Abercrombie & Fitch Co (ANF) 2004 Q3 法說會逐字稿

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  • Operator

  • Good day, and welcome to the Abercrombie & Fitch third quarter results conference call.

  • [OPERATOR INSTRUCTIONS].

  • At this time, I'll turn the call over to Mr. Tom Lennox.

  • Please go ahead.

  • Tom Lennox - Director, IR and Corporate Communications

  • Good morning and welcome to our third-quarter conference call.

  • Before I begin, I would like to explain that we issued our press release, and moved the call to this morning in response to our signing a consent decree last evening regarding the pending class-action diversity lawsuits.

  • We apologize for any inconveniences this late and unusual change may have caused, and thank you for rearranging your schedules to participate in the call.

  • We e-mailed to your offices the quarterly sales and earnings release, the balance sheet, income statement, and an updated financial history.

  • And if you haven't received these materials, please call Jill Swansiger (ph) at 614-283-6751 and she will forward them to you.

  • This call is being taped and can be replayed by dialing 1-888-203-1112.

  • You will need to reference the conference ID number, 627270, to access the replay.

  • You may also access the replay through the internet at Abercrombie.com.

  • With me today are Mike Jeffries, our Chairman and Chief Executive Officer, Bob Singer, President and Chief Operating Officer, and Sue Riley, Senior Vice President and Chief Financial Officer.

  • After Sue reviews our financial results, Bob will comment on the business, and then Mike will discuss the business from a merchandising perspective.

  • Today's earnings call will be limited in time to one hour.

  • After our prepared comments, we will be available to take your questions for as long as time permits.

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

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

  • Now, to Sue.

  • Sue Riley - SVP and CFO

  • Thanks, Tom.

  • Thanks everybody for joining us this morning.

  • Total sales for the third quarter were $520.7 million, a 17% increase versus last year's third-quarter sales of $445 million.

  • Comparable store sales increased 1% for the quarter.

  • By business, comps were as follows.

  • In the Adult business, Abercrombie & Fitch comp store sales declined 2%.

  • Men's comps increased by 8%, while Women's comps decreased by 6% for the quarter.

  • In our Kids business, Abercrombie, comps decreased 3%, with Girls and Boys both negative.

  • In Hollister, comps increased 13% compared with last year for the quarter.

  • Guys' comps increased by 15%, while Girls' comps increased 13% for the quarter.

  • On a regional basis, comps were strongest in the West and Northeast, and weakest in the Midwest and South.

  • The gross income rate for the quarter was 43.6%, increasing 230 basis points from last year's rate of 41.3%.

  • The increase in gross income rate resulted largely from higher average unit retail prices in the Abercrombie & Fitch, and Hollister businesses in the quarter.

  • We ended the third quarter with inventories down 15% per gross square foot versus last year at cost.

  • The decline in inventory reflects stronger-than-planned sales volume, combined with a reduced cost percentage in our ending inventory resulting from improved initial markups.

  • At this point, we expect inventory per square foot to be down slightly versus last year at the end of the fourth quarter.

  • The third quarter selling, general and administrative expense rate was 31.6% of sales, 850 basis points higher than last year's 23% rate.

  • The increase includes 630 basis points, due to the $32.9 million non-recurring expense, resulting from the settlement.

  • The additional 230 basis points, results primarily from the increase in store expenses associated with the store investment program that we discussed in our second quarter conference call.

  • Operating income for the quarter was $52.3 million versus $81.5 million last year.

  • Net income for the quarter was $40.1 million, compared to net income of $50.5 million for the third quarter of fiscal 2003.

  • Third quarter net income per share, on a fully diluted basis was $0.42 versus $0.51 for the comparable period last year.

  • The one-time settlement expense of $32.9 million, net of the related tax effect, reduced reported net income for fully diluted share in the third quarter by $0.22.

  • During the third quarter of 2004, we repurchased 5.4 million shares, as part of our existing 6 million share of stock repurchase program at a cost of $179.3 million.

  • In addition, the board of directors has authorized the repurchase of an additional 6 million shares of Abercrombie & Fitch stock.

  • We will also continue to focus on returning capital in excess of funds required to support the company's growth to shareholders.

  • We intend to manage our capital structure by maintaining a base level of approximately $300 to $350 million of cash.

  • We opened six Abercrombie & Fitch stores, three Abercrombie stores, 27 Hollister stores and three Ruehl stores during the quarter.

  • We ended the quarter with a total of 363 Abercrombie & Fitch stores, 174 Abercrombie stores, 224 Hollister stores, and three Ruehl stores.

  • During the fourth quarter of fiscal 2004, we planned to open one Abercrombie & Fitch store, 4 Abercrombie stores, 33 Hollister stores and one Ruehl store.

  • Total square footage is expected to increase by approximately 14% by the end of 2004, than it was at the end of fiscal 2003.

  • For fiscal 2004, we expect total capital expenditures to be between $130 and $135 million.

  • The majority of these expenditures are related to new store construction, with the balance being invested in store remodels.

  • I'd like to finish by discussing our profit expectations for the fourth quarter of 2004.

  • While we are very pleased with the recent improvement in our sales trend, we hesitate to predict the holiday sales levels.

  • As you may recall, we were highly promotional during the fourth quarter of fiscal 2003.

  • Last year, we implemented an aggressive markdown program during early November in response to weak initial holiday selling.

  • In addition, we issued two direct-mail pieces that influenced business between Thanksgiving and Christmas.

  • We do not intend to anniversary promotions this year, and therefore remain cautious about our sales volume.

  • In order to assist you in projecting fourth quarter, assuming sales growth of approximately 12%, which would imply flat comparable store sales, net income for the fourth quarter would be similar to last year's net income.

  • I'd now like to turn the call over to Bob.

  • Bob Singer - President and COO

  • Thank you, Sue, and good morning to everyone.

  • This has truly been a very exciting and successful quarter for the company.

  • On the second quarter conference call, we discussed plans to increase investment in our store organization.

  • The store investment program, which was implemented during the third quarter, focuses on increasing our controls and discipline over store operations, as well as an improving in-store experience for our customers.

  • We've increased staff coverage throughout most of our stores.

  • We believe this enhances customer service levels, and also enables us to improve the presentation of merchandise.

