience was used to determine the fair value by asset type.

In the third quarter of 2015, the Company incurred non-cash asset impairment charges of $12.1 million as it was determined that the carrying value of certain assets would not be recoverable and exceeded fair value. The asset impairment charges primarily related to the Company's Abercrombie & Fitch flagship store in Hong Kong. The Company incurred $18.2 million in asset impairment charges for the thirty-nine weeks ended October 31, 2015.

In the third quarter of Fiscal 2014, the Company incurred non-cash asset impairment charges of $16.7 million, as it was determined that the carrying value of certain store-related assets would not be recoverable and exceeded fair value. The asset impairment charges primarily related to the Company's Abercrombie & Fitch flagship store in Tokyo, Japan, as well as three other Abercrombie & Fitch stores, five Hollister stores and nine abercrombie kids stores.

In certain lease arrangements, the Company is involved in the construction of a building and is deemed to be the owner of the construction project. In those instances, the Company records an asset for the amount of the total project costs, including the portion funded by the landlord, and an amount related to the value of the pre-existing leased building in property and equipment, net, and a corresponding financing obligation in leasehold financing obligations, on the Condensed Consolidated Balance Sheets. Once construction is complete, if it is determined that the asset does not qualify for sale-leaseback accounting treatment, the amounts remain on the Company's Condensed Consolidated Balance Sheets and the Company continues to amortize the obligation over the lease term and depreciates the asset over its useful life. The Company had $38.2 million and $40.1 million of construction project assets in property and equipment, net at October 31, 2015 and January 31, 2015, respectively.


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6. INCOME TAXES

The Company's quarterly tax provision and quarterly estimate of the annual effective tax rate are subject to significant variation due to several factors. These include variability in the pre-tax jurisdictional mix of earnings, changes in how the Company does business such as entering into new businesses or geographies, changes in foreign currency exchange rates, changes in laws, regulations, and administrative practices, relative changes in expenses or losses for which tax benefits are not recognized, and the impact of discrete items. The impact of these items on the effective tax rate will be greater at lower levels of pre-tax income (loss).

The effective tax rates for the thirteen and thirty-nine weeks ended October 31, 2015 reflect benefits related to a change in the estimated annual effective tax rate and discrete benefits of $9.7 million and $8.6 million, respectively. The discrete benefits include the release of $5.9 million of valuation allowance established on certain net operating losses, as the Company believes it is more likely than not these deferred tax assets will be utilized due to the expectation of future taxable income in the related jurisdiction.

A provision for U.S. income tax has not been recorded on undistributed profits generated through the third quarter of Fiscal 2015 of non-U.S. subsidiaries that the Company has determined to be indefinitely reinvested outside the U.S. Determination of the amount of unrecognized deferred U.S. income tax liability on these unremitted earnings is not practicable because of the complexities associated with this hypothetical calculation. Unremitted earnings from foreign subsidiaries generated after October 31, 2015 are not considered to be invested indefinitely, and the Company plans to recognize deferred U.S. income taxes on these earnings.


7. SHARE-BASED COMPENSATION

The Company issues stock appreciation rights and restricted stock units, including those with service, performance and market vesting conditions. The Company recognized share-based compensation expense of $7.6 million and $21.7 million for the thirteen and thirty-nine weeks ended October 31, 2015, respectively, and $6.0 million and $17.4 million for the thirteen and thirty-nine weeks ended November 1, 2014, respectively. The Company also recognized tax benefits related to share-based compensation of $2.6 million and $7.4 million for the thirteen and thirty-nine weeks ended October 31, 2015, respectively, and $2.3 million and $6.6 million for the thirteen and thirty-nine weeks ended November 1, 2014, respectively.

Stock Options

The following table summarizes stock option activity for the thirty-nine weeks ended October 31, 2015:
 
Number of
Underlying
Shares
 
Weighted-Average
Exercise Price
 
Aggregate
Intrinsic Value
 
Weighted-Average
Remaining
Contractual Life
Outstanding at January 31, 2015
328,100

 
$
64.64

 
 
 
 
Granted
—

 
—

 
 
 
 
Exercised
—

 
—

 
 
 
 
Forfeited or expired
(34,300
)
 
69.71

 
 
 
 
Outstanding at October 31, 2015
293,800

 
$
64.05

 
$
—

 
1.9
Stock options exercisable at October 31, 2015
293,800

 
$
64.05

 
$
—

 
1.9

The Company did not grant any stock options during the thirty-nine weeks ended October 31, 2015 or November 1, 2014. No stock options were exercised during the thirty-nine weeks ended October 31, 2015. The intrinsic value of stock options exercised was insignificant during the thirty-nine weeks ended November 1, 2014.

As of October 31, 2015, there was no unrecognized compensation cost related to currently outstanding stock options.


