Edgar Filing: ABERCROMBIE & FITCH CO /DE/

Document

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 28, 2017



¨	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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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	¨
		Emerging growth company	¨

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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 November 30, 2017
$.01 Par Value		68,101,770 Shares

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ABERCROMBIE & FITCH CO.

TABLE OF CONTENTS



		Page No.
Part I

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)	3

	Condensed Consolidated Balance Sheets	4

	Condensed Consolidated Statements of Cash Flows	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31

Item 4.	Controls and Procedures	32

Part II

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34

Item 6.	Exhibits	35

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PART I. FINANCIAL INFORMATION


ITEM 1.	FINANCIAL STATEMENTS (UNAUDITED)

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 28, 2017			October 29, 2016			October 28, 2017			October 29, 2016
Net sales	$	859,112		$	821,734		$	2,299,532		$	2,290,377
Cost of sales, exclusive of depreciation and amortization	332,485			310,995			913,085			876,810
Gross profit	526,627			510,739			1,386,447			1,413,567
Stores and distribution expense	375,944			386,609			1,105,168			1,138,644
Marketing, general and administrative expense	124,533			105,307			343,779			331,473
Asset impairment	3,480			—			10,345			6,356
Other operating income, net	(70		)	(822		)	(4,555		)	(16,835		)
Operating income (loss)	22,740			19,645			(68,290		)	(46,071		)
Interest expense, net	4,571			4,609			12,780			13,856
Income (loss) before taxes	18,169			15,036			(81,070		)	(59,927		)
Income tax expense (benefit)	7,553			6,762			(16,062		)	(17,540		)
Net income (loss)	10,616			8,274			(65,008		)	(42,387		)
Less: Net income attributable to noncontrolling interests	541			393			2,108			2,448
Net income (loss) attributable to A&F	$	10,075		$	7,881		$	(67,116	)	$	(44,835	)

Net income (loss) per share attributable to A&F
Basic	$	0.15		$	0.12		$	(0.98	)	$	(0.66	)
Diluted	$	0.15		$	0.12		$	(0.98	)	$	(0.66	)

Weighted-average shares outstanding
Basic	68,512			67,975			68,347			67,848
Diluted	69,425			68,277			68,347			67,848

Dividends declared per share	$	0.20		$	0.20		$	0.60		$	0.60

Other comprehensive income (loss)
Foreign currency translation, net of tax	$	(3,496	)	$	(12,194	)	$	21,183		$	870
Derivative financial instruments, net of tax	5,518			3,937			(9,230		)	557
Other comprehensive income (loss)	2,022			(8,257		)	11,953			1,427
Comprehensive income (loss)	12,638			17			(53,055		)	(40,960		)
Less: Comprehensive income attributable to noncontrolling interests	541			393			2,108			2,448
Comprehensive income (loss) attributable to A&F	$	12,097		$	(376	)	$	(55,163	)	$	(43,408	)

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 28, 2017			January 28, 2017
Assets
Current assets:
Cash and equivalents	$	459,293		$	547,189
Receivables	78,554			93,384
Inventories, net	570,484			399,795
Other current assets	68,903			98,932
Total current assets	1,177,234			1,139,300
Property and equipment, net	767,930			824,738
Other assets	352,737			331,719
Total assets	$	2,297,901		$	2,295,757
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	248,963		$	187,017
Accrued expenses	292,479			273,044
Short-term portion of deferred lease credits	19,314			20,076
Income taxes payable	6,189			5,863
Total current liabilities	566,945			486,000
Long-term liabilities:
Long-term portion of deferred lease credits	74,782			76,321
Long-term portion of borrowings, net	263,910			262,992
Leasehold financing obligations	48,082			46,397
Other liabilities	174,023			172,008
Total long-term liabilities	560,797			557,718
Stockholders’ equity
Class A Common Stock - $0.01 par value: 150,000 shares authorized and 103,300 shares issued at each of October 28, 2017 and January 28, 2017	1,033			1,033
Paid-in capital	389,384			396,590
Retained earnings	2,361,055			2,474,703
Accumulated other comprehensive loss, net of tax	(109,349		)	(121,302		)
Treasury stock, at average cost: 35,184 and 35,542 shares at October 28, 2017 and January 28, 2017, respectively	(1,481,363		)	(1,507,589		)
Total Abercrombie & Fitch Co. stockholders’ equity	1,160,760			1,243,435
Noncontrolling interests	9,399			8,604
Total stockholders’ equity	1,170,159			1,252,039
Total liabilities and stockholders’ equity	$	2,297,901		$	2,295,757

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 28, 2017			October 29, 2016
Operating activities
Net loss	$	(65,008	)	$	(42,387	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	146,147			146,666
Asset impairment	10,345			6,356
Loss on disposal	5,624			1,914
Amortization of deferred lease credits	(16,510		)	(18,601		)
Benefit from deferred income taxes	(15,597		)	(26,103		)
Share-based compensation	15,774			16,691
Changes in assets and liabilities
Inventories, net	(167,546		)	(91,375		)
Accounts payable and accrued expenses	73,214			9,533
Lessor construction allowances	12,954			4,976
Income taxes	93			(6,463		)
Long-term lease deposits	(421		)	23,653
Other assets	40,706			(4,544		)
Other liabilities	(10,036		)	1,776
Net cash provided by operating activities	29,739			22,092
Investing activities
Purchases of property and equipment	(86,300		)	(96,814		)
Proceeds from sale of property and equipment	203			4,098
Net cash used for investing activities	(86,097		)	(92,716		)
Financing activities
Dividends paid	(40,776		)	(40,526		)
Other financing activities	(2,423		)	(4,840		)
Net cash used for financing activities	(43,199		)	(45,366		)
Effect of exchange rates on cash	11,661			(2,868		)
Net decrease in cash and equivalents	(87,896		)	(118,858		)
Cash and equivalents, beginning of period	547,189			588,578
Cash and equivalents, end of period	$	459,293		$	469,720
Significant non-cash investing activities
Change in accrual for construction in progress	$	(10,445	)	$	(12,453	)
Supplemental information
Cash paid for interest	$	9,849		$	11,538
Cash paid for income taxes, net of refunds	$	(14,921	)	$	20,516

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 through store and direct-to-consumer operations, as well as through various wholesale, franchise and licensing arrangements. The Company has operations in North America, Europe, Asia and the Middle East.

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 assets, liabilities, results of operations and cash flows of these VIEs.