  • In addition, we have obtained preliminary indications that the increased coverage is contributing to a reduction of shrink.

  • If this trend continues, we expect it may make a meaningful contribution to improving sales levels.

  • In August, we secured a highly prestigious location for a 17,700 sq. ft flagship store on the corner of 5th Ave. and 56th St. in New York, which we plan to open by the fall of 2005.

  • This store is not only expected to achieve significant sells volume, but also provide a highly visible presence that will enhance the Abercrombie & Fitch brand image for both domestic U.S. and international customers.

  • In addition, we have secured an additional 12,000 sq. ft above our existing location at the Grove at Farmer's Market in Los Angeles, which will enable us to expand that space significantly.

  • These two flagship locations, in the media capitals of our country, will significantly enhance our brand recognition, again, both domestically and internationally.

  • Over the next 12 to 18 months, we will be remodeling our inherited Abercrombie & Fitch chain stores to the current canoe format in an effort to ensure brand consistency across the entire fleet.

  • We will also be assessing the conversion of certain kids stores to smaller Hollister formats.

  • If successful, we will consider rolling out this smaller format to selected markets throughout the country.

  • In September, we launched our fourth concept, Ruehl, with the opening of three stores in Garden State Plaza in Paramus, New Jersey, International Plaza in Tampa, Florida and the Woodfield Shopping Center in Chicago.

  • We are planning to open additional stores in Detroit, Columbus, the Washington Metropolitan Area and Denver, through the first half of fiscal 2005, and are presently seeking five to eight additional locations for Ruehl openings through the end of next year.

  • Although Ruehl is just getting started, we are very excited by this potential to support the future growth of our company.

  • The international strength of our brand continues to grow.

  • International e-commerce sales increased 140% versus last year, and now accounted for over or, expected to account for over $30 million of this year's total e-commerce business.

  • In addition, sales at our two largest international tourist destination stores, South Street Seaport in New York, and Ala Moana in Hawaii have increased dramatically.

  • Both the South Street Seaport and Ala Moana stores recorded gross sales of over $6 million each in the third quarter, an increase of 36% at the Seaport, and an astonishing 84% in Ala Moana.

  • We have also begun to explore the opportunity to enter the Canadian market, and we hope to execute leases, and open stores in Canada by the end of fiscal 2005.

  • Earlier this morning, or actually last - Earlier this morning we announced the settlement of the class-action diversity law suit, which we signed last evening.

  • As Sue mentioned earlier, we include a one-time charge of $32.9 million, representing the residual amount of the settlement in excess of previous accruals.

  • We decided to settle this suit, because we felt that a long, drawn-out dispute would have been harmful to the company, and distracting to management.

  • Although we have announced that we have signed a consent decree, our attorneys have advised us that we should not comment on the non-financial terms of the agreement, until it has been reviewed and approved by the court.

  • We are hopeful that this will occur in the near future, so that we may proceed with our diversity program.

  • In this connection, Todd Corley (ph), our new vice president of diversity, has begun to work in the company as of yesterday.

  • We are happy to emphasize diversity as a core value of the company, and we believe that it will enhance our performance.

  • Now Mike will discuss the business in more detail.

  • Mike Jeffries - Chairman and CEO

  • Good morning.

  • I am really thrilled with our performance for the quarter, as all three brands recorded strong sales and margin improvement.

  • There has been acceleration in the business, and most importantly we have achieved it in a non-promotional way, which is essential to the aspirational positioning of our brands.

  • I believe this is evidence that our brands are the most aspirational for each of our targeted age groups.

  • In keeping with this commitment, we recently transitioned from our back to school to holiday assortment, without implementing a big sale as we did in the past, and as our competitors continue to do.

  • By brand, I am pleased with where we are at Abercrombie & Fitch, especially on the men's side of the business.

  • In addition to strong volume in men's, initial markup increased significantly, and the mark down rate was lower than prior levels, yielding strong merchandise margins.

  • While strength in the men's business was broad, I am particularly pleased with woven tops and denim, and I continue to see opportunities in these areas.

  • Although women's knit tops were weaker than I would have liked for the quarter, I believe we are making progress in this area, and I am very satisfied with the performance of fleece sweaters and denim.

  • The kids' business Abercrombie showed improvement during the quarter as well, where initial markup improved by over 200 basis points.

  • While we will continue to manage the kids' business conservatively, we are optimistic that the business can continue to improve over the holiday season.

  • Hollister continues to perform extraordinarily well, with broad strength in both the guys' and girls' businesses.

  • Since its introduction four years ago, Hollister has developed into the dominant aspirational lifestyle brand for the high school guy and girl.

  • From a profitability standpoint, it has surpassed the industry-leading operating margin of the adult business, Abercrombie & Fitch.

  • We expect Hollister to approach $500 million in sales for the fiscal year.

  • I believe the Hollister brand possesses huge potential for future growth.

  • From a marketing perspective we created exciting, interactive programs in each of our businesses for the holiday shopping season.

  • Rather than being on sale, our customers will experience a truly unique in-store environment, that differentiates our brands from the competition, while reinforcing the aspirational elements of our brands.

  • In conclusion, I could not be more excited with the progress we are making, and I believe that we are well-positioned to achieve significant growth in revenue and profit in the coming years.

  • Now we are available to take your questions.

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

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

  • Operator

  • First question comes from Stacy Pak with Prudential Equity Group.

  • Stacy Pak - Analyst

  • ... question on spending.

  • Bob, maybe you could talk a little bit just qualitatively...

  • Bob Singer - President and COO

  • Stacy, we didn't hear the first part.

  • Stacy Pak - Analyst

  • Oh, sorry...

  • Bob Singer - President and COO

  • How are you?

  • Stacy Pak - Analyst

  • I'm good, thanks.

  • Just a question on spending, Bob.

  • Could you talk a little bit qualitatively about where you see needs for investments going forward beyond the next quarter.

  • You know, going forward beyond the next quarter.

  • And then, just about the Q4 guidance.

  • It looks like that would assume about a 400 basis point hit to operating margin.

  • Is that all SG&A dollar growth?

  • Or sort of what's going on there?

