| The Company cautions that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained in this Form 10-K or made by management involve risks and uncertainties and are subject to change based on various important factors, many of which may be beyond its control |
| Words such as “estimate,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” and similar expressions may identify forward-looking statements |
| The following factors in some cases have affected and in the future could affect the Company’s financial performance and could cause actual results to differ materially from those expressed or implied in any of the forward-looking statements included in this report or otherwise made by management: • changes in consumer spending patterns and consumer preferences; • the impact of competition and pricing; • disruptive weather conditions; • availability and market prices of key raw materials; • currency and exchange risks and changes in existing or potential duties, tariffs or quotas; • availability of suitable store locations on appropriate terms; • ability to develop new merchandise; • ability to hire, train and retain associates; and • the effects of political and economic events and conditions domestically and in foreign jurisdictions in which the Company operates, including, but not limited to, acts of terrorism or war |
| Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict |
| Therefore, there can be no assurance that the forward-looking statements included in this report will prove to be accurate and the inclusion of such information should not be regarded as a representation by the Company, or any other person, that its objectives will be achieved |
| Except as may be required by applicable law, the Company assumes no obligation to publicly update or revise its forward-looking statements |
| Because forward-looking statements involve risks and uncertainties, the Company cautions that there are important factors, in addition to those listed above, that may cause actual results to differ materially from those contained in the forward-looking statements |
| These factors include the following: 7 _________________________________________________________________ [42]Table of Contents The Loss of the Services of Skilled Senior Executive Officers Could Have a Material Adverse Effect on the Company’s Business |
| The success of the Company’s business is dependent upon its senior executive officers closely supervising all aspects of its business, in particular the designing of its merchandise and operation of its stores |
| The Company’s senior executive officers have substantial experience and expertise in the retail business and have made significant contributions to the growth and success of its brands |
| If the Company 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, John W Lough, Executive Vice President – Distribution Center Logistics and Michael W Kramer, Senior Vice President and Chief Financial Officer, its business could be adversely affected |
| Competition for such senior executive officers is intense and the Company cannot be sure that it will be able to attract and retain a sufficient number of qualified senior executive officers in future periods |
| The Company’s success is largely dependent on its ability to anticipate and gauge the fashion preferences of its customers, and provide merchandise that satisfies constantly shifting demands in a timely manner |
| The merchandise must appeal to each brand’s corresponding target market of consumers whose preferences cannot be predicted with certainty and are subject to rapid change |
| Because the Company enters into agreements for the manufacture and purchase of merchandise well in advance of the applicable selling season, it is vulnerable to changes in consumer preference and demand, pricing shifts and the sub-optimal selection and timing of merchandise purchases |
| There can be no assurance that the Company will be able to continue successfully to anticipate consumer demands in the future |
| To the extent that the Company fails to anticipate, identify and respond effectively to changing consumer preferences and fashion trends, its sales will be adversely affected and inventory levels for certain merchandise styles no longer considered to be “on trend” may increase, leading to higher markdowns to reduce excess inventory or increases in inventory valuation reserves, which could have a material adverse effect on its financial condition or results of operations |
| Comparable Store Sales Will Fluctuate on a Regular Basis, Which in Turn May Cause Volatility in the Price of the Company’s Common Stock |
| The Company’s 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 20prca, have fluctuated significantly in the past on an annual, quarterly and monthly basis and are expected to continue to fluctuate in the future |
| The Company believes that a variety of factors affect comparable store sales results including, but not limited to, fashion trends, actions by competitors, economic conditions, weather conditions, opening or closing of Company stores nearby, such as the opening of the New York City Flagship store, and calendar shifts of holiday periods |
| Comparable store sales fluctuations may have in the past been an important factor in the volatility of the price of the Company’s common stock, and it is likely that future comparable store sales fluctuations could contribute to future stock volatility |
| Although the Company considers comparable store sales an important metric when it analyzes its results, the Company primarily focuses on the long-term aspirational positioning and profit potential of each brand |
| 8 _________________________________________________________________ [43]Table of Contents The Company’s Market Share May Be Adversely Impacted at any Time by a Significant Number of Competitors |
| The specialty retail industry is highly competitive |
| The Company competes primarily on brand differentiation |
| It competes against a diverse group of retailers, including national and local specialty retail stores, traditional department stores and mail-order retailers |
