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Operator
Welcome to the Abercrombie & Fitch third quarter earnings results conference call.
Today's conference is being recorded.
If you have a question at any time during today's conference you may signal us by pressing star one on your touch-tone phone.
We will open the call to take your questions at the end of the presentation.
At this time, I would like to turn the conference over to Mr. Tom Lennox.
Please go ahead, sir.
- Director IR and Corporate Communications
Good afternoon and welcome to our third quarter conference call.
After the market closed, we publicly released the quarterly sales and earnings release, balance sheet, income statement and an updated financial history.
If you haven't seen these materials, they are available on our Web site.
This call is being taped and can be replayed by dialing 888-203-1112.
You will need to reference the conference ID number 9447177.
You may also access the replay through the Internet at abercrombie.com.
With me today are Mike Jeffries, Chairman and CEO, Mike Kramer, Chief Financial Officer, Jay Yano, General Counsel and Brian Logan, the Company's Controller.
Today's earnings call will be limited 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.
A reconciliation of the non-GAAP results discussed in this call is contained in a schedule attached to our earnings release.
Now to Mike Kramer.
- CFO
Good afternoon.
Total sales for the third quarter were $704.9 million, up 35% over last year's third quarter sales.
This was driven primarily by a comparable store sales increase of 25% for the quarter.
By brand, comparable store sales increases were as follows: Abercrombie & Fitch, 16%; abercrombie the kids business, 62%;
Hollister, 27%.
Women's and girl's comps were significantly stronger than men's and boy's in every brand with the exception of Abercrombie & Fitch, where the likes were similar between men's and women's.
From a regional standpoint, comps were strongest in the north Atlantic and on the West Coast.
The gross margin rate was 66.0%, 140 basis points higher than last year's rate of 64.6%.
The increase in rate was driven by higher initial mark-up, as well as a lower markdown rate.
We experienced the greatest IMU increases in the better performing classifications, including knit tops, jeans, and graphic T-shirts.
We ended the third quarter with inventories at cost up 87% per gross square foot versus last year and up 44% on a unit basis, driven by a focused build in jeans, knit tops and other basic categories possessing low markdown risks.
Going forward, we expect inventory levels to moderate, ending the fourth quarter with a slightly lower increase per foot at cost when compared to the third quarter of fiscal 2005.
However, we believe inventory position should be viewed on a go-forward revenue basis and not on a static square footage basis.
In short, it is difficult to come to a qualitative conclusion on our inventory position if you are comparing cost increases on a gross square footage basis with the comparable store increases year-over-year.
Stores and distribution expense as a percentage of sales decreased 30 basis points to 35.9% versus 36.2% last year.
Although there was a slight leverage for the third quarter, we experienced significant improvement in leverage during the second half of the quarter as we adjusted store payroll levels.
While we were pleased with this leverage trend, we remain committed to increased investment in our stores.
This investment has not only paid off in sales, but has elevated the in-store experience to be consistent with our brands premium image.
Marketing, general and administrative expenses as a percentage of sales decreased 270 basis points to 13.9% from 16.6% last year.
In third quarter of 2005, the Company recorded a non-recurring charge of 13.5 million related to an executive severance agreement.
In the third quarter of 2004, the Company recorded a non-recurring charge of 32.9 million related to a legal settlement.
Excluding charges in both periods, marketing, general and administrative increased 170 basis points as a percentage of sales to 11.9% compared to 10.2% last year.
This increase in rate reflects long overdue investments in key product-related areas of the Company.
We are confident these investments will enable us to maintain our high creative and product standards while reducing production lead times.
Although we will continue to invest at the home office, we believe that we are well positioned to grow the business in the near future with a much smaller increase to home office head count than was reflected in the first half of fiscal 2005.
Operating income increased 87% to 115.9 million compared to 62.0 million last year.
Net income for the quarter increased 79% to 71.6 million compared to 39.9 million last year.
Third quarter net income per share on a fully diluted basis was $0.79 versus $0.42, representing an increase of 88% versus last year.
Excluding the non-recurring charges in both years, net income per share on a fully diluted basis was $0.88 versus $0.64 last year, representing an increase of 38%.
During the quarter, we repurchased 1.3 million shares in the open market as part of our previously authorized share repurchase program.
There are currently 5.7 million shares remaining on our 6 million share repurchase authorization.
Going forward, the timing of share repurchases will depend upon market condition.
We ended the quarter with a total of 354 Abercrombie & Fitch stores, 163 abercrombie stores, 297 Hollister stores, and 6 RUEHL stores.
By fiscal year end we plan to operate 360 Abercrombie & Fitch stores, 163 abercrombie stores, 318 Hollister stores, and 8 RUEHL stores.
Total square footage for the year will grow about 8% versus 2004.
For fiscal 2006, we are targeting at least 90 new stores generating approximately 10% square footage growth versus fiscal 2005.
For fiscal 2005, our planned capital expenditures will be between 270 million and 280 million.