Fiscal Year

The Company’s fiscal year ends on the Saturday closest to January 31. All references herein to “Fiscal 2017” and “Fiscal 2016” represent the fifty-three week fiscal year ending on February 3, 2018 and the fifty-two week fiscal year ended on January 28, 2017, respectively.

Interim Financial Statements

The Condensed Consolidated Financial Statements as of October 28, 2017, and for the thirteen and thirty-nine week periods ended October 28, 2017 and October 29, 2016, 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 2016 filed with the SEC on March 27, 2017. The January 28, 2017 consolidated balance sheet data, included herein, 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 2017.

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Recent Accounting Pronouncements

The following table provides a brief description of recent accounting pronouncements that could affect the Company’s financial statements:



Accounting Standards Update (ASU)	Description	Date of Adoption	Effect on the Financial Statements or Other Significant Matters
Standards adopted
ASU 2015-11, Simplifying the Measurement of Inventory	This update amends ASC 330, Inventory. The new guidance applies to inventory measured using first-in, first-out (FIFO) or average cost. Under this amendment, inventory is to 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 guidance did not have any impact on the Company’s consolidated financial statements.
ASU 2016-09, Compensation—Stock Compensation	This update amends ASC 718, Compensation. Under the new guidance, tax benefits and certain tax deficiencies arising from the vesting of share-based payments are to be recognized as income tax benefits or expenses in the statement of operations; whereas, under the previous guidance, such benefits and deficiencies were recorded in additional paid in-capital. The cash flow effects of the tax benefit are to be reported in cash flows from operating activities; whereas, they were previously reported in cash flows from financing activities. This guidance also allows for entities to make a policy election to estimate forfeitures or account for them when they occur.	January 29, 2017	As required by the update, all excess tax benefits and tax deficiencies recognized on share-based compensation expense are reflected in the condensed consolidated statements of operations as a component of the provision for income taxes on a prospective basis. This update resulted in additional non-cash income tax expense of $0.2 million and $10.1 million for the thirteen and thirty-nine weeks ended October 28, 2017, respectively. In addition, excess tax benefits and tax deficiencies recognized on share-based compensation expense are now classified as an operating activity on the condensed consolidated statements of cash flows. The Company has applied this provision on a retrospective basis. For the thirty-nine weeks ended October 29, 2016, net cash provided by operating activities increased by $0.7 million with a corresponding offset to net cash used for financing activities. The Company has elected to maintain its practice of estimating forfeitures when recognizing expense for share-based payment awards rather than accounting for forfeitures when they occur. Based on share-based compensation awards currently outstanding and the price of the Company's Common Stock as of October 28, 2017, the adoption of this guidance would result in non-cash income tax expense of approximately $11 million for Fiscal 2017, $19 million for Fiscal 2018 and $3 million for Fiscal 2019.
Standards not yet adopted
ASU 2014-09, Revenue from Contracts with Customers	This update supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. The new 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 impact that this guidance will have on its consolidated financial statements. Based on its preliminary assessment, the Company has determined this guidance will impact the classification and timing of the recognition of gift card breakage. The Company does not expect this guidance to have a material impact on store, direct-to-consumer, wholesale, franchise, or license revenues.
ASU 2016-02, Leases	This update supersedes the leasing requirements in ASC 840, Leases. The new guidance requires an entity to recognize lease assets and lease liabilities on the balance sheet and disclose key leasing information that depicts the lease rights and obligations of an entity.	February 3, 2019*	The Company expects that this guidance will result in a material increase in the Company’s long-term assets and long-term liabilities on the Company's consolidated balance sheets, and is currently evaluating additional impacts that this guidance may have on its consolidated financial statements. The Company will not be early adopting this guidance.
ASU 2017-12, Derivatives and Hedging	This update amends ASC 815, Derivatives and Hedging. The new guidance simplifies certain aspects of hedge accounting for both financial and commodity risks to more accurately present the economic effects of an entity’s risk management activities in its financial statements. Under the new standard, more hedging strategies will be eligible for hedge accounting, including hedges of the benchmark rate component of the contractual coupon cash flows of fixed-rate assets or liabilities and partial-term hedges of fixed-rate assets or liabilities. For cash flow and net investment hedges, the guidance requires a modified retrospective approach while the amended presentation and disclosure guidance requires a prospective approach.	February 3, 2019*	The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements. The Company will not be early adopting this guidance.

* 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 28, 2017		October 29, 2016		October 28, 2017		October 29, 2016
Shares of common stock issued	103,300		103,300		103,300		103,300
Weighted-average treasury shares	(34,788	)	(35,325	)	(34,953	)	(35,452	)
Weighted-average — basic shares	68,512		67,975		68,347		67,848
Dilutive effect of share-based compensation awards	913		302		—		—
Weighted-average — diluted shares	69,425		68,277		68,347		67,848
Anti-dilutive shares ⁽¹⁾	5,181		6,126		5,367		6,209


⁽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.

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.

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 these levels of the Company’s assets and liabilities, which are measured at fair value on a recurring basis, were as follows:



	Assets and Liabilities at Fair Value as of October 28, 2017
(in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Trust-owned life insurance policies (at cash surrender value)	$	—	$	101,962	$	—	$	101,962
Money market funds	25,071		—		—		25,071
Derivative financial instruments	—		1,256		—		1,256
Total assets	$	25,071	$	103,218	$	—	$	128,289

Liabilities:
Derivative financial instruments	$	—	$	3,553	$	—	$	3,553
Total liabilities	$	—	$	3,553	$	—	$	3,553



	Assets and Liabilities at Fair Value as of January 28, 2017
(in thousands)	Level 1		Level 2		Level 3		Total
Assets:
Trust-owned life insurance policies (at cash surrender value)	$	—	$	99,654	$	—	$	99,654
Money market funds	94,026		—		—		94,026
Derivative financial instruments	—		6,042		—		6,042
Total assets	$	94,026	$	105,696	$	—	$	199,722

Liabilities:
Derivative financial instruments	$	—	$	492	$	—	$	492
Total liabilities	$	—	$	492	$	—	$	492

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

Fair value of borrowings:

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 based on market rates for similar types of debt, which are considered to be Level 2 inputs.

The carrying amount and fair value of the Company’s borrowings under the term loan facility were as follows:



(in thousands)	October 28, 2017		January 28, 2017
Gross borrowings outstanding, carrying amount	$	268,250	$	268,250
Gross borrowings outstanding, fair value	$	266,909	$	260,551

No borrowings were outstanding under the Company’s senior secured revolving credit facility as of October 28, 2017 or January 28, 2017.