  • I know we will anniversary this store investments, Q2 of 2005 or Q3 of 2005.

  • But are there other investments beyond that that you see as necessary, Bob, or is that going to cover it?

  • Bob Singer - President and COO

  • To talk about this, I think what we will see is a continuation of what we've been -- what we've started to do toward the end of the third quarter.

  • So the first thing is that we -- the program that we put into place really started to take significant effect toward the end of the quarter.

  • So it's not fully reflected in the third quarter SG&A numbers.

  • What we hope, Stacy, is that we will start to see positive impact on the top line as a result of what we've been spending.

  • And so hopefully, in the sense the investments will pay for themselves.

  • When we talked about it in the second quarter, we were very hesitant to say that , because we knew we were going to spend the money.

  • We didn't know what the impact would be.

  • And I think at the moment, it still is early.

  • And we need to see how the process -- and the progress will be in the fourth quarter.

  • But as we said, the early results in the month of October, and you've seen the sales results in the month of October, we think that those results were to some extent, connected with the additional people in the stores and the other initiatives we've taken.

  • The other thing that I mentioned is that, we are looking very carefully now at the whole fleet of stores.

  • And we will probably be making investments and changes, remodeling and perhaps even switching some of our stores from one brand to another.

  • During the course of 2005.

  • But it's really too early to comment as to what the impact of that might be.

  • But we think if we make the changes, we make the investments, we believe it will enhance the brand but also improve the business.

  • Stacy Pak - Analyst

  • Do you anticipate more flagships potentially?

  • Bob Singer - President and COO

  • Not really.

  • I mean it's a very opportunistic - anyway we have to cut you off , because if you don't respect the one question -

  • Stacy Pak - Analyst

  • --But I need my SG&A from Sue answered.

  • Bob Singer - President and COO

  • This is the only two questions that's -

  • Stacy Pak - Analyst

  • Then it was one SG&A question.

  • Sue Riley - SVP and CFO

  • SG&A is likely to increase in the fourth quarter versus last year, by about 270 -- 290 basis points.

  • Stacy Pak - Analyst

  • Great.

  • Thank you, sue.

  • Sue Riley - SVP and CFO

  • Sure.

  • Operator

  • Our next question comes from Dana Cohen with Bank of America Securities.

  • Dana Cohen - Analyst

  • Following up on the SG&A question.

  • Bob, could you just talk at that little bit more where the dollars are being spent and on what?

  • It sounds like there is more people in the stores but could you drill down so we could understand the expenditures.

  • Bob Singer - President and COO

  • I think the primary expenditure is indeed people in the stores.

  • And that is what we've done.

  • We've increased the staffing in the stores by a significant amount so that -- and you can see it if you go into the stores.

  • There is greater presence.

  • There are more people.

  • We're also investing in managers to get more managers into the store and investing with training for the people.

  • It is to a large extent a people-oriented process.

  • But it's also a question of enhancements to the stores themselves.

  • And making sure the stores are properly maintained, so it's a question of maintenance.

  • And also responding to the creative ideas of Mike and the visual team to put together the stores, put them into the best condition possible.

  • Unidentified Speaker

  • The best image possible.

  • Bob Singer - President and COO

  • These are the primary -- the other thing I should say, we've also been hiring people in the home office.

  • And we're seeing that as well.

  • And we've been taking on a number of additional people, and high quality people.

  • And higher quality people in design, and in merchandising.

  • And I think that will also be a contributor to the greater expanse.

  • Compared to where we were a year ago.

  • Operator

  • (Inaudible) has the next question.

  • Unidentified Speaker

  • Good morning, everyone.

  • Congratulations on a great quarter.

  • I wanted to ask on the outlook for flat comps, Sue, what your outlook for gross margin would be?

  • And also, Bob, if you could talk about the SG&A increases.

  • I know we should expect them for the next year.

  • Do you see another layer coming in following that as you review the effect of the incremental spending?

  • Thank You.

  • Sue Riley - SVP and CFO

  • First on the flat comps.

  • I just want to make sure that we are crystal clear on that.

  • It is not an outlook of flat comps.

  • We're simply trying to define some parameters, so that you can work through models.

  • But assuming comps are flat in the fourth quarter, we would expect the gross margin to be roughly flat to last year.

  • And then SG&A as I just mentioned.

  • Bob?

  • Bob Singer - President and COO

  • And regarding what we will do in the future, it will depend on what we feel is necessary, and on the results that we see of what we've been doing now.

  • It's very difficult to try to quantify that.

  • We're not going to spend money needlessly.

  • We will do what will help us to have the stores be in the perfect condition that we want them to be.

  • And that is going to enhance the brand, and the business, and ultimately sales.

  • So I wouldn't want to make a prediction as to what we might do in the future.

  • If we are still - if you like in the somewhat experimental stage, we will see I think, by the end ft fourth quarter we will have a much better idea of the impact that we are getting on everything in the stores, and then we will react accordingly.

  • Operator

  • [OPERATOR INSTRUCTIONS].

  • Moving on to Jamie (inaudible) from Merrill Lynch.

  • Mark Friedman - Analyst

  • Good morning.

  • It's Mark Friedman.

  • Bob Singer - President and COO

  • Hey, Mark.

  • Mark Friedman - Analyst

  • Hi, guys.

  • OK.

  • One question only.

  • Talk a little bit more about IMUs.

  • You guys have done a great job over the years taking that up and there are still significant gains.

  • What was the primary driver now, versus in the past, and then going forward with the quota, what opportunities does that provide?

  • Unidentified Speaker

  • OK.

  • The current improvement has really been driven through just better sourcing.

  • The same thing I've been saying quarter after quarter, Mark.

  • A better sourcing base.

  • Better quality sourcing base.

  • I do expect this to be mitigated in the future.

  • I think we will see some improvement.

  • But not at the rate that we have seen it in the past.

  • I would say that's for fourth quarter, and clearly into next year.

  • The quota situation is a question mark, in terms of what the result of that will in fact be.

  • So, we will continue to push it better and better sourcing.

  • I think there is room for some margin improvement.

  • It's not in any of our models.

  • But don't expect the kind of improvement we've seen in the last year and a half.

  • Operator

  • Moving on to Dana Tesley of Bear Stearns.