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Stock Appreciation Rights

The following table summarizes stock appreciation rights activity for the thirty-nine weeks ended October 31, 2015:
 
Number of
Underlying
Shares
 
Weighted-Average
Exercise Price
 
Aggregate
Intrinsic Value
 
Weighted-Average
Remaining
Contractual Life
Outstanding at January 31, 2015
8,953,675

 
$
40.28

 
 
 
 
Granted
709,758

 
21.90

 
 
 
 
Exercised
—

 
—

 
 
 
 
Forfeited or expired
(165,150
)
 
39.70

 
 
 
 
Outstanding at October 31, 2015
9,498,283

 
$
38.92

 
$
—

 
2.3
Stock appreciation rights exercisable at October 31, 2015
8,326,609

 
$
40.31

 
$
—

 
1.4
Stock appreciation rights expected to become exercisable in the future as of October 31, 2015
1,039,928

 
$
29.31

 
$
—

 
8.9

The Company estimates the fair value of stock appreciation rights using the Black-Scholes option-pricing model. The weighted-average assumptions used in the Black-Scholes option-pricing model for stock appreciation rights granted during the thirty-nine weeks ended October 31, 2015 and November 1, 2014, were as follows:
 
Executive Officers
 
All Other Associates
 
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Grant date market price
$
22.46

 
$
37.85

 
$
21.99

 
$
38.58

Exercise price
$
22.46

 
$
38.44

 
$
21.99

 
$
38.79

Fair value
$
9.11

 
$
14.04

 
$
7.84

 
$
13.56

Assumptions:
 
 
 
 
 
 
 
Price volatility
49
%
 
50
%
 
49
%
 
50
%
Expected term (years)
6.1

 
4.9

 
4.4

 
4.1

Risk-free interest rate
1.5
%
 
1.6
%
 
1.3
%
 
1.4
%
Dividend yield
1.7
%
 
2.0
%
 
1.7
%
 
1.9
%

Compensation expense for stock appreciation rights is recognized on a straight-line basis over the awards’ requisite service period, net of forfeitures. As of October 31, 2015, there was $8.8 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock appreciation rights. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 17 months.

No stock appreciation rights were exercised during the thirty-nine weeks ended October 31, 2015. The total intrinsic value of stock appreciation rights exercised during the thirty-nine weeks ended November 1, 2014 was $1.5 million. The grant date fair value of stock appreciation rights that vested during the thirty-nine weeks ended October 31, 2015 and November 1, 2014 was $4.5 million and $7.3 million, respectively.


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Restricted Stock Units

The following table summarizes activity for restricted stock units for the thirty-nine weeks ended October 31, 2015:
 
Service-based Restricted
Stock Units
 
Performance-based Restricted
Stock Units
 
Market-based Restricted
Stock Units
 
Number of 
Underlying
Shares
 
Weighted-
Average Grant
Date Fair Value
 
Number of 
Underlying
Shares
 
Weighted-
Average Grant
Date Fair Value
 
Number of 
Underlying
Shares
 
Weighted-
Average Grant
Date Fair Value
Unvested at January 31, 2015
1,566,272

 
$
37.81

 
205,420

 
$
32.05

 
36,374

 
$
40.13

Granted (1)
1,060,293

 
20.49

 
113,331

 
20.10

 
113,337

 
19.04

Adjustments for performance achievement
—

 
—

 
(28,250
)
 
36.14

 
—

 
—

Vested
(437,946
)
 
41.00

 
(48,668
)
 
38.24

 
—

 
—

Forfeited
(181,378
)
 
35.62

 
(30,208
)
 
36.19

 
(7,000
)
 
28.31

Unvested at October 31, 2015
2,007,241

 
$
28.16

 
211,625

 
$
23.09

 
142,711

 
$
23.96


(1)
Includes 226,668 shares granted at 100% of their target vesting amount related to restricted stock units with performance vesting conditions.

Fair value of both service-based and performance-based restricted stock units is calculated using the market price of the underlying common stock on the date of grant reduced for anticipated dividend payments on unvested shares. In determining fair value, the Company does not take into account performance-based vesting requirements. Performance-based vesting requirements are taken into account in determining the number of awards expected to vest. For market-based restricted stock units, fair value is calculated using a Monte Carlo simulation with the number of shares that ultimately vest dependent on the Company's total stockholder return measured against the total stockholder return of a select group of peer companies over a three-year period. For an award with performance-based or market-based vesting requirements, the number of shares that ultimately vest can vary from 0% to 200% of target depending on the level of achievement of performance criteria.

Service-based restricted stock units are expensed on a straight-line basis over the total requisite service period, net of forfeitures. Performance-based restricted stock units subject to graded vesting are expensed on an accelerated attribution basis, net of forfeitures. Market-based restricted stock units without graded vesting features are expensed on a straight-line basis over the requisite service period, net of forfeitures.

As of October 31, 2015, there was $31.6 million, $1.9 million and $2.2 million of total unrecognized compensation cost, net of estimated forfeitures, related to service-based, performance-based and market-based restricted stock units, respectively. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 15 months, 14 months and 13 months for service-based, performance-based and market-based restricted stock units, respectively.

Additional information pertaining to restricted stock units for the thirty-nine weeks ended October 31, 2015 and November 1, 2014 follows:
(in thousands)
October 31, 2015
 
November 1, 2014
Service-based restricted stock units:
 
 
 
Total grant date fair value of awards granted
$
21,725

 
$
20,847

Total grant date fair value of awards vested
17,956

 
16,470

 
 
 
 
Performance-based restricted stock units:
 
 
 
Total grant date fair value of awards granted
$
2,278

 
$
4,470

Total grant date fair value of awards vested
1,861

 
515

 
 
 
 
Market-based restricted stock units:
 
 
 
Total grant date fair value of awards granted
$
2,158

 
$
3,576

Total grant date fair value of awards vested
—

 
—



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The weighted-average assumptions used for market-based restricted stock units used in the Monte Carlo simulation during the thirty-nine weeks ended October 31, 2015 and November 1, 2014 were as follows:
 
October 31, 2015
 
November 1, 2014
Grant date market price
$
22.46

 
$
38.50

Fair value
$
19.04

 
$
46.86

Assumptions:
 
 
 
Price volatility
45
%
 
50
%
Expected term (years)
2.8

 
2.8

Risk-free interest rate
0.9
%
 
0.8
%
Dividend yield
3.5
%
 
2.1
%
Average volatility of peer companies
34.0
%
 
37.3
%
Average correlation coefficient of peer companies
0.3288

 
0.3786



8. DERIVATIVES

The Company is exposed to risks associated with changes in foreign currency exchange rates and uses derivative instruments, primarily forward contracts, to manage the financial impacts of these exposures. The Company does not use forward contracts to engage in currency speculation and does not enter into derivative financial instruments for trading purposes.

