XFRA:AFT Abercrombie & Fitch Co Class A Annual Report 10-K Filing - 1/28/2012

Effective Date 1/28/2012

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Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-K

(Mark One)

 

  þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

   For the fiscal year ended January 28, 2012

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

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Class A Common Stock, $.01 Par Value

  New York Stock Exchange

Series A Participating Cumulative Preferred

Stock Purchase Rights

  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    þ  Yes    ¨  No

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  Yes    þ  No

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.    þ  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 during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).)     þ  Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    þ

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  þ  

Accelerated filer  ¨

  Non-accelerated filer  ¨   Smaller reporting company  ¨
  (Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  Yes    þ  No

Aggregate market value of the Registrant’s Class A Common Stock (the only outstanding common equity of the Registrant) held by non-affiliates of the Registrant (for this purpose, executive officers and directors of the Registrant are considered affiliates) as of July 29, 2011: $6,358,940,247.

Number of shares outstanding of the Registrant’s common stock as of March 16, 2012: 84,723,859 shares of Class A Common Stock.

DOCUMENT INCORPORATED BY REFERENCE:

Portions of the Registrant’s definitive proxy statement for the Annual Meeting of Stockholders, to be held on June 14, 2012, are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 


Table of Contents

ABERCROMBIE & FITCH CO.

TABLE OF CONTENTS

PART I

 

ITEM 1.

   BUSINESS    1

ITEM 1A.

   RISK FACTORS    7

ITEM 1B.

   UNRESOLVED STAFF COMMENTS    25

ITEM 2.

   PROPERTIES    26

ITEM 3.

   LEGAL PROCEEDINGS    27

ITEM 4.

   MINE SAFETY DISCLOSURES    29

SUPPLEMENTAL ITEM.

   EXECUTIVE OFFICERS OF THE REGISTRANT    30
PART II   

ITEM 5.

   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES    31

ITEM 6.

   SELECTED FINANCIAL DATA    34

ITEM 7.

   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    36
   FINANCIAL SUMMARY    39
   CURRENT TRENDS AND OUTLOOK    39

ITEM 7A.

   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK    58

ITEM 8.

   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA    60
   CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME    60
   CONSOLIDATED BALANCE SHEETS    61
   CONSOLIDATED STATEMENTS OF STOCKHOLDERS’
EQUITY
   62
   CONSOLIDATED STATEMENTS OF CASH FLOWS    63
   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS    64

ITEM 9.

   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE    102

ITEM 9A.

   CONTROLS AND PROCEDURES    103

ITEM 9B.

   OTHER INFORMATION    105
PART III   

ITEM 10.

   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE    106

ITEM 11.

   EXECUTIVE COMPENSATION    107

ITEM 12.

   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS    108

ITEM 13.

   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE    109

ITEM 14.

   PRINCIPAL ACCOUNTANT FEES AND SERVICES    110


Table of Contents
PART IV   

ITEM 15.

   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES    111

EX-12.1

     

EX-21.1

     

EX-23.1

     

EX-24.1

     

EX-31.1

     

EX-31.2

     

EX-32.1

     

EX-101

   INSTANCE DOCUMENT   

EX-101

   SCHEMA DOCUMENT   

EX-101

   CALCULATION LINKBASE DOCUMENT   

EX-101

   LABELS LINKBASE DOCUMENT   

EX-101

   PRESENTATION LINKBASE DOCUMENT   

EX-101

   DEFINITION LINKBASE DOCUMENT   


Table of Contents

PART I

 

ITEM 1. BUSINESS.

GENERAL.

Abercrombie & Fitch Co. (“A&F”), a company incorporated in Delaware in 1996, through its subsidiaries (collectively, A&F and its subsidiaries, are referred to as “Abercrombie & Fitch” or the “Company”), is a specialty retailer that operates stores and direct-to-consumer operations. Through these channels, the Company sells a broad array of products, including: casual sportswear apparel, including knit 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 also operates stores and direct-to-consumer operations offering bras, underwear, personal care products, sleepwear and at-home products for girls under the Gilly Hicks brand. As of January 28, 2012, the Company operated 946 stores in the United States (“U.S.”) and 99 stores outside of the U.S.

The Company’s fiscal year ends on the Saturday closest to January 31, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. 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 2011” represent the 52-week fiscal year ended January 28, 2012; to “Fiscal 2010” represent the 52-week fiscal year ended January 29, 2011; and to “Fiscal 2009” represent the 52-week fiscal year ended January 30, 2010. In addition, all references herein to “Fiscal 2012” represent the 53-week fiscal year that will end on February 2, 2013.

A&F makes available free of charge on its Internet website, www.abercrombie.com, under “Investors, SEC Filings,” its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as well as A&F’s definitive proxy materials filed pursuant to Section 14 of the Exchange Act, as soon as reasonably practicable after A&F electronically files such material with, or furnishes it to, the Securities and Exchange Commission (“SEC”). The SEC maintains a website that contains electronic filings by A&F and other issuers at www.sec.gov. In addition, the public may read and copy any materials A&F files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

The Company has included its Internet website addresses throughout this filing as textual references only. The information contained within these Internet websites is not incorporated into this Annual Report on Form 10-K.

DESCRIPTION OF OPERATIONS.

Brands.

Abercrombie & Fitch.    Rooted in East Coast traditions and Ivy League heritage, Abercrombie & Fitch is the essence of privilege and casual luxury. The Adirondacks supply a clean inspiration to this preppy, youthful All-American lifestyle. A combination of classic and sexy creates a charged atmosphere that is confident and just a bit provocative. Idolized and respected, Abercrombie & Fitch is timeless and always cool.

 

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abercrombie kids.    The essence of privilege and prestigious East Coast prep schools, abercrombie kids directly follows in the footsteps of Abercrombie & Fitch. With an energetic attitude, abercrombie kids are popular, wholesome and athletic. Casual, with classic, preppy style, abercrombie kids aspire to be like their older sibling, Abercrombie & Fitch. The perfect combination of maturity and mischief, abercrombie kids are the signature of All-American cool.

Hollister.    Hollister is the fantasy of Southern California. It’s all about hot lifeguards and beautiful beaches. Young and fun, with a sense of humor, Hollister never takes itself too seriously. Hollister’s laidback lifestyle and All-American image is timeless and effortlessly cool. Hollister brings Southern California to the world.

Gilly Hicks.    Gilly Hicks is the cheeky cousin of Abercrombie & Fitch. Inspired by the free spirit of Sydney, Australia, Gilly Hicks makes the hottest Push ‘Em Up bras and the cutest Down Undies for young, naturally beautiful, confident girls. Carefree and undeniably pretty, Gilly Hicks is the All-American brand with a Sydney sensibility.

Though each of the Company’s brands embodies its own heritage and handwriting, the brands share common elements and characteristics. The brands are classic, casual, confident, intelligent, privileged and possess a sense of humor.

Refer to the “FINANCIAL SUMMARY” in “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of this Annual Report on Form 10-K for information regarding net sales and other financial and operational data by segment and by brand.

FINANCIAL INFORMATION ABOUT SEGMENTS.

The Company determines its segments on the same basis that it uses to evaluate performance. In connection with international expansion, the way the Company allocates resources and assesses performance has changed. All of the Company’s segments sell a similar group of products — casual sportswear apparel, personal care products and accessories for men, women and kids and bras, underwear and sleepwear for women. The Company has three reportable segments, U.S. Stores, International Stores and Direct-to-Consumer. Refer to Note 2, “Segment Reporting,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K for further discussion of the Company’s reportable segments.

IN-STORE EXPERIENCE AND STORE OPERATIONS.

The Company views the customer’s in-store experience as the primary means for communicating the spirit of each brand. The Company emphasizes the senses of sight, sound, smell, touch and energy by utilizing the visual presentation of merchandise, in-store marketing, music, fragrances, rich fabrics and its sales associates to reinforce the aspirational lifestyles represented by the brands.

The Company’s in-store marketing is designed to convey the principal elements and personality of each brand. The store design, furniture, fixtures and music are all carefully planned and coordinated to create a shopping experience that reflects the Abercrombie & Fitch, abercrombie kids, Hollister or Gilly Hicks lifestyle.

The Company’s sales associates and managers are a central element in creating the atmosphere of the stores. In addition to serving customers, sales associates and managers reflect the casual, energetic and aspirational attitude of the brands.

 

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Merchandise is similarly displayed, regardless of location, to ensure a consistent in-store experience. Store managers receive detailed plans designating fixture and merchandise placement to ensure coordinated execution of the Company-wide merchandising strategy. In addition, standardization of each brand’s store design and merchandise presentation enables the Company to open new stores efficiently.

At the end of Fiscal 2011, the Company operated 1,045 stores. The following table details the number of retail stores operated by the Company at January 28, 2012:

 

Fiscal 2011

   Abercrombie &
Fitch
     abercrombie
kids
     Hollister      Gilly Hicks      Total  

U.S.

     280        154        494        18        946  

International

     14        5        77        3        99  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     294        159        571        21        1,045  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

DIRECT-TO-CONSUMER BUSINESS.

The Company operates websites for each brand, both domestically and internationally. The websites reinforce each particular brand’s lifestyle, and are designed to complement the in-store experience. Aggregate total net sales through direct-to-consumer operations, including shipping and handling revenue, were $552.6 million for Fiscal 2011, representing 13.3% of total net sales. The Company believes its direct-to-consumer operations have broadened its market and brand recognition worldwide.

MARKETING AND ADVERTISING.

The Company considers the in-store experience to be its primary marketing vehicle. The Company’s marketing strategy emphasizes the senses to reinforce the aspirational lifestyle represented by each brand. The Company’s flagship stores represent the pinnacle of the Company’s in-store branding efforts. The Company also engages its customers through the internet, social media and mobile commerce in ways that reinforce the aspirational lifestyle of the brands. Flagship stores and social media both attract a substantial number of international consumers and have significantly contributed to the worldwide status of the Company’s iconic brands.

MERCHANDISE SUPPLIERS.

During Fiscal 2011, the Company sourced merchandise through approximately 170 vendors located throughout the world; primarily in Asia and Central and South America. The Company did not source more than 10% of its merchandise from any single factory or supplier during Fiscal 2011. The Company pursues a global sourcing strategy that includes relationships with vendors in 16 countries as well as the United States. The Company’s foreign sourcing of merchandise is negotiated and settled in U.S. dollars.

All product sources, including independent manufacturers and suppliers, must achieve and maintain the Company’s high quality standards, which are an integral part of the Company’s identity. The Company has established supplier product quality standards to ensure the high quality of fabrics and other materials used in the Company’s products. The Company utilizes both home office and field employees to help monitor compliance with the Company’s product quality standards.

Before the Company begins production with any factory, the factory must first go through a rigorous quality assurance inspection to ensure it meets Company standards. This includes factories that are subcontractors to the factories and vendors with whom the Company works. All business partners are

 

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contractually required to adhere to our vendor Code of Conduct, and all new factories go through an initial social audit, which includes a factory walk-through to appraise the physical working conditions and health and safety practices. Social audits on the factories are also performed once a year after the initial audit. The Company strives to partner with suppliers who respect local laws and share our dedication to utilize best practices in human rights, labor rights and workplace safety.

DISTRIBUTION AND MERCHANDISE INVENTORY.

The Company’s merchandise is shipped to the Company’s distribution centers (“DCs”) where it is received and inspected before being shipped to stores or direct-to-consumer customers. The Company uses its two DCs in New Albany, Ohio to support its North American stores, and North American and Asian direct-to-consumer customers. The Company is in the process of consolidating the operations of its two DCs in New Albany, Ohio into one, with an expected completion date by the end of Fiscal 2012. The Company uses a third-party DC in the Netherlands for the distribution of merchandise to stores and direct-to-consumer customers located in Europe, and a third-party DC in Hong Kong for the distribution of merchandise to stores located in Asia. The Company utilizes primarily one contract carrier to ship merchandise and related materials to its North American stores and direct-to-consumer customers, and a separate contract carrier for its European and Asian stores and direct-to-consumer customers.

The Company strives to maintain sufficient quantities of inventory in its retail stores and DCs to offer customers a full selection of current merchandise. The Company attempts to balance in-stock levels and inventory turnover, and to take markdowns when required to keep merchandise fresh and current with fashion trends.

INFORMATION SYSTEMS.

The Company’s management information systems consist of a full range of retail, merchandising and financial systems. The systems include applications related to point-of-sale, direct-to-consumer, inventory management, supply chain, planning, sourcing, merchandising and financial reporting. The Company continues to invest in technology to upgrade core systems to make the Company scalable, efficient, and more accurate, including support of its international expansion.

SEASONAL BUSINESS.

The retail apparel market has two principal selling seasons: the Spring season which includes the first and second fiscal quarters (“Spring”); and the Fall season which includes the third and fourth fiscal quarters (“Fall”). As is typical in the apparel industry, the Company experiences its greatest sales activity during the Fall season due to the Back-to-School (August) and Holiday (November and December) selling periods, particularly in the U.S.

TRADEMARKS.

The Abercrombie & Fitch®, abercrombie®, Hollister®, Gilly Hicks®, “Moose” and “Seagull” trademarks are registered with the U.S. Patent and Trademark Office and the registries of countries where stores are located or likely to be located in the future. In addition, these trademarks are either registered, or the Company has applications for registration pending, with the registries of many of the foreign countries in which the manufacturers of the Company’s products are located. The Company has also registered, or has applied to register, certain other trademarks in the U.S. and around the world. The Company believes its products are identified by its trademarks and, therefore, its trademarks are of significant value. Each

 

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registered trademark has a duration of ten to 20 years, depending on the date it was registered, and the country in which it is registered, and is subject to an indefinite number of renewals for a like period upon continued use and appropriate application. The Company intends to continue using its core trademarks and to renew each of its registered trademarks that remain in use.

OTHER INFORMATION.

Additional information about the Company’s business, including its revenues and profits for the last three fiscal years and gross square footage of stores, is set forth under “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” of this Annual Report on Form 10-K.

COMPETITION.

The sale of apparel, accessories and personal care products through stores and direct-to-consumer channels is a highly competitive business with numerous participants, including individual and chain fashion specialty stores, as well as regional and national department stores. As the Company continues expanding internationally, it also faces competition in local markets from established chains, as well as local specialty stores. Brand recognition, fashion, price, service, store location, selection and quality are the principal competitive factors in retail store and direct-to-consumer sales.

The competitive challenges facing the Company include anticipating and quickly responding to changing fashion trends; and maintaining the aspirational positioning of its brands. Furthermore, the Company faces additional competitive challenges as many retailers continue promotional activities regardless of economic conditions, particularly in the U.S. In response to these conditions, the Company has engaged in promotional activity in the U.S. while continuing to focus on preserving the value of its brands.

ASSOCIATE RELATIONS.

As of March 16, 2012, the Company employed approximately 90,000 associates. Approximately 80,000 of the Company’s associates were part-time associates.

On average, the Company employed approximately 27,000 full-time equivalents during Fiscal 2011 which included approximately 17,000 full-time equivalents comprised of part-time associates, including temporary associates hired during peak periods, such as the Back-to-School and Holiday seasons.

The Company believes it maintains a good relationship with its associates. However, in the normal course of business, the Company is party to lawsuits involving former and current associates. Please see the discussion in “ITEM 3. LEGAL PROCEEDINGS” in this Annual Report on Form 10-K.

ENVIRONMENTAL MATTERS.

Compliance with domestic and international regulations related to environmental matters has not had, nor is it expected to have, any material effect on capital expenditures, earnings, or the Company’s competitive position based on information and circumstances known to us at this time.

DISCONTINUED OPERATIONS.

On June 16, 2009, A&F’s Board of Directors approved the closure of the Company’s 29 RUEHL branded stores and related direct-to-consumer operations. The Company completed the closure of the RUEHL branded stores and related direct-to-consumer operations during the fourth quarter of Fiscal 2009.

 

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Accordingly, the results of operations of RUEHL are reflected in Income (Loss) from Discontinued Operations, Net of Tax on the Consolidated Statements of Operations and Comprehensive Income included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K, for all periods presented. Results from discontinued operations were immaterial for the fifty-two weeks ended January 29, 2011.

 

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ITEM 1A.    RISK FACTORS

FORWARD-LOOKING STATEMENTS AND RISK FACTORS.

We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this Annual Report on Form 10-K or made by us, our management or our spokespeople involve risks and uncertainties and are subject to change based on various factors, many of which may be beyond our control. Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend” and similar expressions may identify forward-looking statements. Except as may be required by applicable law, we assume no obligation to publicly update or revise our forward-looking statements.

The following factors could affect our financial performance and could cause actual results to differ materially from those expressed or implied in any of the forward-looking statements:

 

   

changes in economic and financial conditions, and the resulting impact on consumer confidence and consumer spending, could have a material adverse effect on our business, results of operations and liquidity;

 

   

if we are unable to anticipate, identify and respond to changing fashion trends and consumer preferences in a timely manner, and manage our inventory commensurate with customer demand, our sales levels and profitability may decline;

 

   

fluctuations in the cost, availability and quality of raw materials, labor and transportation, could cause manufacturing delays and increase our costs;

 

   

equity-based compensation awarded under the employment agreement with our Chief Executive Officer could adversely impact our cash flows, financial position or results of operations and could have a dilutive effect on our outstanding Common Stock;

 

   

our growth strategy relies significantly on international expansion, which adds complexity to our operations and may strain our resources and adversely impact current store performance;

 

   

our international expansion plan is dependent on a number of factors, any of which could delay or prevent successful penetration into new markets or could adversely affect the profitability of our international operations;

 

   

our direct-to-consumer sales are subject to numerous risks that could adversely impact sales;

 

   

we have incurred, and may continue to incur, significant costs related to store closures;

 

   

our development of a new brand concept such as Gilly Hicks could have a material adverse effect on our financial condition or results of operations;

 

   

fluctuations in foreign currency exchange rates could adversely impact our financial condition and results of operations;

 

   

our business could suffer if our information technology systems are disrupted or cease to operate effectively;

 

   

comparable store sales may continue to fluctuate on a regular basis and impact the volatility of the price of our Common Stock;

 

   

our market share may be negatively impacted by increasing competition and pricing pressures from companies with brands or merchandise competitive with ours;

 

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our stock price may be volatile and investors may not be able to resell shares of our Common Stock at or above the price paid to acquire the shares;

 

   

our ability to attract customers to our stores depends, in part, on the success of the shopping malls in which most of our stores are located;

 

   

our net sales fluctuate on a seasonal basis, causing our results of operations to be susceptible to changes in Back-to-School and Holiday shopping patterns;

 

   

our inability to accurately plan for product demand and allocate merchandise effectively could have a material adverse effect on our results;

 

   

our failure to protect our reputation could have a material adverse effect on our brands;

 

   

we rely on the experience and skills of our senior executive officers, the loss of whom could have a material adverse effect on our business;

 

   

interruption in the flow of merchandise from our key vendors and international manufacturers could disrupt our supply chain, which could result in lost sales and could increase our costs;

 

   

we do not own or operate any manufacturing facilities and, therefore, depend upon independent third parties for the manufacture of all our merchandise;

 

   

our reliance on two distribution centers domestically and two third-party distribution centers internationally makes us susceptible to disruptions or adverse conditions affecting our distribution centers;

 

   

our reliance on third parties to deliver merchandise from our distribution centers to our stores and direct-to-consumer customers could result in disruptions to our business;

 

   

we may be exposed to risks and costs associated with credit card fraud and identity theft that would cause us to incur unexpected expenses and loss of revenues;

 

   

modifications and/or upgrades to our information technology systems may disrupt our operations;

 

   

our facilities, systems and stores, as well as the facilities and systems of our vendors and manufacturers, are vulnerable to natural disasters, pandemic disease and other unexpected events, any of which could result in an interruption to our business and adversely affect our operating results;

 

   

our litigation exposure could have a material adverse effect on our financial condition and results of operations;

 

   

our inability or failure to adequately protect our trademarks could have a negative impact on our brand image and limit our ability to penetrate new markets;

 

   

fluctuations in our tax obligations and effective tax rate may result in volatility in our operating results;

 

   

the effects of war or acts of terrorism could have a material adverse effect on our operating results and financial condition;

 

   

our inability to obtain commercial insurance at acceptable prices or our failure to adequately reserve for self-insured exposures might increase our expenses and adversely impact our financial results;

 

   

operating results and cash flows at the store level may cause us to incur impairment charges;

 

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we are subject to customs, advertising, consumer protection, privacy, zoning and occupancy and labor and employment laws that could require us to modify our current business practices, incur increased costs or harm our reputation if we do not comply;

 

   

changes in the regulatory or compliance landscape could adversely affect our business and results of operations;

 

   

our unsecured Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) and our Term Loan Agreement include financial and other covenants that impose restrictions on our financial and business operations;

 

   

our operations may be affected by regulatory changes related to climate change and greenhouse gas emissions; and

 

   

compliance with changing regulations and standards for accounting, corporate governance and public disclosure could adversely affect our business, results of operations and reported financial results.