Now, I would like to discuss our profit outlook.
Overall, we feel confident with the position of our business, as well as the assortments we have set for the Christmas shopping season.
We are planning the business to a downside scenario while ensuring that we do not limit the upside.
We are increasing our previously issued net income per share guidance of $3.10 to $3.30 per diluted share for fiscal 2005, to be in the range of $3.44 to $3.49 per diluted share for fiscal 2005.
Including the non-recurring third quarter charge previously discussed, we are comfortable with a range of $3.35 to $3.40 per diluted share for fiscal 2005.
Now, Mike will comment on the business.
- Chairman, CEO
Thank you, Mike.
We are extremely pleased with our performance for the third quarter.
Our financial results, which include 35% sales growth, a 38% improved gross profit, and record earnings, reflect the broad strength and successful differentiation of our brands versus the competition.
These outstanding financial results reflect our entire organization's dedication to building dominant iconic brands.
We believe our success in achieving this status is clearly evident at the Abercrombie & Fitch brand.
In addition to being well known domestically, where our stores remain one of the top destinations in the malls, the brand is widely recognized on an international basis.
Over the past two years, our organization has done an excellent job differentiating the Abercrombie & Fitch brand from the competition by leveraging attributes we have methodically developed over the years.
An intense focus on getting it exactly right is why Abercrombie & Fitch is better positioned now than it has ever been.
What's most exciting now is that despite its relative maturity, this brand posted a comparable sales, store sales increase of 16%.
As you can see, the brand is still achieving excellent growth and provides us with a significant opportunity for further growth.
Indeed, even as the business has grown to an established destination at most U.S. malls, the brand's future will also be focused on opening select flagship locations here and abroad.
As many of you know, we opened our Abercrombie & Fitch Fifth Avenue flagship store in midtown Manhattan last Thursday.
The store's off so a very strong start, which makes me believe it will achieve high productivity levels and strong profits.
The location also provides us with an incredible platform to expand internationally since the location is heavily trafficked by visitors from all over the world.
Going forward, we will also open flagship locations in the Grove at Farmer's Market in Los Angeles and the Fashion Show in Las Vegas.
From an international standpoint, we will open two mall-based Abercrombie & Fitch locations in Canada by the end of 2005, with a London flagship planned in 2007.
Momentum in the quarter was most evident in our kids business, abercrombie, where comp store sales increased 62% in the quarter.
We attribute the brand's tremendous improvement over the past year to our offering of more fashion-forward assortments to the customer.
In the past, we may not have recognized the opportunity to drive the business by incorporating the same trends we apply in our other brands.
But although the abercrombie kid is less sophisticated than his older brother and sister, the customer is intelligent and does respond to trend.
While it is unrealistic to expect us to sustain the recent dramatic comparable store increases over the long-term, we are convinced that the kids business is on track and we expect to continue to achieve solid results out of abercrombie in the future.
With such strong results at Abercrombie & Fitch and abercrombie, Hollister's exceptional strength is at times overshadowed.
The numbers achieved at that brand, however, demonstrate how solidly this concept performs.
During the third quarter net sales increased 69% with comparable store sales increasing 27%.
On a year-to date-basis sales have increased 73%, comps are up 26%, and the business is generating nearly $500 per foot on a trailing 12-month basis.
Most importantly, the business has been consistently strong for over five straight years with substantial potential going forward.
We plan to end this year with approximately 318 Hollister stores, representing less than half of its domestic store potential.
We see great opportunity for continued strength in the coming years and believe that the brand is well on its way to attaining the iconic status of the Abercrombie & Fitch brand.
I'm also pleased with the development of our newest concept, RUEHL.
RUEHL is now positioned to leverage our Company's product category expertise, enabling us to better identify and develop assortments which are consistent with overall casual apparel trends.
In fact, we see considerable improvement at the product level.
We recently opened a RUEHL accessories store on Bleeker Street in the West Village, which is also off to a fast start.
The store carries an assortment of accessories for men and women, including handbags, leather goods and belts, which will help establish RUEHL as a leader in the casual leather goods business and afford brand leverage to the apparel business.
From an operational standpoint, we adjusted spending levels during the third quarter.
Over the past year, we made much needed investments at the store level, largely in store payroll.
While investment in this area was needed after four years of tight expense management, we are monitoring store staffing levels closely, and as Mike Kramer indicated a few minutes ago, we are now starting to leverage store payroll expense.
I'm pleased with the progress made during the quarter and look for more efficiency in this area going forward.
I would like to emphasize that I believe the results of our strategy to invest in key merchandise categories, as well as in the home office and the store's organization, are driving the success of our business.
We are uniquely positioned as the top of mind premium provider of sportswear with brands that appeal to a broad spectrum of customers in the pre-teen through post college demographic.
This is a position we have worked hard to attain and I can assure you we will defend vigorously.