In order to qualify for hedge accounting treatment, a derivative instrument must be considered highly effective at offsetting changes in either the hedged item’s cash flows or fair value. Additionally, the hedge relationship must be documented to include the risk management objective and strategy, the hedging instrument, the hedged item, the risk exposure, and how hedge effectiveness will be assessed prospectively and retrospectively. The extent to which a hedging instrument has been, and is expected to continue to be, effective at offsetting changes in fair value or cash flows is assessed and documented at least quarterly. Any hedge ineffectiveness is reported in current period earnings and hedge accounting is discontinued if it is determined that the derivative instrument is not highly effective.

For derivative instruments that either do not qualify for hedge accounting or are not designated as hedges, all changes in the fair value of the derivative instrument are recognized in earnings. For qualifying cash flow hedges, the effective portion of the change in the fair value of the derivative instrument is recorded as a component of Other comprehensive income (loss) (“OCI”) and recognized in earnings when the hedged cash flows affect earnings. The ineffective portion of the derivative instrument gain or loss, as well as changes in the fair value of the derivative’s time value is recognized in current period earnings. The effectiveness of the hedge is assessed based on changes in the fair value attributable to changes in spot prices. The changes in the fair value of the derivative instrument related to the changes in the difference between the spot price and the forward price are excluded from the assessment of hedge effectiveness and are also recognized in current period earnings. If the cash flow hedge relationship is terminated, the derivative instrument gains or losses that are deferred in OCI will be recognized in earnings when the hedged cash flows occur. However, for cash flow hedges that are terminated because the forecasted transaction is not expected to occur in the original specified time period, or a two-month period thereafter, the derivative instrument gains or losses are immediately recognized in earnings.

The Company uses derivative instruments, primarily forward contracts designated as cash flow hedges, to hedge the foreign currency exposure associated with forecasted foreign-currency-denominated inter-company inventory sales to foreign subsidiaries and the related settlement of the foreign-currency-denominated inter-company receivables. Fluctuations in exchange rates will either increase or decrease the Company’s inter-company equivalent cash flows and affect the Company’s U.S. Dollar earnings. Gains or losses on the foreign currency exchange forward contracts that are used to hedge these exposures are expected to partially offset this variability. Foreign currency exchange forward contracts represent agreements to exchange the currency of one country for the currency of another country at an agreed-upon settlement date. These forward contracts typically have a maximum term of twelve months. The sale of the inventory to the Company’s customers will result in the reclassification of related derivative gains and losses that are reported in accumulated other comprehensive loss ("AOCL"). Substantially all of the unrealized gains or losses related to designated cash flow hedges as of October 31, 2015 will be recognized in cost of goods sold over the next twelve months.

The Company presents its derivative assets and derivative liabilities at their gross fair values on the Condensed Consolidated Balance Sheets. However, our master netting and other similar arrangements allow net settlements under certain conditions.


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As of October 31, 2015, the Company had outstanding the following foreign currency exchange forward contracts that were entered into to hedge either a portion, or all, of forecasted foreign-currency-denominated intercompany inventory sales, the resulting settlement of the foreign-currency-denominated intercompany accounts receivable, or both:
(in thousands)
Notional Amount(1)
Euro
$
68,803

British pound
$
22,992

Canadian dollar
$
11,027


(1) 
Amounts are reported in U.S. Dollar equivalent as of October 31, 2015.

The Company also uses foreign currency exchange forward contracts to hedge certain foreign-currency-denominated net monetary assets/liabilities. Examples of monetary assets/liabilities include cash balances, receivables and payables. Fluctuations in exchange rates result in transaction gains/(losses) being recorded in earnings as U.S. GAAP requires that monetary assets/liabilities be remeasured at the spot exchange rate at quarter-end or upon settlement. The Company has chosen not to apply hedge accounting to these instruments because there are no differences in the timing of gain or loss recognition on the hedging instrument and the hedged item.

As of October 31, 2015, the Company had outstanding the following foreign currency forward contracts that were entered into to hedge foreign currency denominated net monetary assets/liabilities:
(in thousands)
Notional Amount(1)
Euro
$
18,772

Japanese yen
$
13,232

British pound
$
6,887

Singapore dollar
$
6,449

Hong Kong dollar
$
1,936


(1) 
Amounts are reported in U.S. Dollar equivalent as of October 31, 2015.

