Abercrombie & Fitch Co (ANF) 2002 Q2 法說會逐字稿

Good afternoon.

My name is Jill and I will be your conference facilitator today.

At this time, I would like to welcome everyone to Abercrombie & Fitch second quarter earnings 2002 conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star then the number one on your telephone keypad.

If you would like to withdraw your questions, press the pound key.

Thank you.

Mr. Lennox, you may begin your conference.

Good afternoon and welcome to our second quarter conference call.

After the market closed, we emailed to your offices the second quarter sales and earnings release, balance sheet, income statement, and an updated financial history.

If you haven't received these materials, call Courtney Depenhart at 614-283-6751 and she will forward them to you.

This call is being taped and can be replayed by dialing 1-800-642-1687.

You will need to reference the conference ID number 2426045 to access the replay.

You may also access the replay through the Internet at www.abercrombie.com.

With me today are Mike Jeffries our Chairman and CEO, Seth Johnson, Executive Vice President and COO, and Wes McDonald, Vice President and CFO.

After Seth reviews our financial results, Mike will have some comments and then we'll take your questions.

Before we begin, I remind that you any forward-looking statements we may make today are subject to the Safe Harbor statement found in our SEC filings.

Now to Seth.

Good afternoon.

Total sales for the second quarter of fiscal 2002 were $329.2 million, up 18 percent over last year's second quarter sales of $280.1 million.

Comparable store sales for the quarter decreased 5 percent.

By business, comps for the quarter were as follows.

For Abercrombie & Fitch, comps declined in the mid single digits with women's stronger than men's.

Comps for our kids business Abercrombie were slightly better than the adult business.

As Mike will discuss in more detail, girls business is showing significant improvement and achieved a positive comp for the quarter.

By regions our comps were strongest in the Northeast and weakest in the Midwest.

During July, we performed best in Texas, the South and the Northeast.

Gross income rate for the quarter was 40.1 percent, up 140 basis points from last year's rate of 38.7 percent.

The increase in margin resulted largely from higher initial markup.

Continued progress in sourcing has been an important factor in improving our markup in all three of our businesses.

We are particularly pleased with the progress we are making in Hollister, where our initial markup improved almost 10 percentage points versus last year in the quarter.

Partially offsetting improvement in markup was an increase in buying and occupancy cost as a percent of sales.

This increase reflects the inability to leverage fixed costs with the comp store decrease.

The second quarter markdown rate was also slightly higher due to the impact of our promotional strategies and our desire to end the quarter as clean as possible in Spring carryover inventory.

Our carryover as measured in dollars per average store was more than 20 percent below last year at the end of July.

We continue to maintain very tight control of inventory.

We ended the second quarter with inventories down 9 percent per square foot versus last year at cost.

With better-than-projected July sales, we were more aggressive in markdowns of summer carryover merchandise.

As we enter the fall season, we will begin to anniversary significant decreases in inventory last year.

Although we remain cautious in our commitments to protect our sales potential, we are planning to be up versus last year in inventory per square foot at the end of the both the third and fourth quarters.

As many of you recall, we ended January last year down 30 percent per square foot in inventory.

A level that negatively impacted our first quarter volume.

To protect the Spring 2003 business we are targeting a double-digit increase per square foot at the end of this year.

The second quarter SG&A rate was 25.0 percent, 60 basis points higher than last year's 24.4 percent rate.

The increase in rate versus last year resulted from increases in home office and marketing expenses.

Partially offsetting the increases of the percentage of sales were improvements in store expenses and distribution costs.

The increase in the home office expense rate largely resulted from higher incentive compensation costs versus last year reflecting the strong increase in year-to-date net income.

Marketing costs increased as a percent of sales primarily due to the costs of our direct mail strategies.

During the second quarter, we reduced our store payroll hours by 5 percent per average Abercrombie & Fitch adult store and realized savings in part-time hourly wage rates of 1 percent versus last year.

The reduction in hours in our kids' stores for the quarter was 15 percent per average store and we achieved a 2 percent rate reduction in the part-time hourly wage rate.

We continue to be very pleased with the performance of our distribution center.

During the second quarter, our productivity as measured in units processed per labor hour was 67 percent higher than we achieved last year.

For the quarter, we processed 45 percent more units than last year with fewer labor hours.

We continued to improve the operational productivity of our e-Commerce business since we brought our e-Commerce and catalog fulfillment in-house in mid-April, we have reduced our fulfillment costs per order over 20 percent.

We have also benefited from more efficient inventory management.

Operating income increased for the quarter by 24 percent from $39.9 million to $49.6 million.

Net income for the quarter also increased 24 percent from $25 million to $31.1 million.

Second quarter earnings per share on a fully diluted basis were 31 cents versus 24 cents last year, an increase of 29 percent.

During the quarter, we repurchased 1 million shares in the open market as part of our previously authorized share repurchase program.

At our most recent Board of Directors meeting, the Board authorized the repurchase of an additional 5 million shares of Abercrombie & Fitch Class A common stock.

This action increases the total number of shares authorized for repurchase to $5.85 million.

The timing of share purchases will depend upon market condition.

We opened 6 adult stores, 4 kids and 17 Hollister stores during the second quarter, giving us a total of 316 adult stores, 157 kids' stores, and 60 Hollister stores.

We temporarily closed 1 Abercrombie & Fitch store for remodeling which will re-open later this year.

For fiscal 2002, our current plans are to open 35 adult stores, 18 kids stores, and 61 Hollister stores for a total of 114 stores.

Total square footage will grow 19 percent over last year.

This is slightly less than our previous estimate and reflects our policy of not compromising the quality of our real estate deals.

We continue to be pleased with the sales productivity generated by our new stores.

During the quarter, Abercrombie & Fitch adult stores opened during the past 12 months generated approximately 90 percent of the sales per square foot of the existing store base.

This relationship has been fairly consistent over the past several years.

For fiscal 2002, our planned capital expenditures will be between $105 and $115 million.

The vast majority of these expenditures relate to new store construction with the remainder invested in IT and distribution center projects.

We have increased our CAP-X projection for this year roughly $10 million as a result of our decision to expand our current distribution center.

Our DC initially was designed to be easily expanded and the added square footage will handle our growth needs through 2007.