| The Company faces a variety of competitive challenges, including: • anticipating and quickly responding to changing consumer demands and preferences; • maintaining favorable brand recognition and effectively marketing its products to consumers in several diverse market segments; • developing innovative, high-quality products in colors and styles that appeal to its target consumer; and • sourcing merchandise efficiently |
| There can be no assurance that the Company will be able to compete successfully in the future |
| The Interruption of the Flow of Merchandise from Key International Manufacturers Could Disrupt the Company’s Supply Chain |
| The Company purchases the majority of its merchandise from outside the United States through arrangements with approximately 240 foreign manufacturers located throughout the world, primarily in Southeast Asia and Central and South America |
| In addition, many of its domestic manufacturers maintain production facilities overseas |
| Political, social or economic instability in Southeast Asia as well as Central and South America, or in other regions in which the Company’s manufacturers are located, could cause disruptions in trade, including exports to the United States |
| Other events that could also cause disruptions to exports to the United States include: • the imposition of additional trade law provisions or regulations; • the imposition of additional duties, tariffs and other charges on imports and exports; • quotas imposed by bilateral textile agreements; • foreign currency fluctuations; • restrictions on the transfer of funds; and • significant labor disputes, such as dock strikes |
| Historically, substantially all of the merchandise the Company imports has been subject to quotas that restrict the quantity of textile or apparel products that can be imported into the United States annually from a given country, and a significant majority of the Company’s purchases of such products was from World Trade Organization (WTO) member countries |
| The United States has agreed, as of January 1, 2005, to a phase out of import quotas for WTO member countries |
| As a result, the Company should be able to freely import textile and apparel products from WTO member countries in which its suppliers have their manufacturing facilities |
| However, the United States and China have reached an agreement to place quantitative restrictions on a number of products, including many textiles and apparel products |
| The outcome of this agreement could have a significant impact on worldwide sourcing patterns in Fiscal 2006 and going forward |
| The extent of this impact, if any, and the possible effect on the Company’s purchasing patterns and costs, cannot be determined at this time |
| 9 _________________________________________________________________ [44]Table of Contents In addition, the Company cannot predict whether any of the countries in which its merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the United States or other foreign governments, including the likelihood, type or effect of any such restrictions |
| Trade restrictions, including increased tariffs or quotas, embargoes, safeguards and customs restrictions against apparel items, as well as US or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of apparel available to the Company and adversely affect its business, financial condition or results of operations |
| The Company does not maintain any long-term or exclusive commitments or arrangements to purchase from any single supplier |
| The success of the Company’s operations depends, to a significant extent, upon a number of factors that influence discretionary consumer spending, including economic conditions affecting disposable consumer income such as employment, consumer debt, interest rates, inflation and consumer confidence |
| In addition, the Company estimates that a material portion of its sales in urban areas are to foreign tourists |
| As a result, fluctuations in foreign currency exchange rates and strengthening of the US dollar with respect to foreign currencies could result in decreased sales to these consumers |
| There can be no assurance that consumer spending will not be negatively affected by general or local economic conditions, thereby adversely impacting the Company’s business, financial condition or results of operations |
| The Company’s Reliance on a Single Distribution Center Makes It Susceptible to Disruptions at or Adverse Conditions Affecting Its Distribution Center |
| The Company’s only distribution center for the receipt, storage, sorting, packing and distribution of merchandise to all of its stores and direct consumers is located in New Albany, Ohio |
| As a result, the Company’s operations are susceptible to local and regional factors, such as accidents, system failures, economic and weather conditions, natural disasters, and demographic and population changes, as well as other unforeseen events and circumstances |
| If the Company’s distribution center operations were disrupted, its ability to replace inventory in its stores could be interrupted and sales could be negatively impacted |
| In addition, the Company ‘s distribution center operations could reach capacity |
| Currently, a second distribution center is under construction at the Company’s New Albany campus, which is expected to be fully functional in late Fiscal 2006 |
| Any significant interruption in the operation of the Company’s distribution center or delay in the construction of the second distribution center could have a material adverse effect on its financial condition or results of operations |
| The Company’s Growth Strategy Relies on the Addition of New Stores and Remodeling of Stores Each Year, Which May Strain the Company’s Resources and Adversely Impact the Current Store Base Performance |
| Part of the Company’s growth strategy depends on opening new stores, remodeling existing stores in a timely manner and operating them profitably |