The location and amounts of derivative fair values on the Condensed Consolidated Balance Sheets as of October 31, 2015 and January 31, 2015 were as follows:
 
Asset Derivatives
 
Liability Derivatives
(in thousands)
Location
 
October 31,
2015
 
January 31,
2015
 
Location
 
October 31,
2015
 
January 31,
2015
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
Other current assets
 
$
1,688

 
$
10,283

 
Accrued expenses
 
$
305

 
$
—

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
Other current assets
 
$
81

 
$
10

 
Accrued expenses
 
$
91

 
$
—

Total
Other current assets
 
$
1,769

 
$
10,293

 
Accrued expenses
 
$
396

 
$
—


Refer to Note 3, “FAIR VALUE,” for further discussion of the determination of the fair value of derivative instruments.

The location and amounts of derivative gains and losses for the thirteen and thirty-nine weeks ended October 31, 2015 and November 1, 2014 on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) were as follows:
 
 
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
 
 
 
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
(in thousands)
Location
 
Gain/(Loss)
 
Gain/(Loss)
 
Gain/(Loss)
 
Gain/(Loss)
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
Other operating income, net
 
$
10

 
$
793

 
$
434

 
$
564


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Table of Contents


 
 
Effective Portion
 
Ineffective Portion and Amount Excluded from Effectiveness Testing
 
Amount of Gain (Loss) Recognized in OCI on Derivative Contracts (a)
 
Location of Gain (Loss) Reclassified from AOCL into Earnings
 
Amount of Gain (Loss) Reclassified from AOCL into Earnings (b)
 
Location of Gain Recognized in Earnings on Derivative Contracts
 
Amount of Gain  Recognized in Earnings on Derivative Contracts (c)
 
Thirteen Weeks Ended
(in thousands)
October 31,
2015
 
November 1,
2014
 
 
 
October 31,
2015
 
November 1,
2014
 
 
 
October 31,
2015
 
November 1,
2014
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
$
933

 
$
9,265

 
Cost of goods sold
 
$
2,886

 
$
(856
)
 
Other operating income, net
 
$
58

 
$
78

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Thirty-nine Weeks Ended
(in thousands)
October 31, 2015
 
November 1, 2014
 
 
 
October 31, 2015
 
November 1, 2014
 
 
 
October 31, 2015
 
November 1, 2014
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
 
 
 
Foreign currency exchange forward contracts
$
3,318

 
$
8,128

 
Cost of goods sold
 
$
13,761

 
$
(4,212
)
 
Other operating income, net
 
$
297

 
$
248


(a)
The amount represents the change in fair value of derivative contracts due to changes in spot rates.
(b)
The amount represents the reclassification from AOCL into earnings when the hedged item affects earnings, which is when merchandise is sold to the Company’s customers.
(c)
The amount represents the change in fair value of derivative contracts due to changes in the difference between the spot price and forward price that is excluded from the assessment of hedge effectiveness and, therefore, recognized in earnings.


9. ACCUMULATED OTHER COMPREHENSIVE LOSS

The activity in accumulated other comprehensive loss for the thirteen and thirty-nine weeks ended October 31, 2015 was as follows:
 
Thirteen Weeks Ended October 31, 2015
(in thousands)
Unrealized Gain (Loss) on Derivative Financial Instruments
 
Foreign Currency Translation Adjustment
 
Total
Beginning balance at August 1, 2015
$
4,764

 
$
(106,551
)
 
$
(101,787
)
Other comprehensive income (loss) before reclassifications
(123
)
 
(1,384
)
 
(1,507
)
Reclassified from accumulated other comprehensive income (loss) (1)
(2,886
)
 
—

 
(2,886
)
Tax effect on other comprehensive income (loss)
57

 
(107
)
 
(50
)
Other comprehensive loss
(2,952
)
 
(1,491
)
 
(4,443
)
Ending balance at October 31, 2015
$
1,812

 
$
(108,042
)
 
$
(106,230
)
 
Thirty-nine Weeks Ended October 31, 2015
(in thousands)
Unrealized Gain (Loss) on Derivative Financial Instruments
 
Foreign Currency Translation Adjustment
 
Total
Beginning balance at January 31, 2015
$
13,100

 
$
(96,680
)
 
$
(83,580
)
Other comprehensive income (loss) before reclassifications
2,263

 
(11,255
)
 
(8,992
)
Reclassified from accumulated other comprehensive income (loss) (1)
(13,761
)
 
—

 
(13,761
)
Tax effect on other comprehensive income (loss)
210

 
(107
)
 
103

Other comprehensive loss
(11,288
)
 
(11,362
)
 
(22,650
)
Ending balance at October 31, 2015
$
1,812

 
$
(108,042
)
 
$
(106,230
)

(1)  
For the thirteen and thirty-nine weeks ended October 31, 2015, a gain was reclassified from other comprehensive income (loss) to the cost of goods sold line item on the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).


16
Table of Contents


The activity in accumulated other comprehensive loss for the thirteen and thirty-nine weeks ended November 1, 2014 was as follows:
 
Thirteen Weeks Ended November 1, 2014
(in thousands)
Unrealized Gain (Loss) on Derivative Financial Instruments
 
Foreign Currency Translation Adjustment
 
Total
Beginning balance at August 2, 2014
$
108

 
$
(15,177
)
 
$
(15,069
)
Other comprehensive income (loss) before reclassifications
9,265

 
(39,119
)
 
(29,854
)
Reclassified from accumulated other comprehensive income (loss) (2)
856

 
—

 
856

Tax effect on other comprehensive income (loss)
(1,050
)
 
—

 
(1,050
)
Other comprehensive income (loss)
9,071

 
(39,119
)
 
(30,048
)
Ending balance at November 1, 2014
$
9,179

 
$
(54,296
)
 