In total the project will add slightly over 200,000 square feet bringing our total DC space to around 900,000-square-foot.

The added square footage will enable to us handle fulfillment in house for a Hollister e-Commerce business which we expect to begin in 2003.

We expect the project to be complete in less than a year and cause no disruption to the business.

Now I'd like to discuss our profit expectations for the remainder of the year.

Based on the continued uncertainty regarding the economy, the stock market, and consumer confidence, we must be very cautious in our expectations for the balance of fiscal 2002.

We are comfortable with the First Call consensus estimate of 49 cents per share for the third quarter.

Looking further out, which is very difficult in this environment, we are taking a very cautious approach.

As you know, this year there will be fewer shopping days between Thanksgiving and Christmas and in the fourth quarter, we will anniversary the significant expense reductions and productivity improvements we achieved last year.

These factors will limit our ability to achieve significant earnings growth without an improvement on the comp trend.

Nevertheless, at this point we are comfortable with an EPS estimate of 85 cents for the fourth quarter, which would put us at the mean current street First Call EPS estimates of $1.88 for the year.

Now Mike will talk about our results in more detail.

The second quarter was a very solid quarter for Abercrombie & Fitch.

Despite a challenging economic environment, we continued to focus on what we can control, our brand and the bottom line.

We exceeded our financial goals and I believe we will be well positioned when the economy recovers.

Now I would like to talk about our business from a merchandising perspective.

July is a transitional month for our business with sales a combination of summer clearance and initial selling of our back-to-school assortment.

Year our back-to-school assortment is much more focused on wear now merchandise as opposed to more traditional heavier weight goods.

So far this wear now emphasis has been effective with each categories trending much better than than heavier weight classifications such as sweaters.

We continue to see stronger trend in women's than men's.

The fashion focus in women's remains feminine, sexy with woven and knit tops performing very well.

In bottoms I feel very good about the denim business and there is a very strong trend in corduroy.

Women's jackets have been excellent with corduroy and denim driving the classification.

I'm also very pleased with the women's underwear business.

On the negative side, sweaters continue to be a very tough classification.

The men's business continues to be tough.

July's men's comps were similar to women's due to a very strong short business.

A year ago we had very little short inventory entering July and missed significant business.

This year, we plan to enter the month in a much stronger inventory position in both planned and achieved very strong comps in men's shorts in July.

So far, our back-to-school selling in men's has been focused on wear now with polos and tees performing well.

As in women's, the sweater business has been tough.

As we expected, denim is a very important classification in our back-to-school men's business.

Although I feel very good about our men's assortment, I expect women's to outperform men's through the fall season.

I believe we are making progress in our kids business.

Kids overall had a slide slightly better comp than adults for the quarter and the girls business is starting to trend very well.

Girls had a solid positive comp for both the quarter and July.

We have focused on adding more newness and more SKUs in girls and we are beginning to see results.

Shirts, skirts, denim and knit tops are trending well in girls with denim and knit tops doing well in boys.

I'm very pleased with the performance of Hollister.

For the second quarter, sales per square foot in the Hollister stores were over 80 percent of the Abercrombie & Fitch adult stores in the same malls.

We believe ultimately that Hollister can be as productive, if not more productive, on a per square foot basis as A&F.

The girls business continues to be more significant than guys representing over 60 percent of the overall business.

More importantly, Hollister's productivity is consistent and there remains no evidence of cannibalizing the A&F stores in the same centers.

As the Hollister store base expands, the business continues to become more efficient.

We have made solid progress in reducing the construction costs of the store and we see additional opportunity in this area.

Seth mentioned our progress in improving our IMU in Hollister and we have remained on track with our plan to be at a similar initial markup as the A&F business in 2003.

Earlier today, we announced an agreement with Creative Artists Agency, a leading talent and literary agency to help with strategic marketing programs for Hollister.

CAA will provide motion picture, music and television property tie-in opportunities for Hollister especially as it relates to our Club Callie program.

Club Callie which is designed to reward our most loyal customers is off to a great start.

Since we kicked off the Club Callie program in mid-July we have added over 170,000 members that have accounted for almost 220,000 in-store transactions.

Prizes associated with the Club Callie program may include television show walk-on roles, VIP trips to major movie premieres or back stage passes to concerts.

I believe Club Callie will create exciting brand-building opportunities for Hollister much like the magalogue does for the adult business.

Our e-Commerce business continues to become a larger part of our business.

Internet sales in both the kids and adult businesses grew by over 40 percent during the second quarter as compared to last year.

As Seth mentioned earlier, we are planning to add a Hollister e-Commerce business in 2003.

As we look forward to the balance of the year, I feel we have the right fashion and our businesses are well positioned.

Our organization has never been stronger.

However, with the environment still very uncertain, we have to be very cautious.

We will remain disciplined in our approach to manage the business and will continue to focus on building our business for the future.

Now we are available to take your questions.

Please limit yourself to one question so that we can speak with as many callers as possible.

After everyone has had a chance, we will be happy to take follow-up questions.

At this time, I would like to remind everyone in order to ask a question, please press Star then the number 1 on the telephone keypad.

We'll pause for just a moment to compile the Q & A roster.

Your first question comes from -- Robert Ohms with Morgan Stanley.

Thank you.

My one question is, can we get a bit of a discussion on, you know, the gross margin opportunities related to IMU for the back half of this year?

And then how that might tie into the way you would be planning average price points for fall and holiday as well as, you know, the approach to promotional activity for fall and holiday.

Thanks.

Okay.

The first question relates to IMU outlook for the balance of the season and then a the -- other question related to average -- how that related to average retails.

We expect to see some continued improvement versus LY in markups through the balance of the year.

As we mentioned, we have made dramatic improvement in Hollister and we're also above last year in both Abercrombie & Fitch and Little Abercrombie.

From a planning standpoint, we are targeting to try to keep retail as close to last year as possible.

The wear now emphasis for back to school has created a mix difference in which it's been difficult to maintain the total AUR versus last year.

We are selling many more units but the AUR is less because they are more weighted towards lower retail items like tee shirts and polos versus the sweaters and heavier weight goods but there is no strategy going forward to, uhm, sell comparable goods at lower retails.

Your next question is from Jeb Klinefelter with US Bancorp.

One quick question, Mike.