Finally, it is important to note that the ongoing success of this business is due to the efforts of an extraordinary group of people.
I am totally satisfied that we have the strongest functional leadership and to that point, I do not feel compelled to search for a COO at this time.
We are in a very, we are in very secure control of this business.
Thank you for your support.
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
Thank you, gentlemen. [OPERATOR INSTRUCTIONS] We'll take our first question from Brian Tunick with JPMorgan.
- Analyst
Hey, thanks, and great quarter.
Hey, Mike, just your thoughts as you look out to next year, there's obviously a lot of concern about how the comp's been driven primarily by the AURs, and I was just hoping you could talk about either how you view the Ezra Fitch penetration opportunity for next year, or are there other categories where you still see pricing opportunities as you head into '06?
- Chairman, CEO
I see opportunities in the Abercrombie & Fitch brand.
I don't in the kids brand and Hollister.
We're working very hard to maintain our pricing levels in those businesses.
In terms of the AUR increases driving the business, I believe that's not true at all.
I believe that we have fewer markdowns than we had last year.
We work very hard to maintain price points.
We have to keep these businesses competitive.
The Abercrombie & Fitch business does have the opportunity to expand on its Ezra offerings because they have been very successful and represent an opportunity to increase that business.
So I would believe that's the only brand that we should see AUR increases unless the markdowns goes to virtually nothing in the other divisions, which I would hope for, but I don't think is going happen.
- CFO
Let me just, this is Mike Kramer.
Let me just validate that.
Our AUR increase year-over-year was around 9% compared to our comps of 25%, as well as I think a mix shift to our Abercrombie & Fitch, or higher priced items.
- Chairman, CEO
And there's a classification mix issue there as well.
Thank you, Brian.
Operator
We'll take our next question from Jeff Black with Lehman Brothers.
- Analyst
Yes, thanks.
Let me add my congratulations.
- Chairman, CEO
Thanks, Jeff.
- Analyst
I guess I heard you say during the call that inventory should be looked at on a go-forward revenue basis and when you gave the last guidance, you laid out a revenue target of 2.7 billion.
Could you tell us what the new guidance implies in terms of revenues, and really just how to put to rest all the fretting that's going go on tomorrow about this high inventory number?
Thanks.
- Director IR and Corporate Communications
It's Tom Lennox.
Before we get, Mike wants to address the inventory question.
We didn't tie sales expectation to the earnings that we increased today, so we'll defer to answering that.
I think Mike can carry on with the inventory.
- CFO
Obviously you can expect the sales to be north of our previous guidance given our increase in EPS, but we've decided obviously not to elaborate further on that.
Now, let's talk about inventory.
First of all, to reiterate, remember, Q2 was the first quarter with inventory increases on gross square footage basis since 1999.
Now, I'm going to talk qualitatively and not quantitatively with regards to weeks of supply.
All this information is available and you can actually go calculate it obviously yourself, but if you go take a look back in the eight quarters in 2003 and 2004, there was a range from the lowest weeks of supply on a forward-looking basis to the highest weeks of supply, roughly a five-week window there.
I'll refer to that a five-week window.
If you take a look at Q2 inventory levels increase year-over-year, it falls well within that category, or that five-week window that we saw in 2003 and 2004.
As well as Q3 falls within that window as well.
So the number is 67% of last year, or last quarter and 87% of this quarter, albeit sounds high, it falls well within the weeks of supply that we've been managing to for almost three years.
- Chairman, CEO
I would also--
- CFO
On a unit basis, let me clarify that.
- Chairman, CEO
I would also like to say the same thing that I've been saying for a long time.
One, these inventories are on plan.
We run a tightly controlled business.
We plan to have these inventories because we know they drive the business.
As I have said repeatedly, it is very unsophisticated to look at this business and say a certain percentage increase in sales only warrants a certain percentage increase in inventories or making them the same.
These inventories are divided into a number of categories.
Denim, we've made a major investment in denim, as we should have done.
Our weeks of supply are long in that category.
We are turning the category less quickly than we have in the past, and we plan to do both of those things.
I think those of you who follow us in the malls can clearly say that we are in a dominant denim position on a week-by-week basis.
We're not wavering from that.
The business continues to be excellent and will always be a foundation of the casual business.
This was an investment that was necessary currently and for the future.
I think we clearly dominate the quality denim business brand by brand in the mall.
The second category is what we call fashion basics and we have made increased investments there.
These are goods as the basic denim, has no markdown risk.
I have to back up to the denim to say there isn't markdown risk in this inventory.
There's not markdown risk in the fashion basic inventory.
It consists of polos for both sexes and applique logo tees.
Third category is personal care.
We've made increased investment there and it's absolutely paying off in increases in sales.
The increases in the sales aren't as great as the increases in inventory, but that was necessary to be in that category consistently.
It's a very tough category to stay on top of.
No markdown risk in that category.
The fourth category is fashion.
These are perishable goods.
We control this level of inventory very carefully.