$
(45,117
)
 
Thirty-nine Weeks Ended November 1, 2014
(in thousands)
Unrealized Gain (Loss) on Derivative Financial Instruments
 
Foreign Currency Translation Adjustment
 
Total
Beginning balance at February 1, 2014
$
(2,166
)
 
$
(18,751
)
 
$
(20,917
)
Other comprehensive income (loss) before reclassifications
8,128

 
(35,545
)
 
(27,417
)
Reclassified from accumulated other comprehensive income (loss) (2)
4,212

 
—

 
4,212

Tax effect on other comprehensive income (loss)
(995
)
 
—

 
(995
)
Other comprehensive income (loss)
11,345

 
(35,545
)
 
(24,200
)
Ending balance at November 1, 2014
$
9,179

 
$
(54,296
)
 
$
(45,117
)

(2) 
For the thirteen and thirty-nine weeks ended November 1, 2014, a loss was reclassified from other comprehensive income (loss) to cost of goods sold on the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).


10. GILLY HICKS RESTRUCTURING

On November 1, 2013, A&F’s Board of Directors approved the closure of the Company’s 24 stand-alone Gilly Hicks stores. The Company substantially completed the store closures as planned by the end of the first quarter of Fiscal 2014. As a result of exiting the Gilly Hicks branded stores, approximately $88.3 million of cumulative pre-tax charges have been incurred to date, including a benefit of $1.6 million for the thirty-nine weeks ended October 31, 2015, primarily related to better than expected lease exit terms. During Fiscal 2015, the Company's liability related to the Gilly Hicks restructuring decreased from approximately $6.0 million to approximately $2.6 million as of October 31, 2015 as a result of lease termination benefits and cash payments applied against the liability.


11. SEGMENT REPORTING

During the first quarter of Fiscal 2015, the Company substantially completed its transition to a branded organizational structure. In conjunction with the change, the Company determined its brand-based operating segments to be Abercrombie, which includes the Company's Abercrombie & Fitch and abercrombie kids brands, and Hollister. These operating segments have similar economic characteristics, class of consumers, products, and production and distribution methods, and have been aggregated into one reportable segment.


17
Table of Contents


The following table provides the Company's net sales by operating segment for the thirteen and thirty-nine weeks ended October 31, 2015 and November 1, 2014.
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
(in thousands)
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
Abercrombie
$
411,259

 
$
439,702

 
$
1,131,626

 
$
1,246,486

Hollister
467,313

 
468,118

 
1,274,040

 
1,354,330

Other (1)
—

 
3,633

 
84

 
23,670

Total
$
878,572

 
$
911,453

 
$
2,405,750

 
$
2,624,486


(1)  
Represents net sales from the Company's Gilly Hicks operations. See Note 10, "GILLY HICKS RESTRUCTURING," for additional information on the Company's exit from Gilly Hicks branded stores.

The following table provides the Company’s net sales by geographic area for the thirteen and thirty-nine weeks ended October 31, 2015 and November 1, 2014.
 
Thirteen Weeks Ended
 
Thirty-nine Weeks Ended
(in thousands)
October 31, 2015
 
November 1, 2014
 
October 31, 2015
 
November 1, 2014
United States
$
572,736

 
$
594,713

 
$
1,536,151

 
$
1,645,354

Europe
206,538

 
222,631

 
572,772

 
706,641

Other
99,298

 
94,109

 
296,827

 
272,491

Total
$
878,572

 
$
911,453

 
$
2,405,750

 
$
2,624,486



12. CONTINGENCIES

The Company is a defendant in lawsuits and other adversary proceedings arising in the ordinary course of business. Legal costs incurred in connection with the resolution of claims and lawsuits are generally expensed as incurred, and the Company establishes reserves for the outcome of litigation where losses are deemed probable and reasonably estimable. The Company’s assessment of the current exposure could change in the event of the discovery of additional facts with respect to legal matters pending against the Company or determinations by judges, juries, administrative agencies or other finders of fact that are not in accordance with the Company’s evaluation of claims. Actual liabilities may exceed the amounts reserved, and there can be no assurance that final resolution of these matters will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

As of October 31, 2015, the Company had accrued charges of approximately $18 million for certain legal contingencies. In addition, there are certain claims and legal proceedings pending against the Company for which accruals have not been established.


18
Table of Contents



Report of Independent Registered Public Accounting Firm

To the Board of Directors and
Stockholders of Abercrombie & Fitch Co.:

We have reviewed the accompanying condensed consolidated balance sheet of Abercrombie & Fitch Co. as of October 31, 2015, and the related condensed consolidated statements of operations and comprehensive income (loss) for the thirteen and thirty-nine week periods ended October 31, 2015 and November 1, 2014 and the condensed consolidated statements of cash flows for the thirty-nine week periods ended October 31, 2015 and November 1, 2014. These interim financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of January 31, 2015, and the related consolidated statements of operation and comprehensive income, of stockholders’ equity, and of cash flows for the year then ended (not presented herein), and in our report dated March 30, 2015, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of January 31, 2015, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.




/s/ PricewaterhouseCoopers LLP
Columbus, Ohio
December 7, 2015
 

19
Table of Contents


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


OVERVIEW

BUSINESS SUMMARY

The Company is a specialty retailer that operates stores in North America, Europe, Asia and the Middle East and direct-to-consumer operations in North America, Europe and Asia that service its brands throughout the world. The Company sells casual sportswear apparel, including knit tops and woven shirts, graphic t-shirts, fleece, jeans and woven pants, shorts, sweaters, and outerwear; personal care products; and accessories for men, women and kids under the Abercrombie & Fitch, abercrombie kids and Hollister brands.