4. PROPERTY AND EQUIPMENT, NET

Property and equipment, net consisted of:



(in thousands)	October 28, 2017			January 28, 2017
Property and equipment, at cost	$	2,810,471		$	2,772,139
Less: Accumulated depreciation and amortization	(2,042,541		)	(1,947,401		)
Property and equipment, net	$	767,930		$	824,738

Long-lived assets, primarily comprised of leasehold improvements, furniture, fixtures and equipment, are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of the long-lived assets might not be recoverable. These include, but are not limited to, material declines in operational performance, a history of losses, an expectation of future losses, adverse market conditions and store closure or relocation decisions. On at least a quarterly basis, the Company reviews for indicators of impairment at the individual store level, the lowest level for which cash flows are identifiable.

Stores that display an indicator of impairment are subjected to an impairment assessment. The Company’s impairment assessment requires management to make assumptions and judgments related, but not limited, to management’s expectations for future operations and projected cash flows. The key assumptions used in the Company’s undiscounted future cash flow models include sales, gross profit and, to a lesser extent, operating expenses.

An impairment loss may be recognized when these undiscounted future cash flows are less than the carrying amount of the asset group. In the circumstance of impairment, any loss would be measured as the excess of the carrying amount of the asset group over its fair value. The key assumptions used in estimating the fair value of impaired assets may include projected cash flows and discount rate.

The Company incurred store asset impairment charges of $3.5 million and $10.3 million for the thirteen and thirty-nine weeks ended October 28, 2017, respectively, and $6.4 million for the thirty-nine weeks ended October 29, 2016. There were no asset impairment charges for the thirteen weeks ended October 29, 2016.

The Company had $36.6 million and $35.6 million of construction project assets in property and equipment, net at October 28, 2017 and January 28, 2017, respectively, related to the construction of buildings in certain lease arrangements where the Company is deemed to be the owner of the construction project.

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5. INCOME TAXES

The Company’s quarterly tax provision and the 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 including entering into new businesses or geographies, changes in foreign currency exchange rates, changes in law, regulations, and administrative practices, relative changes of 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).

In Fiscal 2017, the Company adopted ASU 2016-09, “Compensation—Stock Compensation,” which resulted in discrete non-cash income tax charges recognized in income tax expense (benefit) on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) of $0.2 million and $10.1 million for the thirteen and thirty-nine week periods ended October 28, 2017, respectively. Refer to Note 1, “BASIS OF PRESENTATION--Recent Accounting Pronouncements” for further discussion regarding the adoption of this standard.

6. BORROWINGS

Asset-Based Revolving Credit Facility

On August 7, 2014, A&F, through its subsidiary Abercrombie & Fitch Management Co. (“A&F Management”) as the lead borrower (with A&F and certain other subsidiaries as borrowers or guarantors), entered into an asset-based revolving credit agreement.

As of October 19, 2017, the Company, through A&F Management, entered into the Second Amendment to Credit Agreement (the “ABL Second Amendment”), amending and extending the maturity date of the asset-based revolving credit agreement. As amended, the asset-based revolving credit agreement continues to provide for a senior secured revolving credit facility of up to $400 million (the “Amended ABL Facility”). The Amended ABL Facility is subject to a borrowing base, consisting primarily of U.S. inventory, with a letter of credit sub-limit of $50 million (reduced from $100 million by the ABL Second Amendment) and an accordion feature allowing A&F to increase the revolving commitment by up to $100 million subject to specified conditions. The Amended ABL Facility is available for working capital, capital expenditures and other general corporate purposes. The Amended ABL Facility will mature on October 19, 2022.

Obligations under the Amended ABL Facility are unconditionally guaranteed by A&F and certain of its subsidiaries. The Amended ABL Facility is secured by a first-priority security interest in certain working capital of the borrowers and guarantors consisting of inventory, accounts receivable and certain other assets. The Amended ABL Facility is also secured by a second-priority security interest in certain property and assets of the borrowers and guarantors, including certain fixed assets, intellectual property, stock of subsidiaries and certain after-acquired material real property.

At the Company’s option, borrowings under the Amended ABL Facility will bear interest at either (a) an adjusted LIBOR rate plus a margin of 1.25% to 1.50% per annum, or (b) an alternate base rate plus a margin of 0.25% to 0.50% per annum. The applicable margins with respect to LIBOR loans and base rate loans, including swing line loans, under the Amended ABL Facility are 1.25% and 0.25% per annum, respectively, and are subject to adjustment each fiscal quarter based on average historical availability during the preceding quarter. The Company is also required to pay a fee of 0.25% per annum on undrawn commitments under the Amended ABL Facility. Customary agency fees and letter of credit fees are also payable in respect of the Amended ABL Facility.

No borrowings were outstanding under the Amended ABL Facility as of October 28, 2017.

Term Loan Facility

A&F, through its subsidiary A&F Management as the borrower (with A&F and certain other subsidiaries as guarantors), also entered into a term loan agreement on August 7, 2014, which provides for a term loan facility of $300 million (the “Term Loan Facility” and, together with the Amended ABL Facility, the “Credit Facilities”).

The Term Loan Facility has not changed materially from that disclosed in Note 11, “BORROWINGS,” 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 2016.

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Representations, Warranties and Covenants

The Credit Facilities contain various representations, warranties and restrictive covenants that, among other things and subject to specified exceptions, restrict the ability of A&F and its subsidiaries to incur indebtedness (including guarantees), grant liens, make investments, pay dividends or distributions with respect to capital stock, make prepayments on other indebtedness, engage in mergers, dispose of certain assets or change the nature of their business. In addition, availability equal to the greater of 10% of the loan cap or $30 million must be maintained under the Amended ABL Facility. The Credit Facilities do not otherwise contain financial maintenance covenants.

The Company was in compliance with the covenants under the Credit Facilities as of October 28, 2017.

7. SHARE-BASED COMPENSATION

The Company recognized share-based compensation expense of $5.4 million and $15.8 million for the thirteen and thirty-nine weeks ended October 28, 2017, respectively, and $5.7 million and $16.7 million for the thirteen and thirty-nine weeks ended October 29, 2016, respectively. The Company recognized tax benefits associated with share-based compensation expense of $2.0 million and $6.0 million for the thirteen and thirty-nine weeks ended October 28, 2017, respectively, and $2.2 million and $6.3 million for the thirteen and thirty-nine weeks ended October 29, 2016, respectively.