The following sets forth a description of the preceding risk factors that we believe may be relevant to an understanding of our business. These risk factors could cause actual results to differ materially from those expressed or implied in any of our forward-looking statements.

Changes in economic and financial conditions, and the resulting impact on consumer confidence and consumer spending, could have a material adverse effect on our business, results of operations and liquidity.

Our business depends on consumer demand for our merchandise. Consumer purchases of discretionary items, including our merchandise, generally decline during recessionary periods and other periods where disposable income is adversely affected. Our performance is subject to factors that affect worldwide economic conditions including unemployment, consumer credit availability, consumer debt levels, reductions in net worth based on declines in the financial, residential real estate and mortgage markets, sales tax rates and rate increases, fuel and energy prices, interest rates, consumer confidence in future economic and political conditions, consumer perceptions of personal well-being and security, the value of the U.S. dollar versus foreign currencies and other macroeconomic factors.

During Fiscal 2008 and Fiscal 2009, the combination of these factors caused consumer spending in the U.S. to deteriorate significantly. While consumer spending began to improve in Fiscal 2010 and continued to improve in Fiscal 2011, these factors may cause levels of spending to remain depressed relative to historical levels for the foreseeable future. In addition, these factors may cause consumers to purchase products from lower-priced competitors or to defer purchases of apparel and personal care products altogether.

In addition, we have significantly expanded our presence in the European market. The ongoing Euro financial crisis may impact consumer demand for our merchandise. The economic conditions and factors described above could adversely affect the productivity of our stores, as well as adversely affect the pace of opening new international stores, or their productivity once opened.

Economic uncertainty could have a material adverse effect on our results of operations, liquidity, and capital resources if reduced consumer demand for our merchandise should occur. It could also impact our ability to fund growth and/or result in our becoming reliant on external financing, the availability of which may be uncertain.

 

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In addition, the economic environment may exacerbate some of the risks noted below, including consumer demand, strain on available resources, international growth strategy, store growth, interruption of the flow of merchandise from key vendors and manufacturers, and foreign currency exchange rate fluctuations. The risks could be exacerbated individually, or collectively.

If we are unable to anticipate, identify and respond to changing fashion trends and consumer preferences in a timely manner, and manage our inventory commensurate with customer demand, our sales levels and profitability may decline.

Our success largely depends on our ability to anticipate and gauge the fashion preferences of our customers and provide merchandise that satisfies constantly shifting demands in a timely manner. Our merchandise must appeal to our consumers, whose preferences cannot be predicted with certainty and are also subject to rapid change. We must translate market trends into appropriate, saleable merchandise far in advance of its sale in our stores or through our websites. Because we enter into agreements for the manufacture and purchase of merchandise well in advance of the applicable selling season, we are vulnerable to changes in consumer preferences and demand, pricing shifts, and the sub-optimal selection and timing of merchandise purchases. Moreover, there can be no assurance that we will continue to anticipate consumer demands successfully in the future. To the extent we fail to anticipate, identify and respond effectively to changing consumer preferences and fashion trends, our sales will be adversely affected. Inventory levels for certain merchandise styles no longer considered to be “on trend” may increase, leading to higher markdowns to sell through excess inventory or increases in inventory valuation reserves. A distressed economic and retail environment, in which many of our competitors continue to engage in aggressive promotional activities, particularly in the U.S., increases the importance of reacting appropriately to changing consumer preferences and fashion trends. Conversely, if we underestimate consumer demand for our merchandise, or if our manufacturers fail to supply quality products in a timely manner, we may experience inventory shortages, which may negatively impact customer relationships, diminish brand loyalty and result in lost sales. Any of these events could significantly harm our operating results and financial condition.

Fluctuations in the cost, availability and quality of raw materials, labor and transportation, could cause manufacturing delays and increase our costs.

Fluctuations in the cost, availability and quality of the fabrics or other raw materials used to manufacture our merchandise could have a material adverse effect on our cost of goods, or our ability to meet customer demand. The prices for such fabrics depend largely on the market prices for the raw materials used to produce them, particularly cotton. The price and availability of such raw materials may fluctuate significantly, depending on many factors, including crop yields and weather patterns. Such factors may be exacerbated by legislation and regulations associated with global climate change.

In addition, the cost of labor at many of our third-party manufacturers has been increasing significantly, and as the middle class in developing countries continues to grow, it is unlikely such cost pressure will abate. The cost of transportation has been increasing as well and, if the price of oil continues to increase, and there continues to be significant unrest in the Middle East, it is unlikely that such cost pressure will abate.

We may not be able to pass all or a portion of higher raw materials prices or labor or transportation costs on to our customers, which could adversely affect our gross margin and results of our operations.

 

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Equity-based compensation awarded under the employment agreement with our Chief Executive Officer could adversely impact our cash flows, financial position or results of operations and could have a dilutive effect on our outstanding Common Stock.

Under the Employment Agreement entered into as of December 19, 2008, between A&F and Michael S. Jeffries, our Chairman and Chief Executive Officer (the “Employment Agreement”), Mr. Jeffries received grants (the “Retention Grants”) of stock appreciation rights. In addition to the Retention Grants, Mr. Jeffries is eligible to receive two equity-based grants during each fiscal year of the term of the Employment Agreement starting with Fiscal 2009 (each, a “Semi-Annual Grant”). The value of a Semi-Annual Grant is uncertain and dependent on the future market price of our Common Stock and our financial performance. To date, Mr. Jeffries has received Semi-Annual Grants, in the aggregate, of 3,752,259 stock appreciation rights.

In connection with the Semi-Annual Grants contemplated by the Employment Agreement, the related compensation expense could significantly impact our results of operations. In addition, the significant number of shares of Common Stock which could be issued to settle the Retention Grants and the Semi-Annual Grants is uncertain and dependent on the future market price of our Common Stock and our financial performance and would, if issued, have a dilutive effect with respect to our outstanding shares of Common Stock, which may adversely affect the market price of our Common Stock.

In the event that there are not sufficient shares of Common Stock available to be issued under our Amended and Restated 2007 Long-Term Incentive Plan (the “2007 LTIP”), or under a successor or replacement plan at the time these equity-based awards are ultimately settled, we will be required to settle some portion of the awards in cash, which could have an adverse impact on our cash flow from operations, financial position or results of operations. Furthermore, the awards may not be deductible pursuant to Internal Revenue Code Section 162(m). In addition, under applicable accounting rules, if our stock price increases to a point where, as of any measurement date, we would be unable to settle outstanding equity-based awards in shares of Common Stock from our existing plans, we will be required to classify and account for all or a portion of the equity-based awards as liabilities. This could further adversely impact our results of operations.

Our growth strategy relies significantly on international expansion, which adds complexity to our operations and may strain our resources and adversely impact current store performance.

Our growth strategy largely depends on the opening of new international stores. This international expansion has placed, and will continue to place, increased demands on our operational, managerial and administrative resources at all levels of the Company. These increased demands may cause us to operate our business less efficiently, which in turn could cause deterioration in the performance of our existing stores or could adversely affect our inventory levels. Furthermore, our ability to conduct business in international markets may be adversely affected by legal, regulatory, political and economic risks. Our international expansion strategy and success could also be adversely impacted by the global economy. Failure to properly implement our growth strategy could have a material adverse effect on our financial condition and results of operations or could otherwise adversely affect our ability to achieve our objectives.

In addition, as we continue to expand our overseas operations, we are subject to certain U.S. laws, including the Foreign Corrupt Practices Act, in addition to the laws of the foreign countries in which we operate. We must use all commercially reasonable efforts to ensure our employees comply with these laws. If any of our overseas operations, or our employees or agents, violate such laws, we could become subject to sanctions or other penalties that could negatively affect our reputation, business and operating results.

 

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Our international expansion plan is dependent on a number of factors, any of which could delay or prevent successful penetration into new markets or could adversely affect the profitability of our international operations.

As we expand internationally, we may incur significant costs related to starting up and maintaining foreign operations. Costs may include, but are not limited to, obtaining prime locations for stores, setting up foreign offices and distribution centers, as well as hiring experienced management. We may be unable to open and operate new stores successfully, or we may face operational issues that delay our intended pace of international store openings, and, in any such case, our growth may be limited, unless we can:

 

   

identify suitable markets and sites for store locations;

 

   

address the different operational characteristics present in each country to which we expand, including employment and labor, transportation, logistics, real estate, lease provisions and local reporting or legal requirements;

 

   

negotiate acceptable lease terms, in some cases in locations in which the relative rights and obligations of landlords and tenants differ significantly from the customs and practices in the United States;

 

   

hire, train and retain competent store personnel;

 

   

gain and retain acceptance from foreign customers;

 

   

manage inventory effectively to meet the needs of new and existing stores on a timely basis;

 

   

expand infrastructure to accommodate growth;

 

   

foster current relationships and develop new relationships with vendors that are capable of supplying a greater volume of merchandise;

 

   

generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plan;

 

   

manage foreign currency exchange risks effectively; and

 

   

achieve acceptable operating margins from new stores.

Failure to implement our international expansion plan consistent with our internal expectations, whether as a result of one or more of the factors listed above or other factors could adversely affect our ability to achieve the objectives that we have established for ourselves.

Our direct-to-consumer sales are subject to numerous risks that could adversely impact sales.

We sell merchandise for each brand over the Internet, both domestically and internationally. Our direct-to-consumer operations are subject to numerous risks, including:

 

   

reliance on third-party computer hardware/software providers;

 

   

rapid technological change and the implementation of new systems and platforms;

 

   

diversions of sales from our stores;

 

   

liability for online content;

 

   

violations of state, federal or international laws, including those relating to online privacy;

 

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credit card fraud;

 

   

the failure of the computer systems that operate our websites and their related support systems, including computer viruses;

 

   

telecommunication failures and electronic break-ins and similar disruptions; and

 

   

disruption of Internet service, whether for technical reasons or as a result of state-sponsored censorship.

Our failure to successfully respond to these risks might adversely affect sales in our direct-to-consumer business, as well as damage our reputation and brands.

We have incurred, and may continue to incur, significant costs related to store closures.

We may incur costs associated with store closures resulting from, among other things, lease termination agreements associated with closing stores prior to the stores’ lease expiration date. These costs could be significant and could have a material adverse effect on our financial condition and results of operations. We previously announced our intention to close underperforming domestic stores, primarily through natural lease expirations, as part of our efforts to increase domestic store productivity.

Our development of a new brand concept such as Gilly Hicks could have a material adverse effect on our financial condition or results of operations.

Historically, we have developed and launched new brands internally that have contributed to our sales growth. Our most recent brand, Gilly Hicks, offers bras, underwear, personal care products, sleepwear and at-home products for girls. The development of new brand concepts such as Gilly Hicks requires management’s focus and attention, as well as significant capital investments. Furthermore, a new brand concept is susceptible to risks, including lack of customer acceptance, competition from existing or new retailers, product differentiation, production and distribution inefficiencies and unanticipated operating issues. There is no assurance that a new brand concept, including Gilly Hicks, will achieve successful results. The failure of Gilly Hicks to be launched successfully, and to achieve profitability, could have a material adverse effect on our financial condition and results of operations. The costs of exiting a brand are significant. In Fiscal 2009, we incurred pre-tax exit costs of $56.1 million and pre-tax impairment charges of $51.5 million associated with the closure of RUEHL. In addition, the ongoing development of new concepts may place a strain on available resources.

Fluctuations in foreign currency exchange rates could adversely impact our financial condition and results of operations.

The functional currency of our international subsidiaries is generally the local currency in which each operates, which includes British Pounds, Canadian Dollars, Chinese Yuan, Danish Kroner, Euros, Hong Kong Dollars, Japanese Yen, Singapore Dollars, Swedish Kronor and Swiss Francs. Our consolidated financial statements are presented in U.S. dollars. Therefore, we must translate revenues, expenses, assets and liabilities from functional currencies into U.S. dollars at exchange rates in effect during, or at the end of the reporting period. In addition, our international subsidiaries transact in currencies other than their functional currency, including intercompany transactions, which could result in foreign currency transaction gains or losses. The fluctuation in the value of the U.S. dollar against other currencies could impact our financial results.

 

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Furthermore, we purchase substantially our entire inventory in U.S. dollars. As a result, our gross margin rate from international operations is subject to volatility from movements in exchange rates over time, which could have an adverse effect on our financial condition and results of operations and profitability from the growth desired from international operations.

Our business could suffer if our information technology systems are disrupted or cease to operate effectively.

We rely heavily on our information technology systems: to operate our websites; record and process transactions; respond to customer inquiries; manage inventory; purchase; sell and ship merchandise on a timely basis; and maintain cost-efficient operations. Given the significant number of transactions that are completed annually, it is vital to maintain constant operation of our computer hardware and software systems and maintain cyber security. Despite efforts to prevent such an occurrence, our information technology systems are vulnerable from time-to-time to damage or interruption from computer viruses, power outages, third-party intrusions and other technical malfunctions. If our systems are damaged, or fail to function properly, we may have to make monetary investments to repair or replace the systems, and we could endure delays in our operations. Any material disruption or slowdown of our systems, including a disruption or slowdown caused by our failure to successfully upgrade our systems, could cause information, including data related to customer orders, to be lost or delayed. Such a loss or delay could — especially if the disruption or slowdown occurred during our peak selling seasons — result in delays of merchandise delivery to our stores and customers, which could reduce demand for our merchandise and cause our sales and profitability to decline.

Comparable store sales may continue to fluctuate on a regular basis and impact the volatility of the price of our Common Stock.

Our comparable store sales, defined as year-over-year sales for a store that has been open as the same brand at least one year and the square footage of which has not been expanded or reduced by more than 20%, have fluctuated significantly in the past on an annual and quarterly basis and are expected to continue to fluctuate in the future. We believe that a variety of factors affect comparable store sales results including, but not limited to, fashion trends, actions by competitors or mall anchor tenants, changes in economic conditions and consumer spending patterns, weather conditions, opening and/or closing of our stores in proximity to each other, the timing of the release of new merchandise and promotional events, changes in our merchandise mix and the calendar shifts of tax free and holiday periods.

Comparable store sales fluctuations may impact our ability to leverage fixed direct expenses, including store rent and store asset depreciation, which may adversely affect our financial condition or results of operations.

In addition, comparable store sales fluctuations may have been an important factor in the volatility of the price of our Common Stock in the past, and it is likely that future comparable store sales fluctuations will contribute to stock price volatility in the future.

Our market share may be negatively impacted by increasing competition and pricing pressures from companies with brands or merchandise competitive with ours.

The sale of apparel and personal care products through stores and direct-to-consumer channels is a highly competitive business with numerous participants, including individual and chain fashion specialty stores, as well as regional, national and international department stores. The substantial sales growth in the

 

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direct-to-consumer channel within the last few years has encouraged the entry of many new competitors and an increase in competition from established companies. We face a variety of competitive challenges, including:

 

   

anticipating and quickly responding to changing consumer demands or preferences better than our competitors;

 

   

maintaining favorable brand recognition and effectively marketing our products to consumers in several diverse demographic markets;

 

   

sourcing merchandise efficiently;

 

   

developing innovative, high-quality merchandise in styles that appeal to our consumers and in ways that favorably distinguish us from our competitors; and

 

   

countering the aggressive promotional activities of many of our competitors without diminishing the aspirational nature of our brands and brand equity.

In light of the competitive challenges we face, we may not be able to compete successfully in the future. Further, increases in competition could reduce our sales and harm our operating results and business.

Our stock price may be volatile and investors may not be able to resell shares of our Common Stock at or above the price paid to acquire the shares.

The price of our Common Stock fluctuates significantly, which may result in losses for investors. The market price of our Common Stock has been volatile. From February 1, 2009 to January 28, 2012, the price of our Common Stock reported by the New York Stock Exchange ranged from a low of $16.95 per share to a high of $78.25 per share. We expect our Common Stock to continue to be subject to fluctuations as a result of a variety of factors, including factors beyond our control.

Our ability to attract customers to our stores depends, in part, on the success of the shopping malls in which most of our stores are located.

In order to generate customer traffic, we locate many of our stores in prominent locations within successful shopping malls. Our stores benefit from the ability of the malls’ “anchor” tenants, generally large department stores and other area attractions, to generate consumer traffic in the vicinity of our stores and the continuing popularity of malls in the U.S. and, increasingly, in many international locations as shopping destinations. We cannot control the development of new shopping malls in the United States or around the world; the availability or cost of appropriate locations within existing or new shopping malls; competition with other retailers for prominent locations; or the success of individual shopping malls. All of these factors may impact our ability to meet our productivity targets for our domestic stores and our growth objectives for our international stores, which are primarily mall-based, and could have a material adverse effect on our financial condition or results of operations. Unfavorable economic conditions, particularly in certain regions, have affected mall traffic and resulted in the closing of certain anchor stores. The viability of certain commercial and real estate firms, which operate major shopping malls, has also been threatened. In addition, some malls that were in prominent locations when we opened stores may cease to be viewed as prominent. If this trend continues or if the popularity of mall shopping continues to decline generally among our customers, our sales may decline, which would impact our gross profits and net income.

 

 

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Part of our future growth is dependent on our ability to operate stores in desirable locations with capital investment and lease costs providing the opportunity to earn a reasonable return. We cannot be sure as to when or whether such desirable locations will become available at reasonable costs.

Our net sales fluctuate on a seasonal basis, causing our results of operations to be susceptible to changes in Back-to-School and Holiday shopping patterns.

Historically, our operations have been seasonal, with a significant amount of net sales and net income occurring in the fourth fiscal quarter, due to the increased sales during the Holiday selling season and, to a lesser extent, the third fiscal quarter, reflecting increased sales during the Back-to-School selling season in the U.S. Our net sales and net income during the first and second fiscal quarters are typically lower due, in part, to the traditional slowdown in retail sales immediately following the Holiday selling season. As a result of this seasonality, net sales and net income during any fiscal quarter cannot be used as an accurate indicator of our annual results. Any factors negatively affecting us during the third and fourth fiscal quarters of any year, including inclement weather or unfavorable economic conditions, could have a material adverse effect on our financial condition and results of operations for the entire year.

Our inability to accurately plan for product demand and allocate merchandise effectively could have a material adverse effect on our results.

We must order and keep appropriate merchandise in stock to meet demand. As a result, the inability to accurately plan for product demand and allocate merchandise effectively could have a material adverse effect on our financial condition and results of operations. High inventory levels due to unanticipated decreases in demand for our products, misidentification of fashion trends, or excess inventory purchases could require us to sell merchandise at a substantial markdown, which could reduce our net sales and gross margins and negatively impact our profitability. Low levels of inventory due to conservative planning could also affect product offerings in our stores and on our websites, and negatively impact net sales and profitability.

Our failure to protect our reputation could have a material adverse effect on our brands.

Our ability to maintain our reputation is critical to our brands. Our reputation could be jeopardized if we fail to maintain high standards for merchandise quality and integrity. Any negative publicity about these types of concerns may reduce demand for our merchandise. Failure to comply with ethical, social, product, labor, health and safety or environmental standards, or related political considerations, could also jeopardize our reputation and potentially lead to various adverse consumer actions, including boycotts. Public perception about our products or our stores, whether justified or not, could impair our reputation, involve us in litigation, damage our brands and have a material adverse effect on our business. Failure to comply with local laws and regulations, to maintain an effective system of internal controls or to provide accurate and timely financial statement information could also hurt our reputation. Damage to our reputation or loss of consumer confidence for any of these or other reasons could have a material adverse effect on our results of operations and financial condition, as well as require additional resources to rebuild our reputation.

We rely on the experience and skills of our senior executive officers, the loss of whom could have a material adverse effect on our business.

Our senior executive officers closely supervise all aspects of our business — in particular, the design of our merchandise and the operation of our stores. Our senior executive officers have substantial

 

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experience and expertise in the retail business and have made significant contributions to the growth and success of our brands. If we were to lose the benefit of their involvement — in particular the services of any one or more of Michael S. Jeffries, Chairman and Chief Executive Officer; Diane Chang, Executive Vice President — Sourcing; Leslee K. Herro, Executive Vice President — Planning and Allocation; Jonathan E. Ramsden, Executive Vice President and Chief Financial Officer; and Ronald A. Robins, Jr., Senior Vice President, General Counsel and Secretary — without adequate succession plans, our business could be adversely affected. Competition for such senior executive officers is intense, and we cannot be sure we will be able to attract, retain and develop a sufficient number of qualified senior executive officers in future periods.