Could you discuss a little bit on the Hollister trends?

It seems like you're sounding as much if not even more confident about that strategy and we're also hearing things from a few other companies that this West Coast Lifestyle is definitely gaining momentum.

Looking back at when you started it, are you seeing even more strength and a more positive reception to it now?

And, you know, and how might that change your strategy going forward?

I'm very, very bullish about Hollister, and the thing that makes me most bullish is how well we're opening and operating that business in all locations across the country.

We're in some malls that are certainly -- would be considered malls that we wouldn't put in Abercrombie & Fitch, where we're performing very well from a demographic point of view, we're performing, uhm, well in all areas of the country.

And we're opening these stores very strongly.

I think there is a fashion cycle to what we're talking about.

There's a vintage surf thing that's going on that is help that business but I think a California lifestyle has an ongoing relevance to the young people in this country.

So I -- I -- I view the long-term prospects of Hollister just as -- as -- as excellent.

Am I more bullish about the business than when we opened it?

Yeah, because we have really solid results.

Okay, thank you.

Your next question comes from Stacy Pak with Prudential Securities.

Hi.

I was wondering if you could tell us how comps are so far in August and what SG&A dollars we should be looking for in the back half.

First question is can we talk about comps so far for August.

The answer is no, we never talk about comps within a month.

We'll report those comps after we complete the month.

In terms of SG&A, we have added some jobs, not a lot, in the home office for the balance of fall, primarily in the Hollister organization.

We continue to manage the store payroll hours very tightly and are continuing to improve D.C. productivity.

But the SG&A rates will improvement there, uhm, or uhm, higher rates will depend on what the comps are.

At the current comp trend it's represented by July's minus 3, SG&A rates will be higher in the back half of the year than last year.

Your next question comes from Mark Friedman with Merrill Lynch.

Thank you.

Good afternoon, guys.

High, Mark.

Hey.

Mike, could you talk a little bit more about sweaters with this shift to buy now wear now are you still disappointed as to where sweaters performed in July or you know, we did still have a hot month?

Do you still think that's an issue?

Is there a trend that you should -- you can discuss with us about the sweater business?

What you might be doing?

Yeah.

To start I think the trend -- the sweater trend is poor, regardless of the weather.

There's just not good trend in sweaters.

Our sweater -- the sweaters we have now are more wear now than last year.

They are cotton, they're not wool.

We're in new classifications, crochet, uhm, but it's still a tough business.

And I anticipate that's women's and it's the same issue in men's.

I anticipate the sweater business remaining tough for third and fourth quarter and we simply have to overcome those dollars with other classifications.

I'm confident that we can.

But I don't have great optimism for the sweater business for the balance of this year.

Your next question comes from Dana Cohen with Bank of America.

Oh.

Hi guys.

Mike, can you talk a little bit, maybe just aggregate again the men's versus the women's business?

I mean, the women's business looks terrific.

The product looks great and yet, you know, the comps have not gone positive here.

Can you just aggregate how much you think in product versus competition versus macro women's versus men's?

And then second, Seth, could you -- I apologize.

Could you just repeat the inventory numbers again and why they are still down 9 percent?

I was getting a call interrupting me.

I apologize.

Thanks.

I -- I honestly, uhm, don't think we're -- we're missing much in the women's business.

I think we're up against a pretty healthy business and a think the environment is tough out there we have been impacted in the women's business by negative comps in women's sweaters.

And I'm pretty comfortable that we can overcome those for the balance of the year.

But I don't see an ebullient business in the women's business.

I think it's going to be better than men's but I don't think we are going to see breakthrough comps.

Are we going to be positive?

Yeah.

How positive I don't know.

But the women's business is doing what I would consider to be very well.

We are turning our inventories faster than last year.

Our margins are up significantly.

Our merchandise margins are up significantly.

We're selling what we have.

We're just not pushing for big increases in that business.

The men's business continues to be tough but at the same time, -- but the same thing holds there we're turning our inventories faster, our margins are up considerably over the last year.

Our sell-throughs are good.

We are not stretching in terms of inventory.

We are not -- because demand for the whole classification, I don't think, is great.

And I think -- what I -- what I have said before I'll say again.

We do not chase businesses with low margin.

We're not pursuing a low margin promotional strategy in the business which could impact our comps, but would not do anything for the brand long term and I think would be negative not bottom line.

This is a time that we look to maximizing the bottom line and improving the health of the brand.

And I think that's exactly what we are doing.

To follow up on the inventory question, we ended the second quarter down 9 percent per square foot of cost versus last year.

We exceeded our sales projection for July and were able to take additional clearance markdowns on our carryover goods versus our previous projections.

We ended the quarter with our carryover inventory meaning spring and summer goods down 20 percent a store versus last year.

One additional factor in our inventory management is that as we started back to school and saw the very strong trend even stronger than we had estimated in the selling of wear now goods, we pushed out some deliveries of some of the heavier weight fall goods into August and early September.

So thats would -- those with the elements that resulted the lower inventory level which we're very comfortable with.

Great, thank you.

Your next question comes from Jeff Stinson with Midwest Research.

Good afternoon.

I was wondering if you could talk a little bit about the promotional strategy you guys had in place here for the second quarter and how we may see that trend for you guys in the back half of the year.

The promotional strategy involves some direct mail and bouncebacks.

We continue to evaluate the effectiveness of those promotions and are still doing so.

I'm not at liberty to talk about what we're going to be doing in the back half for competitive reasons.

But I can say we're spending a lot of time evaluating the effectiveness of what we've done and we'll continue to do so. [ Pause ]

Your next question comes from Marcia Aaron with Pacific Growth Equity.

Good afternoon.

Could you talk a little bit more about inventory levels and, Mike, do you think you're constraining your business by not investing more and maybe you can give us a sense for if you back out the carryover, what the level is of Fall inventory on a per store basis or a per foot base this year versus last year?

Can you give us those figures, Seth?

I don't have the figure off the top of, uhm, my head.

But obviously, we're, uhm, we're not down as significantly as the minus 9 at the end of the quarter in fall and basic goods but I think we're being very cautious in our commitments.

We don't know what the sales trend's going to be throughout the rest of the season.

And I think the answer is yes, we always err on the side of missing business, versus putting ourselves at risk.