Stock Options

The following table summarizes stock option activity for the thirty-nine weeks ended October 28, 2017:



	Number of Underlying Shares		Weighted-Average Exercise Price		Aggregate Intrinsic Value		Weighted-Average Remaining Contractual Life
Outstanding at January 28, 2017	189,800		$	76.62
Granted	—		—
Exercised	—		—
Forfeited or expired	(88,600	)	74.74
Outstanding at October 28, 2017	101,200		$	78.26	$	—	0.3
Stock options exercisable at October 28, 2017	101,200		$	78.26	$	—	0.3

Stock Appreciation Rights

The following table summarizes stock appreciation rights activity for the thirty-nine weeks ended October 28, 2017:



	Number of Underlying Shares		Weighted-Average Exercise Price		Aggregate Intrinsic Value		Weighted-Average Remaining Contractual Life
Outstanding at January 28, 2017	4,079,050		$	47.49
Granted	—		—
Exercised	—		—
Forfeited or expired	(982,928	)	42.85
Outstanding at October 28, 2017	3,096,122		$	49.09	$	—	2.2
Stock appreciation rights exercisable at October 28, 2017	2,846,623		$	51.14	$	—	1.7
Stock appreciation rights expected to become exercisable in the future as of October 28, 2017	225,010		$	25.87	$	—	7.2

As of October 28, 2017, there was $1.5 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 8 months.

The grant date fair value of stock appreciation rights that vested during the thirty-nine weeks ended October 28, 2017 and October 29, 2016 was $2.2 million and $4.1 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 28, 2017:



	Service-based Restricted Stock Units				Performance-based Restricted Stock Units				Market-based Restricted Stock Units
	Number of Underlying Shares⁽¹⁾		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 28, 2017	1,915,461		$	25.47	203,923		$	22.53	184,892		$	26.89
Granted	1,673,528		9.89		524,030		9.11		236,872		11.79
Adjustments for performance achievement	—		—		—		—		—		—
Vested	(676,345	)	25.92		—		—		—		—
Forfeited	(293,668	)	23.00		(37,779	)	21.75		(37,784	)	26.14
Unvested at October 28, 2017	2,618,976		$	15.61	690,174		$	11.82	383,980		$	16.50

⁽¹⁾

Includes 730,736 unvested restricted stock units as of October 28, 2017 which are subject to the vesting requirement that the Company must achieve at least $1.00 of GAAP net income attributable to A&F for the fiscal year immediately preceding the vesting date. Holders of these restricted stock units have the opportunity to earn back one or more installments of the award if the cumulative performance requirements are met in a subsequent year.

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. Unvested shares related to restricted stock units with performance-based vesting conditions are reflected at 100% of their target vesting amount in the table above.

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 28, 2017, there was $30.1 million, $4.0 million and $3.7 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, 15 months and 13 months for service-based, performance-based and market-based restricted stock units, respectively.

The actual tax benefit realized for tax deductions associated with restricted stock units vesting was $0.2 million and $2.7 million for the thirteen and thirty-nine weeks ended October 28, 2017, respectively, and $0.2 million and $6.6 million for the thirteen and thirty-nine weeks ended October 29, 2016, respectively.

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Additional information pertaining to restricted stock units for the thirty-nine weeks ended October 28, 2017 and October 29, 2016 follows:



(in thousands)	October 28, 2017		October 29, 2016
Service-based restricted stock units:
Total grant date fair value of awards granted	$	16,551	$	28,310
Total grant date fair value of awards vested	17,531		18,337

Performance-based restricted stock units:
Total grant date fair value of awards granted	$	4,774	$	3,334
Total grant date fair value of awards vested	—		1,178

Market-based restricted stock units:
Total grant date fair value of awards granted	$	2,793	$	4,023
Total grant date fair value of awards vested	—		—

The weighted-average assumptions used for market-based restricted stock units in the Monte Carlo simulation during the thirty-nine weeks ended October 28, 2017 and October 29, 2016 were as follows:



	October 28, 2017			October 29, 2016
Grant date market price	$	11.43		$	28.06
Fair value	$	11.79		$	31.01
Assumptions:
Price volatility	47		%	45		%
Expected term (years)	2.9			2.7
Risk-free interest rate	1.5		%	1.0		%
Dividend yield	7.0		%	3.0		%
Average volatility of peer companies	35.2		%	34.5		%
Average correlation coefficient of peer companies	0.2664			0.3415

8. DERIVATIVE INSTRUMENTS

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.

The Company uses derivative instruments, primarily foreign currency exchange forward contracts designated as cash flow hedges, to hedge the foreign currency exchange rate exposure associated with forecasted foreign-currency-denominated intercompany inventory sales to foreign subsidiaries and the related settlement of the foreign-currency-denominated intercompany receivables. Fluctuations in foreign currency exchange rates will either increase or decrease the Company’s intercompany 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 foreign currency exchange 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 28, 2017 will be recognized in cost of sales, exclusive of depreciation and amortization, 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, the Company's derivative contracts allow net settlements under certain conditions.

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As of October 28, 2017, 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	$	105,638
British pound	$	45,689
Canadian dollar	$	22,851
Japanese yen	$	8,476


⁽¹⁾	Amounts reported are the U.S. Dollar notional amounts outstanding as of October 28, 2017.

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 foreign currency 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 instruments and the hedged items.

As of October 28, 2017, the Company had outstanding the following foreign currency exchange forward contracts that were entered into to hedge foreign-currency-denominated net monetary assets/liabilities:



(in thousands)	Notional Amount⁽¹⁾
Euro	$	23,424
British pound	$	1,313


⁽¹⁾	Amounts reported are the U.S. Dollar notional amounts outstanding as of October 28, 2017.