The Company’s fiscal year ends on the Saturday closest to January 31. Fiscal years are designated in the consolidated financial statements and notes by the calendar year in which the fiscal year commences. All references herein to “Fiscal 2015” represent the 52-week fiscal year that will end on January 30, 2016, and to “Fiscal 2014” represent the 52-week fiscal year that ended January 31, 2015.

For the third quarter of Fiscal 2015, net sales decreased 4% to $878.6 million from $911.5 million for the third quarter of Fiscal 2014. The gross profit rate for the third quarter of Fiscal 2015 was 63.7% compared to 62.2% for the third quarter of Fiscal 2014. Operating income was $41.0 million for the third quarter of Fiscal 2015 compared to $33.4 million for the third quarter of Fiscal 2014. Net income and net income per diluted share attributable to Abercrombie & Fitch Co. was $41.9 million and $0.60, respectively, for the third quarter of Fiscal 2015, compared to net income and net income per diluted share attributable to Abercrombie & Fitch Co. of $18.2 million and $0.25, respectively, for the third quarter of Fiscal 2014.
For the Fiscal 2015 year-to-date period, net sales decreased 8% to $2.406 billion from $2.624 billion for the comparable period of Fiscal 2014. The gross profit rate for the Fiscal 2015 year-to-date period was 61.6% compared to 62.2% for the comparable period of Fiscal 2014. Operating loss was $47.2 million for the Fiscal 2015 year-to-date period compared to operating income of $21.4 million for the comparable period of Fiscal 2014. Net loss and net loss per diluted share attributable to Abercrombie & Fitch Co. was $22.2 million and $0.32, respectively, for the Fiscal 2015 year-to-date period, compared to net income and net income per diluted share attributable to Abercrombie & Fitch Co. of $7.4 million and $0.10, respectively, for the comparable period of Fiscal 2014.
Excluding certain items, adjusted non-GAAP gross profit rate was 63.4%, operating income was $51.1 million and net income and net income per diluted share attributable to Abercrombie & Fitch Co. was $32.9 million and $0.48, respectively, for the third quarter of Fiscal 2015, compared to adjusted non-GAAP gross profit rate of 62.2%, operating income of $53.6 million, and net income and net income per diluted share attributable to Abercrombie & Fitch Co. of $30.4 million and $0.42, respectively, for the third quarter of Fiscal 2014. Excluding certain items, adjusted non-GAAP gross profit rate was 62.5%, operating income was $15.2 million and net income and net income per diluted share attributable to Abercrombie & Fitch Co. was $4.3 million and $0.06, respectively, for the year-to-date period of Fiscal 2015, compared to adjusted non-GAAP gross profit rate of 62.2%, operating income of $59.6 million and net income and net income per diluted share attributable to Abercrombie & Fitch Co. of $31.5 million and $0.43, respectively, for the year-to-date period of Fiscal 2014.
The Company believes that non-GAAP financial measures presented above, and under "RESULTS OF OPERATIONS," are useful to investors as they provide the ability to measure the Company’s operating performance and compare it against that of prior periods excluding certain items which affect the comparability of our financial information. See "RESULTS OF OPERATIONS," for additional discussion on non-GAAP financial measures.




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The table below reconciles GAAP financial measures to non-GAAP financial measures for the thirteen and thirty-nine week periods ended October 31, 2015 and November 1, 2014.

 
 
October 31, 2015
(in thousands, except gross profit rate and per share amounts)
 
GAAP
 
Excluded Items(1)
 
Non-GAAP
Thirteen Weeks Ended
 
 
 
 
 
 
Gross profit rate
 
63.7
%
 
(0.3
)%
 
63.4
%
Operating income
 
$
40,990

 
$
10,086

 
$
51,076

Net income attributable to Abercrombie & Fitch Co.
 
$
41,891

 
$
(8,974
)
 
$
32,917

Net income per diluted share attributable to Abercrombie & Fitch Co.
 
$
0.60

 
$
(0.12
)
 
$
0.48

 
 
 
 
 
 
 
Thirty-nine Weeks Ended
 
 
 
 
 
 
Gross profit rate
 
61.6
%
 
0.9
 %
 
62.5
%
Operating (loss) income
 
$
(47,245
)
 
$
62,466

 
$
15,221

Net (loss) income attributable to Abercrombie & Fitch Co.
 
$
(22,165
)
 
$
26,505

 
$
4,340

Net (loss) income per diluted share attributable to Abercrombie & Fitch Co.
 
$
(0.32
)
 
$
0.38

 
$
0.06

 
 
November 1, 2014
(in thousands, except gross profit rate and per share amounts)
 
GAAP
 
Excluded Items(1)
 
Non-GAAP
Thirteen Weeks Ended
 
 
 
 
 
 
Gross profit rate
 
62.2
%
 
—
%
 
62.2
%
Operating income
 
$
33,366

 
$
20,268

 
$
53,634

Net income attributable to Abercrombie & Fitch Co.
 
$
18,227

 
$
12,179

 
$
30,406

Net income per diluted share attributable to Abercrombie & Fitch Co.
 