But I think, Marcia, the point is we continue to focus on improving the bottom line.

We have a very healthy business.

We're turning our stocks aggressively.

Could we be missing some business?

Yes.

But I think it only helps the brand on an ongoing basis.

We don't have significant end-of-season markdowns to clear through.

We have high sell-through at regular prices.

We are enhancing the brand and we're improving the bottom line significantly.

And that's going to be our continued focus.

Mike, do you have the opportunity to capitalize on some of the real strength that you've seen, for example, you know, as I have been out in the stores, your cord skirt and cord jacket are virtually nonexistent at the store level at this point.

Can you capitalize on that business or is it just gone?

Oh, no.

Well, the skirt business is practically -- that's really an early back-to-school business.

But clearly, the rest of corduroy, we're going to maximize.

We're very aggressive about that business.

Very.

Great.

Thank you.

Thanks, Marcia

Your next question comes from Maura Byrne with Salomon Smith Barney.

Good afternoon.

With respect to the inventory, Seth, could you just give a little bit more guidance on third quarter -- I think you gave year end but if you could just clarify year end as well as the end of the third quarter?

And then an update on the dock workers strike.

Do you do a fair amount of reordering on quick turns?

If you could talk a little bit about your quick strategies there.

At the end of the third quarter our best guess, at this point is that we'll be up in likely the mid single digits per square foot.

In terms of the dock workers strike, it really had minimal impact on our deliveries back to school.

Most of our goods had already come before that issue started.

And it's just something that we're monitoring on a daily basis.

We don't expect any significant impact.

So you have had no slowdown of goods coming in?

No.

No.

Not at all.

Thank you.

Thanks Maura.

Your next question comes from John Morris with Gerard Klauer Mattison.

Hi, Mike.

Unless I missed it earlier, can you talk a little bit about the accessories business?

It seems like that's been a key area of strength for you guys.

Can you confirm that?

And tell us, you know, as a percent of the mix, uhm, you know, where you see it going in the second half of this year and, you know, what kind of margins come with that?

Is that -- I think that's a higher margin business, also.

Thanks.

Yeah.

Our accessory business has been growing.

We are projecting increases in it for the second half.

It probably should increase just about a percentage point as a percent of the business.

It's currently about 5 percent of the women's business.

We plan to take it to 10 but for the second half, probably only a percentage point increase.

It does carry higher margins but that -- I wouldn't project that difference into any kind of model in terms of our total business.

The belt business has been very strong, continues to be strong.

We think that offers us opportunity for the whole fall season.

The women's belt business.

In men's accessories, we're very successful with knit hats at this point.

That carries a high margin rate.

But again, there won't be significant impact on the business in terms of those businesses for the second half.

Thanks.

Thanks

Your next question comes from Emmie Kozloff with Stanford Bernstein.

Mike, can you talk about the drivers of the IMU improvement at Hollister?

Is it sourcing or pricing and in terms of the execution of the back-to-school product at Hollister, it does look surprisingly similar to A&F.

Do you consider it sufficiently differentiated?

Thanks.

First, the differentiation, I think it is very different from Abercrombie & Fitch.

And I think it -- it -- it gets more, uhm, differentiated by season.

I'm -- I'm really -- I'm really proud of the differences in that business.

And, and -- and I think the mark of that is that it is a very successful business at very high productivity rate and it's not cannibalizing any of the A&F business in the same mall.

Were it that similar to A&F, we would certainly see cannibalization because we're committed to prices that are 30 percent lower than A&F.

So the improvement in the IMU has come exclusively from better sourcing, from better costs.

The pricing is static.

The retail pricing is fixed and the improvement came from better costs.

This was expected because we have been a very small business and as we grew, as we grow that business, we're achieving a critical mass that does enable us to source better.

So, it was planned.

In terms of the tax rate going down a full percentage from last year, is that sustainable going forward.

Yeah.

I think you should use the base tax rate should be 38.75 going forward.

The reason it's down so much is that we have chosen to invest the cash in tax-frees which you calculate the tax rate quarterly and the first and second quarters it's usually a bigger -- [ lost audio ]

Your next question comes from Barbara Wycoff with Buckingham Research.

Hi, guys.

Uhm, couple questions.

Hollister women's 60 percent of the total.

Is Abercrombie in the kids, girls, starting to get towards that level from the 55 percent range?

And then I have a question about the operating margins in Hollister.

[ no audio from the executives ]

Hello?

One moment, please.

Okay, go ahead.

Barbara?

Hi.

Hi, I'm sorry.

I think we cut out.

Your question was the percentage of business in A&F and Abercrombie women's versus men's.

Right.

A&F and Little Abercrombie is in excess of 50 percent but is not as high as Hollister which is slightly in excess of 60 percent.

I believe that A&F and Abercrombie will achieve that kind of percentage over time because that's just the ratio of masculine to feminine business in most businesses like this.

Go ahead.

Okay.

Second question I had was, uhm, is it possible that over time, Hollister operating margins can be, you know, similar to A&F with a different sourcing structure, uhm.

Yes.

That's our expectation.

And as I said, in 2003, our initial markup percentage in Hollister will be very similar to A&F.

I believe that their markdowns should run at the same rate should take it to operating margin.

I believe it's on track to achieve higher per square foot productivity than A&F.

It's not at this point but I think as the brand gains momentum, it clearly will be and even in smaller square footage stores, I believe the potential -- we strongly believe that the potential is to achieve A&F operating margins.

Okay.

And where would we expect kids operating margins to go relative to A&F?

We expect them to be lower and to -- and to, uhm, not get to the A&F levels.

There is a difference in initial markup percentage and merchandise margin of about 2 points.

And I think it's going to be a stretch to get that kids business to the dollars per foot productivity of the adult business.

I think it can grow but I don't think it's going to be to the A&F level.

So the operating margin in kids will not equal adults.

Okay.

Thanks.

Thanks Barbara.

Your next question is from Jennifer Black with Wells Fargo Securities.

Congratulations on a business you -- you manage the business well.

Thank you.

Uhm, I wondered if you can talk a bit about the variety of price points you have on the girls and guys side?

It seems as though you kind of mixed up the price points a little more than what you had last year which seems like that would be a positive.

Mixed them up in what sense, Jennifer?