The location and amounts of derivative fair values on the Condensed Consolidated Balance Sheets as of October 28, 2017 and January 28, 2017 were as follows:



(in thousands)	Location	October 28, 2017		January 28, 2017		Location	October 28, 2017		January 28, 2017
Derivatives designated as hedging instruments:
Foreign currency exchange forward contracts	Other current assets	$	894	$	5,920	Accrued expenses	$	3,553	$	486
Derivatives not designated as hedging instruments:
Foreign currency exchange forward contracts	Other current assets	$	362	$	122	Accrued expenses	$	—	$	6
Total	Other current assets	$	1,256	$	6,042	Accrued expenses	$	3,553	$	492

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

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The location and amounts of derivative gains and losses for the thirteen and thirty-nine weeks ended October 28, 2017 and October 29, 2016 on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) were as follows:

Thirteen Weeks Ended

Thirty-nine Weeks Ended

October 28, 2017

October 29, 2016

October 28, 2017

October 29, 2016

(in thousands)

Location

Gain/(Loss)

Derivatives not designated as hedging instruments:

Foreign currency exchange forward contracts

Other operating income, net

634

152

295



	Effective Portion											Ineffective Portion and Amount Excluded from Effectiveness Testing
	Amount of Gain (Loss) Recognized in AOCL on Derivative Contracts ⁽¹⁾					Location of Gain (Loss) Reclassified from AOCL into Earnings	Amount of Gain (Loss) Reclassified from AOCL into Earnings ⁽²⁾					Location of Gain Recognized in Earnings on Derivative Contracts	Amount of Gain Recognized in Earnings on Derivative Contracts ⁽³⁾
	Thirteen Weeks Ended
(in thousands)	October 28, 2017			October 29, 2016			October 28, 2017			October 29, 2016			October 28, 2017		October 29, 2016
Derivatives in cash flow hedging relationships:
Foreign currency exchange forward contracts	$	1,775		$	4,986	Cost of sales, exclusive of depreciation and amortization	$	(3,544	)	$	450	Other operating income, net	$	975	$	695

	Thirty-nine Weeks Ended
(in thousands)	October 28, 2017			October 29, 2016			October 28, 2017			October 29, 2016			October 28, 2017		October 29, 2016
Derivatives in cash flow hedging relationships:
Foreign currency exchange forward contracts	$	(10,627	)	$	3,026	Cost of sales, exclusive of depreciation and amortization	$	536		$	2,551	Other operating income, net	$	2,136	$	1,308


⁽¹⁾	The amount represents the change in fair value of derivative contracts due to changes in spot rates.


⁽²⁾	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.


⁽³⁾	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.

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9. ACCUMULATED OTHER COMPREHENSIVE LOSS

The activity in accumulated other comprehensive loss for the thirteen and thirty-nine weeks ended October 28, 2017 was as follows:



	Thirteen Weeks Ended October 28, 2017
(in thousands)	Foreign Currency Translation Adjustment			Unrealized Gain (Loss) on Derivative Financial Instruments			Total
Beginning balance at July 29, 2017	$	(101,448	)	$	(9,923	)	$	(111,371	)
Other comprehensive (loss) income before reclassifications	(2,451		)	1,775			(676		)
Reclassified from accumulated other comprehensive loss ⁽¹⁾	—			3,544			3,544
Tax effect	(1,045		)	199			(846		)
Other comprehensive (loss) income	(3,496		)	5,518			2,022
Ending balance at October 28, 2017	$	(104,944	)	$	(4,405	)	$	(109,349	)



	Thirty-nine Weeks Ended October 28, 2017
(in thousands)	Foreign Currency Translation Adjustment			Unrealized Gain (Loss) on Derivative Financial Instruments			Total
Beginning balance at January 28, 2017	$	(126,127	)	$	4,825		$	(121,302	)
Other comprehensive income (loss) before reclassifications	22,228			(10,627		)	11,601
Reclassified from accumulated other comprehensive loss ⁽¹⁾	—			(536		)	(536		)
Tax effect	(1,045		)	1,933			888
Other comprehensive income (loss)	21,183			(9,230		)	11,953
Ending balance at October 28, 2017	$	(104,944	)	$	(4,405	)	$	(109,349	)


⁽¹⁾	Amount represents gains reclassified from accumulated other comprehensive loss to cost of sales, exclusive of depreciation and amortization, on the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).

The activity in accumulated other comprehensive loss for the thirteen and thirty-nine weeks ended October 29, 2016 was as follows:



	Thirteen Weeks Ended October 29, 2016
(in thousands)	Foreign Currency Translation Adjustment			Unrealized Gain (Loss) on Derivative Financial Instruments			Total
Beginning balance at July 30, 2016	$	(106,132	)	$	1,197		$	(104,935	)
Other comprehensive (loss) income before reclassifications	(12,194		)	4,986			(7,208		)
Reclassified from accumulated other comprehensive loss ⁽²⁾	—			(450		)	(450		)
Tax effect	—			(599		)	(599		)
Other comprehensive (loss) income	(12,194		)	3,937			(8,257		)
Ending balance at October 29, 2016	$	(118,326	)	$	5,134		$	(113,192	)



	Thirty-nine Weeks Ended October 29, 2016
(in thousands)	Foreign Currency Translation Adjustment			Unrealized Gain (Loss) on Derivative Financial Instruments			Total
Beginning balance at January 30, 2016	$	(119,196	)	$	4,577		$	(114,619	)
Other comprehensive income before reclassifications	870			3,026			3,896
Reclassified from accumulated other comprehensive loss ⁽²⁾	—			(2,551		)	(2,551		)
Tax effect	—			82			82
Other comprehensive income	870			557			1,427
Ending balance at October 29, 2016	$	(118,326	)	$	5,134		$	(113,192	)


⁽²⁾	Amount represents gains reclassified from accumulated other comprehensive loss to cost of sales, exclusive of depreciation and amortization, on the Condensed Consolidated Statement of Operations and Comprehensive Income (Loss).

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10. SEGMENT REPORTING

The Company has two operating segments: (a) Hollister, and (b) Abercrombie, which includes the Company’s Abercrombie & Fitch and abercrombie kids brands. These operating segments have similar economic characteristics, classes of consumers, products, and production and distribution methods, and have been aggregated into one reportable segment.

The following table provides the Company’s net sales by operating segment for the thirteen and thirty-nine weeks ended October 28, 2017 and October 29, 2016.



	Thirteen Weeks Ended				Thirty-nine Weeks Ended
(in thousands)	October 28, 2017		October 29, 2016		October 28, 2017		October 29, 2016
Hollister	$	508,086	$	463,479	$	1,329,401	$	1,245,710
Abercrombie	351,026		358,255		970,131		1,044,667
Total	$	859,112	$	821,734	$	2,299,532	$	2,290,377

The following table provides the Company’s net sales by geographic area for the thirteen and thirty-nine weeks ended October 28, 2017 and October 29, 2016.