$
0.25

 
$
0.17

 
$
0.42

 
 
 
 
 
 
 
Thirty-nine Weeks Ended
 
 
 
 
 
 
Gross profit rate
 
62.2
%
 
—
%
 
62.2
%
Operating income
 
$
21,353

 
$
38,249

 
$
59,602

Net income attributable to Abercrombie & Fitch Co.
 
$
7,433

 
$
24,056

 
$
31,489

Net income per diluted share attributable to Abercrombie & Fitch Co.
 
$
0.10

 
$
0.33

 
$
0.43


(1)
Refer to "RESULTS OF OPERATIONS" for details on excluded items.

As of October 31, 2015, the Company had $405.6 million in cash and equivalents, and $297.0 million in gross borrowings outstanding under its term loan facility. Net cash provided by operating activities was $66.5 million for the thirty-nine weeks ended October 31, 2015. The Company also used cash of $105.2 million for capital expenditures, $50.0 million to repurchase approximately 2.5 million shares of A&F's Common Stock and $41.7 million to pay dividends during the thirty-nine weeks ended October 31, 2015.

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. The seasonality of the Company’s operations may also lead to significant fluctuations in certain asset and liability accounts.


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CURRENT TRENDS AND OUTLOOK

Our third quarter results reflected positive customer response to actions we have been taking on a number of fronts and provided the strongest validation yet that we our initiatives are working. A number of key metrics turned positive during the quarter, including comparable sales for our Hollister brand and across our international business. In addition, our gross margin rate increased year-over-year, as promotional frequency and intensity were moderated, which resulted in meaningful adjusted non-GAAP operating income growth over last year on a constant currency basis. We have continued our efforts to reduce expenses, and we remain intensely focused on continuing to execute against our strategic initiatives.

Our ongoing efforts to improve our business are focused on:
•
Putting the customer at the center of everything we do.
•
Delivering a compelling and differentiated assortment.
•
Optimizing our brand reach domestically and internationally and optimizing our performance in each channel.
•
Defining a clear positioning for our brands.
•
Continuing to improve efficiency and reduce expense.
•
Ensuring we are organized to succeed.

We remain cautious given the mixed signals coming from the retail sector; however, we are confident that the work we are doing is laying the foundation for long-term profitability and growth.

For the fourth quarter of Fiscal 2015, we expect:
•
Comparable sales to be approximately flat.
•
Continued adverse effects from foreign currency exchange rates.
•
Gross margin rate to be approximately flat with last year on a constant currency basis, resulting in a reduction in relation to last year's reported gross margin rate.
•
Operating expense dollars to be approximately flat to last year after absorbing a provision for the restoration of incentive compensation.
•
A weighted average diluted share count of approximately 68 million shares, excluding effects of potential share buybacks.

On a full year basis, we expect the adjusted non-GAAP effective tax rate to be in the mid-to-upper 30s, including discrete benefits relating to the release of a valuation allowance and other discrete tax items recognized through the third quarter. On a go-forward basis, we expect the annual effective tax rate to be in the upper 30s.

We expect capital expenditures of approximately $150 million for the full year.

In addition to the 23 new stores opened year-to-date, we expect to open seven new stores in the fourth quarter, including five international stores and two North American stores. Also, in addition to the 19 stores closed year-to-date, we anticipate closing approximately 40 stores in the U.S. in the fourth quarter through natural lease expirations.

Excluded from our outlook for the remainder of Fiscal 2015 are potential charges related to impairments and store closings and other potential charges related to its restructuring efforts and related tax effects.



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RESULTS OF OPERATIONS

REPORTING AND USE OF GAAP AND NON-GAAP MEASURES

The Company's reported results are presented in accordance with GAAP. The reported cost of goods sold, stores and distribution expense, marketing, general and administrative expense, operating income (loss), tax (benefit) expense, net income (loss) and net income (loss) per diluted share attributable to Abercrombie & Fitch Co. for the thirteen and thirty-nine week periods ended October 31, 2015 and November 1, 2014 reflect certain items affecting the comparability of our financial information. This financial information is also presented on a non-GAAP basis for the periods presented to exclude the impact of these items.

The Company believes that non-GAAP measures are useful to investors as they provide the ability to assess the Company's operating performance and compare it against that of prior periods excluding certain items which affect the comparability of our financial information. These non-GAAP measures should not be used as alternatives to cost of goods sold, stores and distribution expense, marketing, general and administrative expense, operating income (loss), tax (benefit) expense, and net income (loss) and net income (loss) per diluted share attributable to Abercrombie & Fitch Co. and are also not intended to be indicators of ongoing operating performance of the Company or to supersede or replace the Company's GAAP reported results.


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STORE ACTIVITY

Store count and gross square footage by brand for the thirteen weeks ended October 31, 2015 and November 1, 2014, respectively, were as follows:
Store activity
 
Abercrombie(1)
 
Hollister(2)
 
Total
U.S. stores
 
 
 
 
 
 
August 1, 2015
 
354

 
429

 
783

New
 
7

 
2

 
9

Closed
 
(2
)
 
—

 
(2
)
October 31, 2015
 
359

 
431

 
790

Gross square feet at October 31, 2015 (in thousands)
 
2,743

 
2,966

 
5,709

 
 
 
 
 
 
 
International stores
 
 
 
 
 
 
August 1, 2015
 
34

 
137

 
171

New
 
2

 
2

 
4

Closed
 
—

 
—

 
—

October 31, 2015
 
36

 
139

 
175

Gross square feet at October 31, 2015 (in thousands)
 