Well.

It seems you have some lower priced and higher price versus last year, I don't remember you have a $59.50 pair of denim but maybe I'm wrong.

That is just a function of fashion.

We are taking more fashion chances there.

So it's not a change in strategy.

Just where fashion's taking us.

Ok.

And when will you be reporting comps on Hollister?

Likely we won't be doing it this year because it's just not significant enough yet in the number of comp stores.

It's something we'll be looking at next year when we have a lot more comp stores.

Okay.

Thank you very much.

Your next question is from Ellen Schlossberg with William Blair.

Thanks.

Mike, a couple of questions.

First just a follow-up.

You mentioned that you weren't overly concerned about the negative comps for sweaters as other categories could make up for it and if you could just be more specific there.

That would be helpful.

And then also as you look back to early back-to-school in summer, is there anything that would you do differently next year?

Whether it's slow timing merchandise or what is it not.

Back to school -- uhm, I think -- the classifications that are trending well now are to make up for sweaters in women's - wovens, fleece and cutting some knits and those classifications will continue to trend into fourth quarter.

I believe that in those classifications, we could make up the sweater dollars.

The back-to-school, what I would do differently in back-to-school, uhm, I probably would have, uhm, front-loaded, uhm, more denim in that we did have some fallout in terms of production in the denim classification.

Denim is a very difficult thing to source.

We do experience some quality fallouts and I think I would have just front loaded that business more aggressively than I did this year.

That's the primary difference I would think.

Okay.

And then with respect to inventory levels, uhm, you had mentioned where they would go by the end of third quarter, but I'm assuming that they are going to build pretty fast in August?

Given that some of the deliveries were late?

So, in other words, should most of August see inventory per-square-foot actually even if not up, not kind of using the negative trend that we would into the month?

I don't know that we're going to necessarily be up during the month.

It will be -- it will be increasing versus the beginning of the month.

We're also going to begin clearing some of the initial back-to-school wear now merchandise in August.

So that will be going the other way in terms of inventory.

But we're -- some of where we are now is by intent in terms of pushing out some of the deliveries of the heavier-weight goods and those will be impacting us more as we get further into August and September.

Okay.

All right.

Thanks.

Thanks, Ellen.

Your next question comes from Richard Baum with CSFB.

Good afternoon, everybody.

Hi, Richard.

Hi, guys.

Most of my questions have been asked but I just -- I guess I had one other that I just wanted to talk to you about which is the IMU and the sourcing improvements that you have done.

I guess -- I understand on the with regard to Hollister that is mostly just a question of critical mass and size.

But what have you been able to do specifically on the Abercrombie side to improve the IMU and I know, Seth, you indicated that you expected this to continue through the end of the year.

But when you get into next year, could you just give us a sense of whether or not you think you can continue to get better IMUs and what sorts of steps you would take in order to do that

The improvement in sourcing is an ongoing program, Richard, and that is that we're constantly searching the world for new quality factories at -- at better wage rates.

We have been successful in doing that.

Our sourcing arm is doing a terrific job at identifying these factories for us.

It has been on on going basis.

As you look at the history of our business, we have seen better costs in goods for the last few years.

I think you also have to recognize we're in a deflationary cycle in terms of apparel, and it is -- it's -- it's, uhm, a combination for us of that and new factories, new labor sources, that are enabling us to make these improvements in the existing businesses.

Will we count on doing that on an ongoing basis?

We can't I can't count on it for next year because I can't really -- it's tough to see around that corner but we're going to fight like crazy to make it happen as we do on a weekly basis here.

Are you finding like better factories in your current countries or are you finding -- are you moving production into new countries?

It's mostly into new countries.

Into -- into new labor markets.

Can you you can you provide any comments about the countries?

No, I'd rather not.

I'd rather not.

Okay.

Just enough to say that there aren't many automobiles in most of those countries.

Your next question comes from Kindra Devaney with Fulcrum Global Partners. [ Audio cutout ]

... property margin, with both Hollister and Abercrombie kids being below the company average, can you quantify how much that's dragging down the total company?

In terms of what, dollars per foot --

No total operating margin.

Fabulous operating margin performed with the negative comps and you have two underdeveloped businesses and I'm just wondering, you know, how much those are dragging down, a couple hundred basis points?

It's -- without giving out a specific number it depends a lot on what our comps are in the other businesses.

I think at the current trend, it's probably a few hundred basis points.

And you expect that that can improve as Hollister matures?

Well, Hollister will get better and we also believe at some point we'll start doing better comps than Abercrombie & Fitch and the kids business and that can help drive the margin there, as well.

Great.

Thanks a lot.

Good luck.

Thanks.

Your next question comes from Joe Teklits with Wachovia Securities.

Thanks, hi and good quarter.

Thanks, Joe.

Mike you - your guidance for Q4.

I think you gave the guidance for Q4, of 85 cents, you said if current comp trends continue, I believe, this is what we expect in Q4.

I'm just curious in that EPS guidance for Q4 what the comp assumption actually is.

I think we said if the current trend continues, that's what we expect.

That would incorporate negative comps then?

That's what we are saying.

That's correct.

That's correct?

That is correct.

Even though you expect inventory per square foot to be up at the end of the third quarter.

And --

Because I'm really driving for better than that, I would hope for that.

And is that mostly because of this issue of less days between Thanksgiving and Christmas or just a combination of everything that, you know, we're hearing today?

Uhm, I think we're being cautious just because we're, uhm, we're still in a negative comp trend and, uhm, it -- it's not prudent to just expect a turnaround until we see something more -- we are going to have to deal with having fewer days between Thanksgiving and Christmas.

We're not sure what that will do.

But we just need to be cautious right now.

Okay so that implication also is basically you're applying that comps in your guidance are negative for the remainder of the year?

We don't really believe in giving comps guidance.

We're giving earnings guidance.

We're giving earnings guidance and saying that these earnings are -- are -- are what we're projecting with the continued comp trend.

Okay.

We hope to do better.

Good.

Hope you do.

Good luck.

Thanks.

Your next question comes from Kimberly Greenberger with Lehman Brothers.

Great.

Thank you.

Good afternoon.

Hi, Kimberly.

Uhm, last year if I remember post 9/11 I believe you cancelled a catalog.

Can you confirm that?