Interruption in the flow of merchandise from our key vendors and international manufacturers could disrupt our supply chain, which could result in lost sales and could increase our costs.

We source the majority of our merchandise outside of the U.S. through arrangements with approximately 170 vendors which includes foreign manufacturers located throughout the world, primarily in Asia and Central and South America. In addition, many of our domestic manufacturers maintain production facilities overseas. Political, social or economic instability in Asia, Central or South America, or in other regions in which our manufacturers are located, could cause disruptions in trade, including exports to the U.S. Other events that could also cause disruptions to exports to the U.S. include:

 

   

the imposition of additional trade law provisions or regulations;

 

   

reliance on a limited number of shipping and air carriers who may experience capacity issues that adversely affect our ability to ship inventory in a timely manner or for an acceptable cost;

 

   

the imposition of additional duties, tariffs and other charges on imports and exports;

 

   

quotas imposed by bilateral textile agreements;

 

   

economic uncertainties and adverse economic conditions (including inflation and recession);

 

   

fluctuations in the value of the U.S. dollar against foreign currencies;

 

   

restrictions on the transfer of funds;

 

   

the potential of manufacturer financial instability, inability to access needed liquidity or bankruptcy;

 

   

significant labor disputes, such as dock strikes;

 

   

significant delays in the delivery of cargo due to port security considerations;

 

   

financial or political instability in any of the countries in which our merchandise is manufactured;

 

   

natural disasters; and

 

   

regulations to address climate change.

In addition, we cannot predict whether the countries in which our merchandise is manufactured, or may be manufactured in the future, will be subject to new or additional trade restrictions imposed by the U.S. or foreign governments, including the likelihood, type or effect of any such restrictions. Trade restrictions, including new or increased tariffs or quotas, embargoes, safeguards and customs restrictions against apparel items, as well as U.S. or foreign labor strikes and work stoppages or boycotts, could increase the cost or reduce the supply of apparel available to us and adversely affect our business, financial condition or results of operations.

 

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We do not own or operate any manufacturing facilities and, therefore, depend upon independent third parties for the manufacture of all our merchandise.

We do not own or operate any manufacturing facilities. As a result, the continued success of our operations is tied to our timely receipt of quality merchandise from third-party manufacturers. Our products are manufactured to our specifications primarily by foreign manufacturers. We cannot control all of the various factors, which include inclement weather, natural disasters, political and financial instability, strikes, health concerns regarding infectious diseases in countries in which our merchandise is produced, and acts of terrorism, that might affect a manufacturer’s ability to ship orders of our merchandise in a timely manner or to meet our quality standards. A manufacturer’s inability to ship orders in a timely manner or meet our quality standards could cause delays in responding to consumer demands and negatively affect consumer confidence in the quality and value of our brands or negatively impact our competitive position, any of which could have a material adverse effect on our financial condition and results of operations. We are also susceptible to increases in sourcing costs from our manufacturers which we may not be able to pass on to our customers and could adversely affect our financial condition or results of operations.

Additionally, while we utilize third-party compliance auditors to visit and monitor the operations of our manufacturers, we do not have control of the independent manufacturers or their labor practices. As a result, the risk remains that one or more of our manufacturers will not adhere to our global compliance standards and violate labor laws or other laws, including consumer and product safety laws. Non-governmental organizations might attempt to create an unfavorable impression of our sourcing practices or the practices of some of our vendors or manufacturers that could harm our image. If either of these events occur, we could lose customer goodwill and favorable brand recognition.

Our reliance on two distribution centers domestically and two third-party distribution centers internationally makes us susceptible to disruptions or adverse conditions affecting our distribution centers.

Our two distribution centers located in New Albany, Ohio, manage the receipt, storage, sorting, packing and distribution of merchandise to our North American stores and to our North American and Asian direct-to-consumer customers. We also use a third-party distribution center in the Netherlands to manage the receipt, storage, sorting, packing and distribution of merchandise delivered to our stores and direct-to-consumer customers in Europe and a third-party distribution center in Hong Kong to manage receipt, storage, sorting, packing and distribution of merchandise delivered to our stores in Asia. As a result, our operations are susceptible to local and regional factors, such as system failures, accidents, economic and weather conditions, natural disasters, demographic and population changes, as well as other unforeseen events and circumstances. If our distribution operations were disrupted, our ability to replace inventory in our stores and process direct-to-consumer orders could be interrupted and sales could be negatively impacted.

We are in the process of consolidating our two distribution centers in New Albany into one distribution center, with an expected completion date at the end of Fiscal 2012. This consolidation requires management’s focus and attention, as well as significant capital investments. We believe this consolidation will result in improved operational efficiencies and that one distribution center in New Albany is adequate. However, if we are unable to operate effectively with one distribution center, our distribution operations could be disrupted. Furthermore, consolidation into one distribution center increases our susceptibility to risks associated with system failures, accidents, weather conditions, natural disasters, and other unforeseen

 

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circumstances. If our operations are disrupted, our ability to replace inventory in our stores and process direct-to-consumer orders could be interrupted and sales could be negatively impacted.

Our reliance on third parties to deliver merchandise from our distribution centers to our stores and direct-to-consumer customers could result in disruptions to our business.

The efficient operation of our stores and direct-to-consumer business depends on the timely receipt of merchandise from our distribution centers. We deliver our merchandise to our stores and direct-to-consumer customers using independent third parties. We utilize primarily one contract carrier to ship merchandise and related materials to our North American stores and direct-to-consumer customers, and a separate contract carrier for our European and Asian stores and direct-to-consumer customers. The independent third parties employ personnel that may be represented by labor unions. Disruptions in the delivery of merchandise or work stoppages by employees or contractors of any of these third parties could delay the timely receipt of merchandise. There can be no assurance that such stoppages or disruptions will not occur in the future. Any failure by a third party to respond adequately to our distribution needs would disrupt our operations and could have a material adverse effect on our financial condition or results of operations. Furthermore, we are susceptible to increases in fuel costs which may increase the cost of distribution. If we are not able to pass this cost on to our customers, our financial condition and results of operations could be adversely affected.

We may be exposed to risks and costs associated with credit card fraud and identity theft that would cause us to incur unexpected expenses and loss of revenues.

A significant portion of our customer orders are placed through our websites. In addition, a significant portion of sales made through our retail stores requires the collection of certain customer data, such as credit card information. In order for our sales channels to function and develop successfully, we and other parties involved in processing customer transactions must be able to transmit confidential information, including credit card information, securely over public networks. Third parties may have the technology or knowledge to breach the security of customer transaction data. Although we have security measures related to our systems and the privacy of our customers, we cannot guarantee these measures will effectively prevent others from obtaining unauthorized access to our information and our customers’ information. Any person who circumvents our security measures could destroy or steal valuable information or disrupt our operations. A security breach could cause customers to lose confidence in the security of our websites or stores and choose not to purchase from us. Any security breach could also expose us to risks of data loss, litigation and liability, and could seriously disrupt operations and harm our reputation, any of which could adversely affect our financial condition and results of operations.

In addition, state, federal and foreign governments are increasingly enacting laws and regulations to protect consumers against identity theft. These laws and regulations will likely increase the costs of doing business and if we fail to implement appropriate security measures, or to detect and provide prompt notice of unauthorized access as required by some of these laws and regulations, we could be subject to potential claims for damages and other remedies, which could adversely affect our business and results of operations.

Modifications and/or upgrades to our information technology systems may disrupt our operations.

We regularly evaluate our information technology systems and requirements and are currently implementing modifications and/or upgrades to the information technology systems that support our business. Modifications include replacing existing systems with successor systems, making changes to

 

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existing systems, or acquiring new systems with new functionality. We are aware of the inherent risks associated with replacing and modifying these systems, including inaccurate system information, system disruptions and user acceptance and understanding. We believe we are taking appropriate action to mitigate the risks through disciplined adherence to methodology, program management, testing and user involvement, as well as securing appropriate commercial contracts with third-party vendors supplying the replacement technologies. Information technology system disruptions and inaccurate system information, if not anticipated and appropriately mitigated, could have a material adverse effect on our financial condition and results of operations. Additionally, there is no assurance that a successfully implemented system will deliver the anticipated value to us.

Our facilities, systems and stores, as well as the facilities and systems of our vendors and manufacturers, are vulnerable to natural disasters, pandemic disease and other unexpected events, any of which could result in an interruption to our business and adversely affect our operating results.

Our retail stores, corporate offices, distribution centers, infrastructure projects and direct-to-consumer operations, as well as the operations of our vendors and manufacturers, are vulnerable to damage from natural disasters, pandemic disease and other unexpected events. If any of these events result in damage to our facilities, systems or stores, or the facilities or systems of our vendors or manufacturers, we may experience interruptions in our business until the damage is repaired, resulting in the potential loss of customers and revenues. In addition, we may incur costs in repairing any damage which exceeds our applicable insurance coverage.

Our business is also vulnerable to any interruption related to an outbreak of a pandemic disease in countries where we have retail locations or source our merchandise.

Our litigation exposure could have a material adverse effect on our financial condition and results of operations.

We are involved, from time-to-time, in litigation incidental to our business, such as litigation regarding overtime compensation and other employment or wage and hour related matters. Our current exposure could change in the event of the discovery of damaging facts with respect to legal matters pending against us or determinations by judges, juries or other finders of fact that are not in accordance with management’s evaluation of the claims. Should management’s evaluation prove incorrect, our exposure could greatly exceed expectations and have a material adverse effect on our financial condition, results of operations or cash flows.

Our inability or failure to adequately protect our trademarks could have a negative impact on our brand image and limit our ability to penetrate new markets.

We believe our trademarks, Abercrombie & Fitch®, abercrombie®, Hollister®, Gilly Hicks® and the “Moose” and “Seagull” logos, are an essential element of our strategy. We have obtained or applied for federal registration of these trademarks with the U.S. Patent and Trademark Office and the registries of countries where stores are located or likely to be located in the future. In addition, we own registrations and have pending applications for other trademarks in the U.S. and have applied for or obtained registrations from the registries in many foreign countries in which our stores or our manufacturers are located. There can be no assurance that we will obtain registrations that have been applied for or that the registrations we obtain will prevent the imitation of our products or infringement of our intellectual property rights by others. If a third party copies our products in a manner that projects lesser quality or carries a negative connotation, our brand image could be materially adversely affected.

 

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Because we have not yet registered all of our trademarks in all categories, or in all foreign countries in which we source or offer our merchandise now, or may in the future, our international expansion and our merchandising of products using these marks could be limited. For example, we cannot ensure that others will not try to block the manufacture, export or sale of our products as a violation of their trademarks or other proprietary rights. The pending applications for international registration of various trademarks could be challenged or rejected in those countries because third parties of whom we are not currently aware have already registered similar marks in those countries. Accordingly, it may be possible, in those foreign countries where the status of various applications is pending or unclear, for a third-party owner of the national trademark registration for a similar mark to prohibit the manufacture, sale or exportation of branded goods in or from that country. If we are unable to reach an arrangement with any such party, our manufacturers may be unable to manufacture our products, and we may be unable to sell in those countries. Our inability to register our trademarks or purchase or license the right to use our trademarks or logos in these jurisdictions could limit our ability to obtain supplies from, or manufacture in, less costly markets or penetrate new markets should our business plan include selling our merchandise in those non-U.S. jurisdictions.

We have an anti-counterfeiting program, under the auspices of the Abercrombie & Fitch Brand Protection Team, whose goal is to eliminate the supply of illegal pieces of our products. The Brand Protection Team interacts with investigators, customs officials and law enforcement entities throughout the world to combat the illegal use of our trademarks. Although brand security initiatives are in place, we cannot guarantee that our efforts against the counterfeiting of our brands will be successful.

Fluctuations in our tax obligations and effective tax rate may result in volatility in our operating results.

We are subject to income taxes in many U.S. and certain foreign jurisdictions. In addition, our products are subject to import and excise duties and/or sales, consumption or value-added taxes (or “VAT”) in many jurisdictions. We record tax expense based on our estimates of future payments, which include reserves for estimates of probable settlements of foreign and domestic tax audits. At any one time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. As a result, we expect that throughout the year there could be ongoing variability in our quarterly tax rates as taxable events occur and exposures are evaluated. In addition, our effective tax rate in any given financial statement period may be materially impacted by changes in the mix and level of earnings or by changes to existing accounting rules or regulations. Fluctuations in duties could also have a material impact on our financial condition, results of operations or cash flows. In some international markets, we are required to hold and submit VAT to the appropriate local tax authorities. Failure to correctly calculate or submit the appropriate amounts could subject us to substantial fines and penalties that could have an adverse effect on our financial condition, results of operations or cash flows. In addition, tax legislation may be enacted in the future, domestically or abroad, that impacts our current or future tax structure and effective tax rate.

The effects of war or acts of terrorism could have a material adverse effect on our operating results and financial condition.

The continued threat of terrorism and the associated heightened security measures and military actions in response to acts of terrorism have disrupted commerce and have intensified uncertainties in the U.S. economy. Any further acts of terrorism or a future war may disrupt commerce and undermine consumer confidence, which could negatively impact our sales revenue by causing consumer spending and/or mall

 

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traffic to decline. Furthermore, an act of terrorism or war, or the threat thereof, or any other unforeseen interruption of commerce, could negatively impact our business by interfering with our ability to obtain merchandise from foreign manufacturers. Our inability to obtain merchandise from our foreign manufacturers or substitute other manufacturers, at similar costs and in a timely manner, could adversely affect our operating results and financial condition.

Our inability to obtain commercial insurance at acceptable prices or our failure to adequately reserve for self-insured exposures might increase our expenses and adversely impact our financial results.

We believe that commercial insurance coverage is prudent for risk management in certain areas of our business. Insurance costs may increase substantially in the future and may be affected by natural catastrophes, fear of terrorism, financial irregularities and other fraud at publicly-held companies, intervention by the government or a decrease in the number of insurance carriers. In addition, the carriers with which we hold our policies may go out of business, or may be otherwise unable to fulfill their contractual obligations. Furthermore, for certain types or levels of risk, such as risks associated with earthquakes, hurricanes or terrorist attacks, we may determine that we cannot obtain commercial insurance at acceptable prices, if at all. Therefore, we may choose to forego or limit our purchase of relevant commercial insurance, choosing instead to self-insure one or more types or levels of risk. We are primarily self-insured for workers’ compensation and employee health benefits. If we suffer a substantial loss that is not covered by commercial insurance or our self-insurance reserves, the loss and attendant expenses could harm our business and operating results. In addition, exposures could exist for which no insurance may be available and for which we have not reserved.

Operating results and cash flows at the store level may cause us to incur impairment charges.

Long-lived assets, primarily property and equipment, are reviewed at the store level at least annually for impairment, or whenever changes in circumstances indicate that a full recovery of net asset values through future cash flows is in question. The review could result in significant charges related to underperforming stores which could impact our results of operations.

Furthermore, our impairment review requires us to make estimates and projections regarding, but not limited to, future cash flows. We make certain estimates and projections in connection with impairment analyses for our store locations and other property and equipment. If these estimates or projections change or prove incorrect, we may be, and have been, required to record impairment charges on certain store locations and other property and equipment. We have recognized significant impairment charges in the past and may do so in the future.

We are subject to customs, advertising, consumer protection, privacy, zoning and occupancy and labor and employment laws that could require us to modify our current business practices, incur increased costs or harm our reputation if we do not comply.

We are subject to numerous laws and regulations, including customs, truth-in-advertising, consumer protection, general privacy, health information privacy, identity theft, online privacy, unsolicited commercial communication and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of retail stores and distribution centers. As our business becomes more international in scope and we enter more countries internationally, the number of laws and regulations that we are subject to, as well as their scope and reach, increase significantly and heighten our risks. If these laws and regulations were to change, or were violated by our management, employees, suppliers, vendors or other parties with whom we do business, the costs of

 

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certain merchandise could increase, or we could experience delays in shipments of our merchandise, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our merchandise and adversely affect our business and results of operations. Failure to protect personally identifiable information of our customers or associates could subject us to considerable reputational harm, as well as significant fines, penalties and sanctions both domestically and abroad. In addition, changes in federal, state and international minimum wage laws and other laws relating to employee benefits could cause us to incur additional wage and benefits costs, which could hurt our profitability. We are also subject to U.S. securities laws and regulations as well as stock exchange rules which could subject us to enforcement actions, de-listing and adverse legal sanctions for non-compliance.

Changes in the regulatory or compliance landscape could adversely affect our business and results of operations.

Laws and regulations at the state, federal and international levels frequently change, and the ultimate cost of compliance cannot be precisely estimated. In addition, we cannot predict the impact that may result from changes in the regulatory landscape. Any changes in regulations, the imposition of additional regulations, or the enactment of any new or more stringent legislation including those related to health care, taxes, transportation and logistics, privacy, environmental issues, trade, product safety or employment and labor, could adversely affect our business and results of operations.

Our unsecured Amended and Restated Credit Agreement (the “Amended and Restated Credit Agreement”) and our Term Loan Agreement include financial and other covenants that impose restrictions on our financial and business operations.

Our Amended and Restated Credit Agreement expires on July 27, 2016, and market conditions could potentially impact the size and terms of a replacement facility. The commitment of the lenders to make loans under the Term Loan Agreement expires on February 22, 2013 and the Term Loan Agreement has a maturity date of February 23, 2017.

Both our Amended and Restated Credit Agreement and our Term Loan Agreement contain financial covenants that require us to maintain a minimum coverage ratio and a maximum leverage ratio. If we fail to comply with the covenants and are unable to obtain a waiver or amendment, an event of default would result, and the lenders could declare outstanding borrowings immediately due and payable. If that should occur, we cannot guarantee that we would have sufficient liquidity at that time to repay or refinance borrowings under the Amended and Restated Credit Agreement and/or the Term Loan Agreement.

The inability to obtain credit on commercially reasonable terms, or a default under the current Amended and Restated Credit Agreement and/or the Term Loan Agreement, could adversely impact our liquidity and results of operations.

Our operations may be affected by regulatory changes related to climate change and greenhouse gas emissions.

Our operations may be affected by regulatory changes related to climate change and greenhouse gas emissions. We are uncertain how the U.S. and international economies will be affected by potential legislation and public reactions. As a result, the effect this could have on our operations is presently unknown.

 

 

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Compliance with changing regulations and standards for accounting, corporate governance and public disclosure could adversely affect our business, results of operations and reported financial results.

Changing regulatory requirements for corporate governance and public disclosure, including SEC regulations and the Financial Accounting Standards Board’s accounting standards requirements are creating additional complexities for public companies. For example, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas such as “say on pay” and proxy access. Stockholder activism, the current political environment, financial reform legislation and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations. In addition, the expected future requirement to transition to, or converge with, international financial reporting standards is creating uncertainty and additional complexities. These changing regulatory requirements may lead to additional compliance costs, as well as the diversion of our management’s time and attention from strategic business activities and could have a significant effect on our reported results for the affected periods.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES.

The Company’s headquarters and support functions occupy 491 acres, consisting of the home office, distribution and shipping facilities centralized on a campus-like setting in New Albany, Ohio and an additional small distribution and shipping facility located in the Columbus, Ohio area, all of which are owned by the Company. Additionally, the Company leases small facilities to house its design and sourcing support centers in Hong Kong, New York City and Los Angeles, California, as well as offices in the United Kingdom, Japan, Switzerland, Italy and China.

All of the retail stores operated by the Company, as of March 16, 2012, are located in leased facilities, primarily in shopping centers in North America, Europe and Asia. The leases expire at various dates, between 2012 and 2031.

The Company’s home office, distribution and shipping facilities, design support centers and stores are currently suitable and adequate.