  • Dana Tesley - Analyst

  • Good morning everyone, and congratulations on a great quarter.

  • Unidentified Speaker

  • Thanks Dana.

  • Dana Tesley - Analyst

  • The theme of casual luxury, seems to be pervading Abercrombie, how do you see it as going through the other concepts?

  • And do you see the other brands being repositioned also?

  • And with that as with Fitch, do you see another line being added to Hollister?

  • And then second thing just on Hollister, first time, given quarterly sales gain, what are the key elements driving the Hollister operating margin above the core A&F, and how many kids' stores could be converted (ph) to Hollister?

  • Unidentified Speaker

  • Oh boy.

  • That's one question, Dana.

  • You are good.

  • Dana Tesley - Analyst

  • How do you like that, got it in with that one breathe?

  • Bob Singer - President and COO

  • Wow.

  • Let me go for the first one.

  • We are thrilled with the layer that we have put on to the A&F business, through a.

  • Ezra Fitch, and b. improved quality in the non Ezra Fitch goods.

  • We are operating with AURs that are significantly higher than last year.

  • And that is a significant part of our plan for Abercrombie, to separate it even more from Hollister.

  • Hollister is not going to change, we are not considering a premium line for that brand, we are very happy at it's current prices, and we think we understand who we are competing with in that market, and where we have to be price wise.

  • So you won't see a change in Hollister.

  • Now, (inaudible) answer any of the other questions?

  • Unidentified Speaker

  • Bob.

  • Just on the kids' stores, this is something we are looking into, Dana.

  • We haven't made decisions yet.

  • But we have observed that there are some kids' stores in malls, where we think that -- hypothesize that we could probably do more business with Hollister - to the Hollister store.

  • The store format for Hollister, right now, the standard format is larger than the kids' store format.

  • So, we need to experiment with this.

  • But what we also realize is that Hollister, which is a brand positioned at a lower price point than Abercrombie & Fitch, is a brand that probably could be successful in many secondary, and tertiary markets in the country.

  • But which couldn't necessarily support a standard size Hollister store format.

  • So, we need to experiment with this, and then if it works, it's possible that we may roll these out in a number of locations.

  • Unidentified Speaker

  • I think there was a question about the operating margin differential as well, Between A&F and Hollister.

  • Sue Riley - SVP and CFO

  • Whether (ph) that is more productive space for Hollister, and that the Hollister spaces are small and so we are generating more sales per square foot which really drives the operating margins.

  • Unidentified Speaker

  • How's that for one question Dana?

  • Thank You.

  • Operator

  • Dorothy Lakner with CIBC World Markets has our next question.

  • Dorothy Lakner - Analyst

  • Well thanks, good morning everyone.

  • Mike, I wanted to ask about the women's business at Abercrombie.

  • You've made so much progress on the men's side.

  • And you say you are seeing some progress in knit tops in women's.

  • But you are pleased with some.

  • Other businesses.

  • I just wondered when we might see some kind of evening up between the men's and the women's side at Abercrombie?

  • Mike Jeffries - Chairman and CEO

  • Well, we're working hard at it, Dorothy.

  • And I don't expect that you would see an evening up for the fourth quarter, although it is getting closer.

  • Our recent figures have been much closer.

  • And I think it will make steady improvement.

  • I can't tell you when it will comp at the same rate.

  • But there is steady improvement.

  • We've had a lot of restructuring to do there as we know.

  • And adding of talent.

  • But it will get close -- I would say in the first half of next year.

  • Sometime.

  • Dorothy Lakner - Analyst

  • But you're pleased also, with the sweater business, which should be a more significant part of that business, right in the fourth quarter versus the third.

  • Mike Jeffries - Chairman and CEO

  • Absolutely.

  • Which will be a big help to that business.

  • I have to say, I wish I had more inventory there, but it is a very good business now.

  • Operator

  • Richard Baum from Credit Suisse First Boston has our next question.

  • Richard Baum - Analyst

  • Good morning everybody, I'll add my congratulations as well.

  • Unidentified Speaker

  • Thank you.

  • Richard Baum - Analyst

  • On the SG&A side, I want to, try to understand what metrics we might be able to look at, in order to perhaps monitor the kinds of investments that you're making.

  • You know historically, we have been able to look at SG&A per square foot.

  • Which had peaked at $28 or $29, and bottomed at $22 or so, and now seems to be back in the middle of that range.

  • I don't know if that's a metric that you look at, if so, you could give us some directional commentary about how it would go or, what sorts of metrics you look at in order to -

  • (Audio break)

  • Operator

  • Moving on to Margaret Mager from Goldman Sachs.

  • Sue Riley - SVP and CFO

  • Well wasn't we -- ?

  • Unidentified Speaker

  • We should answer their question.

  • Sue Riley - SVP and CFO

  • Even though he was cut off.

  • Unidentified Speaker

  • Could we get Richard back?

  • Operator

  • Richard, if you please press star one.

  • Unidentified Speaker

  • Richard?

  • Richard Baum - Analyst

  • Hello?

  • Unidentified Speaker

  • Are you there?

  • OK.

  • We didn't do that on purpose, we promise.

  • Richard Baum - Analyst

  • OK.

  • Can you hear me now on the line?

  • Unidentified Speaker

  • Yes.

  • Richard Baum - Analyst

  • OK.

  • Let me repeat it and I'll be brief.

  • Just -- in terms of the investment that you are making on the SG&A side, we had been able to monitor it in the past.

  • Looking at something like sales -- SG&A per square foot.

  • I guess a question for Bob is, what sort of metric ought we look at, in order to help us understand what direction you're going or, what metrics you are looking at, in order to understand what the appropriate level of SG&A investment might be, relative to A&F historically or, relative to any of your competitors?

  • Bob Singer - President and COO

  • I'll let Sue talk about the number.

  • I understand you are trying to do a model.

  • I think it is important to state the principle that at the moment, what we're trying to do is ensure that our stores, in particular our stores, but also our home office team, meaning in particularly in the design and merchandising areas, are at the level that they should be.

  • And I think that right now, we have more focussed on ensuring they are at the right level, because we think that will drive the success of the business, and enable us to maintain long term our high margins.