The rate of increase in fashion is roughly the same as the rate of increase in the business in fashion.
We protect that business to a very conservative downside in terms of markdowns.
This is where the markdown risk is in the business and this is what we're very good at controlling.
I've said this before.
I think that over some period of time, this Company should be given credit for excellent management of inventory because that's what we've demonstrated.
Operator
Our next will come from Kimberly Greenberger with Citigroup.
- Analyst
Great, thank you.
Mike, I'm wondering if you can comment on your carry-over inventory as a component of that inventory increase?
And also, as you look at your store's and distribution center costs, I know you were pleased with the slight leverage you got here in the third quarter, what sort of opportunity do you see there going forward, and do you think that in certain situations there has been too much payroll expense at the store level?
Thanks.
- Chairman, CEO
Well, it's two questions.
First, carry-over, I'm not sure how you're defining that.
Fashion carry-over, virtually nothing.
We own nothing from spring and summer and our stocks are very clear, clean in terms of third quarter.
I think you can see that in the stores.
In terms of leverage, I believe that we are working very hard on the store payroll to make sure that we're very efficient.
We did put a lot of dollars out there.
Mike Kramer and his team are studying the dollars that we spent and we are becoming more efficient and I think you can see that in the leverage and his comment that the fact that the second half of the third quarter was really remarkable in terms of the leverage that we experienced while the first half was not.
So think we've spent dollars wisely for the business, but we're now really working to make sure that they're efficient.
- CFO
Is this Kimberly?
- Chairman, CEO
Yes.
- CFO
Kimberly, this is Mike Kramer.
Let me add to that.
With regards to the carry-over on, an average store basis, it was consistent with prior year, no increase to that.
- Chairman, CEO
That was August BOM we're discussing?
- CFO
Correct.
- Chairman, CEO
August BOM.
- CFO
Let's talk about the store and distribution expense.
To reiterate what we said in the past is we really increased our investment spending in this area, the store payroll area in October of last year.
Now, if you remember, last quarter Bob Singer had indicated that this would not have reached full crescendo in terms of our investment till mid Q4, so not to expect any leverage until basically Q4 of this year.
Basically what happened is in the mid quarter, third quarter, we actually took a look at our investment in this area.
There are two key areas that we invested.
One was increased floor coverage, which I'm sure you've seen as you visited our stores.
We've gotten incredible positive comments with regards to that.
Number two is the impact program.
And I won't go into a lot of detail there, but basically what this is is in terms of inventory management within our four walls.
Now, mid third quarter, we made some changes in this investment and basically what we did is we took a look at particularly the impact program and over time as we've invested in this, we found some efficiencies, which would create less hours and i.e., we'd be able to leverage a little bit more.
And as Mike indicated, we truly feel that there's still opportunities in this area, so we are actually implementing more measures within our stores to really truly understand this investment because this is a dollar that once it's spent, you can't get it back.
- Chairman, CEO
Great.
- CFO
Does that answer your question, Kimberly?
Operator
We'll take our next question from Margaret Mager with Goldman Sachs.
- Analyst
Hi.
- Chairman, CEO
Hi, Margaret.
- Analyst
Let's see, I have a question about how many consecutive quarters is this of up earnings?
I think the last time I heard you update that number it was 49 or something.
- Chairman, CEO
Yes, it's 49, with the exception of this quarter last year with the non-recurring expense, but excluding that, it's about 49 or 50.
- CFO
Yes.
- Chairman, CEO
Right.
And we don't plan on breaking that trend.
Operator
Our next question comes from Dana Telsey with Bear Stearns.
- Analyst
Good afternoon, everyone, and congratulations.
- Chairman, CEO
Thanks, Dana.
- CFO
Hi, Dana.
- Analyst
Hi.
The New York flagship looks great.
What elements of the flagship do you think can be implemented in your other stores or any processes or just the way it looks or things like that?
And also, is RUEHL still on track for an operating loss of 20 million this year?
- Chairman, CEO
Okay.
Let me address the first.
I think the most exciting thing about Fifth Avenue is what it teaches us as a whole company.
And there are a lot of things that we learned or are in the process of learning in the whole process of running that business.
Recruiting is a major challenge there, and I think we're doing better than we've done.
Training, we embarked upon a training program that was unique from what we've done in the past, and we'll certainly pass that on to our other divisions.
Movement of merchandise, just the movement of units, how we plan to take units from the sidewalk right to the floor, we're using more sophisticated systems than we've ever used and will certainly take what we learned from that to the chain.
Merchandise, there's merchandise in that store that's forward, that is, for the most part, in seaport and that store.
We're learning a lot about what we can sell in Ezra in more stores, and we've got forward trend that's being fed into the business.
We've made refinements in the physical plant, which I think are important to maintaining the Abercrombie & Fitch fleet, and those of you who have followed us know that we don't remodel whole stores for the most part.
We have a chain that has been the same for a number of years, but we keep adding details and refining that.