	Thirteen Weeks Ended				Thirty-nine Weeks Ended
(in thousands)	October 28, 2017		October 29, 2016		October 28, 2017		October 29, 2016
United States	$	554,673	$	531,449	$	1,434,019	$	1,435,633
Europe	192,698		187,184		543,578		541,711
Other	111,741		103,101		321,935		313,033
Total	$	859,112	$	821,734	$	2,299,532	$	2,290,377

11. 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 estimated liabilities 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. As of October 28, 2017, the Company had accrued charges of approximately $15.9 million for certain legal contingencies, which are classified within other current liabilities on the accompanying Condensed Consolidated Balance Sheet. Actual liabilities may differ from the amounts recorded, 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. There are certain claims and legal proceedings pending against the Company for which accruals have not been established.

The Company is a defendant in two separate class action lawsuits filed by former associates of the Company who are represented by the same counsel. The first lawsuit, filed on September 16, 2013, alleges failure to indemnify business expenses and a series of derivative claims for compelled patronization, inaccurate wage statements, waiting time penalties, minimum wage violations and unfair competition under California state law on behalf of all non-exempt hourly associates at Abercrombie & Fitch, Abercrombie kids, Hollister, and Gilly Hicks stores in California. Four subclasses of associates have since been certified, and the matter is now before the United States (“U.S.”) District Court for the Central District of California. The second lawsuit, filed on December 15, 2015, alleges that associates were required to purchase uniforms without reimbursement in violation of federal law, and laws of the states of New York, Florida and Massachusetts, as well as derivative putative state law claims and seeks to pursue such claims on a class and collective basis. This matter is now before the U.S. District Court for the Southern District of Ohio and is stayed pending mediation. Both matters have been mediated, and the parties have reached a framework for settling both cases on a class-wide basis through a proposed $25.0 million claims-made settlement agreement. The parties continue to negotiate the details of the proposed settlement, and the ultimate settlement amount is dependent upon the actual claims made by members of the classes and is also subject to the approval of a court of competent jurisdiction.

The Company incurred a pre-tax charge of $11.1 million within marketing, general and administrative expense on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) during the thirteen weeks ended October 28, 2017 and has a total estimated liability of $13.1 million as of October 28, 2017 related to the proposed settlement. The estimated liability represents what the Company believes to be a reasonable estimate of the loss exposure related to these matters and is included in the accrued charges disclosed above. The ultimate outcome of these matters may differ from the Company’s estimated loss exposure, due to uncertainties regarding final settlement agreement negotiations, actual claims rate experience, and court approvals. The

Company may be subject to an incremental loss of as much as $11.9 million, and there can be no absolute assurance that a settlement will be finalized and approved or of the ultimate outcome of the litigation.

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

OVERVIEW

BUSINESS SUMMARY

The Company is a specialty retailer who primarily sells its products through store and direct-to-consumer operations, as well as through various wholesale, franchise and licensing arrangements. The Company offers a broad array of apparel products, including knit tops, woven shirts, graphic t-shirts, fleece, sweaters, jeans, woven pants, shorts, outerwear, dresses, intimates and swimwear; and personal care products and accessories for men, women and kids under the Hollister, Abercrombie & Fitch and abercrombie kids brands. The Company has operations in North America, Europe, Asia and the Middle East.

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 2017” represent the fifty-three week fiscal year that will end on February 3, 2018, and to “Fiscal 2016” represent the fifty-two week fiscal year that ended January 28, 2017.

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.

SUMMARY RESULTS OF OPERATIONS

The table below summarizes the Company's results of operations and reconciles GAAP financial measures to non-GAAP financial measures for the thirteen and thirty-nine week periods ended October 28, 2017 and October 29, 2016. Additional discussion about why the Company believes that these non-GAAP financial measures are useful to investors is provided below under “NON-GAAP FINANCIAL MEASURES.”



	October 28, 2017									October 29, 2016
(in thousands, except change in comparable sales, gross profit rate and per share amounts)	GAAP			Excluded Items⁽¹⁾			Non-GAAP			GAAP			Excluded Items⁽¹⁾			Non-GAAP
Thirteen Weeks Ended
Net sales	$	859,112		$	—		$	859,112		$	821,734		$	—		$	821,734
Change in comparable sales⁽²⁾							4		%							(6		)%
Gross profit rate	61.3		%	—		%	61.3		%	62.2		%	—		%	62.2		%
Operating income	$	22,740		$	(14,550	)	$	37,290		$	19,645		$	6,000		$	13,645
Net income attributable to A&F	$	10,075		$	(10,433	)	$	20,508		$	7,881		$	6,479		$	1,402
Net income per diluted share attributable to A&F	$	0.15		$	(0.15	)	$	0.30		$	0.12		$	0.09		$	0.02

Thirty-nine Weeks Ended
Net sales	$	2,299,532		$	—		$	2,299,532		$	2,290,377		$	—		$	2,290,377
Change in comparable sales⁽²⁾							0		%							(5		)%
Gross profit rate	60.3		%	—		%	60.3		%	61.7		%	—		%	61.7		%
Operating loss	$	(68,290	)	$	(20,685	)	$	(47,605	)	$	(46,071	)	$	11,926		$	(57,997	)
Net loss attributable to A&F	$	(67,116	)	$	(14,958	)	$	(52,158	)	$	(44,835	)	$	10,158		$	(54,993	)
Net loss per diluted share attributable to A&F	$	(0.98	)	$	(0.22	)	$	(0.76	)	$	(0.66	)	$	0.15		$	(0.81	)


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

⁽²⁾

Changes in comparable sales are calculated on a constant currency basis by converting prior year store and online sales at current year exchange rates. For inclusion in this calculation, a store must have been open as the same brand at least one year and its square footage must not have been expanded or reduced by more than 20% within the past year. Excludes revenue other than store and online sales.

As of October 28, 2017, the Company had $459.3 million in cash and equivalents, and $268.3 million in gross borrowings outstanding under its term loan facility. Net cash provided by operating activities was $29.7 million for the thirty-nine weeks ended October 28, 2017. The Company used cash of $86.3 million for capital expenditures and $40.8 million to pay dividends during the thirty-nine weeks ended October 28, 2017.

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CURRENT TRENDS AND OUTLOOK

Our results for the third quarter of Fiscal 2017 reflect progress across all brands, as we continue to execute against our strategic plan. We delivered our fourth consecutive quarter of sequential comparable sales improvement, resulting in overall net sales up 5% compared to last year and a return to positive overall comparable sales for the quarter. We maintained strategic investment in omnichannel and marketing, while managing our expenses effectively, resulting in operating expense leverage and profit growth. Hollister continued to leverage high levels of customer engagement to drive another strong quarter, with 10% net sales growth. Abercrombie showed further improvement and early signs of stabilization.