| For Fiscal 2006, the Company expects to open approximately 100 to 110 new stores and remodel 10 to 20 stores |
| Successful implementation of the Company’s growth strategy depends on a number of factors including, but not limited to, obtaining desirable prime store locations, negotiating acceptable leases, completing projects on budget, supplying proper levels of merchandise and the hiring and training of store managers and brand associates |
| Additionally, the new stores may place increased demands on the Company’s operational, managerial and administrative resources, which could cause the Company to operate less effectively |
| Furthermore, there is a possibility that new stores that are opened in existing markets may have an adverse effect on previously existing stores in that market |
| Failure to properly implement the Company’s growth strategy could have a material adverse effect on its financial condition or results of operations |
| Historically, the Company’s operations have been seasonal, with a significant amount of net sales and net income occurring in the fourth fiscal quarter, reflecting 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 |
| The Company’s net sales and net income during the first and second fiscal quarters typically are lower due, in part, to the traditional retail slowdown immediately following the Holiday season |
| As a result of this seasonality, net sales and net income during any fiscal quarter cannot be used as an accurate indicator of the Company’s annual results |
| In addition, any factors negatively affecting the Company during the third and fourth fiscal quarters of any year, including adverse weather or unfavorable economic conditions, could have a material adverse effect on its financial condition or results of operations for the entire year |
| Also, in order to prepare for the Back-to-School and Holiday selling seasons, the Company must order and keep in stock significantly more merchandise than it would carry during other parts of the year |
| High inventory levels due to an unanticipated decreases in demand for the Company’s products during peak selling seasons, misidentification of fashion trends or excess inventory purchases could require the Company to sell merchandise at a substantial markdown, which could reduce its net sales and gross margins and negatively impact its profitability |
| The Company does not own or operate any manufacturing facilities |
| As a result, the continued success of the Company’s operations is tied to its timely receipt of quality merchandise from third-party manufacturers |
| A manufacturer’s inability to ship orders in a timely manner or meet the Company’s quality standards could cause delays in responding to consumer demands, negatively affect consumer confidence in the quality and value of the Company’s brands and negatively impact the Company’s competitive position and could have a material adverse effect on the Company’s financial condition or results of operations |
| In order to generate customer traffic, the Company locates many of its stores in prominent locations within successful shopping centers |
| The Company cannot control the development of new shopping centers, the availability or cost of appropriate locations within existing or new shopping centers, competition with other retailers for prominent locations or the success of individual shopping centers |
| In addition, factors beyond the Company’s control impact shopping center traffic, such as general economic conditions and consumer spending levels |
| A slowdown in the US economy could negatively affect consumer spending and reduce shopping center traffic |
| A significant decrease in shopping center traffic could have a material adverse effect on the Company’s financial condition or results of operations |
| Furthermore, in pursuing its growth strategy, the Company will be competing with other retailers for prominent locations within successful shopping centers |
| If the Company is unable to secure these locations or is unable to renew store leases on acceptable terms – as they expire from time-to-time – it may not be able to continue to attract the number or quality of customers it normally has attracted or would need to attract to sustain its projected growth |
| All these factors may also impact the Company’s ability to meet its growth targets and could have a material adverse effect on its financial condition or results of operations |
| 11 _________________________________________________________________ [46]Table of Contents The Company’s Reliance on Third Parties To Deliver Merchandise from Its Distribution Center to Its Stores Could Result in Disruptions to Its Business |
| The efficient operation of the Company’s stores depends on their timely receipt of merchandise from the Company’s distribution center |
| An independent third party transportation company delivers the Company’s merchandise to its stores |
| This company employs personnel represented by labor unions |
| Disruptions in the delivery of merchandise or work stoppages by employees of this third party 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 this third party to respond adequately to the Company’s distribution needs would disrupt its operations and could have a material adverse effect on its financial condition or results of operations |
| The Company has spent significant time and money designing, documenting and testing its internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act |
| Section 404 requires management’s assessment of the effectiveness of the Company’s internal controls over financial reporting as of the end of each fiscal year and a report by the Company’s independent registered public accounting firm addressing management’s assessment and the effectiveness of the internal controls as of that date (See “Item 9A Controls and Procedures”) |
| The Company does not expect that its internal control over financial reporting and, more broadly, its disclosure controls and procedures will prevent and/or detect all errors and all fraud |