And what are your direct plans for the second half of this year?

And then lastly, at the beginning of the season, I noticed some sweaters were brought out that were on promotion it seemed like from the beginning of the floor set.

Were those -- do you have a strategy in terms of carryover merchandise?

Were those from last year?

And if so, can you talk about the margin potential impact from that?

Okay.

The answer is that the sweaters that were promoted were not last year's sweaters.

They were this year's sweaters.

And they were promoted because they were tested in June and we felt we would do better by promoting them than not.

But they were new sweaters.

The second part of the -- the first part of your question was about canceling the magazine last year, we did cancel it for Christmas.

We will have a magazine for Christmas this year.

We did not cancel the catalog, however.

That did go out.

There was a catalog but the magazine was cancelled.

But we will have a magazine this year.

Okay, great.

Thank you.

Thank you.

Your next question comes from Dorothy Lakner with CIBC World Markets.

Thanks.

Good afternoon, everyone.

Could you give us a little bit of color in terms of merchandising strength at Hollister, whether those are the really the same as what you spoke about earlier, Mike, or are there any particular differences you might highlight and specifically speaking to the women's and the men's business?

The women's is obviously a big part of Hollister.

Yeah.

The women's is a bigger percentage of Hollister than it is for A&F.

The trends by classification are similar.

The merchandise is different.

I'd say the -- probably the biggest difference in, uhm, Hollister would be the relative strength of the top business in both men's and in both guys and girls in Hollister versus bottoms at -- in those businesses.

We're more highly penetrated in tops in Hollister.

That's penetrated versus A&F than in bottoms.

Which I think is interesting but is a reflection of a new brand and I think as that business develops, the bottoms business, we are concentrating on developing the bottoms business but I think that comes naturally as a brand becomes more familiar and more of a destination store.

So that's something that you saw early on in the Abercrombie brand as well?

Yes.

And so as you look at the penetration rate in tops versus bottoms.

Just to take the bottoms to the tops presentation -- penetration, we have huge volume potential in Hollister.

That's what gives me great confidence that the productivity per foot in Hollister really will at some point in the future exceed A&F's.

That's a natural growth prospect.

Okay.

And then just one other thing on the sweater issue.

You also mentioned one of the strengths is in the jacket business?

Correct.

Would that be something that's taking a way some of the sweater business?

It was really -- was it much of a category a year ago for you?

No.

It wasn't.

That's a really good question.

Because what that jacket business is anniversarying was that strong cardigan wrap sweater business of last year, kind of that second layer business.

Right.

So it actually -- it is.

Thank you.

That's a good question.

Thanks.

Okay.

Your next question comes from Lauren Levitan with S.G. Cowen.

Good afternoon.

I want to revisit the back half guidance again if we could.

I understand that the 85 cents that you've mention assumes a continuation of the recent comp trends which have been negative.

Although I also understand that you hope that you can exceed that.

If we assume as of that as you mentioned it would be much less likely to achieve leverage on SG&A during the fourth quarter, given the dramatic expense cuts that you had last year, what should we anticipate driving that 8 to 9 percent EPS growth and are additional repurchase shares assumed in that kind of level of earnings??

Thanks.

The answer is we're' not basing this on lowering the share count through share repurchase.

Our assumptions really don't have repurchase in them from a projection standpoint.

We obviously have square footage growth.

We have new stores opening that have been very productivity and A&F and Hollister and were -- we have a strong -- as we talked about a strong trend in initial markup and we think our margin can be very strong with, uhm, continued tight control of inventory markdowns.

That's helpful.

Mike you mentioned you thought over time Club Callie as important to Hollister as the magazine is to Abercrombie & Fitch.

Do you see any opportunity to use a similar type of loyalty program in either Little Abercrombie or the adult business?

Not in the adult business.

I'm very happy with the way that business is marketed.

There could be an opportunity in the kids business.

That's a very good question.

I think that the Club Callie the -- part of the Club Callie that is the most intriguing is not the frequent purchase kind of giveaway part of the program but more tying us to the romance of California through how we're marketing (indiscernible) with the club.

So I don't view it as -- I don't view it as the -- I don't view the primary importance of that program as any kind of a price promotional strategy, although that's part of it.

But the real driving force is in how we're positioning the business.

Thank you.

Thanks.

Your next question comes from Rob Wilson with Retail Stock Investors.

Yes.

Stellar quarter.

Can you give us some guidance on store count for next year given that you've lowered store counted for this year and maybe a preliminary number of capital expenditures for next year?

And also last year same quarter you had a deferred tax asset.

This year you have a deferred tax liability.

Did something change in your tax strategy this year versus last?

Thanks.

I'll talk about the store count.

We're not ready to put out a specific number but I think you can expect that next year, we'll open at least a number of stores that we have had this year.

They will likely be more , -- Hollisters', probably 30 or so A&Fs and we expect to probably have more kids stores next year than this year.

But I think it's safe to assume at least this year's amount of store openings.

I think CAP-X would be pretty similar to this year less the distribution center that we talked earlier.

So ballpark 100 million dollars.

In reference to the shift in the deferred tax asset to liability, it's really a function of some accelerated depreciation methods that you use for tax.

As we have increased our store base, we have added more and more newer stores versus previous years.

We expect it to remain a liability for the next few years.

All right.

Thank you.

Thank you.

Your next question comes from Dana Tellcy with Bear Stearns.

Good afternoon.

Just wanted to follow up a little bit on denim.

Denim was popular this year and last year.

How do you think denim is different this year from last year in terms of the longevity of the cycle of the performance of denim?

And also it sounds like corduroy is going to increase in importance.

Does the percentage of the mix dedicated to those bottoms differ as we move over time?

Thank you.

Yeah.

The answer to that question, Dana, is that corduroy has increased as a percentage of the business and will continue to do so through the fourth quarter.

Denim is growing as a percentage of the business but not as great a rate as corduroy.

Does that answer your question?

Your next question is from Elliot Laurence with Jefferies & Company.

Good afternoon.

I hope she gets back on that question.

This question was actually touched on a little bit but could I have a little more detail on how the subtle differences associated with transitioning from wear now from full fall weight in August, that's when markdowns start to what level the markdowns hit and how you transition new product into the store and how that new product flows in prior to Labor Day particularly in the markets with later back to schools?