  • We are more focused on what we need, than on trying to measure it or limit it by some kind of metric compared to sales.

  • And I just want to emphasize that, I think that, to some extent the company in the past, and again, I wasn't here, and I'm not looking to criticize.

  • But I think to some extent, the company got a little bit trapped into trying to maintain a certain metric.

  • And got into a little bit of a downward spiral.

  • And I think that what we need to do now is just stop that.

  • And that is what we're doing.

  • By reinvesting in the stores, and reinvesting in our team here.

  • And as a business expands, we need to build a stronger merchandising team, a stronger design team.

  • That is going to allow us to grow the business.

  • We'll get into a positive cycle.

  • And then we will be able to keep good control over the expense levels.

  • You want to give a --

  • Richard Baum - Analyst

  • Well stated.

  • Sue Riley - SVP and CFO

  • I think you really said it all.

  • We don't really manage it on a per square foot basis.

  • If you want the number for your models, it's between $24 and $26 a square foot.

  • It has come down versus historical levels, as we have grown, and leveraged our overhead.

  • But none the less, we are making the investment as Bob just articulated.

  • Operator

  • Our next question from Margaret Mager from Goldman Sachs.

  • Margaret Mager - Analyst

  • Hi.

  • Good morning.

  • It's Margaret Mager.

  • Clearly, October was a very good month.

  • And I was just wondering if you could go over why -- why was it so good, particularly at Hollister, and why would you think that you would just drop off so dramatically into the fourth quarter?

  • So is there something that changed in the business between October into November and the outlook for December?

  • If you could just talk about holiday flows or whatever it was that -- please give me some perspective.

  • Thanks.

  • Unidentified Speaker

  • Let me talk to that Margaret.

  • We did have a very good October.

  • I think that we were positioned correctly in key classifications across the business.

  • And I think we got it resolved.

  • We did not anniversary a promotion of last year.

  • But that effect was more in September than October.

  • I think we have very strong trend going into the fourth quarter.

  • What I cannot predict is the volume effect on the promotional activities last year.

  • It's very difficult to predict what the actual volume is going to turn out to be.

  • We started to reduce the prices of our inventories in November as Christmas looked like it was a problem.

  • And we're up against as you mentioned direct mail that we're not anniversarying this year.

  • We have to get through this fourth quarter.

  • That's the last quarter that we will anniversary promotions because we will not be in the promotional business after this.

  • I think our trend is strong.

  • The brands are strong.

  • I just can't predict what the actual level of the volume is going to be.

  • So we're taking a conservative stance in our projections.

  • Operator

  • Michael Delahare(ph) with Jefferies and company has our next question.

  • Michael Delahare - Analyst

  • Good morning.

  • Congratulations.

  • I have a merchandising question for Mike.

  • Are the current denim inventories on the floor at Hollister and adult Abercrombie what you envision or are you still dealing with some delivery issues?

  • Mike Jeffries - Chairman and CEO

  • We are still dealing with some delivery issues.

  • But we are getting a lot closer.

  • Michael Delahare - Analyst

  • How close would you guess?

  • Mike Jeffries - Chairman and CEO

  • I would say in the base inventories we are there in what we would call our ongoing base inventories.

  • Michael Delahare - Analyst

  • What about the distressed goods?

  • Mike Jeffries - Chairman and CEO

  • Our distressed-- We are still pushing those levels.

  • We are getting closer in distress.

  • What is performing well for us are the decorated goods.

  • And we are a little farther away from those levels than we would like.

  • But part of that has to do with the fact that they have taken off like crazy.

  • Michael Delahare - Analyst

  • Right, so the inventory, they are turning so quickly--

  • Mike Jeffries - Chairman and CEO

  • They are Turning so quickly that it's practically impossible to get back in.

  • We probably also have a $198 jean in Abercrombie that we turned out over in almost a week .

  • And we had to raise the retail.

  • Which is not a terrible, terrible thing.

  • Michael Delahare - Analyst

  • You raised the retail on your Whitney sweater also.

  • Is it the same logic on raising the retail on that garment?

  • Mike Jeffries - Chairman and CEO

  • Absolutely.

  • We do that when things sell.

  • I think we're getting there in denim.

  • We have a very aggressive plan for next year.

  • Sourcing plan, a merchandising plan.

  • And we will be there.

  • We will be there.

  • Thank you.

  • Operator

  • Gabrielle Kevich (ph) from Deutsche Bank has our next question.

  • Gabriel Kevich - Analyst

  • Hi, wondering if you could talk about the new merchandising management addition at the core brand and the recent changes at Hollister with the departure of Carol Kerner (ph).

  • Thanks.

  • Mike Jeffries - Chairman and CEO

  • Merchandising on the core brand.

  • We are restructuring the business as you all know.

  • In that we are merchandising across brands.

  • Across the brands. and the final change there took place about four weeks ago.

  • We are very pleased with the progress and what that is going to offer us in classifications, specialization.

  • Tom is joining us in the -- at the end of November.

  • And he is going to come into the business and merchandise a category for six months.

  • At the end of that time he will become the general manager of the Abercrombie and Fitch and Abercrombie brands.

  • It will be his jobs to coordinate all the assortments for Abercrombie & Fitch to help us as we proceed into a concept of flagship stores.

  • And to look at how we grow that business internationally.

  • I am delighted to have him onboard.

  • Carol Kerner left us.

  • And her responsibility has been taken by Chad Kessler who is just a superb merchant.

  • He gave birth to the Hollister concept.

  • And has been the vice president in charge of women's in Hollister since the inception of that brand.

  • I'm really delighted with where he is going to take that business.

  • Operator

  • Monica Brisnehan with R.B.C.

  • Capital Markets.

  • Monica Brisnehan - Analyst

  • Good morning.

  • Congratulations on your quarter.

  • Mike Jeffries - Chairman and CEO

  • Thank you.

  • Monica Brisnehan - Analyst

  • Could you give us a little bit of color on how the rural stores are doing.

  • Mike Jeffries - Chairman and CEO

  • Rural stores?

  • Monica Brisnehan - Analyst

  • Yes.

  • Mike Jeffries - Chairman and CEO

  • We think we are off to a great start.

  • It's very difficult to look at what the volume figures are.