As of March 16, 2012, the Company’s 1,047 stores were located in North America, Europe and Asia as follows:

 

U.S. & U.S. Territories:

  

Alabama

     6      Kentucky      9      North Dakota      1  

Alaska

     1      Louisiana      10      Ohio      31  

Arizona

     16      Maine      4      Oklahoma      7  

Arkansas

     7      Maryland      19      Oregon      10  

California

     130      Massachusetts      34      Pennsylvania      44  

Colorado

     10      Michigan      26      Rhode Island      3  

Connecticut

     20      Minnesota      16      South Carolina      10  

Delaware

     5      Mississippi      2      South Dakota      1  

District Of Columbia

     1      Missouri      14      Tennessee      21  

Florida

     74      Montana      2      Texas      87  

Georgia

     22      Nebraska      4      Utah      8  

Hawaii

     5      Nevada      13      Vermont      2  

Idaho

     3      New Hampshire      10      Virginia      23  

Illinois

     40      New Jersey      40      Washington      20  

Indiana

     21      New Mexico      3      West Virginia      5  

Iowa

     7      New York      54      Wisconsin      13  

Kansas

     5      North Carolina      26      Puerto Rico      1  

International Stores:

              

Canada

     19      France      5      Sweden      2  

Denmark

     1      China      3        

Germany

     15      Belgium      3        

Italy

     7      Ireland      1        

Japan

     2      Austria      3        

Spain

     9      Hong Kong      1        

United Kingdom

     29      Singapore      1        

 

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ITEM 3. LEGAL PROCEEDINGS.

A&F 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 it deems appropriate to do so under applicable accounting rules. Moreover, 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.

The Company intends to defend the following pending matters vigorously, as appropriate. The Company’s identified contingencies include the following matters:

On September 16, 2005, a derivative action, styled The Booth Family Trust v. Michael S. Jeffries, et al., was filed in the United States District Court for the Southern District of Ohio, naming A&F as a nominal defendant and seeking to assert claims for unspecified damages against nine of A&F’s present and former directors, alleging various breaches of the directors’ fiduciary duty and seeking equitable and monetary relief. In the following three months, four similar derivative actions were filed (three in the United States District Court for the Southern District of Ohio and one in the Court of Common Pleas for Franklin County, Ohio) against present and former directors of A&F alleging various breaches of the directors’ fiduciary duty allegedly arising out of antecedent employment law and securities class actions brought against the Company. A consolidated amended derivative complaint was filed in the federal proceeding on July 10, 2006. On February 16, 2007, A&F announced that its Board of Directors had received a report of the Special Litigation Committee established by the Board to investigate and act with respect to claims asserted in the derivative cases, which concluded that there was no evidence to support the asserted claims and directed the Company to seek dismissal of the derivative cases. On September 10, 2007, the Company moved to dismiss the federal derivative cases on the authority of the Special Litigation Committee Report. On March 12, 2009, the Company’s motion was granted and, on April 10, 2009, plaintiffs filed an appeal from the order of dismissal in the United States Court of Appeals for the Sixth Circuit. On April 5, 2011, a panel of the United States Court of Appeals for the Sixth Circuit reversed the decision of the District Court and remanded the action for further proceedings. On November 1, 2011, the District Court entered an order which gave preliminary approval to a proposed settlement of the consolidated derivative litigation. The District Court also set a hearing (the “Fairness Hearing”) for December 13, 2011 to determine whether the proposed settlement should be finally approved and to consider an award of fees and expenses to plaintiffs’ counsel. The District Court also directed that notice be given to the Company’s stockholders concerning the proposed settlement and their right to be heard in connection with the Fairness Hearing. On December 19, 2011, the District Court, after the Fairness Hearing, entered a final order (1) approving the proposed settlement submitted to the District Court by the parties to the derivative litigation and (2) dismissing with prejudice all claims contained in the 2005 derivative cases. The District Court’s order also resulted in dismissal of the state-court derivative action, which had been stayed pending resolution of the federal derivative cases.

On December 21, 2007, Spencer de la Cruz, a former employee, filed an action against Abercrombie & Fitch Co. and Abercrombie & Fitch Stores, Inc. (collectively, the “Defendants”) in the Superior Court of Orange County, California (the “Court”). He sought to allege, on behalf of himself and a putative class of past and present employees in the period beginning on December 19, 2003, claims for

 

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failure to provide meal breaks, for waiting time penalties, for failure to keep accurate employment records, and for unfair business practices. By successive amendments, plaintiff added 10 additional plaintiffs and additional claims seeking injunctive relief, unpaid wages, penalties, interest, and attorney’s fees and costs. Defendants denied the material allegations of plaintiffs’ complaints throughout the litigation and asserted numerous affirmative defenses. On July 23, 2010, plaintiffs moved for class certification in the action. On December 9, 2010, after briefing and argument, the Court granted in part and denied in part plaintiffs’ motion, certifying sub-classes to pursue meal break claims, meal premium pay claims, work related travel claims, travel expense claims, termination pay claims, reporting time claims, bag check claims, pay record claims, and minimum wage claims. The parties continued to litigate questions relating to the Court’s certification order and to the merits of plaintiffs’ claims until January 25, 2012. On that date, the named plaintiffs and the Defendants signed a memorandum of understanding which, subject to final Court approval, was intended to result in a full and final settlement of all claims in the action on a class-wide basis. A formal Settlement Agreement and related papers were filed with the Court on February 21, 2012 and the Court scheduled a hearing on March 14, 2012 to determine whether to provide preliminary approval to the proposed settlement and to order that notice of the proposed settlement be given to the absent members of the settlement class. On March 14, 2012, the Court continued the hearing to April 18, 2012. As of January 28, 2012, the Company increased its litigation reserve to cover the expected cost of the proposed settlement.

On October 17, 2011, Amber Echavez a former employee, filed an action against Abercrombie & Fitch Co. and two of its subsidiaries (collectively, the “Defendants”) in the Superior Court of Los Angeles County, California. She alleged the Defendants violated California labor laws by failing to provide suitable seats for her and for other current and former employees. She sought to maintain the suit as a class action on behalf of a class of retail sales employees and also as a representative action under California’s Private Attorney General Act of 2004 (“PAGA”). On November 23, 2011, the Defendants removed the action to the United States District Court for the Central District of California (the “Court”) and on February 6, 2012, moved (1) to dismiss the action for failure to state a claim and (2) to strike plaintiff’s class allegations. On March 12, 2012, the Court entered an order denying Defendants’ motion to dismiss and granting Defendants’ motion to strike plaintiff’s class allegations. The parties are continuing to litigate plaintiff’s remaining claims.

 

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ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

 

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SUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.

Set forth below is certain information regarding the executive officers of A&F as of March 16, 2012:

Michael S. Jeffries, 67, has been Chairman of A&F since May 1998. Mr. Jeffries has been Chief Executive Officer of A&F since February 1992. From February 1992 to May 1998, Mr. Jeffries held the title of President of A&F. Under the terms of the Employment Agreement, entered into as of December 19, 2008, between A&F and Mr. Jeffries, A&F is obligated to cause Mr. Jeffries to be nominated as a director of A&F during his employment term.

Diane Chang, 56, has been Executive Vice President — Sourcing of A&F since May 2004. Prior thereto, Ms. Chang held the position of Senior Vice President — Sourcing of A&F from February 2000 to May 2004 and the position of Vice President — Sourcing of A&F from May 1998 to February 2000.

Leslee K. Herro, 51, has been Executive Vice President — Planning and Allocation of A&F since May 2004. Prior thereto, Ms. Herro held the position of Senior Vice President — Planning and Allocation of A&F from February 2000 to May 2004 and the position of Vice President — Planning & Allocation of A&F from February 1994 to February 2000.

Jonathan E. Ramsden, 47, has been Executive Vice President and Chief Financial Officer of A&F since December 2008. From December 1998 to December 2008, Mr. Ramsden served as Chief Financial Officer and a member of the Executive Committee of TBWA Worldwide, a large advertising agency network and a division of Omnicom Group Inc. Prior to becoming Chief Financial Officer of TWBA Worldwide, he served as Controller and Principal Accounting Officer of Omnicom Group Inc. from June 1996 to December 1998.

Ronald A. Robins, Jr., 48, has been Senior Vice President, General Counsel and Secretary of A&F since August 2010. Mr. Robins joined A&F in November 2009 as Deputy General Counsel after spending 16 years at Vorys, Sater, Seymour and Pease LLP, 13 years as a partner in the firm’s corporate and finance practice group. Mr. Robins clerked for The Honorable Milton Pollack of the United States District Court for the Southern District of New York from 1989 to 1990. Before joining Vorys, Mr. Robins practiced for several years as an associate at Davis Polk & Wardwell in New York City.

The executive officers serve at the pleasure of the Board of Directors of A&F and, in the case of Mr. Jeffries, pursuant to an employment agreement.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

A&F’s Class A Common Stock (the “Common Stock”) is traded on the New York Stock Exchange under the symbol “ANF.” The table below sets forth the high and low sales prices of A&F’s Common Stock on the New York Stock Exchange for Fiscal 2011 and Fiscal 2010:

 

     Sales Price  
     High      Low  

Fiscal 2011

     

4th Quarter

   $ 76.33       $ 43.56   

3rd Quarter

   $ 77.49       $ 55.70   

2nd Quarter

   $ 78.25       $ 62.46   

1st Quarter

   $ 72.61       $ 48.40   

Fiscal 2010

     

4th Quarter

   $ 58.50       $ 41.55   

3rd Quarter

   $ 45.75       $ 33.97   

2nd Quarter

   $ 45.71       $ 29.94   

1st Quarter

   $ 51.12       $ 31.31   

A quarterly dividend, of $0.175 per share, was paid in each of March, June, September and December in each of Fiscal 2009, Fiscal 2010 and Fiscal 2011. A&F expects to continue to pay a quarterly dividend, subject to the Board of Directors’ review of the Company’s cash position and results of operations.

As of March 16, 2012, there were approximately 4,300 stockholders of record. However, when including investors holding shares in broker accounts under street name, active associates of the Company who participate in A&F’s stock purchase plan, and associates of the Company who own shares through A&F-sponsored retirement plans, A&F estimates that there are approximately 42,360 stockholders.

The following table provides information regarding the purchase of shares of the Common Stock of A&F made by or on behalf of A&F or any “affiliated purchaser” as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended, during each fiscal month of the quarterly period ended January 28, 2012:

 

Period (Fiscal Month)

   Total Number
of Shares
Purchased(1)
     Average
Price  Paid
per Share(2)
     Total Number of
Shares  Purchased as
Part of Publicly
Announced Plans or
Programs(3)
    Maximum Number of
Shares that May Yet
be Purchased under
the Plans or
Programs(4)
 

October 30, 2011 through November 26, 2011

     1,019,876        $ 49.15          1,017,290         7,218,968    

November 27, 2011 through December 31, 2011

     1,002,878        $ 47.91          1,000,000         6,218,968    

January 1, 2012 through January 28, 2012

     471        $ 47.40                 6,218,968    
  

 

 

       

 

 

   

Total

     2,023,225        $ 48.53          2,017,290         6,218,968    
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1)

An aggregate of 5,935 of the shares of A&F’s Common Stock purchased during the thirteen-week period ended January 28, 2012, represented shares which were withheld for tax payments due upon the

 

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  vesting of employee restricted stock unit and restricted share awards and upon the exercise of employee stock appreciation rights. All other shares of A&F Common Stock purchased during the quarterly period were purchased pursuant to A&F’s publically announced stock repurchase authorization described in footnote 3 below.

 

(2)

The average price paid per share includes broker commissions, as applicable.

 

(3)

The reported shares were purchased pursuant to A&F’s publicly announced stock repurchase authorization. On November 21, 2007, A&F announced the November 20, 2007 authorization by A&F’s Board of Directors to repurchase 10.0 million shares of A&F’s Common Stock.

 

(4) The number shown represents, as of the end of each period, the maximum number of shares of Common Stock that may yet be purchased under A&F’s publicly announced stock repurchase authorization described in footnote 3 above. The shares may be purchased, from time-to-time, depending on market conditions.

During Fiscal 2011, A&F repurchased approximately 3.5 million shares of A&F’s Common Stock in the open market with a cost of approximately $196.6 million. During Fiscal 2010, A&F repurchased approximately 1.6 million shares of A&F’s Common Stock in the open market with a cost of approximately $76.2 million. A&F did not repurchase any shares of A&F’s Common Stock in the open market during Fiscal 2009. Both the Fiscal 2011 and the Fiscal 2010 repurchases were pursuant to authorizations of A&F’s Board of Directors.

 

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The following graph shows the changes, over the five-year period ended January 28, 2012 (the last day of A&F’s Fiscal 2011) in the value of $100 invested in (i) shares of A&F’s Common Stock; (ii) the Standard & Poor’s 500 Stock Index (the “S&P 500 Index”) and (iii) the Standard & Poor’s Apparel Retail Composite Index (the “S&P Apparel Retail Index”), including reinvestment of dividends. The plotted points represent the closing price on the last trading day of the fiscal year indicated.

PERFORMANCE GRAPH(1)

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among Abercrombie & Fitch Co., the S&P 500 Index

and the S&P Apparel Retail Index

 

LOGO

 

* $100 invested on 2/3/07 in stock or 1/31/07 in index, including reinvestment of dividends.
   Indexes calculated on month-end basis.
  

Copyright© 2011 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

 

(1) This graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to SEC Regulation 14A or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), except to the extent that A&F specifically requests that the graph be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act of 1933, as amended, or the Exchange Act.

 

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ITEM 6. SELECTED FINANCIAL DATA.

ABERCROMBIE & FITCH CO.

FINANCIAL SUMMARY

(Thousands, except per share and per square foot amounts, ratios and store and associate data)

Summary of Operations

(Information below excludes amounts related to discontinued operations, except where otherwise noted)

 

     2011     2010     2009     2008     2007  

Net Sales

   $ 4,158,058      $ 3,468,777     $ 2,928,626     $ 3,484,058     $ 3,699,656   

Gross Profit

   $ 2,518,870      $ 2,212,181     $ 1,883,598     $ 2,331,095     $ 2,488,166   

Operating Income

   $ 190,030      $ 231,932     $ 117,912     $ 498,262     $ 778,909   

Net Income from Continuing Operations

   $ 126,862      $ 150,283     $ 78,953     $ 308,169     $ 499,127   

Income (Loss) from Discontinued Operations, Net of Tax(1)

   $ 796      $      $ (78,699   $ (35,914   $ (23,430 )  

Net Income(1)

   $ 127,658      $ 150,283     $ 254     $ 272,255     $ 475,697   

Dividends Declared Per Share

   $ 0.70      $ 0.70     $ 0.70     $ 0.70     $ 0.70   

Net Income Per Share from Continuing Operations

          

Basic

   $ 1.46      $ 1.71     $ 0.90     $ 3.55     $ 5.72   

Diluted

   $ 1.42      $ 1.67     $ 0.89     $ 3.45     $ 5.45   

Net Income (Loss) Per Share from Discontinued Operations(1)

          

Basic

   $ 0.01      $      $ (0.90   $ (0.41   $ (0.27 )  

Diluted

   $ 0.01      $      $ (0.89   $ (0.40   $ (0.26 )  

Net Income Per Share(1)

          

Basic

   $ 1.47      $ 1.71     $ 0.00     $ 3.14     $ 5.45   

Diluted

   $ 1.43      $ 1.67     $ 0.00     $ 3.05     $ 5.20   

Basic Weighted-Average Shares Outstanding

     86,848        88,061       87,874       86,816       87,248   

Diluted Weighted-Average Shares Outstanding

     89,537        89,851       88,609       89,291       91,523   

Other Financial Information

          

Total Assets (including discontinued operations)

   $ 3,048,153      $ 2,941,415     $ 2,821,866     $ 2,848,181     $ 2,567,598   

Return on Average Assets(2)

     4     5     0     10     20 %  

Working Capital(3)

   $ 783,422      $ 874,417     $ 776,311     $ 622,213     $ 585,575   

Current Ratio(4)

   $ 2.11      $ 2.56     $ 2.73     $ 2.38     $ 2.08   

Net Cash Provided by Operating Activities(1)

   $ 365,219      $ 391,789     $ 395,487     $ 491,031     $ 817,524   

Capital Expenditures

   $ 318,598      $ 160,935     $ 175,472     $ 367,602     $ 403,345   

Long-Term Debt

   $ 57,851      $ 68,566     $ 71,213     $ 100,000     $   

Stockholders’ Equity (including discontinued operations)

   $ 1,862,456      $ 1,890,784     $ 1,827,917     $ 1,845,578     $ 1,618,313   

Return on Average Stockholders’ Equity(5)

     7 %       8     0     16     31 %  

Comparable Store Sales(6)

     5 %       7     (23 )%      (13 )%      (1 )%  

Net Store Sales Per Average Gross Square Foot

   $ 463      $ 390     $ 339     $ 432     $ 503   

Stores at End of Year and Average Associates

          

Total Number of Stores Open

     1,045        1,069       1,096       1,097       1,013   

Gross Square Feet

     7,778        7,756       7,848       7,760       7,133   

Average Number of Associates(7)

     91,000        83,000       83,000       96,200       94,600   

 

(1)

Includes results of operations from RUEHL branded stores and related direct-to-consumer operations. Results from discontinued operations were immaterial in Fiscal 2010.

 

(2)

Return on Average Assets is computed by dividing net income (including discontinued operations) by the average asset balance (including discontinued operations).

 

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(3)

Working Capital is computed by subtracting current liabilities (including discontinued operations) from current assets (including discontinued operations).

 

(4)

Current Ratio is computed by dividing current assets (including discontinued operations) by current liabilities (including discontinued operations).

 

(5)

Return on Average Stockholders’ Equity is computed by dividing net income (including discontinued operations) by the average stockholders’ equity balance (including discontinued operations).

 

(6)

A store is included in comparable store sales when it has been open as the same brand at least one year and its square footage has not been expanded or reduced by more than 20% within the past year.

 

(7)

Includes employees from RUEHL operations.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW

The Company’s fiscal year ends on the Saturday closest to January 31, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. A store is included in comparable store sales when it has been open as the same brand at least one year and its square footage has not been expanded or reduced by more than 20% within the past year.

For purposes of this “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” the fifty-two week period ended January 28, 2012 is compared to the fifty-two week period ended January 29, 2011 and the fifty-two week period ended January 29, 2011 is compared to the fifty-two week period ended January 30, 2010.

The Company had net sales of $4.158 billion for the fifty-two weeks ended January 28, 2012, an increase of 20% from $3.469 billion for the fifty-two weeks ended January 29, 2011. Operating income for Fiscal 2011 was $190.0 million, which was down from $231.9 million in Fiscal 2010.

Net income from continuing operations was $126.9 million and net income from continuing operations per diluted share was $1.42 in Fiscal 2011, compared to net income from continuing operations of $150.3 million and net income from continuing operations per diluted share of $1.67 in Fiscal 2010.

Excluding charges for impairments and write-downs of store-related long-lived assets, charges related to store closures and lease exits, and other charges associated with legal settlements and a change in intent regarding the Company’s auction rate securities (ARS), the Company reported adjusted, non-GAAP net income per diluted share from continuing operations of $2.30 for the fifty-two weeks ended January 28, 2012. Excluding store-related asset impairment charges and exit charges associated with domestic store closures, the Company reported non-GAAP net income per diluted share from continuing operations of $2.05 for the fifty-two weeks ended January 29, 2011.

 

 

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The Company believes that the non-GAAP financial measures are useful to investors as they provide the ability to measure the Company’s operating performance and compare it against that of prior periods without reference to the Consolidated Statements of Operations and Comprehensive Income impact of non-cash, store-related asset impairment charges, charges related to store closures and lease exits, and other charges associated with legal settlements during the fiscal year and a change in intent regarding the Company’s ARS. These non-GAAP financial measures should not be used as alternatives to net income per diluted share or as indicators of the ongoing operating performance of the Company and are also not intended to supersede or replace the Company’s GAAP financial measures. The table below reconciles the GAAP financial measures to the non-GAAP financial measures discussed above.

 

     Fifty-Two Weeks Ended  
     January 28, 2012      January 29, 2011  

Net income per diluted share from continuing operations on a GAAP basis

   $ 1.42      $ 1.67  

Plus: Asset impairment charges(1)

     0.49        0.34  

Plus: Asset write-downs(2)

     0.10          

Plus: Store closure and lease exit charges(3)

     0.13        0.03  

Plus: Legal charges(4)

     0.07          

Plus: ARS charges(5)

     0.09          
  

 

 

    

 

 

 

Net income per diluted share from continuing operations on a non-GAAP basis

   $ 2.30      $ 2.05  

Plus: Net income from discontinued operations

     0.01          
  

 

 

    

 

 

 

Net income per diluted share on a non-GAAP basis

   $ 2.31      $ 2.05  

 

(1) 

The store-related asset impairment charges relate to stores whose asset carrying value exceeded their fair value. For the fifty-two week period ended January 28, 2012, the charge was associated with 14 Abercrombie & Fitch, 21 abercrombie kids, 42 Hollister and two Gilly Hicks stores. For the fifty-two week period ended January 29, 2011, the charge was associated with two Abercrombie & Fitch, two abercrombie kids, nine Hollister and 13 Gilly Hicks stores.