| A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met |
| Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected |
| These inherent limitations include the realities that judgments in decision-making can be faulty, projections of any evaluation of effectiveness to future periods have risks and breakdowns can occur because of a simple error or mistake |
| Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management’s override of any control |
| Because of its inherent limitations, disclosure controls and procedures and internal control over financial reporting may not prevent or detect misstatements |
| Further, these sorts of controls and procedures must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs |
| A Manufacturer’s Failure To Comply with Applicable Laws, Regulations and Ethical Business Practices Could Adversely Impact the Company’s Business |
| The Company’s policy is to use only those sourcing agents and independent manufacturers who operate in compliance with applicable laws and regulations |
| The violation of laws, particularly labor laws, by an independent manufacturer, or by one of the sourcing agents, or the divergence of an independent manufacturer’s or sourcing agent’s labor practices from those generally accepted as ethical in the United States or in the country in which the manufacturing facility is located, and the public revelation of those illegal or unethical practices could cause significant damage to the Company’s reputation |
| Although the Company’s manufacturer operating guidelines promote ethical business practices and Company representatives periodically visit and monitor the operations of the independent manufacturers, the Company does not control these manufacturers and cannot guarantee their legal and regulatory compliance |
| 12 _________________________________________________________________ [47]Table of Contents The Company’s Litigation Exposure Could Exceed Expectations, Having a Material Adverse Effect on Its Financial Condition or Results of Operations |
| The Company is involved, from time-to-time, in litigation incidental to its business, such as litigation regarding overtime compensation and other employment related matters |
| In addition, the Company currently is involved in several purported class action lawsuits and several shareholder derivative actions, as well as a SEC investigation, all regarding trading in the Company’s Class A Common Stock in the summer of Fiscal 2005 (collectively, the “Securities Matters”) |
| (See “Legal Proceedings |
| ”) Management believes that the outcome of the pending litigation and administrative investigation will not have a material adverse effect upon the financial condition or results of operations of the Company |
| However, management’s assessment of the Company’s current exposure could change in the event of the discovery of damaging facts with respect to legal matters pending against the Company or determinations by judges, juries or other finders of fact that are not in accord with management’s evaluation of the claims |
| Should management’s evaluation prove incorrect, particularly in regard to the overtime compensation and other employment related claims and the Securities Matters, the Company’s exposure could greatly exceed expectations and have a material adverse effect upon the financial condition or results of operations |
| The Company’s Failure To Adequately Protect Its Trademarks, Abercrombie & Fitch®, abercrombie®, Hollister Co |
| ® and Ruehl Nodtta 925® Could Have a Negative Impact on Its Brand Image and Limit Its Ability To Penetrate New Markets |
| The Company believes that its trademarks Abercrombie & Fitch®, abercrombie®, Hollister Co |
| ® and Ruehl Nodtta 925® are an essential element of the Company’s strategy |
| The Company has obtained or applied for federal registration of these trademarks, has pending trademark registration applications for other trademarks in the United States and has applied for or obtained registrations in many foreign countries in which its manufacturers are located |
| There can be no assurance that the Company will obtain such registrations or that the registrations the Company obtains will prevent the imitation of its products or infringement of its intellectual property rights by others |
| If any third party copies the Company’s products in a manner that projects lesser quality or carries a negative connotation, the Company’s brand image could be materially adversely affected |
| Because the Company has not yet registered all of its trademarks in all categories or in all foreign countries in which it now or may in the future source or offer its merchandise, its international expansion and its merchandising of products using these marks could be limited |
| For example, the Company cannot assure that others will not try to block the manufacture, export or sale of its products as violative 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 which the Company is 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 registration applications is pending or unclear, for a third party owner of the national trademark registration for a similar mark to enjoin the manufacture, sale or exportation of branded goods in or from that country |
| If the Company is unable to reach a licensing arrangement with these parties, the Company’s manufacturers may be unable to manufacture its products, and the Company may be unable to sell, in those countries |
| The Company’s inability to register its trademarks or purchase or license the right to use its trademarks or logos in these jurisdictions could limit its ability to obtain supplies from or manufacture in less costly markets or penetrate new markets should the Company’s business plan include selling its merchandise in those non-US jurisdictions |
| The Company recently launched a new anti-counterfeiting program, under the auspices of the Abercrombie & Fitch Brand Protection Team, whose goal will be to improve the current practices and strategies by focusing on eliminating the supply of illicit Abercrombie & Fitch Co |