  • They differ by store.

  • But we're doing a healthy amount of business where we thought we would be doing business.

  • And we're pushing very hard to flow inventory.

  • And I have to tell you I wish we had a little more than we did do right now.

  • But I'm sure that Chad is going to help us to organize that effort.

  • We think that the figures are good enough that we're expanding at the rate that we described.

  • I'm very pleased at that business.

  • It is going to be a significant business to give you a little color on the business, it is skewing a little older in age than we targeted.

  • Which I think is a very healthy business.

  • Healthy proposition.

  • For that brand, in terms of the potential size.

  • Operator

  • Our next question comes from Andrea Newell with Wells Fargo.

  • Andrea Newell - Analyst

  • Hi, everyone.

  • Just wanted to come back to the October question.

  • Obviously you did a great job in October of remaining non promotional and still delivering a strong 11% comp.

  • If we compare that to July, when you are also non promotional, and it was a typically clearance period for other mall based retailers and your July comp wasn't as strong as Dow nine, wondering, is there anything different about the competitive environment for those two months that enabled you to benefit from your full price strategy or is there something different about your inventory management systems that's helping inventory stay at the right levels with the right items?

  • To get a better comp?

  • Mike Jeffries - Chairman and CEO

  • I think in fact it is one additional factor and that is that we were better positioned in the right items for October.

  • I don't believe that it had anything to do with the competitive environment.

  • Because I think it is -- as you guys know, it is a highly promotional environment.

  • It was in October.

  • It was in July.

  • And I think that we had more of the right stuff.

  • Moving on to Jeff Black from Lehman brothers.

  • Jeff Black - Analyst

  • Yeah, good morning.

  • A question on guidance.

  • You never blessed consensus in October out of the sales release.

  • And the guidance today seems pretty conservative given the trends we've seen.

  • Could you just contrast the approach of the new operating team as it relates to guidance with the approach of the old operating team at Abercrombie?

  • Thanks.

  • Unidentified Speaker

  • It's very different for us.

  • Because we were not here.

  • And I think our approach right now is -- tied to help you all predict where the business is going to be and what results will be.

  • And we're giving indications that will allow you to do your calculations based upon the view that you take about the business.

  • But what we don't see -- we see ourselves as being in the business of running a business.

  • And that's what we're trying to do.

  • We're trying to make as must have money as possible for the shareholders.

  • And to increase the value of the company.

  • To do that, we're looking to build our brands.

  • And make our operations work in as good of fashion as possible.

  • So we don't feel that we need to or that we should try to say to you sales will be this, profits will be this.

  • We obviously have a view.

  • We have a budget.

  • But at the same time, there are many variables.

  • You're aware of the variables as well.

  • And we're trying to help you to do the calculations.

  • And that is basically summing up what we've been trying to do with our guidance.

  • Operator

  • Josh Schwartz from Flat Brush WaterMill with our next question.

  • Josh Schwartz - Analyst

  • Good morning.

  • Mike Jeffries - Chairman and CEO

  • Hey, Josh.

  • Josh Schwartz - Analyst

  • Great job.

  • I just wanted to ask, Bob, how should we read this $300 million to $350 million level?

  • Obviously you are above.

  • That but you said you will generate more -- above that.

  • But you said you will generate more cash going forward unless something devastating happens in the world.

  • But will there be some effort to get that down to that level above and beyond what's taking place?

  • Are you more prone to repurchasing stock at this level versus increasing the dividend?

  • I just want to understand what you meant by saying --

  • Unidentified Speaker

  • The objective is to maintain a cash balance of $300 million to $350 million.

  • So yes.

  • It is our intention to get the cash balance down to that level.

  • You may recall from the prepared remarks we did buy back over five million shares of stock against the previously authorized repurchase program.

  • We are prone toward stock repurchase however, dividend factors into our view of how we should be returning value to shareholders.

  • So we will be evaluating dividend increases as well.

  • Unidentified Speaker

  • But we wanted do is to give a sense of what we think is an appropriate capital structure for the company.

  • We believe that it is important for us to have a positive cash balance and a fairly significant one.

  • And we are also cognizant of the fact that beyond a certain level, the cash really becomes access to the business.

  • And at that point, and at that point, we feel it is appropriate to return -- to continue obviously to invest in the business.

  • Which is our first need.

  • And to the extent that we have access cash, to return it. -- have excess cash, to return it.

  • Operator

  • Moving on to Lauren Levitan with S.G. Cowen.

  • Lauren Levitan - Analyst

  • Good morning.

  • I'm hoping you could give us an update on where you see the investment program and what additional opportunities you see there, how we should think about the expense impact over the next couple of quarters and then how we should think about any potential sales and annual cost savings and opportunities over time.

  • Thank you.

  • Unidentified Speaker

  • It's just the store investment program, how you see that and how you see it going forward and opportunities.

  • Unidentified Speaker

  • Again, the store investment program is really as we've said before, there are two things.

  • One are investing in the staff in the stores through additional people.

  • And additional training for the people.

  • And there is a certain expenditure that again is getting underway or got under way in October in which we will be rolling through in the fourth quarter.

  • After we have seen the results, we will evaluate what we need to do going forward.

  • And in terms of capital program, right now, our program is to continue at a level that is similar to what we've done in the past.

  • But as we've said before, we are evaluating alternative -- some alternatives in terms of remodeling stores and converting stores.

  • But we don't have any numbers now to give you.

  • When we have finished our evaluations , and we've done our budget for -- our evaluation, and we've done our budget for the next year, we will talk about that in the next quarter's call.

  • Operator

  • Our next question comes from Joe Teklitz from Wachovia.

  • Joe Teklitz - Analyst

  • Hi, guys.

  • Unidentified Speaker

  • Thanks, Joe.

  • Joe Teklitz - Analyst

  • This might be a strange question it is about your flagship stores and to focus in on your growth.

  • Unidentified Speaker

  • Yeah.

  • Joe Teklitz - Analyst

  • I thought I remember that being a large store already.

  • So first, is it so productive and profitable that you think even more space would produce a good return, whatever the investment is?

  • Unidentified Speaker

  • The answer to that is an emphatic yes.

  • That it is a large volume store for us.