 

(2) 

For the fifty-two week period ended January 28, 2012, the charge associated with the asset write-downs was related to the reconfiguration of three flagship stores and a small write-off related to a cancelled flagship project.

 

(3) 

For the fifty-two week periods ended January 28, 2012 and January 29, 2011, the charges for store closures and lease exits were associated with lease buyouts and other lease obligations related to stores closing prior to natural lease expirations, other lease terminations, and other incidental costs associated with store closures.

 

(4) 

For the fifty-two week period ended January 28, 2012, the charge was related to legal settlements during the fourth quarter.

 

(5) 

For the fifty-two week period ended January 28, 2012, the charge associated with the ARS was related to a change in intent with regard to the Company’s auction rate securities portfolio, which resulted in recognition of an other-than-temporary impairment.

Net cash provided by operating activities, the Company’s primary source of liquidity, was $365.2 million for Fiscal 2011. This source of cash was primarily driven by results from operations, adjusted for non-cash items, an increase in accounts payable and accrued expenses partially offset by increases in inventory. The Company used $318.6 million of cash for capital expenditures. The Company

 

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also repurchased $196.6 million of Common Stock, paid dividends totaling $61.0 million, repaid borrowings under the credit agreement of $45.0 million and received $46.5 million in proceeds from the exercise of stock options during Fiscal 2011. As of January 28, 2012, the Company had $583.5 million in cash and equivalents, no outstanding debt aside from that related to landlord financing obligations, and immaterial stand-by letters of credit.

The following data represents the amounts shown in the Company’s Consolidated Statements of Operations and Comprehensive Income for the last three fiscal years, expressed as a percentage of net sales:

 

     2011     2010     2009  

NET SALES

     100.0     100.0     100.0

Cost of Goods Sold

     39.4       36.2       35.7  
  

 

 

   

 

 

   

 

 

 

GROSS PROFIT

     60.6       63.8       64.3  

Stores and Distribution Expense

     45.4       45.8       48.7  

Marketing, General and Administrative Expense

     10.5       11.6       12.1  

Other Operating Expense (Income), Net

     0.1       (0.3     (0.5
  

 

 

   

 

 

   

 

 

 

OPERATING INCOME

     4.6       6.7       4.0  

Interest Expense (Income), Net

     0.1       0.1       (0.1
  

 

 

   

 

 

   

 

 

 

INCOME FROM CONTINUING OPERATIONS BEFORE TAXES

     4.5       6.6       4.1  

Tax Expense from Continuing Operations

     1.4       2.3       1.4  
  

 

 

   

 

 

   

 

 

 

NET INCOME FROM CONTINUING OPERATIONS

     3.1       4.3       2.7  
  

 

 

   

 

 

   

 

 

 

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, Net of Taxes

     0.0              (2.7
  

 

 

   

 

 

   

 

 

 

NET INCOME

     3.1     4.3     0.0
  

 

 

   

 

 

   

 

 

 

 

 

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FINANCIAL SUMMARY

The following summarized financial and statistical data compares Fiscal 2011 to Fiscal 2010, Fiscal 2010 to Fiscal 2009, and Fiscal 2009 to Fiscal 2008:

 

     2011     2010     2009  

Net sales by segment (in thousands)

   $ 4,158,058     $ 3,468,777     $ 2,928,626  

U.S. Stores

   $ 2,710,842     $ 2,546,798     $ 2,377,771  

International Stores

   $ 876,613     $ 505,136     $ 256,216  

Direct-to-consumer

   $ 552,603     $ 404,974     $ 290,102  

Other

   $ 18,000     $ 11,869     $ 4,537  

Increase (decrease) in net sales from prior year

     20     18     (16 )% 

U.S. Stores

     6     7     (21 )% 

International Stores

     74     97     70

Direct-to-consumer

     36     40     (8 )% 

Other

     52     162     15

Net sales by brand (in thousands)

   $ 4,158,058     $ 3,468,777     $ 2,928,626  

Abercrombie & Fitch

   $ 1,665,135     $ 1,493,101     $ 1,272,287  

abercrombie

   $ 397,904     $ 382,579     $ 343,164  

Hollister

   $ 2,022,002     $ 1,552,814     $ 1,287,241  

Gilly Hicks**

   $ 73,017     $ 40,283     $ 25,934  

Increase (decrease) in net sales from prior year

     20     18     (16 )% 

Abercrombie & Fitch

     12     17     (17 )% 

abercrombie

     4     11     (18 )% 

Hollister

     30     21     (15 )% 

Gilly Hicks

     81     55     45

Increase (decrease) in comparable store sales*

     5     7     (23 )% 

Abercrombie & Fitch

     3     9     (19 )% 

abercrombie

     4     5     (23 )% 

Hollister

     8     6     (27 )% 

 

  * A store is included in comparable store sales when it has been open as the same brand 12 months or more and its square footage has not been expanded or reduced by more than 20% within the past year.

 

** Net sales for the fifty-two week periods ended January 28, 2012, January 29, 2011 and January 30, 2010 reflect the activity of 21, 19 and 16 stores, respectively.

CURRENT TRENDS AND OUTLOOK

Our results for Fiscal 2011 were below our expectations in a very challenging environment. During Fiscal 2011, we saw all-time high cotton costs, resulting in higher average unit costs. In addition, we were not able to offset the increases in the costs with increased average unit retail prices due to a highly aggressive promotional environment in the U.S. We expect to see a significant reversal in the average unit cost trend in Fiscal 2012, especially in the second half of the year; however, we remain cautious about our ability to raise average unit retail prices in the U.S. We expect significant margin improvement in Fiscal 2012 due primarily to a combination of average unit cost reductions and the expected performance of our

 

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new international stores and our direct-to-consumer business. We will continue to take a long-term approach, and will not sacrifice quality to achieve cost reductions.

We are confident that we are on track in regard to our long-term strategy of leveraging the international appeal of our brands to build a highly profitable, sustainable, global business. There are five key elements to this strategy.

First, continuing to provide high-quality, trend-right merchandise and a compelling and differentiated store experience.

Second, continuing to close underperforming U.S. chain stores. During Fiscal 2011, we closed 68 U.S. chain stores, predominately at the end of the year through natural lease expirations, bringing the total stores closed over the last two years to 135 stores.

Third, advancing our direct-to-consumer business, which should benefit from multiple investments we are making in the business and from our growing international presence.

Fourth, continuing to focus on our highly profitable international real estate plan. During Fiscal 2011, we opened five new A&F flagship stores and 39 international Hollister stores. In Fiscal 2012, we expect to open A&F flagship or “Tier 1” stores in Hamburg, Hong Kong, Munich, Amsterdam and Dublin, and we expect to open close to 40 Hollister international stores.

Finally, maintaining tight control over expenses and seeking greater efficiencies, for example, through consolidation of our two domestic distribution centers. The consolidation is expected to be completed by the end of Fiscal 2012 and is expected to facilitate the sale or lease of the second distribution center and result in reduced operating costs.

Based on these factors, we anticipate strong EPS growth in Fiscal 2012, notwithstanding an approximately flat same-store sales assumption. Longer-term, our objective remains to deliver consistent and sustainable growth in sales and EPS. We believe trend rates of close to 15% in sales and somewhat above that in EPS are realistic goals.

The following measurements are among the key business indicators reviewed by various members of management to gauge the Company’s results:

 

   

Comparable store sales, defined as year-over-year sales for a store that has been open as the same brand at least one year and its square footage has not been expanded or reduced by more than 20% within the past year;

 

   

Direct-to-consumer sales growth;

 

   

U.S. and International store performance;

 

   

Store productivity;

 

   

Initial Mark Up (“IMU”);

 

   

Markdown rate;

 

   

Gross profit rate;

 

   

Selling margin, defined as sales price less original cost, by brand and by product category;

 

   

Stores and distribution expense as a percentage of net sales;

 

   

Marketing, general and administrative expense as a percentage of net sales;

 

 

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Operating income and operating income as a percentage of net sales;

 

   

Net income;

 

   

Inventory per gross square foot;

 

   

Cash flow and liquidity determined by the Company’s current ratio and cash provided by operations; and

 

   

Store metrics such as sales per gross square foot, sales per selling square foot, average unit retail, average number of transactions per store, average transaction values, store contribution (defined as store sales less direct costs of running the store), and average units per transaction.

While not all of these metrics are disclosed publicly by the Company due to the proprietary nature of the information, the Company publicly discloses and discusses many of these metrics as part of its “Financial Summary” and in several sections within this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

FISCAL 2011 COMPARED TO FISCAL 2010

Net Sales

Net sales for Fiscal 2011 were $4.158 billion, an increase of 20% from Fiscal 2010 net sales of $3.469 billion. The net sales increase was attributable to new stores, primarily international, a 5% increase in comparable store sales, and a 36% increase in the direct-to-consumer business, including shipping and handling revenue. The impact of foreign currency on sales (based on converting prior year sales at current year exchange rates) for Fiscal 2011 and Fiscal 2010 was a benefit of $21.6 million and $4.9 million, respectively.

Total Company U.S. store sales for Fiscal 2011 were $2.711 billion, an increase of 6% from Fiscal 2010 sales of $2.547 billion. Total Company international store sales for Fiscal 2011 were $876.6 million, an increase of 74% from Fiscal 2010 sales of $505.1 million.

Direct-to-consumer sales in Fiscal 2011, including shipping and handling revenue, were $552.6 million, an increase of 36% from Fiscal 2010 direct-to-consumer sales of $405.0 million. The direct-to-consumer business, including shipping and handling revenue, accounted for 13.3% of total net sales in Fiscal 2011 compared to 11.7% in Fiscal 2010.

Comparable store sales by brand for Fiscal 2011 were as follows: Abercrombie & Fitch increased 3%, with men’s and women’s increasing by a low single digit percent. abercrombie kids increased 4%, with guys increasing by a high single digit and girls increasing by a low single digit. Hollister increased 8%, with dudes and bettys increasing by a high single digit.

On a comparable store sales basis, the Southern and the Western regions of the U.S. were the strongest performing regions, while Canada and Japan were the weakest.

From a merchandise classification standpoint, fleece, active wear, and knit tops were stronger performing categories for the male business while graphics and woven shirts were the weaker performing categories. In the female business, woven shirts, sweaters, and knit tops were stronger performing categories, while graphics and dresses were weaker performing categories.

 

 

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Gross Profit

Gross profit during Fiscal 2011 was $2.519 billion compared to $2.212 billion during Fiscal 2010. The gross profit rate (gross profit divided by net sales) for Fiscal 2011 was 60.6%, down 320 basis points from the Fiscal 2010 rate of 63.8%.

The decrease in the gross profit rate for Fiscal 2011 was primarily driven by an increase in average unit cost combined with higher markdowns.

Stores and Distribution Expense

Stores and distribution expense for Fiscal 2011 was $1.888 billion compared to $1.590 billion in Fiscal 2010. The stores and distribution expense rate (stores and distribution expense divided by net sales) for Fiscal 2011 was 45.4% compared to 45.8% in Fiscal 2010.

Stores and distribution expense for the fifty-two week period ended January 28, 2012 included store-related asset impairment charges of $68.0 million associated with 79 stores, asset write-down charges of $14.6 million related to the reconfiguration of three flagship stores and a small write-off related to a cancelled flagship project, and store exit charges of $19.0 million, associated with lease buyouts and other lease obligations related to stores closing prior to natural lease expirations, other lease terminations, and other incidental costs associated with store closures. For the fifty-two weeks ended January 29, 2011, stores and distribution expense included store-related asset impairment charges associated with 26 stores of $50.6 million and store exit charges of $4.4 million associated with the closure of 64 domestic stores during the year.

The decrease in stores and distribution expense rate for Fiscal 2011 was primarily driven by lower store occupancy costs as a percentage of net sales.

Shipping and handling costs, including costs incurred to store, move and prepare the products for shipment and costs incurred to physically move the product to the customer, associated with direct-to-consumer operations were $53.6 million and $38.9 million for Fiscal 2011 and Fiscal 2010, respectively. Handling costs, including costs incurred to store, move and prepare the products for shipment to the stores were $62.8 million and $42.8 million for Fiscal 2011 and Fiscal 2010, respectively. These amounts are recorded in Stores and Distribution Expense in our Consolidated Statements of Operations.

Marketing, General and Administrative Expense

Marketing, general and administrative expense during Fiscal 2011 was $437.1 million compared to $400.8 million in Fiscal 2010. For Fiscal 2011, the marketing, general and administrative expense rate (marketing, general and administrative expense divided by net sales) was 10.5%, compared to 11.6% for Fiscal 2010. Marketing, general and administrative expense for the fifty-two weeks ended January 28, 2012 included $10.0 million in charges in connection with fourth quarter legal settlements.

In addition to legal settlement charges, the increase in marketing, general and administrative expense for Fiscal 2011 was primarily due to increases in compensation, including equity compensation, outside services, marketing, travel and IT expenses.

Other Operating Expense (Income), Net

Other operating expense, net was $3.5 million compared to other operating income, net of $10.1 million for Fiscal 2010. Other operating expense, net for the fifty-two weeks ended January 28, 2012

 

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included $13.4 million of expense related to a change in the Company’s intent regarding the sale of its ARS portfolio, which resulted in recognition of an other-than-temporary impairment in Fiscal 2011.

Interest Expense (Income), Net and Tax Expense

Fiscal 2011 interest expense was $7.9 million, offset by interest income of $4.3 million, compared to interest expense of $7.8 million, offset by interest income of $4.4 million for Fiscal 2010.

The effective tax rate for Fiscal 2011 was 32.0% compared to 34.3% for Fiscal 2010, in each year benefiting from foreign operations.

As of January 28, 2012, there were approximately $25.6 million of net deferred tax assets in Japan with a valuation allowance of $2.4 million. The valuation allowance in Japan was established as the result of changes to the business configuration of operations in Japan, as well as tax law changes. The realization of the net deferred tax assets not subject to a valuation allowance is dependent upon the future generation of sufficient profits in Japan. While the Company believes it is more likely than not that the net deferred tax assets will be realized, it is not certain. Should circumstances change, some or all of the net deferred tax assets not currently subject to a valuation allowance may be in the future. Any increase in the valuation allowance would result in additional tax expense.

Income from Discontinued Operations, Net of Tax

The Company completed the closure of its RUEHL branded stores and related direct-to-consumer operations in the fourth quarter of Fiscal 2009. Accordingly, the after-tax operating results appear in Income (Loss) from Discontinued Operations, Net of Tax on the Consolidated Statements of Operations and Comprehensive Income for all years presented. Results from discontinued operations, net of tax, were immaterial for Fiscal 2010.

Refer to Note 17, “Discontinued Operations,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K for further discussion.

Net Income and Net Income per Diluted Share

Net income for Fiscal 2011 was $127.7 million compared to $150.3 million for Fiscal 2010. Net income per diluted share for Fiscal 2011 was $1.43 compared to $1.67 for Fiscal 2010. Net income per diluted share for Fiscal 2011 included store-related asset impairment charges of approximately $0.49 per diluted share, asset write-down charges of approximately $0.10 per diluted share, store closure and exit charges of approximately $0.13 per diluted share, legal charges of approximately $0.07 per diluted share, and other-than-temporary impairment charges of approximately $0.09 per diluted share related to a change in intent regarding the Company’s ARS portfolio. Net income per diluted share for Fiscal 2010 included store-related asset impairment charges of approximately $0.34 per diluted share and store exit charges of approximately $0.03 per diluted share. Refer to the GAAP reconciliation table in the “OVERVIEW” section of “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” for a reconciliation of net income per diluted share on a GAAP basis to net income per diluted share on a non-GAAP basis, excluding charges for impairment and write-downs of store related long-lived assets, charges related to store closures and lease exits, and other charges associated with legal settlements during the quarter and with a change in intent regarding the Company’s ARS.

 

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FISCAL 2010 COMPARED TO FISCAL 2009

Net Sales

Net sales for Fiscal 2010 were $3.469 billion, an increase of 18% from Fiscal 2009 net sales of $2.929 billion. The net sales increase was attributable to a 7% increase in comparable store sales, a 40% increase in the direct-to-consumer business, including shipping and handling revenue, and new stores, primarily international. The impact of foreign currency on sales for Fiscal 2010 and Fiscal 2009 was less than 1% of net sales.

Total Company U.S. store sales for Fiscal 2010 were $2.547 billion, an increase of 7% from Fiscal 2009 sales of $2.378 billion. Total Company international store sales for Fiscal 2010 were $505.1 million, an increase of 97% from Fiscal 2009 sales of $256.2 million.

Direct-to-consumer sales in Fiscal 2010, including shipping and handling revenue, were $405.0 million, an increase of 40% from Fiscal 2009 direct-to-consumer sales of $290.1 million. The direct-to-consumer business, including shipping and handling revenue, accounted for 11.7% of total net sales in Fiscal 2010 compared to 9.9% in Fiscal 2009.

Comparable store sales by brand for Fiscal 2010 were as follows: Abercrombie & Fitch increased 9%, with women’s increasing by a high single digit percent and men’s increasing by a low double digit. abercrombie kids increased 5%, with girls and guys each increasing by a mid single digit. Hollister increased 6%, with bettys increasing by a mid single digit and dudes increasing by a high single digit.

On a comparable store sales basis, Europe was the strongest performing region, while Canada and Japan were the weakest.

For Fiscal 2010, from a comparable store sales perspective across all brands, the masculine categories out-paced the feminine categories. From a merchandise classification standpoint, woven shirts, fleece, and outerwear were stronger performing categories for the male business while jeans and graphics were the weaker performing categories. In the female business, woven shirts, dresses, and fleece were stronger performing categories, while knit tops and jeans were weaker performing categories.

Gross Profit

Gross profit during Fiscal 2010 was $2.212 billion compared to $1.884 billion during Fiscal 2009. The gross profit rate for Fiscal 2010 was 63.8%, down 50 basis points from the Fiscal 2009 rate of 64.3%.

The decrease in the gross profit rate for Fiscal 2010 was primarily driven by a 9% decrease in average unit retail, which was partially offset by a reduction in average unit cost.

Stores and Distribution Expense

Stores and distribution expense for Fiscal 2010 was $1.590 billion compared to $1.426 billion in Fiscal 2009. The stores and distribution expense rate for Fiscal 2010 was 45.8% compared to 48.7% in Fiscal 2009.

Stores and distribution expense for the fifty-two week period ended January 29, 2011 included store-related asset impairment charges associated with 26 stores of $50.6 million and store exit charges of $4.4 million associated with the closure of 64 domestic stores during the year. For the fifty-two weeks ended January 30, 2010, stores and distribution expense included store-related asset impairment charges associated with 99 stores of $33.2 million.

 

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The decrease in stores and distribution expense rate for Fiscal 2010 was primarily driven by lower store occupancy and payroll costs as a percentage of net sales.

Shipping and handling costs, including costs incurred to store, move and prepare the products for shipment and costs incurred to physically move the product to the customer, associated with direct-to-consumer operations were $38.9 million and $30.7 million for Fiscal 2010 and Fiscal 2009, respectively. Handling costs, including costs incurred to store, move and prepare the products for shipment to the stores were $42.8 million and $34.1 million for Fiscal 2010 and Fiscal 2009, respectively. These amounts are recorded in Stores and Distribution Expense in our Consolidated Statement of Operations.

Marketing, General and Administrative Expense

Marketing, general and administrative expense during Fiscal 2010 was $400.8 million compared to $353.3 million in Fiscal 2009. For Fiscal 2010, the marketing, general and administrative expense rate was 11.6%, compared to 12.1% for Fiscal 2009.

The increase in marketing, general and administrative expense for Fiscal 2010 was primarily due to increases in compensation and benefits, including incentive and equity compensation, and net legal expense.

Other Operating Income, Net

Other operating income, net for Fiscal 2010 was $10.1 million compared to $13.5 million for Fiscal 2009.

The decrease for Fiscal 2010 was primarily driven by lower net gains from foreign currency denominated transactions compared to Fiscal 2009. In Fiscal 2009, other operating income also benefited from a reduction of an other-than-temporary impairment of $9.2 million related to the Company’s trading auction rate securities, partially offset by a reduction of a related put option of $7.7 million.