| 13 _________________________________________________________________ [48]Table of Contents The Brand Protection Team will interact with investigators, customs officials and law enforcement entities throughout the world to combat the illegal use of the Company’s trademarks |
| Although brand security initiatives are being taken, the Company cannot guarantee that its efforts against the counterfeiting of its brands will be successful |
| The Company’s Long-Term Growth Strategy Depends on the Development of New Brand Concepts |
| Historically, the Company has grown by adding new brand concepts every several years and may continue to do so in the future |
| Each new brand concept requires management’s focus and attention as well as significant capital investments |
| Furthermore, each new brand concept is susceptible to risks such that include lack of customer acceptance, competition from existing or new retailers, product differentiation, production and distribution inefficiencies and unanticipated operating issues |
| Even though the Company’s past brand concepts have been successful, there is no assurance that new brand concepts will achieve similar results |
| Any new brand concept could have a material adverse effect on the Company’s financial condition or results of operations |
| Modifications and/or Upgrades to Information Technology Systems May Disrupt Operations |
| The Company regularly evaluates its information technology systems and requirements and is currently implementing modifications and/or upgrades to its information technology systems supporting the business, including its purchasing and real estate systems |
| Modifications involve replacing legacy systems with successor systems, making changes to legacy systems or acquiring new systems with new functionality |
| The Company is aware of inherent risks associated with replacing and changing these systems, including accurately capturing data and system disruptions and believes it is taking appropriate action to mitigate the risks through testing, training and staging implementation as well as securing appropriate commercial contracts with third-party vendors supplying such replacement technologies |
| Information technology system disruptions, if not anticipated and appropriately mitigated, could have a material adverse effect on its financial condition or results of operations |
| Additionally, there is no assurance that a successfully implemented system will deliver value to the Company |
| The Company’s International Expansion Plan Is Dependent on a Number of Factors, Any of Which Could Delay or Prevent the Successful Penetration into New Markets and Strain Its Resources |
| As the Company expands internationally, it may incur significant costs related to starting up and maintaining foreign operations |
| Costs may include, and are not limited to, obtaining prime locations for stores, setting up foreign offices and distribution centers and hiring experienced management |
| The Company will be unable to open and operate new stores successfully and its growth will be limited unless it can: • identify suitable markets and sites for store locations; • negotiate acceptable lease terms; • hire, train and retain competent store personnel; • successfully gain acceptance from its foreign customers; • foster current relationships and develop new relationships with vendors that are capable of supplying a greater volume of merchandise; • manage inventory effectively to meet the needs of new and existing stores on a timely basis; • expand its infrastructure to accommodate growth; • generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund its expansion plan; and • manage its foreign exchange risks effectively |
| 14 _________________________________________________________________ [49]Table of Contents In addition, the Company’s proposed international expansion will place increased demands on its operational, managerial and administrative resources |
| These increased demands may cause the Company to operate its business less effectively, which in turn could cause deterioration in the performance of its stores |
| Furthermore, the Company’s ability to conduct business in international markets may be affected by legal, regulatory, political and economic risks |
| Direct-to-Consumer Sales Include Risks that Could Have a Material Adverse Effect on the Company’s Financial Condition or Results from Operations |
| The Company’s direct-to-consumer operations are subject to numerous risks that could have a material adverse effect on its operational results |
| Risks include, but are not limited to, the following: (a) diversion of sales from the Company’s stores; (b) difficulty in recreating the in-store experience on a web site; (c) the opportunity that domestic or international resellers will purchase merchandise and re-sell it overseas outside the Company’s control; and (d) risks related to the failure of the systems that operate the web sites and their related support systems, including computer viruses, theft of customer information, telecommunication failures and electronic break-ins and similar disruptions |
| The continued threat of terrorism and related heightened security measures in the United States may disrupt commerce and the US economy |
| Any further acts of terrorism or a war may disrupt commerce and undermine consumer confidence, which could negatively impact sales revenue by causing consumer spending and/or shopping center traffic to decline |
| Furthermore, an act of terrorism or war, or the threat thereof, could negatively impact the Company’s business by interfering with its ability to obtain merchandise from foreign manufacturers |
| The terrorist attacks of September 11, 2001 caused disruptions to the Company’s supply chain |
| Any future inability to obtain merchandise from the Company’s foreign manufacturers or substitute other manufacturers, at similar costs and in a timely manner, could have a material adverse effect on its financial condition or results of operations |