  • Hugely profited, Hugely productive per foot.

  • And we think -- we have a lot of potential to grow it.

  • So the answer is yes, it is a winner.

  • Unidentified Speaker

  • The other thing is if you look at that store, the physical presence that we will have in that location, and again, as we said, in the city, which is the media capital of the country, together with New York, and very significant.

  • And also a location that has a very large tourist flow.

  • And so having that kind of presence, will make a significant impact.

  • And I have to say in addition that the cost of the additional space is not that great.

  • So we think we made a very good deal.

  • Operator

  • Moving on to Adrian Tenet with Webbrush Morgan.

  • Adrian Tenet - Analyst

  • Good Morning and congratulations.

  • Unidentified Speaker

  • Thank you.

  • Adrian Tenet - Analyst

  • I just had a couple of quick questions.

  • Sir, can you give us the tax rate and the share term that we should be using for Q4: And also the ending square footage for Q3?

  • Unidentified Speaker

  • The tax rate for Q4 is 39%.

  • A little less than -- in the third quarter and that was because we had some favorable settlements on our state taxes.

  • And the share count -- sorry.

  • The share count that you should use for Q4, assuming no additional buybacks, and we'll update you on buybacks.

  • The share count should be about 96 million shares.

  • And I'm sorry 95 million shares for Q4.

  • And the ending square footage is 5.4 million square feet.

  • Operator

  • Our next question comes from John Morris with Harris Smith.

  • John Morris - Analyst

  • Congratulations.

  • Unidentified Speaker

  • Thank you.

  • John Morris - Analyst

  • The question about the -- your legal expenses.

  • Not discussing the settlement here.

  • But your legal expenses, I have to think have been pretty high up to this point.

  • And now with this behind you, are you anticipating your legal expenses are going to be down quite a bit?

  • And wouldn't that also offset some of the higher SG&A spending you're talking about?

  • And secondly, again, in the line of SG&A, has your thinking about SG&A, the investment spending that you're talking about, are we talking about an acceleration from the second quarter conference call?

  • Or is it about where you thought it would be?

  • Thanks.

  • Unidentified Speaker

  • OK.

  • First, on legal expenses, the answer to that question is no, because we recall that we took a charge in the first quarter.

  • A special charge of $8 million in the first quarter.

  • Which was intended to provide for defense costs in connection with this series -- this series of lawsuits.

  • So it's not likely that legal expense will be impacted as a result of the settlement of this case because we have provided for such expenses.

  • And separately, with regard to acceleration of second quarter, our third quarter, SG&A, we really as Bob said earlier, we got started on the stores program in October.

  • So early October, so what you will see is a full quarter impact of the stores program in the fourth quarter.

  • Operator

  • Our next question from Jeff Klinefelter with Piper Jaffrey.

  • Jeff Klinefelter;

  • Also congratulations on the quarter to the team.

  • Unidentified Speaker

  • Thanks, Jeff.

  • Jeff Klinefelter - Analyst

  • It sounds like back to the heyday of the Abercrombie brand in terms of the men's performing well in wovens and denim.

  • I guess the difference is there is more denim than cargo.

  • But could you contrast the last cycle with this cycle in terms of how you see the brand fitting in and excelling?

  • And then in terms of the balance between men's and women's, do you see the men's increasing now because of this cycle?

  • Sort of repeating itself going up in terms of percent of total sales?

  • Unidentified Speaker;

  • OK.

  • Percent of sales, I think -- and I've said this before, where we are going to end up in every one of our brands is roughly 66% women's, 33% -- 34% men's, because that's the breakdown of the business in the world.

  • There is twice as much women's business as men's business.

  • And over time we will just come to that level.

  • And I think that the business is very different in this men's cycle in terms of the quality level that we're offering.

  • And probably the age group that we're attracting.

  • In the heyday of our men's business, we had a very young business.

  • And we don't at this point.

  • And I think we're very targeted to the 18 to 22-year-old.

  • We are targeted in terms of -- to that customer.

  • That pleases me very much.

  • I think we are moving in the right direction with women's.

  • Again, a more sophisticated offering than we had in the past.

  • And I'm just delighted with where the brands are coming down by -- very clear where these brands are and where they're going by age group.

  • Thanks, Jeff.

  • Unidentified Speaker

  • Can I Clarify one point?

  • On the weighted average shares outstanding in the fourth quarter, if there is no further buyback, we would have 93 million shares outstanding in the fourth quarter.

  • And of course we will be evaluating buybacks throughout the quarter.

  • Operator

  • Next question comes from Brian Toonen (ph) with JP Morgan.

  • Brian Toonen - Analyst

  • My congratulations as well.

  • Bob, beyond Canada, can you talk about the time line of the opportunity for the international store base?

  • And also a lot of other specialty retailers have problem with the operating margins abroad.

  • Can you talk about what would be unique here?

  • Bob Singer - President and COO

  • OK.

  • In terms of time line, what's -- we're ready to go.

  • I think there is a definite demand for us in both Europe and in Asia and also in Latin America.

  • And what we need to do is build a team of people and infrastructure and most of all get acquired -- acquire the necessary skills in our company to be able to manage this.

  • And Canada is the first step toward doing that.

  • And my belief is that we can go -- we could open stores tomorrow morning in Europe and in Asia and be doing profitable business immediately.

  • But in order to do that, we have to go through the process of learning how to do it.

  • And I want to emphasize something very important.

  • It is relatively easy to give our brand to other people.

  • And I have received since I've been here more than a 100 letters , emails, requests, phone calls, visits from people who want to take our brand into at least 30 countries.

  • And I'm not exaggerating.

  • And we basically are looking to do exactly the opposite.

  • That one of the obvious keys of the success of this company, maybe the most critical key, is the total control that we have.

  • It's very rare.

  • There are very few clients, very few companies that have this kind of control.

  • And it is major contributor to what makes us most appealing.

  • And so what we need to do is to maintain that and find the way to learn how to do business in each country.

  • So that we can maintain that control.

  • That, I think, is the key to success.

  • And it will also be the key to maintaining the margin.

  • And having said that, there are additional costs of doing business.

  • And there are additional local competitive considerations we'll have to look at.