That's one of the reasons that we continue to make a lot of money.
So that's an excellent question.
It's an exciting store, clearly in terms of the business and the profit it's going to produce, but more important as a laboratory.
- CFO
Dana, your 20 million as an operating loss for RUEHL for this year is right on.
- Chairman, CEO
Thank you.
Operator
Next from Buckingham Research, we'll hear from Barbara Wyckoff.
- Analyst
Hi, everyone.
Thanks, and congratulations.
- Chairman, CEO
Hi, Barbara.
Thank you.
- Analyst
Really outstanding quarter.
Mike, what would you have done differently?
You're going to have to pass these numbers next year.
With the opportunities that you missed were there classifications that weren't good that might be cycling around?
How do you view the planning for next year?
- Chairman, CEO
You know, Barbara, I think when you've been in this business long as I have, you look back, you can always do it better and that's how we look at the business.
I think there's not a classification that we can't look at now and say we could have improved upon.
I think that we'll just continue to operate as we have, identifying major trends and going after them.
I am not going to lose a lot of sleep over being over, up against high comps.
I think we have a business that is functioning on a lot of cylinders today.
I think we have an organization that is very good at predicting what's going to happen and then supplying that merchandise, and now running the stores.
So I think in fact the momentum is going to do a lot for us.
Thank you.
Operator
Next we'll hear from Stacy Pak with Prudential.
- Analyst
Hi, thanks.
Question on just how we should think about growing the stores and distribution and the marketing and G&A expenses going forward here.
I know you talked some about leveraging and maybe you could quantify for us the leverage you guys got in the second half of the quarter, but just wanting to get my arms around that to sort of think about going forward.
- CFO
Well, in terms of those two categories, I mean I'm not going really elaborate anything more than what we've already done, but just for clarification purposes, we've posted on our Web site, is that correct, Al?
Posted on our Web site basically the detail in terms of our store expenses for the quarter consistent with what we did last quarter, so you'll be able to at least look at that obviously on a more detailed basis.
But in terms of MG&A, we've been very vocal about the fact that we're going continue to invest in the business where warranted.
We do believe that there is a significant amount investment in the first half of this year that we will not replicate that amount.
We feel that we're pretty well positioned right now for a significant amount of growth without a huge investment going further.
I know that that's not any more detailed than what you already heard, but that's really all that we are going to talk about.
Operator
And Jeff Klinefelter with Piper Jaffray has our next question.
- Analyst
Yes, also congratulations to everyone on a fantastic year.
- Chairman, CEO
Thanks, Jeff.
- Analyst
Couple of questions.
One maybe, Mike, just to clarify, Mike Jeffries, on the fashion percent of business, have you ever talked about or do you want to discuss generally what percent of your business that is during a year, just to put it in perspective with the rest of your basic businesses?
And then also on Hollister, you've been performing very well, as you noted over a long period of time.
The comps accelerated nicely in the third quarter year-over-year against a pretty challenging number.
As you go forward, do you think that Hollister will continue to be a, is it going to be a traffic-driven, a number of transaction-driven business model?
I think you noted that there's a little more price competition in that space.
And then also on Hollister, as you grow the business now, are you finding that it works across a multiple different volume malls in the country, or how are you approaching that sort of A/B volume scenario?
- Chairman, CEO
It's really three questions, but I'll answer them.
I have to look up the fashion percentage.
I can't give you that number, but I'll get back to you on that.
Clearly we're seeing, we'll see transition trends, transaction growth in the Hollister business.
You've been in the malls, you see how we're populating those stores, and the interesting thing about the Hollister business is that the more we put out, the more we seem to sell, which is very exciting, but we at times don't have enough out in the fashion categories.
We are concentrating now on the upper levels of mall-- in terms of classifying them A, B, C. We have some A to go.
We have a lot of B to go, and we see that there's C and D opportunity, but we're taking it from the top down now and the reason for that is that it is a simpler operation.
We don't have to do as many different floor sets for the stores as they're tiered that way.
We clearly see C and D opportunities, but we're going to chew them off more slowly than the A and Bs, simply for an efficiency of operation, from efficiency of operation point of view.
And I'll look at the fashion percentage.
I can't really give you a number at this moment that would be meaningful.
Thanks, Jeff.
Operator
Our next question comes from Janet Kloppenburg with JJK Research.
- Analyst
Hi, everybody.
Congratulations.
- Chairman, CEO
Thank you, Janet.
- CFO
Hi, Janet.
- Analyst
Hi.
Mike, you did a very good job this quarter managing the gross margin.
I'm wondering if that meant that the fashion component of the inventory sold at a higher rate at full price, and if you could just talk about maybe some of the increases in the design staff or maybe some systems improvements that have helped that, and if we could look forward to that continuing?
And for Mike Kramer, I'm a little confused on the MG&A guidance.
It sounded originally that you wanted us to expect that to continue to increase at a pretty hefty rate, but then you just said something about the first half level not being replicated going forward.