Interest Expense (Income), Net and Tax Expense from Continuing Operations

Fiscal 2010 interest expense was $7.8 million, offset by interest income of $4.4 million, compared to interest income of $8.2 million, offset by interest expense of $6.6 million for Fiscal 2009. The decrease in interest income was primarily the result of a lower average rate of return on investments. The increase in interest expense was due primarily to imputed interest expense related to certain store lease transactions and higher fees associated with the unsecured amended credit agreement.

The effective tax rate from continuing operations for Fiscal 2010 was 34.3% compared to 33.9% for Fiscal 2009, in each year benefiting from foreign operations.

Loss from Discontinued Operations, Net of Tax

The Company completed the closure of its RUEHL branded stores and related direct-to-consumer operations in the fourth quarter of Fiscal 2009. Accordingly, the after-tax operating results appear in Income (Loss) from Discontinued Operations, Net of Tax on the Consolidated Statements of Operations and Comprehensive Income. Results from discontinued operations, net of tax, were immaterial for Fiscal 2010. Loss from discontinued operations, net of tax, was $78.7 million for Fiscal 2009.

Refer to Note 17, “Discontinued Operations,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K for further discussion.

 

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Net Income and Net Income per Diluted Share

Net income for Fiscal 2010 was $150.3 million compared to $0.3 million for Fiscal 2009. Net income per diluted share for Fiscal 2010 was $1.67 compared to $0.00 for Fiscal 2009. Net income per diluted share for Fiscal 2010 included store-related asset impairment charges of approximately $0.34 per diluted share associated with 26 stores and store exit charges of approximately $0.03 per diluted share associated with the closure of 64 domestic stores. Net income per diluted share for Fiscal 2009 included store-related asset impairment charges of approximately $0.23 per diluted share associated with 99 stores and a loss per diluted share from discontinued operations, net of tax, of approximately $0.89.

FINANCIAL CONDITION

Liquidity and Capital Resources

Historical Sources and Uses of Cash

Seasonality of Cash Flows

The retail business has two principal selling seasons: the Spring season which includes the first and second fiscal quarters (“Spring”) and the Fall season which includes the third and fourth fiscal quarters (“Fall”). As is typical in the apparel industry, the Company experiences its greatest sales activity during the Fall season due to Back-to-School and Holiday sales periods, particularly in the U.S. The Company relies on excess operating cash flows, which are largely generated in the Fall season, to fund operating expenses throughout the year and to reinvest in the business to support future growth. The Company also has a credit facility and the term loan agreement available as sources of additional funding.

Credit Agreements

On July 28, 2011, the Company entered into an unsecured amended and restated credit agreement (the “Amended and Restated Credit Agreement”) under which up to $350 million will be available. The Amended and Restated Credit Agreement serves to amend and restate, in its entirety, the credit agreement dated April 15, 2008 as previously amended (the “Prior Credit Agreement”). The primary reasons for entering into the Amended and Restated Credit Agreement were to extend the termination date from April 12, 2013 to July 27, 2016 and to reduce fees and interest rates.

As of March 16, 2012, the Company had approximately $350 million available under the Amended and Restated Credit Agreement. The Company had no borrowings outstanding under the Amended and Restated Credit Agreement on January 28, 2012. The Company had $43.8 million outstanding under the Prior Credit Agreement on January 29, 2011 denominated in Japanese Yen. The average interest rate was 2.4% for the fifty-two weeks ended January 28, 2012.

The Amended and Restated Credit Agreement has a Leverage Ratio and a Coverage Ratio. The Company was in compliance with the applicable ratio requirements and other covenants at January 28, 2012.

The Amended and Restated Credit Agreement is described in Note 15, “Long-Term Debt,” of the Notes to Consolidated Financial Statements.

Subsequent to year end, the Company entered into a $300 million Term Loan Agreement to take advantage of the current lending market and to increase its flexibility and liquidity. Refer to Note 21, “Subsequent Event,” of the Notes to Consolidated Financial Statements for further discussion.

Stand-by letters of credit outstanding on January 28, 2012 and January 29, 2011 were immaterial.

 

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Operating Activities

Net cash provided by operating activities was $365.2 million for the fifty-two weeks ended January 28, 2012 compared to $391.8 million for fifty-two weeks ended January 29, 2011. The decrease in cash provided by operating activities was primarily driven by timing in tax payments, partially offset by an increase in net income adjusted for non-cash items.

Investing Activities

Cash outflows for investing activities for the fifty-two weeks ended January 28, 2012 and January 29, 2011 were used primarily for capital expenditures related to new store construction and information technology investments, as well as the acquisition of intangible assets. Cash outflows for capital expenditures were higher in Fiscal 2011 than in Fiscal 2010, due to an increase in the number of new international retail locations, including flashship locations, as well as Home Office, Distribution Centers and Information Technology infrastructure projects. Cash inflows from investing activities were less in Fiscal 2011 due to a reduction in proceeds from sales of marketable securities.

Financing Activities

For the fifty-two week periods ended January 28, 2012 and January 29, 2011, cash outflows for financing activities consisted primarily of the repurchase of A&F’s Common Stock, the payment of dividends and repayments of outstanding borrowings denominated in Japanese Yen under the Company’s Prior Credit Agreement. These outflows were partially offset by cash inflows from the receipt of proceeds associated with the exercise of share-based compensation awards.

During the fifty-two weeks ended January 28, 2012, A&F repurchased approximately 3.5 million shares of A&F’s Common Stock in the open market with a market value of approximately $196.6 million. During the fifty-two weeks ended January 29, 2011, A&F repurchased approximately 1.6 million shares of A&F’s Common Stock in the open market with a market value of $76.2 million. Both the Fiscal 2011 and Fiscal 2010 repurchases were pursuant to the A&F Board of Directors’ authorization.

As of January 28, 2012, A&F had approximately 6.2 million remaining shares available for repurchase as part of the November 20, 2007 A&F Board of Directors’ authorization to repurchase 10.0 million shares of A&F’s Common Stock.

Future Cash Requirements and Sources of Cash

Over the next twelve months, the Company’s primary cash requirements will be to fund operating activities, including the acquisition of inventory, and obligations related to compensation, rent, taxes and other operating activities, as well as increasing capital expenditures and paying of quarterly dividend payments to stockholders subject to the A&F Board of Directors’ approval. The Company also has availability under the Amended and Restated Credit Agreement as a source of additional funding. In addition, on February 24, 2012, the Company entered into a $300 million Term Loan Agreement to take advantage of the current lending market and to increase its flexibility and liquidity.

Subject to suitable market conditions, A&F expects to continue to repurchase shares of its Common Stock. The Company anticipates funding these cash requirements with available cash and as appropriate, the Amended and Restated Credit Agreement and the Term Loan Agreement.

The Company is not dependent on foreign cash to fund its U.S. operations or dividends to shareholders and does not expect the need to repatriate foreign cash to meet cash needs.

 

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Off-Balance Sheet Arrangements

As of January 28, 2012, the Company did not have any off-balance sheet arrangements.

Contractual Obligations

 

            Payments due by period (thousands)  

Operating Activities:

   Total      Less than 1 year      1-3 years      3-5 years      More than 5 years  

Operating Lease Obligations

   $ 3,053,632      $ 389,540      $ 745,994      $ 651,015      $ 1,267,083  

Purchase Obligations

     208,917        208,917                          

Other Obligations

     44,853        15,271        18,918        2,706        7,958  

Interest Related to Total Debt

                                       
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 3,307,402      $ 613,728      $ 764,912      $ 653,721      $ 1,275,041  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financing Activities:

              

Total Debt

     20,917        924        2,099        2,527        15,367  

Dividends

                                       
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 20,917      $ 924      $ 2,099      $ 2,527      $ 15,367  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Obligations for Operating Activities

Operating lease obligations consist primarily of future minimum lease commitments related to store operating leases. See Note 11, “Leased Facilities,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K, for further discussion. Operating lease obligations do not include common area maintenance (“CAM”), insurance, marketing or tax payments for which the Company is also obligated. Total expense related to CAM, insurance, marketing and taxes was $158.8 million in Fiscal 2011.

The purchase obligations category represents purchase orders for merchandise to be delivered during Fiscal 2012 and commitments for fabric expected to be used during upcoming seasons.

Other obligations consist primarily of lease termination obligations related to the closure of stores, asset retirement obligations, agreements to purchase intellectual property and information technology contracts for Fiscal 2011. See Note 15, “Long-Term Debt,” of the Notes to the Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K, for further discussion of the letters of credit and construction debt.

Due to uncertainty as to the amounts and timing of future payments, the contractual obligations table above does not include tax (including accrued interest and penalties) of $19.5 million related to unrecognized tax benefits at January 28, 2012. Deferred taxes are also not included in the preceding table. For further discussion, see Note 14, “Income Taxes,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K.

The table above does not include estimated future retirement payments under the Chief Executive Officer Supplemental Executive Retirement Plan (the “SERP”) for the Company’s Chief Executive Officer with a present value of $14.6 million at January 28, 2012. See Note 18, “Retirement Benefits,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K and the description of the SERP to be

 

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included in the text under the caption “EXECUTIVE OFFICER COMPENSATION” in A&F’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on June 14, 2012, incorporated by reference in “ITEM 11. EXECUTIVE COMPENSATION” of this Annual Report on Form 10-K.

Obligations for Financing Activities

Total debt reflects amounts related to landlord financing obligations for certain leases where the Company is deemed the owner of the construction project for accounting purposes, as substantially all of the risk of ownership during construction of a leased property is held by the Company. The landlord financing obligation is amortized over the life of the related lease. A&F has historically paid quarterly dividends on its Common Stock. There are no amounts included in the above table related to dividends due to the fact that dividends are subject to determination and approval by A&F’s Board of Directors.

 

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Year-To-Date Store Count and Gross Square Feet

Store count and gross square footage by brand for the fifty-two weeks ended January 28, 2012 and January 29, 2011, respectively, were as follows:

 

Store Activity

   Abercrombie & Fitch     abercrombie     Hollister     Gilly Hicks      Total  

U.S. Stores

           

January 29, 2011

     316       181       502       18        1,017  

New

                                    

Closed

     (36     (27     (8             (71
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

January 28, 2012

     280       154       494       18        946  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross Square Feet at January 28, 2012

     2,514       727       3,373       176        6,790  

International Stores

           

January 29, 2011

     9       4       38       1        52  

New

     5       1       39       2        47  

Closed

                                    
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

January 28, 2012

     14       5       77       3        99  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross Square Feet at January 28, 2012

     264       59       642       23        988  

Total Stores

     294       159       571       21        1,045  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross Square Feet at January 28, 2012

     2,778       786       4,015       199        7,778  

Store Activity

   Abercrombie & Fitch     abercrombie     Hollister     Gilly Hicks      Total  

U.S. Stores

           

January 30, 2010

     340       205       507       16        1,068  

New

     4       2       5       1        12  

Remodels/Conversions (net activity)

     (1     1              1        1  

Closed

     (27     (27     (10             (64
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

January 29, 2011

     316       181       502       18        1,017  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross Square Feet at January 29, 2011

     2,813       845       3,424       176        7,258  

International Stores

           

January 30, 2010

     6       4       18               28  

New

     3              20       1        24  

Closed

                                    
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

January 29, 2011

     9       4       38       1        52  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Gross Square Feet at January 29, 2011

     142       34       315       7        498  

Total Stores

     325       185       540       19        1,069  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total Gross Square Feet at January 29, 2011

     2,955       879       3,739       183        7,756  

 

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CAPITAL EXPENDITURES

Capital expenditures totaled $318.6 million, $160.9 million and $175.5 million for Fiscal 2011, Fiscal 2010 and Fiscal 2009, respectively. A summary of capital expenditures is as follows:

 

Capital Expenditures (in millions)

   2011      2010      2009  

New Store Construction, Store Refreshes and Remodels

   $ 258.0      $ 118.0      $ 137.0  

Home Office, Distribution Centers and Information Technology

     60.6        42.9        38.5  
  

 

 

    

 

 

    

 

 

 

Total Capital Expenditures

   $ 318.6      $ 160.9      $ 175.5  
  

 

 

    

 

 

    

 

 

 

During Fiscal 2012, based on new store opening plans and other capital expenditure plans, the Company expects total capital expenditures to be approximately $400 million.

CLOSURE OF RUEHL BRANDED STORES AND RELATED DIRECT-TO-CONSUMER OPERATIONS

On June 16, 2009, A&F’s Board of Directors approved the closure of the Company’s 29 RUEHL branded stores and related direct-to-consumer operations. The Company completed the closure of the RUEHL branded stores and related direct-to-consumer operations during the fourth quarter of Fiscal 2009.

Costs associated with exit or disposal activities are recorded when the liability is incurred. During Fiscal 2011, the Company made gross cash payments totaling approximately $15.9 million, related primarily to the final lease termination agreements associated with the closure of RUEHL branded stores.

 

    Fifty-Two Weeks Ended
January 28, 2012
 

Beginning Balance

  $ 17.2  

Interest Accretion / Other, Net

    (1.3

Cash Payments

    (15.9
 

 

 

 

Ending Balance

  $   
 

 

 

 

Recent Accounting Pronouncements

Accounting Standards Codification 820-10 “Fair Value Measurements and Disclosures,” (“ASC 820-10”) was amended in January 2010 to require additional disclosures related to recurring and nonrecurring fair value measurements. The guidance requires disclosure of transfers of assets and liabilities between Levels 1 and 2 of the fair value hierarchy, including the reasons and the timing of the transfer; and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of the assets and liabilities measured under Level 3 of the fair value hierarchy. The guidance was effective for the Company beginning on January 31, 2010. The disclosure guidance adopted on January 31, 2010, did not have a material impact on our consolidated financial statements.

In May 2011, ASC 820-10 was further amended to clarify certain disclosure requirements and improve consistency with international reporting standards. This amendment is to be applied prospectively and is effective for the Company beginning January 28, 2012. The Company does not expect its adoption to have a material effect on its consolidated financial statements.

Accounting Standards Codification Topic 220, “Comprehensive Income,” was amended in June 2011 to require entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive

 

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income or in two separate but consecutive statements. The amendment does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income under current GAAP. This guidance is effective for the Company’s fiscal year and interim periods beginning January 29, 2012. The Company does not expect its adoption to have a material effect on its consolidated financial statements.

Critical Accounting Estimates

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Since actual results may differ from those estimates, the Company revises its estimates and assumptions as new information becomes available.

The Company believes the following policies are the most critical to the portrayal of the Company’s financial condition and results of operations.

 

Policy

  

Effect if Actual Results Differ from Assumptions

Revenue Recognition

  

The Company recognizes retail sales at the time the customer takes possession of the merchandise. The Company reserves for sales returns through estimates based on historical experience and various other assumptions that management believes to be reasonable. The value of point of sale coupons that result in a reduction of the price paid by the customer is recorded as a reduction of sales.

 

The Company recognized direct-to-consumer sales based on an estimated date for customer receipt of merchandise. The Company reserves for direct-to-consumer sales not received by the customer based on historical experience and various other assumptions that management believes to be reasonable.

 

The Company sells gift cards in its stores and through direct-to-consumer operations. The Company accounts for gift cards sold to customers by recognizing a liability at the time of sale. The liability remains on the Company’s books until the earlier of redemption (recognized as revenue) or when the Company determines the likelihood of redemption is remote, known as breakage (recognized as other operating income), based on historical redemption patterns.

  

The Company has not made any material changes in the accounting methodology used to determine the sales return reserve and revenue recognition for gift cards over the past three fiscal years.

 

The Company does not expect material changes in the near term to the underlying assumptions used to measure the sales return reserve or to measure the timing and amount of future gift card redemptions as of January 28, 2012. However, changes in these assumptions do occur, and, should those changes be significant, the Company may be exposed to gains or losses that could be material.

 

A 10% change in the sales return reserve as of January 28, 2012 would have affected pre-tax income by an immaterial amount for Fiscal 2011.

 

A 10% change in the direct-to-consumer reserve for merchandise not received by the customer as of January 28, 2012 would have affected pre-tax income by an immaterial amount for Fiscal 2011.

 

A 10% change in the assumption of the breakage for gift cards as of January 28, 2012 would have affected pre-tax income by an immaterial amount for Fiscal 2011.

 

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Policy

  

Effect if Actual Results Differ from Assumptions

Auction Rate Securities (“ARS”)

  
As a result of the market failure and lack of liquidity in the current ARS market, the Company measures the fair value of its ARS primarily using a discounted cash flow model, as well as a comparison to similar securities in the market. Certain significant inputs into the model are unobservable in the market including the periodic coupon rate adjusted for the marketability discount, market required rate of return and expected term.   

While the Company changed its intent regarding the sale of its ARS securities, the Company has not made any material changes in the accounting methodology used to determine the fair value of the ARS.

 

The Company does not expect material changes in the near term to the underlying assumptions used to determine the unobservable inputs used to calculate the fair value of the ARS as of January 28, 2012. However, changes in these assumptions do occur, and, should those changes be significant, the Company may be exposed to gains or losses that could be material.

 

Assuming all other assumptions disclosed in Note 7, “Fair Value,” of the Notes to Consolidated Financial Statements included in “ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” of this Annual Report on Form 10-K, being equal, a 50 basis point increase in the market required rate of return would yield approximately a 15% increase in impairment and a 50 basis point decrease in the market required rate of return would yield approximately a 15% decrease in impairment.

 

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Policy

  

Effect if Actual Results Differ from Assumptions

Inventory Valuation

  

Inventories are principally valued at the lower of average cost or market utilizing the retail method.

 

The Company reduces inventory value by recording a valuation reserve that represents estimated future permanent markdowns necessary to sell-through the inventory. The valuation reserve can fluctuate depending on the timing of markdowns previously recognized.

 

Additionally, as part of inventory valuation, an inventory shrink estimate is made each period that reduces the value of inventory for lost or stolen items.

  

The Company has not made any material changes in the accounting methodology used to determine the shrink reserve or the valuation reserve over the past three fiscal years.

 

The Company does not expect material changes in the near term to the underlying assumptions used to determine the shrink reserve or valuation reserve as of January 28, 2012. However, changes in these assumptions do occur, and, should those changes be significant, they could significantly impact the ending inventory valuation at cost, as well as the resulting gross margin(s).

 

An increase or decrease in the valuation reserve of 10% would have affected pre-tax income by approximately $7.2 million for Fiscal 2011.

   An increase or decrease in the inventory shrink accrual of 10% would have been immaterial to pre-tax income for Fiscal 2011.

 

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Policy

  

Effect if Actual Results Differ from Assumptions

Property and Equipment

  

Long-lived assets, primarily comprised of property and equipment, are reviewed whenever events or changes in circumstances indicate that full recoverability of net asset group balances through future cash flows is in question. In addition, the Company conducts an annual impairment analysis in the fourth quarter of each year. For the purposes of the annual review, the Company reviews long-lived assets associated with stores that have an operating loss in the current year and have been open for at least two full years.

 

The Company’s impairment calculation requires management to make assumptions and judgments related to factors used in the evaluation for impairment, including, but not limited to, management’s expectations for future operations and projected cash flows. The key assumptions used in our undiscounted future cash flow model include sales, gross margin and, to a lesser extent, operating expenses.

  

The Company has not made any material changes in the accounting methodology used to determine impairment loss over the past three fiscal years.

 

During Fiscal 2011, 107 stores were tested for impairment during the fourth quarter of Fiscal 2011 as part of our annual review of all stores. Of the 107 stores tested for impairment during the fourth quarter of Fiscal 2011, 79 failed step one and were impaired. Of the 28 stores not impaired, 18 stores, with an aggregate net asset group value of $10.6 million, had undiscounted cash flows which were 150% or more of this net asset group value. Ten stores, with an aggregate net asset group value of $32.3 million, had undiscounted cash flows which were in the range of 105% to 150% of this net asset group value.

 

The Company does not expect material changes in the near term to the assumptions underlying its impairment calculations as of January 28, 2012. However, if changes in these assumptions do occur, and, should those changes be significant, they could have a material impact on the Company’s determination of whether or not there has been an impairment.

 

A 10% decrease in the sales assumption would have increased the impairment charge by approximately $38.0 million for Fiscal 2011. A decrease in the gross margin assumption of 10% would have increased the impairment charge by approximately $39.3 million for Fiscal 2011.

 

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Policy

  

Effect if Actual Results Differ from Assumptions

Income Taxes

  

The provision for income taxes is determined using the asset and liability approach. Tax laws often require items to be included in tax filings at different times than the items are being reflected in the financial statements. A current liability is recognized for the estimated taxes payable for the current year. Deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. Deferred taxes are adjusted for enacted changes in tax rates and tax laws. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

 

A provision for U.S. income tax has not been recorded on undistributed profits 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.