We are focused on the continued execution of our strategic plan, and expect the environment in the fourth quarter to remain challenging and promotional. We maintain our focus on strategic investments in marketing and omnichannel to meet our customers' needs whenever, wherever and however they choose to engage with our brands.

For the fourth quarter of Fiscal 2017, we expect:


•	Comparable sales to be up low-single digits, and net sales to be up mid- to high-single digits, including benefits from the 53rd week and changes in foreign currency exchange rates.


•	The 53rd week to benefit net sales by approximately $38 million and operating income by approximately $2 million.


•	Changes in foreign currency exchange rates to benefit net sales and operating income, net of hedging.


•	A gross profit rate down approximately 100 basis points to last year's rate of 59.3%, in line with the third quarter year-over-year decline.


•	Operating expense, including other operating income, to be down approximately 1% from $553.7 million last year, with expense reductions partially offset by increases in volume-related expenses from higher sales and the adverse effect from changes in foreign currency exchange rates.


•	The effective tax rate to be in the mid 30s.


•	A weighted average diluted share count of approximately 70 million shares, excluding the effect of potential share buybacks.

On a full year basis, we expect the effective tax rate to reflect a core tax rate in the mid 30s, which is highly sensitive at lower levels of pre-tax earnings. Additionally, we expect the full year effective tax rate to reflect discrete non-cash income tax charges of approximately $11 million related to a change in share-based compensation accounting standards.

We now expect capital expenditures to be approximately $110 million for the full year, up from our prior expectation of $100 million.

In addition to the five stores opened year to date, including two outlet stores, we expect to open four new full-price stores in the fourth quarter. We also anticipate closing up to 60 stores in the U.S. by the end of Fiscal 2017 through natural lease expirations, including the 14 stores closed year to date.

NON-GAAP FINANCIAL MEASURES

This Quarterly Report on Form 10-Q includes discussion of certain financial measures under “RESULTS OF OPERATIONS” 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” are useful to investors as they provide a measure of the Company’s operating performance excluding the effect of certain items which the Company believes do not reflect its future operating outlook, and therefore supplements investors’ understanding of comparability 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 supplemental to, not as an alternative to, the Company’s GAAP financial results, and may not be the same as similar measures presented by other companies.

Changes in comparable sales are calculated on a constant currency basis by converting prior year store and online sales at current year exchange rates. For the purpose of this calculation, a store must have been open as the same brand at least one year and its square footage must not have been expanded or reduced by more than 20% within the past year. Excludes revenue other than store and online sales.

In addition, the following financial measures are disclosed on a GAAP basis and, as applicable, on a non-GAAP basis excluding items relating to legal charges, asset impairment, indemnification recovery, and claims settlement benefits: marketing, general and administrative expense; other operating income, net; operating income (loss); income tax expense (benefit); effective tax rate; net

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income (loss) attributable to A&F; and net income (loss) per diluted share attributable to A&F. Certain of these GAAP and non-GAAP measures are also expressed as a percentage of net sales. The income tax effect of non-GAAP items is calculated as the difference in income tax benefit with and without the non-GAAP adjustments to income before income taxes based upon the tax laws and statutory income tax rates of the applicable tax jurisdictions.

STORE ACTIVITY

Store count and gross square footage by brand for the thirty-nine weeks ended October 28, 2017 and October 29, 2016, respectively, were as follows:



	Hollister ⁽¹⁾			Abercrombie ⁽²⁾				Total
	United States		International	United States		International		United States		International
January 28, 2017	398		145	311		44		709		189
New	1		—	3		1		4		1
Closed	(3	)	—	(10	)	(1	)	(13	)	(1	)
October 28, 2017	396		145	304		44		700		189
Gross square feet (in thousands):
October 28, 2017	2,694		1,216	2,355		615		5,049		1,831

	Hollister ⁽¹⁾			Abercrombie ⁽²⁾				Total
	United States		International	United States		International		United States		International
January 30, 2016	414		139	340		39		754		178
New	3		5	3		2		6		7
Closed	(5	)	—	(10	)	—		(15	)	—
October 29, 2016	412		144	333		41		745		185
Gross square feet (in thousands):
October 29, 2016	2,828		1,212	2,548		631		5,376		1,843


⁽¹⁾	Excludes five international franchise stores as of October 28, 2017, three international franchise stores as of January 28, 2017 and October 29, 2016, and two international franchise stores as of January 30, 2016.


⁽²⁾	Includes Abercrombie & Fitch and abercrombie kids brands. Excludes four international franchise stores as of October 28, 2017 and one international franchise store as of January 28, 2017, October 29, 2016 and January 30, 2016.

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RESULTS OF OPERATIONS

THIRTEEN AND THIRTY-NINE WEEKS ENDED OCTOBER 28, 2017 VERSUS OCTOBER 29, 2016

Net Sales



	Thirteen Weeks Ended
	October 28, 2017		October 29, 2016
(in thousands)	Net Sales		Net Sales		$ Change			% Change
Hollister	$	508,086	$	463,479	$	44,607		10%
Abercrombie⁽¹⁾	351,026		358,255		(7,229		)	(2)%
Total net sales	$	859,112	$	821,734	$	37,378		5%

United States	$	554,673	$	531,449	$	23,224		4%
International	304,439		290,285		14,154			5%
Total net sales	$	859,112	$	821,734	$	37,378		5%



	Thirty-nine Weeks Ended
	October 28, 2017		October 29, 2016
(in thousands)	Net Sales		Net Sales		$ Change			% Change
Hollister	$	1,329,401	$	1,245,710	$	83,691		7%
Abercrombie⁽¹⁾	970,131		1,044,667		(74,536		)	(7)%
Total net sales	$	2,299,532	$	2,290,377	$	9,155		0%

United States	$	1,434,019	$	1,435,633	$	(1,614	)	0%
International	865,513		854,744		10,769			1%
Total net sales	$	2,299,532	$	2,290,377	$	9,155		0%



	Thirteen Weeks Ended		Thirty-nine Weeks Ended
	October 28, 2017	October 29, 2016	October 28, 2017	October 29, 2016
Change in Comparable Sales⁽²⁾
Hollister	8%	0%	6%	(1)%
Abercrombie⁽¹⁾	(2)%	(14)%	(6)%	(10)%
Total company	4%	(6)%	0%	(5)%

United States	6%	(5)%	1%	(4)%
International	0%	(10)%	(1)%	(7)%
Total company	4%	(6)%	0%	(5)%


⁽¹⁾	Includes Abercrombie & Fitch and abercrombie kids brands.