So if you could just help me understand how you expect that expense line to move directionally going forward.
Thanks.
- Chairman, CEO
Okay.
My part of the answer is very clear.
Yes, we had a higher sell through of fashion than we've had in the past and we had a lower markdown percentage.
That's, that's pretty easy.
Now we can go to Mike's question.
- CFO
In terms of MG&A, basically what I'm trying to get across is that you will see continued increase in investment but at a much more decreasing rate than what you actually saw at the first half of this year.
- Chairman, CEO
Janet, let me elaborate, because your question was can we sustain this?
I think we've made significant investments in this company, as you can see in fashion, in design prediction, fashion prediction, trend prediction, and I think we're getting better at it.
I think that we've seen that over time.
We're putting people in place and we're paying for it, but we're really getting results.
I think if we make fashion errors now, we're not making errors on identifying the big trends because I don't think we miss big trends today.
Where we take markdowns is, are in areas of forward fashion and sometimes we react too quickly and we make mistakes there, but that's where I'd like to take markdowns, in forward fashion, but sometimes we're just too aggressive.
We might be too early and they might not happen.
But what you have to do, what we have to do is to cover the big major trends to drive the business and I think by operating the way we do, we're able to do that pretty consistently.
And I think those of you who look at our stores can attest to that.
- CFO
Janet, let me also talk a little bit more specifically on the MG&A.
As Bob indicated last quarter, we actually increased our head count by 300 head count at the first part of this year.
I can say with all confidence that we will not continue at that rate.
- Chairman, CEO
Janet, I think we've said all along that there are two areas, two components of the expense that we've taken up over the past year.
We started the stores and distribution in October.
Q4's going to be the first time that we anniversary this.
I think we all know that the investments we've made at the MG&A line item lags that to a degree just in time.
We want to, rather than give guidance as you were asking for it, we'd rather not give guidance because we just don't want to do that, but we're committed to investing in the Company and I think that over time we'll see efficiencies.
But we're not exactly in a position right now to say exactly when that's going to be.
Operator
And we'll take a question from Dorothy Lakner with CIBC.
- Analyst
Thanks, good afternoon, everyone.
I wondered if you could update us on the penetration of women's across the three brands?
And then just how you're looking at marketing in general, the magalogue is smaller than it was before.
I just wonder what the spend is like relative to a couple years ago, because you're still driving much higher comps.
I'm wondering if you're spending less to do it?
- Chairman, CEO
I'll answer the second question first.
Yes, we're spending virtually nothing on sales promotions, very, there is a catalog for AF.
There isn't a magalogue, but that catalog pays for itself.
We do virtually no advertising.
In terms of penetration, women's, the highest penetrated business right now is girls, followed by Hollister, then ANF.
And it ranges from--
- CFO
That's 62% of that 70, Mike.
- Chairman, CEO
Yes, from about 62 to 70.
Operator
Our next question will come from John Morris with Harris Nesbitt.
- Analyst
Thanks.
Adding my congratulations as well on a terrific quarter.
Mike, as you look ahead to spring, I have to ask the question in terms of obviously without you tipping your hand too much, denim's still factoring, it's obviously been an important contributor this year.
Still factoring in as an important piece as you head into the spring season in terms of your investment, you know, what else can you do around that that you're comfortable talking about today?
And then also, maybe for Mike Kramer, your thoughts about the, I think you gave 90-store expansion plan for next year.
Any of those include RUEHL, can you give an approximate breakout across the brands for the store adds?
- Chairman, CEO
To answer the first part of your question, what I can say is that denim has been, will be an important component to casual dressing for our customers, and as such, we will always be in that business.
It's level as a percent to the bottoms business will change, but it's going to always be, as far as I can tell, and I've looked for a lot of years, a very important component to the casual sportswear business.
I'm not really going to comment on what else is going to happen for the spring, but good try.
- CFO
In terms of the store count, or the store investment for next year, the breakdown of the 90 stores, roughly two-thirds of that will be in our Hollister brand.
You can actually see more investment in RUEHL with more store count there.
I really don't want to elaborate in terms of the count.
And quite frankly with the recent infusion in terms of the Abercrombie kids and just explosive growth that we've seen there, it's really opened up more opportunities there for us.
So you're going to actually see probably around 15 to 20 more stores there.
And remainder in Abercrombie & Fitch.
Operator
Our next question will come from Mark Friedman with Merrill Lynch.
- Analyst
Thank you.
Good afternoon, everybody.
Great job.
- Chairman, CEO
Hey Mark.
Hi, Mark.
- Analyst
Mike, could you walk us through RUEHL?
It's out a year.
I know you're not going commit to when you plan on ramping up the store growth, but how are you thinking about that from a timetable?
What are the key things you're looking at in the business to give you the confidence that you're at the right stage to accelerate that?
- Chairman, CEO
One is qualitative and I just believe that we are more firmly entrenched in the casual business than we were a year ago.