  

The Company does not expect material changes in the judgments, assumptions or interpretations used to calculate the tax provision for Fiscal 2011. However, changes in these assumptions may occur and should those changes be significant, they could have a material impact on the Company’s income tax provision.

 

If the Company’s intention or U.S. tax law changes in the future, there may be a significant negative impact on the provision for income taxes to record an incremental tax liability in the period the change occurs.

Equity Compensation Expense

  
The Company’s equity compensation expense related to stock options and stock appreciation rights is estimated using the Black-Scholes option-pricing model to determine the fair value of the stock option and stock appreciation right grants, which requires the Company to estimate the expected term of the stock option and stock appreciation right grants and expected future stock price volatility over the expected term.    During Fiscal 2011, the Company granted stock appreciation rights covering an aggregate of 2,252,895 shares and no stock options. A 10% increase in the expected term would have yielded a 4% increase in the Black-Scholes valuation for stock appreciation rights granted during the year, while a 10% increase in stock price volatility would have yielded a 9% increase in the Black-Scholes valuation for stock appreciation rights granted during the year.

 

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Policy

  

Effect if Actual Results Differ from Assumptions

Supplemental Executive Retirement Plan

  

Effective February 2, 2003, the Company established a Chief Executive Officer Supplemental Executive Retirement Plan to provide additional retirement income to its Chairman and Chief Executive Officer. Subject to service requirements, the CEO will receive a monthly benefit equal to 50% of his final average compensation (as defined in the SERP) for life. The final average compensation used for the calculation is based on actual compensation (base salary and actual annual cash incentive compensation) averaged over the last 36 consecutive full calendar months ending before the CEO’s retirement.

 

The Company’s accrual for the SERP requires management to make assumptions and judgments related to the CEO’s final average compensation, life expectancy and discount rate.

  

The Company does not expect material changes in the near term to the underlying assumptions used to determine the accrual for the SERP as of January 28, 2012. However, changes in these assumptions do occur, and, should those changes be significant, the Company may be exposed to gains or losses that could be material.

 

A 10% increase in final average compensation as of January 28, 2012 would increase the SERP accrual by approximately $1.5 million. A 50 basis point increase in the discount rate as of January 28, 2012 would decrease the SERP accrual by an immaterial amount.

Legal Contingencies

  
The Company is a defendant in lawsuits and other adversarial proceedings arising in the ordinary course of business. Legal costs incurred in connection with the resolution of claims and lawsuits are expensed as incurred, and the Company establishes reserves for the outcome of litigation where it deems appropriate to do so under applicable accounting rules.    Actual liabilities may exceed or be less than 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.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Investment Securities

The Company maintains its cash equivalents in financial instruments, primarily money market funds and United States treasury bills, with original maturities of three months or less.

The Company also holds investments in investment grade auction rate securities (“ARS”) that have maturities ranging from 16 to 31 years. The par and carrying values, and related cumulative other-than-temporary impairment charges for the Company’s available-for-sale marketable securities as of January 28, 2012 were as follows:

 

     Par
Value
     Other-than-
Temporary
Impairment
    Carrying
Value
 
     (in thousands)  

Available-for-sale securities:

       

Auction rate securities — student loan backed

   $ 92,975      $ (8,325   $ 84,650  

Auction rate securities — municipal authority bonds

     19,975        (5,117     14,858  
  

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

   $ 112,950      $ (13,442   $ 99,508  
  

 

 

    

 

 

   

 

 

 

As of January 28, 2012, approximately 46% of the Company’s ARS were “AAA” rated, approximately 16% of the Company’s ARS were “AA” rated, and approximately 38% of the Company’s ARS were “A–” rated, in each case as rated by one or more of the major credit rating agencies. The ratings take into account insurance policies guaranteeing both the principal and accrued interest. Each investment in student loans is insured by (1) the U.S. government under the Federal Family Education Loan Program, (2) a private insurer or (3) a combination of both. The percentage of insurance coverage of the outstanding principal and interest of the ARS varies by security. The credit ratings may change over time and would be an indicator of the default risk associated with the ARS and could have a material effect on the value of the ARS.

During the fifty-two weeks ended January 28, 2012, the Company changed its intent regarding the sale of its ARS, resulting in recognition of an other-than-temporary impairment of $13.4 million recognized in other expense.

The irrevocable rabbi trust (the “Rabbi Trust”) is intended to be used as a source of funds to match respective funding obligations to participants in the Abercrombie & Fitch Co. Nonqualified Savings and Supplemental Retirement Plan I, the Abercrombie & Fitch Co. Nonqualified Savings and Supplemental Retirement Plan II and the Chief Executive Officer Supplemental Executive Retirement Plan. As of January 28, 2012, total assets held in the Rabbi Trust were $85.1 million and related to trust-owned life insurance policies with a cash surrender value of $85.1 million and an immaterial amount of assets held in money market funds. The trust-owned life insurance policies are recorded at cash surrender value, in Other Assets on the Consolidated Balance Sheet and are restricted as to their use as noted above. Net realized and unrealized gains or losses related to the municipal notes and bonds held in the Rabbi Trust were not material for the fifty-two weeks ended January 28, 2012 and January 29, 2011. The change in cash surrender value of the trust-owned life insurance policies held in the Rabbi Trust resulted in realized gains of $2.5 million and $2.3 million for the fifty-two weeks ended January 28, 2012 and January 29, 2011, respectively.

Interest Rate Risks

As of January 28, 2012, the Company had no long-term debt outstanding under the Amended and Restated Credit Agreement.

 

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Foreign Exchange Rate Risk

A&F’s international subsidiaries generally operate with functional currencies other than the U.S. dollar. The Company’s Consolidated Financial Statements are presented in U.S. dollars. Therefore, the Company must translate revenues, expenses, assets and liabilities from functional currencies into U.S. dollars at exchange rates in effect during, or at the end of, the reporting period. The fluctuation in the value of the U.S. dollar against other currencies affects the reported amounts of revenues, expenses, assets and liabilities. The potential impact of currency fluctuation increases as international expansion increases.

A&F and its subsidiaries have exposure to changes in currency exchange rates associated with foreign currency transactions and forecasted foreign currency transactions, including the sale of inventory between subsidiaries and foreign denominated assets and liabilities. Such transactions are denominated primarily in U.S. dollars, British Pounds, Canadian Dollars, Chinese Yuan, Danish Kroner, Euros, Hong Kong Dollars, Japanese Yen and Swiss Francs. The Company has established a program that primarily utilizes foreign currency forward contracts to partially offset the risks associated with the effects of certain foreign currency transactions and forecasted transactions. Under this program, increases or decreases in foreign currency exposures are partially offset by gains or losses on forward contracts, to mitigate the impact of foreign currency gains or losses. The Company does not use forward contracts to engage in currency speculation. All outstanding foreign currency forward contracts are recorded at fair value at the end of each fiscal period.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ABERCROMBIE & FITCH CO.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Thousands, except share and per share amounts)

 

     2011     2010     2009  

NET SALES

   $ 4,158,058     $ 3,468,777     $ 2,928,626  

Cost of Goods Sold

     1,639,188       1,256,596       1,045,028  
  

 

 

   

 

 

   

 

 

 

GROSS PROFIT

     2,518,870       2,212,181       1,883,598  

Stores and Distribution Expense

     1,888,248       1,589,501       1,425,950  

Marketing, General and Administrative Expense

     437,120       400,804       353,269  

Other Operating Expense (Income), Net

     3,472       (10,056     (13,533
  

 

 

   

 

 

   

 

 

 

OPERATING INCOME

     190,030       231,932       117,912  

Interest Expense (Income), Net

     3,577       3,362       (1,598
  

 

 

   

 

 

   

 

 

 

INCOME FROM CONTINUING OPERATIONS BEFORE TAXES

     186,453       228,570       119,510  

Tax Expense from Continuing Operations

     59,591       78,287       40,557  
  

 

 

   

 

 

   

 

 

 

NET INCOME FROM CONTINUING OPERATIONS

   $ 126,862     $ 150,283     $ 78,953  
  

 

 

   

 

 

   

 

 

 

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, Net of Tax

   $ 796     $      $ (78,699
  

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 127,658     $ 150,283     $ 254  
  

 

 

   

 

 

   

 

 

 

NET INCOME PER SHARE FROM CONTINUING OPERATIONS:

      

BASIC

   $ 1.46     $ 1.71     $ 0.90  
  

 

 

   

 

 

   

 

 

 

DILUTED

   $ 1.42     $ 1.67     $ 0.89  
  

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS) PER SHARE FROM DISCONTINUED OPERATIONS:

      

BASIC

   $ 0.01     $      $ (0.90
  

 

 

   

 

 

   

 

 

 

DILUTED

   $ 0.01     $      $ (0.89
  

 

 

   

 

 

   

 

 

 

NET INCOME PER SHARE:

      

BASIC

   $ 1.47     $ 1.71     $ 0.00  
  

 

 

   

 

 

   

 

 

 

DILUTED

   $ 1.43     $ 1.67     $ 0.00  
  

 

 

   

 

 

   

 

 

 

WEIGHTED-AVERAGE SHARES OUTSTANDING:

      

BASIC

     86,848       88,061       87,874  

DILUTED

     89,537       89,851       88,609  
  

 

 

   

 

 

   

 

 

 

DIVIDENDS DECLARED PER SHARE

   $ 0.70     $ 0.70     $ 0.70  
  

 

 

   

 

 

   

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS)

      

Foreign Currency Translation Adjustments

   $ (8,655   $ 3,399     $ 5,942  

Gains (Losses) on Marketable Securities, net of taxes of $(5,526), $366 and $(4,826) for Fiscal 2011, Fiscal 2010 and Fiscal 2009, respectively.

     9,409       (622     8,217  

Unrealized Gain (Loss) on Derivative Financial Instruments, net of taxes of $(1,216), $188 and $265 for Fiscal 2011, Fiscal 2010 and Fiscal 2009, respectively.

     12,217       (320     (451
  

 

 

   

 

 

   

 

 

 

Other Comprehensive Income

   $ 12,971     $ 2,457     $ 13,708  
  

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 140,629     $ 152,740     $ 13,962  
  

 

 

   

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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ABERCROMBIE & FITCH CO.

CONSOLIDATED BALANCE SHEETS

(Thousands, except par value amounts)

 

     January 28,
2012
    January 29,
2011
 

ASSETS

    

CURRENT ASSETS:

    

Cash and Equivalents

   $ 583,495     $ 826,353  

Marketable Securities

     84,650         

Receivables

     89,350       74,777  

Inventories

     569,818       385,857  

Deferred Income Taxes

     77,120       60,405  

Other Current Assets

     84,342       79,389  
  

 

 

   

 

 

 

TOTAL CURRENT ASSETS

     1,488,775       1,426,781  

PROPERTY AND EQUIPMENT, NET

     1,197,271       1,154,759  

NON-CURRENT MARKETABLE SECURITIES

     14,858       100,534  

OTHER ASSETS

     347,249       259,341  
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 3,048,153     $ 2,941,415  
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

CURRENT LIABILITIES:

    

Accounts Payable

   $ 211,368     $ 137,235  

Accrued Expenses

     375,020       300,100  

Deferred Lease Credits

     41,047       41,538  

Income Taxes Payable

     77,918       73,491  
  

 

 

   

 

 

 

TOTAL CURRENT LIABILITIES

     705,353       552,364  

LONG-TERM LIABILITIES:

    

Deferred Income Taxes

     4,123       33,515  

Deferred Lease Credits

     183,022       192,619  

Long-Term Debt

     57,851       68,566  

Other Liabilities

     235,348       203,567  
  

 

 

   

 

 

 

TOTAL LONG-TERM LIABILITIES

     480,344       498,267  

STOCKHOLDERS’ EQUITY:

    

Class A Common Stock — $0.01 par value: 150,000 shares authorized and 103,300 shares issued at each of January 28, 2012 and January 29, 2011

     1,033       1,033  

Paid-In Capital

     369,171       349,258  

Retained Earnings

     2,320,571       2,272,317  

Accumulated Other Comprehensive Income (Loss), net of tax

     6,455       (6,516

Treasury Stock, at Average Cost — 17,662 and 16,054 shares at January 28, 2012 and January 29, 2011, respectively

     (834,774     (725,308
  

 

 

   

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

     1,862,456       1,890,784  
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 3,048,153     $ 2,941,415  
  

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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ABERCROMBIE & FITCH CO.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Thousands, except per share amounts)

 

    Common Stock     Paid-In
Capital
    Retained
Earnings
    Other
Comprehensive
(Loss) Income
    Treasury Stock     Total
Stockholders’
Equity
 
    Shares
Outstanding
    Par
Value
          Shares     At Average
Cost
   

Balance, January 31, 2009

    87,636     $ 1,033     $ 328,488     $ 2,244,936     $ (22,681     15,664     $ (706,198   $ 1,845,578  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

                         254                            254  

Dividends ($0.70 per share)

                         (61,500                          (61,500

Share-based Compensation Issuances and Exercises

    350              (19,690                   (350     18,912       (778

Tax Deficiency from Share-based Compensation Issuances and Exercises

                  (5,454                                 (5,454

Share-based Compensation Expense

                  36,109                                   36,109  

Unrealized Gains on Marketable Securities

                                8,217                8,217  

Net Change in Unrealized Gains or Losses on Derivative Financial Instruments

                                (451              (451

Foreign Currency Translation Adjustments

                                5,942                5,942  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, January 30, 2010

    87,986     $ 1,033     $ 339,453     $ 2,183,690     $ (8,973     15,314     $ (687,286   $ 1,827,917  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

                         150,283                            150,283  

Purchase of Common Stock

    (1,582                                 1,582       (76,158     (76,158

Dividends ($0.70 per share)

                         (61,656                          (61,656

Share-based Compensation Issuances and Exercises

    842              (29,741                   (842     38,136       8,395  

Tax Deficiency from Share-based Compensation Issuances and Exercises

                  (1,053                                 (1,053

Share-based Compensation Expense

                  40,599                                   40,599  

Unrealized Losses on Marketable Securities

                                (622              (622

Net Change in Unrealized Gains or Losses on Derivative Financial Instruments

                                (320              (320

Foreign Currency Translation Adjustments

                                3,399                3,399  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, January 29, 2011

    87,246     $ 1,033     $ 349,258     $ 2,272,317     $ (6,516     16,054     $ (725,308   $ 1,890,784  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

                         127,658                            127,658  

Purchase of Common Stock

    (3,546                                 3,546       (196,605     (196,605

Dividends ($0.70 per share)

                         (60,956                          (60,956

Share-based Compensation Issuances and Exercises

    1,938              (34,153     (18,448            (1,938     87,139       34,538  

Tax Benefit from Share-based Compensation Issuances and Exercises

                  2,973                                   2,973  

Share-based Compensation Expense

                  51,093                                   51,093  

Losses on Marketable Securities reclassed to the Income Statement

                                9,409                9,409  

Net Change in Unrealized Gains or Losses on Derivative Financial Instruments

                                12,217                12,217   

Foreign Currency Translation Adjustments

                                (8,655              (8,655
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, January 28, 2012

    85,638     $ 1,033     $ 369,171     $ 2,320,571     $ 6,455       17,662     $ (834,774   $ 1,862,456  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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ABERCROMBIE & FITCH CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     2011     2010     2009  
     (Thousands)  

OPERATING ACTIVITIES:

      

Net Income

   $ 127,658     $ 150,283     $ 254  

Impact of Other Operating Activities on Cash Flows:

      

Depreciation and Amortization

     232,956       229,153       238,752  

Non-Cash Charge for Asset Impairment

     68,022       50,631       84,754  

Loss on Disposal / Write-off of Assets

     22,460       7,064       10,646  

Lessor Construction Allowances

     41,509       35,281       47,329  

Amortization of Deferred Lease Credits

     (48,258     (48,373     (47,182

Deferred Taxes

     (46,330     (27,823     7,605  

Share-Based Compensation

     51,093       40,599       36,109  

Tax Benefit (Deficiency) from Share-Based Compensation

     2,973       (1,053     (5,454

Excess Tax Benefit from Share-Based Compensation

     (4,821              

Auction Rate Securities Loss

     13,442                

Changes in Assets and Liabilities:

      

Inventories

     (184,784     (74,689     62,720  

Accounts Payable and Accrued Expenses

     130,180        27,108       37,115  

Income Taxes

     4,754       63,807       (7,386

Other Assets and Liabilities

     (45,635     (60,199     (69,775
  

 

 

   

 

 

   

 

 

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

     365,219       391,789       395,487  
  

 

 

   

 

 

   

 

 

 

INVESTING ACTIVITIES:

      

Capital Expenditures

     (318,598     (160,935     (175,472

Purchase of Trust-Owned Life Insurance Policies

            (16,583     (13,539

Proceeds from Sales of Marketable Securities

     2,650       84,542       77,450  

Other Investing

     (24,741              
  

 

 

   

 

 

   

 

 

 

NET CASH USED FOR INVESTING ACTIVITIES

     (340,689     (92,976     (111,561
  

 

 

   

 

 

   

 

 

 

FINANCING ACTIVITIES:

      

Proceeds from Share-Based Compensation

     46,530       13,941       2,048  

Excess Tax Benefit from Share Based Compensation

     4,821                

Proceeds from Borrowings under Credit Agreement

                   48,056  

Purchase of Common Stock

     (196,605     (76,158       

Dividends Paid

     (60,956     (61,656     (61,500

Repayment of Borrowings under Credit Agreement

     (45,002     (12,093     (100,000

Change in Outstanding Checks and Other

     (14,117     (9,367     (24,654
  

 

 

   

 

 

   

 

 

 

NET CASH USED FOR FINANCING ACTIVITIES

     (265,329     (145,333     (136,050
  

 

 

   

 

 

   

 

 

 

EFFECT OF EXCHANGE RATES ON CASH

     (2,059     2,923       3,402  

NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS:

     (242,858     156,403       151,278  

Cash and Equivalents, Beginning of Period

     826,353       669,950       518,672  
  

 

 

   

 

 

   

 

 

 

CASH AND EQUIVALENTS, END OF PERIOD

   $ 583,495     $ 826,353     $ 669,950  
  

 

 

   

 

 

   

 

 

 

SIGNIFICANT NON-CASH INVESTING ACTIVITIES:

      

Change in Accrual for Construction in Progress

   $ 23,040     $ 18,741     $ (21,882
  

 

 

   

 

 

   

 

 

 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. BASIS OF PRESENTATION

Abercrombie & Fitch Co. (“A&F”), through its wholly-owned subsidiaries (collectively, A&F and its wholly-owned subsidiaries are referred to as “Abercrombie & Fitch” or the “Company”), is a specialty retailer of high-quality, casual apparel for men, women and kids with an active, youthful lifestyle.

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

On June 16, 2009, A&F’s Board of Directors approved the closure of the Company’s 29 RUEHL branded stores and related direct-to-consumer operations. The Company completed the closure of the RUEHL branded stores and related direct-to-consumer operations during the fourth quarter of Fiscal 2009. Accordingly, the results of operations of RUEHL are reflected in Income (Loss) from Discontinued Operations, Net of Tax for all periods presented on the Consolidated Statements of Operations and Comprehensive Income. Results from discontinued operations were immaterial for the fifty-two weeks ended January 29, 2011.

FISCAL YEAR

The Company’s fiscal year ends on the Saturday closest to January 31, typically resulting in a fifty-two week year, but occasionally giving rise to an additional week, resulting in a fifty-three week year. 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 2011” represent the 52-week fiscal year ended January 28, 2012; to “Fiscal 2010” represent the 52-week fiscal year ended January 29, 2011; and to “Fiscal 2009” represent the 52-week fiscal year ended January 30, 2010. In addition, all references herein to “Fiscal 2012” represent the 53-week fiscal year that will end on February 2, 2013.

RECLASSIFICATIONS

Certain prior period amounts have been reclassified or adjusted to conform to the current year presentation.

 

2. SEGMENT REPORTING

The Company determines its segments on the same basis that it uses to evaluate performance. In connection with its international expansion, the way the Company allocates resources and assesses performance has changed. All of the Company’s segments sell a similar group of products — casual sportswear apparel, personal care products and accessories for men, women and kids and bras, underwear and sleepwear for girls. The Company has three reportable segments; U.S. Stores, International Stores, and Direct-to-Consumer. Corporate functions, interest income and expense, and other income and expense are evaluated on a consolidated basis and are not allocated to the Company’s segments and are included in Other.