⁽²⁾

For the third quarter of Fiscal 2017, net sales increased 5% as compared to the third quarter of Fiscal 2016, primarily attributable to a 4% increase in comparable sales, with a 8% increase in comparable sales for Hollister, partially offset by a 2% decrease in comparable sales for Abercrombie. Changes in foreign currency exchange rates benefited net sales by approximately 1%.

For the year-to-date period of Fiscal 2017, net sales increased slightly as compared to the year-to-date period of Fiscal 2016.

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Cost of Sales, Exclusive of Depreciation and Amortization



	Thirteen Weeks Ended
	October 28, 2017			October 29, 2016
(in thousands)			% of Net Sales			% of Net Sales
Cost of sales, exclusive of depreciation and amortization	$	332,485	38.7%	$	310,995	37.8%

Gross profit	$	526,627	61.3%	$	510,739	62.2%



	Thirty-nine Weeks Ended
	October 28, 2017			October 29, 2016
(in thousands)			% of Net Sales			% of Net Sales
Cost of sales, exclusive of depreciation and amortization	$	913,085	39.7%	$	876,810	38.3%

Gross profit	$	1,386,447	60.3%	$	1,413,567	61.7%

For the third quarter of Fiscal 2017, cost of sales, exclusive of depreciation and amortization, as a percentage of net sales increased by approximately 90 basis points as compared to the third quarter of Fiscal 2016, primarily due to lower average unit cost that was more than offset by lower average unit retail, in an environment that remained promotional, and includes the adverse effects from changes in foreign currency exchange rates of approximately 10 basis points.

For the year-to-date period of Fiscal 2017, cost of sales, exclusive of depreciation and amortization, as a percentage of net sales increased by approximately 140 basis points as compared to the year-to-date period of Fiscal 2016, primarily due to lower average unit cost that was more than offset by lower average unit retail, in an environment that remained promotional, and includes the adverse effects from changes in foreign currency exchange rates of approximately 20 basis points.

Stores and Distribution Expense



	Thirteen Weeks Ended
	October 28, 2017			October 29, 2016
(in thousands)			% of Net Sales			% of Net Sales
Stores and distribution expense	$	375,944	43.8%	$	386,609	47.0%



	Thirty-nine Weeks Ended
	October 28, 2017			October 29, 2016
(in thousands)			% of Net Sales			% of Net Sales
Stores and distribution expense	$	1,105,168	48.1%	$	1,138,644	49.7%

For the third quarter of Fiscal 2017, stores and distribution expense as a percentage of net sales decreased by approximately 320 basis points as compared to the third quarter of Fiscal 2016, primarily due to expense reduction efforts and the leveraging effect from increased net sales, partially offset by higher direct-to-consumer expense.

For the year-to-date period of Fiscal 2017, stores and distribution expense as a percentage of net sales decreased by approximately 160 basis points as compared to the year-to-date period of Fiscal 2016, primarily due to expense reduction efforts, partially offset by higher direct-to-consumer expense.

For the third quarter of Fiscal 2017, shipping and handling costs incurred to physically move product to the customer, associated with direct-to-consumer operations, including costs incurred to store, move and prepare product for shipment, were $31.6 million as compared to $27.1 million for the third quarter of Fiscal 2016. For the year-to-date period of Fiscal 2017, shipping and handling costs were $92.8 million as compared to $77.3 million for the year-to-date period of Fiscal 2016.

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Marketing, General and Administrative Expense



	Thirteen Weeks Ended
	October 28, 2017				October 29, 2016
(in thousands)				% of Net Sales			% of Net Sales
Marketing, general and administrative expense	$	124,533		14.5%	$	105,307	12.8%
Deduct: legal charges⁽¹⁾	(11,070		)	(1.3)%	—		0.0%
Deduct: indemnification recovery⁽²⁾	—			0.0%	6,000		0.7%
Adjusted non-GAAP marketing, general and administrative expense	$	113,463		13.2%	$	111,307	13.5%



	Thirty-nine Weeks Ended
	October 28, 2017				October 29, 2016
(in thousands)				% of Net Sales			% of Net Sales
Marketing, general and administrative expense	$	343,779		14.9%	$	331,473	14.5%
Deduct: legal charges⁽¹⁾	(11,070		)	(0.5)%			0.0%
Deduct: indemnification recovery⁽²⁾	—			0.0%	6,000		0.3%
Adjusted non-GAAP marketing, general and administrative expense	$	332,709		14.5%	$	337,473	14.7%


⁽¹⁾	Includes legal charges in connection with a proposed settlement of two class action claims related to alleged wage and hour practices dating back to 2009. See Note 11, “CONTINGENCIES.”


⁽²⁾	Includes benefits related to an indemnification recovery of certain legal settlements which were recognized in the second quarter of Fiscal 2015.

For the third quarter of Fiscal 2017, marketing, general and administrative expense as a percentage of net sales increased by approximately 170 basis points as compared to the third quarter of Fiscal 2016, primarily due to certain items presented above. In addition, increases in performance-based compensation and marketing expenses were more than offset by expense reduction efforts and the leveraging effect from increased net sales. Excluding certain items presented above, third quarter Fiscal 2017 adjusted non-GAAP marketing, general and administrative expense as a percentage of net sales decreased approximately 30 basis points as compared to the third quarter of Fiscal 2016.

For the year-to-date period of Fiscal 2017, marketing, general and administrative expense as a percentage of net sales increased by approximately 40 basis points as compared to the year-to-date period of Fiscal 2016, primarily due to due certain items presented above, higher performance-based compensation and marketing expenses, partially offset by expense reduction efforts. Excluding certain items presented above, year-to-date Fiscal 2017 adjusted non-GAAP marketing, general and administrative expense as a percentage of net sales decreased approximately 20 basis points as compared to the year-to-date period of Fiscal 2016.

Asset Impairment

For the third quarter of Fiscal 2017, the Company incurred store asset impairment charges of $3.5 million. There were no asset impairment charges for the third quarter of Fiscal 2016. For the year-to-date period of Fiscal 2017, the Company incurred store asset impairment charges of $10.3 million as compared to $6.4 million for the year-to-date period of Fiscal 2016.

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Other Operating Income, Net



	Thirteen Weeks Ended
	October 28, 2017	October 29, 2016
(in thousands)