We are filling the classification buckets more efficiently because of how we're organized.
And the business is growing at a very nice rate.
We are looking for more locations.
We have a growth plan that we described.
We are looking for quality locations, and are really at the point of making more commitments to that business.
I'm very convinced that that's going to be the next real contributor to the business.
And I think as you guys look at the stores, you can see that.
They're tiered in terms of how good they are.
We have some stores that are excellent, one that's good, one that I would say is fair, and one's God-awful.
We'll have to figure out how to solve the God-awful, but there's huge strength in that business at this point, except for the God-awful.
Operator
Our next question will come from Joe Teklits with Wachovia.
- Analyst
Hi, guys.
Congrats.
- Chairman, CEO
Hi, Joe.
- Analyst
I'll try to keep it to one question here, and of course it's got to be inventory, the one question.
Maybe you can help me approach it a different way.
It seems like you're purposely slowing your turns for the business, so can you offer us a goal for inventory turns or maybe can you say we can obviously calculate it ourselves now for this year, is this the level of turns that you want the business to perform at going forward, and so thus, we can also somewhat calculate how inventory will flow next year?
- Chairman, CEO
Do you want me to address the beginning?
Well, you will see more efficiency, faster turns as we go forward because the denim category, we'll be more efficient in denim as we go forward.
We made big investments in the classification.
We now know the business, where it's going, how to run it, and I think we will see, you will see more efficiency in that category.
Fashion, we turn as fast as we should.
We should not speed that up or slow it down.
In the fashion basics, I think we're kind of where we should be and in personal care, I think we are where we should be.
You'll see increased efficiency in denim and I can't give you a figure as to what that will be, but we know our denim inventories have peaked as of November 1st and will decrease on a store by store basis over time.
- CFO
Yes, let me reiterate this, is Mike Kramer.
I don't think that our strategy is at all to slow our turns.
I mean as Mike has reiterated time and time again during this call and actually the last call, is that we are long in denim.
We've said that very clearly.
We actually hit our peak deliveries, as Mike said, November 1st, the last week of October.
We have ended a commitment with our factory base with regards to denim and you're going to actually see more efficiencies in this category on a go-forward basis.
- Chairman, CEO
Having said that, we did the right thing in terms of denim.
- CFO
Yes.
- Chairman, CEO
There is not a significant markdown risk in basic denim and it is done a lot for the business.
Operator
Our next question will come from Christine Chen with Pacific Growth Equities.
- Analyst
Congratulations on a great quarter, everyone.
- Chairman, CEO
Thank you.
- Analyst
Just wanted to ask, do you still expect, or are you still targeting RUEHL to be breakeven in fiscal year '07 by the end of that, and then D&A and Cap Ex for the quarter?
Maybe I missed that.
- CFO
As far as RUEHL is concerned, yes, that's the case.
We are still shooting for 2007.
Obviously we would love to beat that, but that's our current call.
Cap Ex-- I'll come back to Cap Ex for the quarter as I look for it.
Operator
We'll take our next question from Gabrielle Kivitz with Deutsche Bank.
- Analyst
Hi, congratulations.
- Chairman, CEO
Thank you.
- Analyst
I had a question regarding the store payroll components.
Late, I guess last year or earlier this year, the Company, or I guess it was Bob communicated that the increased payroll at stores helped reduce shrink pretty significantly, which had a meaningful impact on comps and margins.
So my question just was if you reduce the hours for the impact programs in stores, should we expect a reverse effect on shrink, why or why not?
And then the second question was just opening more kids stores.
You mentioned that you're going to open a few more, I think last comment that you made on the store base potential for kids was that the store base would be about static.
Do you want to give us a new potential store base size for the kids business?
Thanks.
- CFO
Before we go there, the Cap Ex for Q3 was roughly 68 million, and for Q4 it will be in the neighborhood of 80, 85 million.
- Chairman, CEO
Sorry, Mike.
- CFO
Let me address the question with regards to the store payroll.
- Chairman, CEO
Let's-- let me just address it while you're--
- CFO
The shrink.
- Chairman, CEO
Yes.
- CFO
The shrink actually, we have actually seen improvement in shrink and because of the reduction in terms of payroll, we do not anticipate that effecting our shrink or it going up at all because of the reduction in the payroll hours were happening in the impact program, not our floor coverage.
Our floor coverage is still consistent with where we've been in terms of our investment, and we believe that customer service is the best deterrent to people walking off with our product.
- Chairman, CEO
What I have to say is that Mike and his team, John Loft and his team, are looking to be efficient with the dollars that we're spending.
We are not just cutting payroll.
This is a very scientific exercise and we're certainly not going to cut it to the point that we jeopardize ourselves in terms of shrink again for sure.
- CFO
And in terms of the abercrombie kids, I mean what we found is we found that if you take a look at those malls that actually have both kids and our adult brand, there's a high correlation in terms of the sales.