The U.S. Stores reportable segment includes the results of stores in the United States and Puerto Rico. The International Stores reportable segment includes the results of stores in Canada, Europe and Asia. The Direct-to-Consumer reportable segment operating income is defined as income directly associated with the website operations, both domestic and international.

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Operating income is the primary measure of profit the Company uses to make decisions on allocating resources to its operating segments. For the U.S. Stores and International Stores reportable segments, operating income is defined as aggregate income directly attributable to individual stores on a four-wall basis. Four-wall costs include all costs contained “within the four walls of the stores”. These include expenses such as cost of merchandise, selling payroll and related costs, rent, utilities, depreciation, other variable expenses such as repairs and maintenance, supplies and packaging, as well as store sales related expenses including credit card and bank fees and taxes. Four-wall costs also reflect pre-opening charges related to stores not yet in operation. Four-wall costs exclude marketing, general and administrative expense, store management, and support functions such as regional and district management and other functions not dedicated to an individual store, distribution center costs, and markdowns on merchandise held in distribution centers, all of which are included in Other.

Reportable segment assets include those used directly in or resulting from the operations of each reportable segment. Total assets for the U.S. Stores and International Stores reportable segments primarily consist of store cash, credit card receivables, prepaid rent, store supplies, lease deposits, merchandise inventory and the net book value of store long-lived assets. International Stores also includes VAT receivables. Total assets for the Direct-to-Consumer reportable segment primarily consist of credit card receivables, merchandise inventory, and the net book value of information technology and distribution center assets. Total assets for Other include cash and cash equivalents, investments, the net book value of corporate property and equipment, the net book value of intangible assets, investments held in the Rabbi Trust for deferred Compensation plans, foreign currency hedge assets and tax-related assets.

The following table provides the Company’s segment information as of, and for, the fiscal years ended January 28, 2012, January 29, 2011 and January 30, 2010:

 

    U.S. Stores     International
Stores
    Direct-to-
Consumer
Operations
    Segment
Total
    Other(1)     Total  
    (In thousands):  

January 28, 2012

           

Net Sales

  $ 2,710,842     $ 876,613     $ 552,603     $ 4,140,058     $ 18,000       $ 4,158,058  

Depreciation and Amortization

    125,827       35,844       2,876       164,547       68,409         232,956  

Operating Income(2)

    390,186       261,461       254,328       905,975       (715,945 )       190,030  

Total Assets

    681,100       659,630       71,318       1,412,048       1,636,105         3,048,153  

Capital Expenditures(3)

    1,105       229,959       8,367       239,431       79,167         318,598  

January 29, 2011

           

Net Sales

    2,546,798       505,136       404,974       3,456,908       11,869         3,468,777  

Depreciation and Amortization

    149,533       17,680       3,154       170,367       58,786         229,153  

Operating Income(4)

    460,233       173,391       214,909       848,533       (616,601 )       231,932  

Total Assets

    835,597       368,299       41,160       1,245,056       1,696,359         2,941,415  

Capital Expenditures(3)

    24,706       85,435       816       110,957       49,978         160,935  

January 30, 2010

           

Net Sales

    2,377,771       256,216       290,102       2,924,089       4,537         2,928,626  

Depreciation and Amortization

    175,286       8,388       3,750       187,424       51,328         238,752  

Operating Income(5)

    433,050       73,813       165,071       671,934       (554,022 )       117,912  

Total Assets

    948,376       231,964       30,574       1,210,914       1,610,952         2,821,866  

Capital Expenditures(3)

    52,964       77,420       428       130,812       44,660         175,472  

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

(1) 

Includes corporate functions such as Design, Merchandising, Sourcing, Planning and Allocation, Store Management and Support, Marketing, Distribution Center Operations, Information Technology, Real Estate and other governance functions such as Finance, Legal and Human Resources and other corporate overhead. Sales are related to third-party sell-off of inventory. Operating Income for Other includes marketing, general and administrative expense; store management and support functions such as regional and district management and other functions not dedicated to an individual store; distribution center costs; and markdowns on merchandise held in distribution centers.

 

(2) 

Includes charges for asset impairments and write-down of store-related long-lived assets of $52.1 million and $15.9 million for U.S. Stores and International Stores, respectively.

 

(3) 

Reportable segment capital expenditures are direct purchases of property and equipment for that segment.

 

(4) 

Includes charges for asset impairments and write-down of store-related long-lived assets of $50.6 million and $0.0 million for U.S. Stores and International Stores, respectively.

 

(5) 

Includes charges for asset impairments of $33.2 million and $0.0 million for U.S. Stores and International Stores, respectively.

Geographic Information

Financial information relating to the Company’s operations by geographic area is as follows:

Net Sales:

Net sales includes net merchandise sales through stores and direct-to-consumer operations, including shipping and handling revenue. Net sales are reported by geographic area based on the location of the customer.

 

     Fifty-Two Weeks Ended  
     January 28, 2012      January 29, 2011      January 30, 2010  
     (in thousands):  

United States

   $ 3,108,380      $ 2,821,993      $ 2,567,141  

Europe

     822,473        443,836        229,446  

Other International

     227,205        202,948        132,039  
  

 

 

    

 

 

    

 

 

 

Total

   $ 4,158,058      $ 3,468,777      $ 2,928,626  
  

 

 

    

 

 

    

 

 

 

Long-Lived Assets:

 

     January 28, 2012      January 29, 2011  
     (in thousands):  

United States

   $ 794,723      $ 959,777  

Europe

     366,647        169,313  

Other International

     156,361        127,741  
  

 

 

    

 

 

 

Total

   $ 1,317,731      $ 1,256,831  
  

 

 

    

 

 

 

Long-lived assets included in the table above include primarily property and equipment (net), store supplies and lease deposits.

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of A&F and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

CASH AND EQUIVALENTS

See Note 5, “Cash and Equivalents.”

INVESTMENTS

See Note 6, “Investments.

RECEIVABLES

Receivables primarily include credit card receivables, construction allowances, value added tax (“VAT”) receivables and other tax credits or refunds.

As part of the normal course of business, the Company has approximately three to four days of sales transactions outstanding with its third-party credit card vendors at any point. The Company classifies these outstanding balances as credit card receivables. Construction allowances are recorded for certain store lease agreements for improvements completed by the Company. VAT receivables are payments the Company has made on purchases of goods and services that will be recovered as sales are made to customers.

INVENTORIES

Inventories are principally valued at the lower of average cost or market utilizing the retail method. The Company determines market value as the anticipated future selling price of merchandise less a normal margin. An initial markup is applied to inventory at cost in order to establish a cost-to-retail ratio. Permanent markdowns, when taken, reduce both the retail and cost components of inventory on hand so as to maintain the already established cost-to-retail relationship. In addition to markdowns already recognized, the Company reduces inventory value by recording a valuation reserve that represents the estimated future anticipated selling price decreases necessary. The valuation reserve can fluctuate depending on the timing of markdowns previously recognized. The valuation reserve was $72.3 million, $24.4 million and $11.4 million at January 28, 2012, January 29, 2011 and January 30, 2010, respectively.

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. The shrink reserve was $9.3 million, $7.6 million and $8.1 million at January 28, 2012, January 29, 2011 and January 30, 2010, respectively.

Ending inventory balances were $569.8 million, $385.9 million and $310.6 million at January 28, 2012, January 29, 2011 and January 30, 2010, respectively. These balances included inventory in transit balances of $103.1 million, $55.0 million and $39.9 million at January 28, 2012, January 29, 2011 and January 30, 2010, respectively. Inventory in transit is considered to be merchandise owned by the Company that has not yet been received at the Company’s distribution centers.

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

OTHER CURRENT ASSETS

Other current assets include prepaid rent, current store supplies, derivative contracts and other prepaids.

STORE SUPPLIES

Store supplies include in-store supplies and packaging, as well as replenishment inventory held on the Company’s behalf by a third party. The initial inventory of supplies for new stores including, but not limited to, hangers, frames, security tags and point-of-sale supplies are capitalized at the store opening date. In lieu of amortizing the initial balances over their estimated useful lives, the Company expenses all subsequent replacements and adjusts the initial balance, as appropriate, for changes in store quantities or replacement cost. The Company believes this policy approximates the expense that would have been recognized under accounting principles generally accepted in the United States of America (“GAAP”). Packaging and consumable store supplies are expensed as used. Current store supplies, including packaging and consumable store supplies held at a third-party replenishment center, were $17.8 million and $20.6 million at January 28, 2012 and January 29, 2011, respectively, and were classified as Other Current Assets on the Consolidated Balance Sheets. Non-current store supplies were $32.0 million and $32.3 million at January 28, 2012 and January 29, 2011, respectively, and were classified as Other Assets on the Consolidated Balance Sheets.

PROPERTY AND EQUIPMENT

Depreciation and amortization of property and equipment are computed for financial reporting purposes on a straight-line basis, using service lives ranging principally: 30 years for buildings; from three to 15 years for leasehold improvements and furniture and fixtures; from three to seven years for information technology; and from three to 20 years for other property and equipment. The cost of assets sold or retired and the related accumulated depreciation or amortization are removed from the accounts with any resulting gain or loss included in net income. Maintenance and repairs are charged to expense as incurred. Major remodels and improvements that extend service lives of the assets are capitalized.

Long-lived assets, primarily comprised of property and equipment, are reviewed whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The primary triggering events are (1) when the Company believes that it is more likely than not that long-lived assets will be disposed of before the end of their previously estimated useful life (e.g. store closures before the end of a lease) and (2) if the Company’s performance in any quarter indicates that there has been a long-term and significant change in the economics of the business. The Company reviews long-lived assets for impairments in the quarter in which a triggering event occurs.

In addition, the Company conducts an annual impairment analysis in the fourth quarter of each year. For the purposes of the annual review, the Company reviews long-lived assets associated with stores that have an operating loss in the current year and have been open for at least two full years.

The reviews are conducted at the individual store level, which is the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The impairment evaluation is performed as a two-step test. First, the Company utilizes an undiscounted future cash flow model to test the individual asset groups for recoverability. If the net carrying value of the asset group exceeds the undiscounted cash flows, the Company proceeds to step two. Under step two, an impairment loss is recognized for the excess of net book value over the fair value of the assets. Factors used in the evaluation include, but are not limited to, management’s plans for future operations, recent operating results and projected cash flows. See Note 8, “Property and Equipment, Net,” for further discussion.

The Company expenses all internal-use software costs incurred in the preliminary project stage and capitalizes certain direct costs associated with the development and purchase of internal-use software within property and equipment. Capitalized costs are amortized on a straight-line basis over the estimated useful lives of the software, generally not exceeding seven years.

INCOME TAXES

Income taxes are calculated using the asset and liability method. Deferred tax assets and liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates in effect for the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred balances are certain judgments and interpretations of enacted tax law and published guidance with respect to applicability to the Company’s operations. A valuation allowance is established against deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Currently, there is a valuation allowance provided for foreign net operating losses.

The effective tax rate utilized by the Company reflects management’s judgment of expected tax liabilities within the various tax jurisdictions. The Company records tax expense or benefit that does not relate to ordinary income in the current fiscal year discretely in the period in which it occurs. Examples of such types of discrete items include, but are not limited to; changes in estimates of the outcome of tax matters related to prior years; provision-to-return adjustments; tax-exempt income; and the settlement of tax audits.

See Note 14, “Income Taxes,” for a discussion regarding the Company’s policies for uncertain tax positions.

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS

The majority of the Company’s international operations use local currencies as the functional currency. Assets and liabilities denominated in foreign currencies were translated into U.S. dollars (the reporting currency) at the exchange rate prevailing at the balance sheet date. Equity accounts denominated in foreign currencies were translated into U.S. dollars at historical exchange rates. Revenues and expenses denominated in foreign currencies were translated into U.S. dollars at the monthly average exchange rate for the period. Gains and losses resulting from foreign currency transactions are included in the results of operations; whereas, translation adjustments and inter-company loans of a long-term investment nature are reported as an element of Other Comprehensive Income (Loss). Foreign currency transactions resulted in a gain of $0.5 million for the fifty-two weeks ended January 28, 2012, a loss of $3.3 million for the fifty-two weeks ended January 29, 2011, and was immaterial for the fifty-two weeks ended January 30, 2010.

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

DERIVATIVES

See Note 16, “Derivatives.

CONTINGENCIES

In the normal course of business, the Company must make estimates of potential future legal obligations and liabilities, which requires the use of management’s judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments may be required. See Note 19, “Contingencies,” for further discussion.

STOCKHOLDERS’ EQUITY

At January 28, 2012 and January 29, 2011, there were 150.0 million shares of A&F’s Class A Common Stock, $0.01 par value, authorized, of which 85.6 million and 87.2 million shares were outstanding at January 28, 2012 and January 29, 2011, respectively, and 106.4 million shares of Class B Common Stock, $0.01 par value, authorized, none of which were outstanding at January 28, 2012 and January 29, 2011. In addition, 15.0 million shares of A&F’s Preferred Stock, $0.01 par value, were authorized, none of which have been issued. See Note 22, “Preferred Stock Purchase Rights” for information about Preferred Stock Purchase Rights.

Holders of Class A Common Stock generally have identical rights to holders of Class B Common Stock, except holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to three votes per share on all matters submitted to a vote of stockholders.

REVENUE RECOGNITION

The Company recognizes store sales at the time the customer takes possession of the merchandise. Direct-to-consumer sales are recorded based on an estimated date for customer receipt of merchandise, which is based on shipping terms and historical delivery terms. Amounts relating to shipping and handling billed to customers in a sale transaction are classified as revenue and the related direct shipping and handling costs are classified as Stores and Distribution Expense. Associate discounts are classified as a reduction of net sales. The Company reserves for sales returns through estimates based on historical experience. The sales return reserve was $7.0 million, $10.3 million and $7.4 million at January 28, 2012, January 29, 2011 and January 30, 2010, respectively.

The Company sells gift cards in its stores and through direct-to-consumer operations. The Company accounts for gift cards sold to customers by recognizing a liability at the time of sale. Gift cards sold to customers do not expire or lose value over periods of inactivity. The liability remains on the Company’s books until the Company recognizes income from gift cards. Income on gift cards is recognized at the earlier of redemption by the customer (recognized as revenue) or when the Company determines that the likelihood of redemption is remote, referred to as “gift card breakage” (recognized as other operating income). The Company determines the probability of the gift card being redeemed to be remote based on historical redemption patterns. At January 28, 2012 and January 29, 2011, the gift card liabilities on the Company’s Consolidated Balance Sheets were $47.7 million and $47.1 million, respectively.

 

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ABERCROMBIE & FITCH CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Company is not required by law to escheat the value of unredeemed gift cards to the states in which it operates. During Fiscal 2011, Fiscal 2010 and Fiscal 2009, the Company recognized other operating income for gift card breakage of $7.2 million, $7.8 million and $9.0 million, respectively.

The Company does not include tax amounts collected as part of the sales transaction in its net sales results.

COST OF GOODS SOLD

Cost of goods sold is primarily comprised of: cost incurred to produce inventory for sale, including product costs, freight, import cost, as well as changes in reserves for shrink and valuation reserves. Gains and losses associated with foreign currency exchange contracts related to hedging of inventory purchases are also recognized in cost of goods sold when the inventory being hedged is sold.

STORES AND DISTRIBUTION EXPENSE

Stores and distribution expense includes store payroll, store management, rent, utilities and other landlord expenses, depreciation and amortization, repairs and maintenance and other store support functions, as well as Direct-to-Consumer expense and Distribution Center (“DC”) expense.

Shipping and handling costs, including costs incurred to store, move and prepare products for shipment, and costs incurred to physically move the product to the customer, associated with direct-to-consumer operations were $53.6 million, $38.9 million and $30.7 million for Fiscal 2011, Fiscal 2010 and Fiscal 2009, respectively. Handling costs, including costs incurred to store, move and prepare the products for shipment to the stores were $62.8 million, $42.8 million and $34.1 million for Fiscal 2011, Fiscal 2010 and Fiscal 2009, respectively. These amounts are recorded in Stores and Distribution Expense in our Consolidated Statement of Operations. Costs incurred to physically move the product to the stores is recorded in Cost of Goods Sold in our Consolidated Statement of Operations.

MARKETING, GENERAL & ADMINISTRATIVE EXPENSE

Marketing, general and administrative expense includes photography and media ads; store marketing; home office compensation, except for those departments included in stores and distribution expense; information technology; outside services such as legal and consulting; relocation; recruiting; samples and travel expenses.

OTHER OPERATING EXPENSE (INCOME), NET

Other operating expense (income) consists primarily of the following: income related to gift card balances whose likelihood of redemption has been determined to be remote; gains and losses on foreign currency transactions; and the net impact of the change in valuation related to other-than-temporary impairments associated with ARS. See Note 6, “Investments.”

WEBSITE AND ADVERTISING COSTS

Website and advertising costs are expensed as incurred as a component of Stores and Distribution Expense on the Consolidated Statements of Operations and Comprehensive Income.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

LEASES

The Company leases property for its stores under operating leases. Lease agreements may contain construction allowances, rent escalation clauses and/or contingent rent provisions.

For construction allowances, the Company records a deferred lease credit on the Consolidated Balance Sheets and amortizes the deferred lease credit as a reduction of rent expense on the Consolidated Statements of Operations and Comprehensive Income over the terms of the leases.

For scheduled rent escalation clauses during the lease terms, the Company records minimum rental expense on a straight-line basis over the terms of the leases on the Consolidated Statements of Operations and Comprehensive Income. The difference between the rent expense and the amount payable under the lease is included in Accrued Expenses and Other Liabilities on the Consolidated Balance Sheets. The term of the lease over which the Company amortizes construction allowances and minimum rental expenses on a straight-line basis begins on the date of initial possession, which is generally when the Company enters the space and begins construction.

Certain leases provide for contingent rents, which are determined as a percentage of gross sales. The Company records a contingent rent liability in accrued expenses on the Consolidated Balance Sheets, and the corresponding rent expense on the Consolidated Statements of Operations and Comprehensive Income when management determines that achieving the specified levels during the fiscal year is probable. In addition, most of the leases require payment of real estate taxes, insurance and certain common area maintenance costs in addition to the future minimum lease payments.

In certain lease arrangements, the Company is involved with the construction of the building. If the Company determines that it has substantially all of the risks of ownership during construction of the leased property and therefore is deemed to be the owner of the construction project, the Company records an asset and related financing obligation for the amount of the total project costs and an amount related to the pre-existing, leased building, which is included in Property and Equipment, Net and Long-Term Debt, respectively, on the Consolidated Balance Sheets. Once construction is complete, the Company determines if the asset qualifies for sale-leaseback accounting treatment. If the arrangement does not qualify for sale-lease back treatment, the Company continues to amortize the obligation over the lease term and depreciates the asset over its useful life. The Company does not report rent expense for the portion of the rent payment determined to be related to the properties which are owned for accounting purposes. Rather, this portion of the rental payments under the lease are recognized as a reduction of the financing obligation and interest expense.

The Company recorded a cumulative correction during the fourth quarter of Fiscal 2011 relating to four specific leasing transactions to recognize approximately $33 million of long-lived assets and a corresponding financing obligation in long-term debt. In connection with the cumulative correction during the fourth quarter of Fiscal 2011, the Company reversed $1.2 million of previously recognized expense, primarily rent expense, of which $1.1 million related to reversal of expense recognized during the first three quarters of the current fiscal year. The Company does not believe the correction was material to any current or prior interim or annual periods that were affected.

STORE PRE-OPENING EXPENSES

Pre-opening expenses related to new store openings are charged to operations as incurred.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

DESIGN AND DEVELOPMENT COSTS

Costs to design and develop the Company’s merchandise are expensed as incurred and are reflected as a component of “Marketing, General and Administrative Expense.”

NET INCOME PER SHARE

Net income per basic share is computed based on the weighted-average number of outstanding shares of Class A Common Stock (“Common Stock”). Net income per diluted share includes the weighted-average effect of dilutive stock options, stock appreciation rights and restricted stock units.

Weighted-Average Shares Outstanding and Anti-Dilutive Shares (in thousands):

 

     2011     2010     2009  

Shares of Common Stock issued

     103,300        103,300        103,300   

Treasury shares

     (16,452     (15,239     (15,426
  

 

 

   

 

 

   

 

 

 

Weighted-Average — basic shares

     86,848        88,061        87,874   

Dilutive effect of stock options, stock appreciation rights and restricted stock units

     2,689        1,790        735   
  

 

 

   

 

 

   

 

 

 

Weighted-Average — diluted shares

     89,537        89,851        88,609   
  

 

 

   

 

 

   

 

 

 

Anti-Dilutive shares