The answer to the question, if I understand it correctly, is that a greater percentage of our back-to-school set, which set the 4th of July was what we would consider to be wear now, warm weather merchandise.

Short-sleeved goods, lighter weight goods, those goods were set as of Labor Day -- as of the 4th of July and will mark down as of Labor Day.

There will be more product that is heavier weight flowing into the stores in the beginning of September this year than last.

So it is a different strategy.

It has fewer -- I believe fueled our business at this point and I think the fact that there will be more newness in September will -- will -- will drive that business.

And to go further, then, the -- while a year ago you -- you aggressively cut your spring, summer inventory -- carryover inventories --

Which we --

And did this year, also, fall weight, but this year, theoretically as we head into Labor Day, you are going to have, you know, wear now clothes on sale -- a fair amount of wear now clothes on sale in the stores for back to school.

That is correct.

And would it therefore be your assumption that if there isn't a collapse in overall mall traffic, that in and of it serve the promotions on the wear now product should drive business?

I would hope so.

But you know, we're in a tough economic cycle, and just tough to predict that you can drive the total business at predictable levels with markdowns today.

It should work, but we're in wear now merchandise now while it's hot, and, uhm, and the increases have been difficult to come by.

So that's our strategy.

I think we're doing what is right for the business and we'll see the result.

Thank you.

Thanks.

Your next question comes from Josh Schwartz with Columbia Partners.

Hey, Josh.

Hey, guys, how are you?

Good.

How are you?

Wonderful, wonderful job.

Only one person has said it to you but this is a second.

Thank you, Josh.

I had a couple of quick ones here.

Mike, on the number of stores, just, you know, for your total plans in the future, is it still the same of four, four and six to eight hundred?

Yes.

Absolutely the same.

I'm more confident than ever that it's 800 not 600 so that might be a subtle change.

Right.

And it sounds -- we should basically -- what you're saying though is Little A now with the lower margin business now so you want to fuel more of the current growth with Hollister stores?

That's -- that's correct.

And again, help us reach critical mass in Hollister at an earlier date.

I know you don't want to touch on this too much, but you are still working on the fourth concept, so is the goal at least for the next three to four years to grow somewhere around 20 percent square feet or is that something you don't want to say right now?

We don't have a specific model we're giving out, but I would expect the square footage growth to drop somewhat from the 20 percent over the next few years.

Okay.

Let me just ask you a question on the way you have been managing the inventory.

Is it the right assumption that you go into the planning processing, you want to have inventory so that you can sell through at a given gross margin rate?

Is that how you think about it?

Yes.

That's absolutely correct.

Okay.

And that takes into what you're seeing in comps and you're saying basically, like last -- you know, going into first quarter, we want to be down 20 percent because we don't know what the comp will be and we just want to make sure we have a gross margin of x percent.

We've protected ourselves to that level.

We are probably too tight in terms of inventory last -- first quarter.

That's why we're going to raise it this year.

But that's exactly the planning process we go through.

And then just a last question.

I'm out of my office.

I don't -- I don't have the balance sheet, so I didn't see what the cash balance was at the end of the quarter.

But the real question I have on that is, have you -- Seth, what's your thinking on what the cash cushion is now with this -- with the level of stores that you have and will have at the end.

Year, what you feel comfortable withholding on the balance sheet?

That's a good question.

I don't know if I have a specific number to give out.

I think the cash cushion gets -- needs to be bigger every year as the base of stores and volume increases.

But, uhm, you know, we did just, uhm, announce a 5 million share repurchase authorization, so we're obviously thinking of using some of that cash strategically to buying shares.

Okay.

Last thing, what was the price on the shares, the million shares?

I think it was around 23 and change.

Okay.

Thanks a lot, guys.

And just great job.

Thanks, Josh.

Your next question comes from Quinton Specter with Lipton Financial.

Good afternoon.

Quick question before I get to the main thing, which is what's the D&A to date or -- in the quarter?

And, uhm, secondly, you've cut back on your, uhm, store payroll quite a bit over time and other overhead, and I just wondered whether, when you start comping positively again, that will snap back or whether you've permanently changed your store model and whether there is anything you've given up in doing that in terms of service or appearance or anything like that?

Okay.

Quinn, I'll take your questions.

D&A by quarter was 12 in the first, 14 in the second, and we project it to be 15 in both the third and the fourth for a total of 56 million for the year.

As far as store hours and the way we give out store hours, it's really fluctuates with sales.

So as comps turn positive, we would expect to be giving the stores out more hours to make sure the customers are taken care of.

But we think that is a function of customer flow.

I don't believe we've given up anything in terms of the look of our stores.

And I don't think there are many people out there who think that we look anything but better than we ever have.

I'm comfortable that we do.

Okay, thank you.

Thanks.

Operator: Your next question comes from Michael Ganzon with [Callboat] Capital.

Good afternoon.

I was wondering if you guys could identify about how many stores from the kids and Hollister were in the comparable store base.

Sure.

We'll lock that up.

And then just another question.

You talked a little bit earlier about potential margin impacts of a few hundred basis points from those two concepts.

Do you guys have a sense of sort of what preopening costs have been running on a quarterly basis?

Okay.

We'll look that up.

First Hollister and kids, what they represented in the comp store number.

Hollister was insignificant.

At the end of July it was about 112 kids stores.

And 12 Hollisters.

And preopening?

Costs?

It was the second part of the question.

Preopening costs is insignificant.

Probably $50,000 a store.

Which is just some payroll for the few weeks of setting up the store and travel for the people that we have pre-opening team we send to do it.

Your next question is from Mark Picard with Omega.

Hi, thank you.

Congratulations, as well.

My question is, if y'all planning flatish to down comps and there hasn't been any full change -- well, you are not planning hoping for, there hasn't been -- you're hoping for better.

There hasn't been any meaningful change it sounds like, to the way that your scheduling labor and it doesn't sound like there is a big variance in preopening quarter to quarter.

How should I look at the quarterly progression of selling expenses vis-a-vis last year and even the year before?

Last year, sequentially, absolute dollars went up $4 million and embedded in some of your guidance now is a much more significant sequential increase in dollars of selling.

And I'm just trying to see why the third quarter as a percent to the total year would grow again so much if the other pieces are being held fairly constant.