So what this has done is this actually enables us to refine our target with regards to abercrombie kids and it's actually opened up some more markets to where we really know that we'll hit it out of the ball park.
- Chairman, CEO
You asked for a quantification.
We think there are probably another 100 kids stores in the future.
We've identified those.
Operator
Our next question will come from Lauren Levitan with SG Cowen.
- Analyst
Thanks.
- Chairman, CEO
Hey, Lauren, how are you?
- Analyst
I'm well.
Thank you, good afternoon.
Mike, you talked in your prepared comments about how some of the MG&A increases are really associated with some long overdue investments.
Can you give us a progress report on where you think you are in terms of catching up on some of those long overdue investments, whether it's in terms of physical plant at the stores, or adding merchandising talent or headquarters facilities or any other area that you were probably underspending in relative to where you'd like to be?
- Chairman, CEO
We're clearly underspending in home office across the classifications.
Clearly underspending in merchandising, head count, design head count, planning and allocation head count.
I believe that Mike said that you would see a much smaller increase in those categories in the future, and I believe that, again, we're testing the efficiencies there.
We still have some positions to fill, primarily in design, but we're really staffed to a level that I think is appropriate for our current business and our business go-forward.
The investment in physical plant is just an ongoing proposition in terms of new stores.
We are expanding the campus but that's in relation to our growth.
So I was really relating to the home office expense and I think we're really getting paid for our investment there.
Operator
Next we'll hear from Robin Murchison with SunTrust.
- Analyst
Thanks very much.
Congratulations.
I had the opportunity to see the RUEHL accessories stores and it does look great.
Small, but great.
- Chairman, CEO
That's how you make a lot of money, small, small, but great.
- Analyst
The returns on the square footage basis is very good, I'm sure.
- Chairman, CEO
Absolutely.
- Analyst
RUEHL, though, Q3 versus Q2 performance, you've seen, it seems to have made a nice turn.
Can you elaborate on what worked well vis-a-vis Q2?
Thanks.
- Chairman, CEO
I'm not sure that I see there was clearly the sales trend.
The momentum continued.
What are you telling me, Brian, here?
I think this was, the quarter was just a continuation of past trend seriously.
We said that we took our markdowns earlier in the second quarter and we took less in the third quarter.
Some of that was a function of taking more second quarter, but it was also a function of our fashion turning better.
I don't look at it as a-- I think this year has been a terrific year.
I don't look at it as a turnaround quarter at all.
The only thing, the only place that I would say that we have gotten better is in the expense area and we're just being more efficient with dollars.
Operator
Our next question will come from Dana Cohen with Banc of America.
- Analyst
Oh, hi, guys.
Mike Kramer, just quickly, in terms of, can you talk a little bit about the tools you're using to measure the SG&A dollars and how you're measuring efficiency?
And then quickly, if you have these shares at the end of the quarter.
- CFO
If we have what?
What was--
- Analyst
Number of shares at the end of the quarter?
- Chairman, CEO
Okay.
I'm going to address the first part.
Well, the number of shares at the end of the quarter, weighted average shares was 90,458,000.
The number, the way that we're looking at store payroll at this point, because this is where a lot of dollars are being spent, is very scientific.
We have stop watches in every store at this point.
We are measuring the time it takes to do a particular function, and that has to do with our impact teams.
We are looking carefully at how we are staffing in terms of peak hours more carefully than we ever have.
It's a long process, but John Loft has brought us a huge amount of expertise in terms of looking at efficiency in store.
And I think everybody knows what a process genius he is in terms of the results we've seen in our distribution center over the last six years, understanding that we're bringing the same kind of expertise to looking at those store dollars.
- CFO
I can't elaborate to that.
I think that was great.
Operator
And we'll take our next question from Paul Ledgeway with Credit Suisse.
- Analyst
Hi, thanks, guys.
Mike Kramer, just to make sure I understand what happened with payroll, if we look back to the first and second quarter, it looked like you guys were deleveraging 2 to 300 basis points.
- CFO
That's correct.
- Analyst
Is it safe to assume that that trend continued through the point in the third quarter when you anniversaried the increase from last year?
And then your comment was that you then got leverage, so are we talking about a 200-plus basis point swing in that line item and is there any reason why we wouldn't see that continue in the fourth quarter?
- CFO
Well, the answer to your first question in terms of was it that wide of a gap at the beginning of the third quarter, the answer to that is yes.
We did see significant leverage at the latter part of the quarter in terms of payroll and I would expect to see that amount of leverage going through Q4.
We haven't broken it out for on you a monthly basis.
Operator
And it looks as though that is all the time that we have for questions.
Gentlemen, I'll hand the conference back to you for any closing comments you may have.
- CFO
That's it.
- Chairman, CEO
Thanks, guys.
We appreciate it.
Operator
And that does conclude our conference.
Again, thank you all for your participation.
We hope you enjoy the rest of your day.