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Casual apparel retailer Abercrombie & Fitch Co. (ANF - Analyst Report) posted third-quarter 2013 earnings per share of 52 cents, missing the Zacks Consensus Estimate of 44 cents by nearly 18%. Lower-than-expected results were primarily due to a decline in sales during the quarter.

Including one-time charges related to the restructuring plans for Gilly Hicks, store impairment charges and implementation of the ongoing profit initiative, the company reported a loss per share of 20 cents compared with earnings per share of $1.02 in the prior-year quarter.

Sales and Comps

Abercrombie’s net sales for the quarter dipped 11.7% to $1,033.3 million from $1,169.6 million in the year-ago quarter, primarily due to weak performance in the domestic market, partially offset by robust sales abroad. Moreover, the quarterly revenue missed the Zacks Consensus Estimate of $1,035.0 million.

Additionally, the weak sales results for the quarter reflect continued weakness in the overall spending among youngsters.

The decrease in total sales reflects a decline of 18% in total domestic sales (including direct-to-consumer sales) to $674.9 million, partially offset by a 2% increase in international business (including direct-to-consumer sales) to $358.4 million.

Overall, direct-to-consumer sales increased 10% year over year to $174.6 million. Including direct-to-consumer sales, the company’s total comparable-store sales (comps) decreased 14%. The plunge in comps mainly resulted from a 14% downside in U.S. comps and a 15% decline in International comps. However, comps benefited from an 11% rise in direct-to-customer comps.

Brand-wise, Abercrombie’s comparable sales including direct-to-consumer sales at its Abercrombie & Fitch, abercrombie kids and Hollister stores declined 13%, 4% and 16%, respectively. The company’s Abercrombie & Fitch, abercrombie kids and Hollister brands generated revenues of $387.8 million, $89.9 million and $534.0 million, respectively.

Quarter in Detail

In the quarter, gross margin contracted 130 basis points (bps) to 63.0% primarily driven by inventory write-downs related to the closures of Gilly Hicks stores.

Stores and distribution expenses, as a percentage of sales, increased 400 bps to 46.5% from the prior-year period, primarily due to the impact from comps decline and higher direct-to-customer expenses, offset partly by lower store payroll, store management and support expenses; as well as other stores and distribution costs.

Moreover, marketing, general and administrative expenses, excluding charges related to restructuring of Gilly Hicks and the ongoing profit enhancement initiative, declined 3% to $119.8.

Balance Sheet

Abercrombie ended the quarter with cash and cash equivalents of $257.5 million, borrowings under the Term Loan Agreement of $138.8 million and shareholders’ equity of $1,675.0 million. As of Nov 2, 2013, inventories were approximately $768.9 million.

Dividend

On Nov 19, 2013, the company’s board of directors announced a quarterly cash dividend of 20 cents per share payable on Dec 17, 2013 to shareholders of record as of Dec 2, 2013.    

Store Update

During the quarter, the company opened 5 international Hollister chain stores and a flagship Abercrombie & Fitch store in Seoul. The Hollister stores opened in the quarter included the company’s first store in Japan. Further, the company launched a combined Abercrombie & Fitch and abercrombie kids store as well as a Hollister store in Italy.

The company ended the quarter with a total of 1,063 stores, including 287 Abercrombie & Fitch stores, 151 abercrombie kids stores, 597 Hollister Co. stores and 28 Gilly Hicks stores.

Restructuring Plans for Gilly Hicks

On Nov 1, 2013, Abercrombie decided to shut down all its stand-alone Gilly Hicks stores and continue offering the brand’s intimate apparel through its Hollister stores and direct-to-customer channels. The company expects to close all its Gilly Hicks stores by the end of first-quarter fiscal 2014.

In relation to the store closures, the company expects to incur about $90 million of pre-tax charges. During the third quarter, the company incurred $37.9 million as asset impairment charges and $6.8 million charges associated with lease and other expenses. Balance of the expected $90 million charges will be incurred in the fourth quarter of fiscal 2013 and first-quarter fiscal 2014.

Apart from the aforementioned charges, the company recorded an operating loss of $12 million in the third quarter associated with the Gilly Hicks operations.

In concurrence with the plans to close Gilly Hicks stores, the company has amended its existing credit and term loan agreements, facilitating the company to exclude a maximum of $60 million cash charges related to the Gilly Hicks restructuring from its calculation of minimum coverage and maximum leverage ratios.

Moreover, the company’s minimum coverage ratio requirement will be reduced for the time being up to second-quarter fiscal 2015. The amendments mentioned became effective from Nov 4, 2013.

Outlook

Abercrombie projects fiscal 2013 adjusted earnings to range from $1.40-$1.50 per share, mainly driven by the expectation of low double-digit comps in the fourth quarter. Additionally, the company expects gross margin to decline substantially in the fourth quarter, keeping the gross margin flat in fiscal 2013. For the full year, the company anticipates tax rate in the mid 30’s range, including a $4.9 million tax benefit in the third quarter.

During fiscal 2013, Abercrombie intends to open nearly 20 international Hollister stores, while opening only a few international and domestic outlet stores. It also plans to shut down 40–50 domestic stores through lease expirations during the year. Further, the company expects to inaugurate its Shanghai Abercrombie & Fitch store in spring 2014.

The company anticipates capital expenditure of approximately $200.0 million towards new store openings and other planned expenditures in fiscal 2013.

Other Stocks to Consider

Currently, Abercrombie carries a Zacks Rank #5 (Strong Sell). Better-ranked stocks in the apparel retail industry include Fossil Group Inc. (FOSL - Analyst Report), Finish Line Inc. (FINL - Snapshot Report) and DSW Inc. (DSW - Snapshot Report). All of these carry a Zacks Rank #2 (Buy).

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