And the same for the fourth quarter.

Well, I -- Mark, I can't really address selling costs as a total number by quarter.

We really plan, uhm, based on the individual stores and, uhm, volume level that the store is at.

So at this point, we're planning hours based on, you know, the overall comp level we're generating.

And we'll flex up if we're doing better comps.

We don't have any, uhm, the -- main driver in the increased payroll dollars is really, uhm, more stores.

Okay.

Okay, so I mean, year-over-year, should there be this dramatic increase in absolute dollars from the second quarter selling expense level to the third quarter level?

To be honest, Mark, we haven't given out selling expense number for the second or third quarters.

So I can't speak to numbers that we haven't even talked about.

I mean, I can tell you in the third quarter, uhm, you know, we'll have additional home office expense because we have added a few heads.

And we also might have some more marketing expense versus last year because we'll have Club Callie in there but that's really it.

The third quarter is --

Your next question comes from Eric Spell with (indiscernible) Capital.

What's the full diluted share count at the end of the quarter?

Fully diluted share count end of the quarter is 101465.

Thanks.

Your next question comes from David [INAUDIBLE] with Deutchen Capital.

Hey, guys.

Sorry to keep this call longer than it necessarily has to but I have one quick question.

Shoot.

A couple of competitors and I know you're focused solely on your business but there obviously is some serious competition out there.

Couple of those competitors have come out recently with news that have basically implied a very strong finish to July and one of the competitors, a very strong beginning to August and I was hoping you could comment in relation to your own business, obviously, without talking about comps, but whether, you know, anything on that -- of that sort that you've seen in your business.

We can't really comment on weekly trends and particularly versus other businesses.

Thank you.

You have a follow-up question from Stacy Pak with Prudential Securities.

That's okay.

I'll talk to you off line.

Thanks.

Your next follow-up question is with John Morris with Gerard Klauer Mattison.

That's okay for me, too.

Thank you guys.

Thanks.

Your next follow-up question is from Barbara Wycoff with Buckingham Research.

Well, I will ask mine. [ Laughter ] Couple of questions about merchandise-related.

Can you talk a little bit about gym issue, how it did through the July period?

And then also, a little bit about Silhouettes, men's and women's, bottoms.

Is this low-rise pant still important?

Are there any in coming Silhouettes sort of an uptown cargo, you know, is athletic going to be bigger?

And then how much of a factor is corduroy in men's?

I presume it's much more important in women's than men's.

Answer corduroy is much more important in women's than men's.

Low-rise critical importance in women's.

Starting to gain momentum in men's.

I think that the whole -- we're in an era of sexy apparel.

And so it makes perfect sense as to why it is happening.

Gym Issue is, uhm, -- -- is successful, uhm, is -- is changing, uhm, the -- the -- that business we're making more technical, more modern, and more different from our sportswear assortments so that we can record incremental business there.

I feel that Gym Issue in the past has been too similar to sportswear and, therefore, has just been a trade-off from the sportswear business.

So we're working very hard to make that look and feel different as a brand within a brand and I think if you look at that carefully you can see that there is -- that that -- that is happening.

It's more modern, more technical fabrics, clearly body conscious, but our total stock is.

But that's even more so than the rest of the inventory.

Okay.

Thanks a lot.

Thanks.

Your next follow-up question is from Ellen Schlossberg with William Blair.

Can you guys give square footage by concept for the end of the quarter?

And then also, just back with this adding back the magalogue for Christmas, does the magalogue pretty much pay for itself such that the additional SG&A in this year versus last year to produce that should be offset by additional sales or not necessarily?

Let me address the magalogue first.

Last year, we did send catalogs to the magalogue subscribers so it wasn't a total save and then we also donated whatever savings we had to charity - trade center victims (overlapping speakers).

Okay.

So there is really no impact there.

This year.

The square footage for adults, it's two million 852.

Kids, 701.

Hollister, 383.

Hollister 383?

Yes.

Okay.

Thanks.

Your next question is a follow-up question from Kindra Devaney with Fulcrum global partners.

I'm all set, thanks, guys.

Your next question is also a follow-up question from Joe Teklits with Wachovia Securities.

Hi, thanks.

Just one quick one.

I don't want to back you into a wall on anything here.

Just looking out the next spring, let me confirm that you said your inventory will be up double digits per square foot at the end of the Q4?

Yeah.

That's correct.

Is it safe to assume given your most recent strategy that you wouldn't push inventory up double digits per square foot if you didn't think could you do positive comps?

I think it's more of a function that we were down 30 percent per square foot at the end of last year and that hurt the early spring business.

Will you talking about positive COMPS for next spring, Joe?

Yes.

Well, I don't think we want to be giving a comp guidance number for spring '03 right now.

There is a long way to go between now and then.

Obviously, we're very optimistic about where our business is going but the environment is very tough.

We hurt ourselves last year being down 30 percent in spring.

We need more just to sustain that level of business we did.

Okay.

Fair enough.

Thanks a lot.

Your last question is a follow-up question from Kimberly Greenberger with Lehman Brothers.

Just a quick question on Hollister.

It sounds like the rollout is going very well for you.

Can you talk about operationally the things that you put in place to ensure a smooth rollout, given the incredible growth on a year-over-year basis that that division is experiencing?

Well, we're building the infrastructure there.

We've appointed a director of stores who was a strong regional manager in Abercrombie and Fitch.

We're building the visual team which is a very important part of our success there.

We are adding to the designer count.

We are adding to the merchant count.

And we're -- we're building the infrastructure of that business, Kimberly, much as we built it for Abercrombie & Fitch, kind of at the same pace, at the same volume level.

We feel very comfortable with where we're going because we did it in the adult business.

But I'm very comfortable with this aggressive rollout that we have the right organization.

We're probably in better shape than we were in Abercrombie & Fitch because the people we're doing it with have been trained in Abercrombie & Fitch.

We had to kind of invent the way as we grew A&F.

So I'm very comfortable with the rollout.

Thank you.

Sir, you have another question from Tom Raboli with SAC Capital.

Shoot.

Hello?

Are you there? [ Pause ]

Sir, at this time, there are no further questions.

Thank you very much.

Thank you for participating in today's conference call.

You may now disconnect.