  • But I think that based on some preliminary ideas that we have here, and some things that we've seen, if we just look at the business that we're doing in the tourist locations, what people are buying and how much they're paying, we can probably have a fairly significant pricing power outside of the country so that hopefully we will be able to achieve and maintain margins that are not dissimilar to what we have here in the states.

  • But obviously, there will be additional costs.

  • I don't want to be misunderstood.

  • And there are areas like logistics, personnel, other things.

  • We're doing business in other ways.

  • It's more complex and probably more costly than in the United States.

  • Operator

  • Moving on to Kimberly Greenberger from Smith Barney.

  • Kimberly Greenberger - Analyst

  • Good morning.

  • Unidentified Speaker

  • Good morning, Kimberly.

  • Kimberly Greenberger - Analyst

  • I'm wondering if you can talk about your comments on the kids business.

  • You indicated the conversion of some of those kids stores to small format Hollisters.

  • Is that in an attempt to improve the performance of some of those stores?

  • And are you selecting kids stores that are maybe performing not as well as the rest of that division?

  • Unidentified Speaker

  • That is correct.

  • I'll jump in here.

  • The kids business is a business that targets a relatively small customer base.

  • Because we have to keep to the quality level of Abercrombie & Fitch.

  • We have some kids stores that are not performing very well.

  • Because they're in areas that are more demographically suited to a Hollister customer than an Abercrombie & Fitch customer.

  • We think this is an opportunity to improve our total business.

  • But also to experiment with this concept of a smaller format Hollister store.

  • We're not clear where the final number of Hollister stores will be.

  • There is debate, is it 600, is it 800?

  • It could very well be the difference between 600 and 800?

  • Those 200 stores are smaller format stores than our current stores.

  • So we're thrilled about this opportunity.

  • Operator

  • We will take our next question from Barbara Wycoff of Buckingham Research Group.

  • Unidentified Speaker

  • Good morning, Barbara.

  • Barbara Wycoff - Analyst

  • This is a question that touches on Bob and then Mike.

  • Inventories looked a little light going into fourth quarter.

  • Can you talk about that?

  • And then Mike, how would you characterize the contents of the inventory going into fourth quarter, qualitatively this year versus last year?

  • A mix of classifications, the rightness of styling, etc.?

  • Unidentified Speaker

  • The first problem in numbers, our inventories were down as we said about 15%.

  • By brand, that was down about 4% in adult.

  • About 18% in kids.

  • And 14% in Hollister.

  • And it's interesting when you absolutely look at it by category within the brand, within women's, we were down on pants, but we're up significantly on jeans year on year.

  • So really, Michael can speak to the qualitative aspect of inventory, but we seem to have reduced our inventories in some of the classifications that are not selling as well.

  • And others.

  • And increased our inventories where we needed to.

  • Jeans are up about 40% in women's year on year.

  • So --

  • Unidentified Speaker

  • Qualitatively, I think we're generally where we need to be, Barbara.

  • I think we're focused in the right classifications.

  • There are certain classifications that we're forcing more inventory through.

  • I would have been happier if I had a little more last week.

  • But we're pushing it in.

  • And I'm very pleased with the content of our stocks.

  • And I can't predict what the likes are going to be because of this promotional activity that we're up against.

  • But we're running a very, very healthy regular price business.

  • Operator

  • Christine Chen with Pacific Growth Equities has our next question.

  • Christine Chen - Analyst

  • Just housekeeping questions since all my other questions have been answered.

  • What is the depreciation and CapEx for this quarter?

  • Unidentified Speaker

  • Depreciation is $18 million for the quarter.

  • And CapEx is $40 million for the quarter.

  • Operator

  • Moving on to Eliot Lawrence from Jefferies and Company.

  • Eliot Lawrence - Analyst

  • Good Morning and congratulations on the quarter.

  • Two quick questions.

  • One.

  • On the sweater inventories, do you feel comfortable with how they will build, going into the holiday?

  • Given the raise in price points on some of them, does it make any sense to airship them and will you be doing that?

  • And secondarily, on the payroll, given the fact that is read weekly, is there any reason to get too far out in front of sales in terms of payroll investment?

  • Unidentified Speaker

  • The sweater conversation is yes, we are pushing goods in as fast as we can.

  • By air.

  • In some cases air to stores.

  • And I think we're going to have an extraordinary women's sweater season.

  • We will probably leave some dollars on the table.

  • But we're going to have a very good season.

  • And make a lot of money.

  • Unidentified Speaker

  • And regarding the payroll, I want to emphasize what we said before.

  • We don't want to manage the payroll in the stores by looking at last week's sales.

  • We're trying to do is present our store in the very best possible way.

  • The image of the stores.

  • You understand that when you walk into our stores they feel different.

  • They look different.

  • They sound different.

  • They smell different from any other store in the malls.

  • And that's what we have to do.

  • And in order to have that, we have to have really good people in the stores.

  • And we have to have the right number of people in the stores.

  • And that's what we're staffing to.

  • And that's what we're trying to do and that's what we're training to and that's what we're trying to do.

  • Again, we -- we're not doing that just because we want to make an aesthetic statement.

  • We are doing it because we firmly believe that is the last -- best way to drive business profitably.

  • If we have a strong downturn in sales, from what can be any number of reasons, last thing we feel we should do and try to tweak the number of hours in the stores.

  • And so I think -- we're taking a position.

  • We're going to carry that position through.

  • And then we will see what the results are.

  • Unidentified Speaker

  • I've got to throw this in here.

  • I hope everybody listening understands where we're going as a company and it is a different mission.

  • We are strategically managing the growth of this business.

  • Managing the growth.

  • We're not just controlling expenses.

  • We'll control expenses.

  • But there is a management issue going on here in terms of planned growth the right way for these brands.

  • I think it's already seeing a bottom line result.

  • And it certainly is going to ensure the best future for each of our brands.

  • Operator

  • We'll take our final question from Robin Murchison from Jefferies and Company.

  • Robin Murchison - Analyst

  • My questions have been answered.

  • Congratulations.

  • Unidentified Speaker

  • Thank you.

  • Unidentified Speaker

  • Thank you for calling in.

  • Operator

  • That does conclude today's conference.

  • Thank you for your participation.

  • You may now disconnect.