584

 
1,185

 
1,769

Total stores
 
395

 
570

 
965

Total gross square feet at October 31, 2015 (in thousands)
 
3,327

 
4,151

 
7,478

 
 
 
 
 
 
 
Store activity
 
Abercrombie(1)
 
Hollister
 
Total
U.S. stores
 
 
 
 
 
 
August 2, 2014
 
377

 
454

 
831

New
 
2

 
—

 
2

Closed
 
(2
)
 
(2
)
 
(4
)
November 1, 2014
 
377

 
452

 
829

Gross square feet at November 1, 2014 (in thousands)
 
2,884

 
3,119

 
6,003

 
 
 
 
 
 
 
International stores
 
 
 
 
 
 
August 2, 2014
 
27

 
131

 
158

New
 
3

 
2

 
5

Closed
 
—

 
—

 
—

November 1, 2014
 
30

 
133

 
163

Gross square feet at November 1, 2014 (in thousands)
 
550

 
1,162

 
1,712

Total stores
 
407

 
585

 
992

Total gross square feet at November 1, 2014 (in thousands)
 
3,434

 
4,281

 
7,715


(1)
Includes Abercrombie & Fitch and abercrombie kids brands. Prior period store counts have been restated to combine abercrombie kids carveouts with Abercrombie & Fitch stores into one store. The change reduced total stores by eight stores as of August 2, 2014 and November 1, 2014.
(2)
Excludes two franchise stores.


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Store count and gross square footage by brand for the thirty-nine weeks ended October 31, 2015 and November 1, 2014, respectively, were as follows:
Store activity
 
Abercrombie(1)
 
Hollister(2)
 
Total
U.S. stores
 
 
 
 
 
 
January 31, 2015
 
361

 
433

 
794

New
 
11

 
2

 
13

Closed
 
(13
)
 
(4
)
 
(17
)
October 31, 2015
 
359

 
431

 
790

Gross square feet at October 31, 2015 (in thousands)
 
2,743

 
2,966

 
5,709

 
 
 
 
 
 
 
International stores
 
 
 
 
 
 
January 31, 2015
 
32

 
135

 
167

New
 
4

 
6

 
10

Closed
 
—

 
(2
)
 
(2
)
October 31, 2015
 
36

 
139

 
175

Gross square feet at October 31, 2015 (in thousands)
 
584

 
1,185

 
1,769

Total stores
 
395

 
570

 
965

Total gross square feet at October 31, 2015 (in thousands)
 
3,327

 
4,151

 
7,478

 
 
 
 
 
 
 
Store activity
 
Abercrombie(1)
 
Hollister
 
Total
U.S. stores
 
 
 
 
 
 
February 1, 2014
 
381

 
458

 
839

New
 
3

 
1

 
4

Closed
 
(7
)
 
(7
)
 
(14
)
November 1, 2014
 
377

 
452

 
829

Gross square feet at November 1, 2014 (in thousands)
 
2,884

 
3,119

 
6,003

 
 
 
 
 
 
 
International stores
 
 
 
 
 
 
February 1, 2014
 
24

 
129

 
153

New
 
6

 
4

 
10

Closed
 
—

 
—

 
—

November 1, 2014
 
30

 
133

 
163

Gross square feet at November 1, 2014 (in thousands)
 
550

 
1,162

 
1,712

Total stores
 
407

 
585

 
992

Total gross square feet at November 1, 2014 (in thousands)
 
3,434

 
4,281

 
7,715


(1)
Includes Abercrombie & Fitch and abercrombie kids brands. Prior period store counts have been restated to combine abercrombie kids carveouts with Abercrombie & Fitch stores into one store. The change reduced total stores by eight stores as of January 31, 2015 and November 1, 2014, and by six stores as of February 1, 2014.
(2)
Excludes two franchise stores.


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Net Sales
 
Thirteen Weeks Ended
 
 
 
 
 
October 31, 2015
 
November 1, 2014
 
 
 
 
(in thousands)
Net Sales
 
Change in
Comparable
Sales(1)
 
Net Sales
 
Change in
Comparable
Sales(1)
 
Net Sales
$ Change
 
Net Sales
% Change
Abercrombie(2)
$
411,259

 
(5)%
 
$
439,702

 
(7)%
 
$
(28,443
)
 
(6)%
Hollister
467,313

 
3%
 
468,118

 
(12)%
 
(805
)
 
—%
Other(3)
—

 
 
 
3,633

 
 
 
(3,633
)
 
(100)%
Total net sales
$
878,572

 
(1)%
 
$
911,453

 
(10)%
 
$
(32,881
)
 
(4)%
 
 
 
 
 
 
 
 
 
 
 
 
U.S.
$
572,736

 
(3)%
 
$
594,713

 
(7)%
 
$
(21,977
)
 
(4)%
International
305,836

 
1%
 
316,740

 
(15)%
 
(10,904
)
 
(3)%
Total net sales
$
878,572

 
(1)%
 
$
911,453

 
(10)%
 
$
(32,881
)
 
(4)%
 
Thirty-nine Weeks Ended
 
 
 
 
 
October 31, 2015
 
November 1, 2014
 
 
 
 
(in thousands)
Net Sales
 
Change in
Comparable
Sales(1)
 
Net Sales
 
Change in
Comparable
Sales(1)
 
Net Sales
$ Change
 
Net Sales
% Change
Abercrombie(2)
$
1,131,626

 
(7)%
 
$
1,246,486

 
(4)%
 
$
(114,860
)