Abercrombie & Fitch - Earnings Call - Q4 2012

Transcript

Speaker 5

We will open the call to take your questions at the end of the presentation. We ask that you limit yourself to one question during the question and answer session. At this time, I would like to turn the conference over to Mr. Eric Cerny. Mr. Cerny, please go ahead.

Speaker 10

Thank you. Good morning and welcome to our fourth quarter earnings call. Earlier today, we released our fourth quarter sales and earnings, income statement, balance sheet, store opening and closing summary, reconciliation of GAAP to non-GAAP financial measures, and an updated financial history. Please feel free to reference these materials available on our website. Also available on our website is an investor presentation, which we will be referring to in our comments during this call. This call is being recorded, and the replay may be accessed through the intranet at abercrombie.com under the investors section. Before we 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. Today's earnings call will be limited to one hour. Joining me today on the call are Mike Jeffries and Jonathan Ramsden.

We'll begin the call with a few brief remarks from Mike, followed by a review of the financial performance for the quarter from Jonathan. After our prepared comments, we will be available to take your questions for as long as time permits. Now I'll turn the call over to Mike.

Speaker 8

Good morning, everyone. Thank you for joining us today. The fourth quarter results we announced today were below our expectations. The difficult macroeconomic environment we saw in the third quarter continued into the fourth quarter and was exacerbated by all-time high cotton costs, unusually warm weather, both in the U.S. and in Europe, and a highly aggressive promotional environment. In this environment, we were unable to sustain higher AURs and therefore unable to offset the increases in AUC we saw both from cotton cost increases and an elevated mix we built into our fall and winter assortment. These effects put pressure on our selling margin beyond what we anticipated at the beginning of the quarter and resulted in additional markdowns on higher carryover inventory. These effects were most significant in fleece, sweaters, and outerwear.

As we look to 2012, and particularly the back half of the year, we are seeing a significant reversal in that AUC trend. In addition, while our results for the fourth quarter fell below our expectations overall, there are a number of indicators that give us confidence that we are on the right track strategically. The first point is the biggest takeaway today. The overall economics of our business in Europe remain very strong. Our top line in Europe grew 85% for the quarter. Hollister Europe, which now represents approximately two-thirds of our store business in Europe, continued to comp positively despite a very difficult environment and despite some cannibalization of existing stores by new store openings. Those new stores performed in line with expectations and ahead of original approved volumes, and overall four-wall margins in Europe remained above 30%. Second, our DTC business was very strong for the quarter.

This was the case both for the U.S. and for our international DTC business, which showed strong sequential acceleration from Q3 to Q4, reflecting the growing awareness of our brands across Europe and beyond. Third, we are pleased with the start we have made in China over the past few months. It is still very early days, but we have seen a steady increase in momentum. We will open our third mall-based store in China in March and expect more Hollister openings during 2012. In addition, we are working toward an Abercrombie & Fitch flagship there opening in 2013. Our overall business with Chinese customers is very modest today, including our European tourist stores, and we see growing awareness and familiarity with our brands in China as a major opportunity. During the quarter, we addressed some underperforming areas of our business as well as other real estate issues.

This included closing 68 U.S. stores, bringing our total closures to 71, downsizing our Ginza and Hollister Soho stores, and converting the Fukuoka store to an outlet as we work to sublet the space. Overall, we believe that the key elements of our long-term strategy are on the right track. These include, one, continue to provide high-quality trend-right merchandise and a compelling and differentiated store experience. Two, continue to close underperforming U.S. chain stores. Three, invest in our DTC business, particularly the international business. Four, continue with our highly profitable international real estate plan. Five, continue to seek ways to operate more efficiently and leverage expenses. Regarding our international real estate plan, during 2011, we opened five new A&F flagship stores and 39 international Hollister stores, which was in line with our plan at the beginning of the year. These stores are performing very well.

Excluding Fukuoka, our nine international A&F flagships are currently annualizing around $400 million, while our 62 European Hollister stores are annualizing around $10 million per store on average, still well ahead of the average volume built into our long-term sales goal. These volumes are based on the trend of the business during the fourth quarter of 2011. In 2012, we expect to open A&F flagship or tier one stores in Hamburg, Hong Kong, Munich, Amsterdam, and Dublin, as well as an Abercrombie Kids flagship in London, and we expect to open around 40 Hollister international stores. We are also confirming an A&F flagship store in Seoul in 2013. We made the decision during the quarter to err on the side of caution on two flagship locations, although we expect to have stores in these locations at a later date.

Beyond 2012, we anticipate a running rate of three to five flagships per year and 30 to 40 international Hollister stores per year, which is consistent with the long-term plan we outlined last April. We remain cautious about sales and AUR trends for 2012, but we are encouraged by the AUC reductions we expect to achieve for 2012, by the performance of our new international stores, and by our direct-to-consumer business, each of which we expect to support significant margin improvement for this year. Based on these factors, we anticipate strong EPS growth in 2012, notwithstanding that same store sales assumption. Longer term, our objective remains to deliver consistent and sustainable growth in sales and EPS, and we believe trend rates of close to 15% in sales and somewhat above that in EPS are realistic goals. Now over to Jonathan.

Speaker 10

Thanks, Mike, and good morning, everyone. I'll start with a quick recap of our results for the quarter and fiscal year. For the fourth quarter, the company's net sales increased 16% to $1.329 billion, while comp store sales were flat, with men's and women's comps similar. Total U.S. sales, including DTC, were up 4%, while total international sales for the quarter, including DTC, were up 62%, and total DTC sales were up 41%. Sales for fiscal 2011 increased 20% to $4.158 billion, while comp store sales increased 5% for the year. Total U.S. sales were up 10% for the year, while total international sales were up 63%, and total DTC sales were up 36%. Foreign currency changes were not significant to our results for the quarter. Our gross margin rate for the quarter was 56.1%, down 750 basis points from last year. This reflected significant erosion in our U.S.

chain store gross margins, primarily driven by an approximately 20% increase in average unit cost, including a significant mixed component. Overall, AUR was up mid-single digits for the quarter, with AUR slightly down in U.S. chain stores. The gross margin rate for the quarter was adversely impacted by about 200 basis points as a result of markdowns on higher carryover inventory. On an adjusted non-GAAP basis, operating income for the quarter was $109.3 million. This excludes pre-tax charges of $125 million, which are detailed on page five of our investor presentation, and which I will review in more detail in a moment. The tax rate for the quarter was 33.5% on an adjusted basis and 33.9% for the full year on the same basis. Adjusted non-GAAP diluted EPS for the quarter was $1.12, down 19% versus last year.

Adjusted non-GAAP diluted EPS for the year was $2.31, up 13% versus last year. Some more detail on our results for fiscal 2011 is shown on page eight of the investor presentation. This schedule also indicates how our aggregate results by channel reconcile to our overall reported operating income. As this summary shows, both our international stores and DTC businesses performed strongly during the year, while our U.S. chain business was weaker, and this effect was more pronounced in Q4. However, as a reminder, our U.S. tourist stores and other top domestic stores continue to perform strongly. In aggregate, our top 250 U.S. stores operate at comparable margins to our international stores, and we believe this both supports our strategy of closing more U.S. stores and the sustainability of our international results.

A summary of our fiscal quarter and fiscal year adjusted operating expenses is on page 10 in the investor presentation. Excluding the impact of legal charges, MG&A for the quarter was $101.6 million and down approximately 5% compared to last year. MG&A for the quarter included equity and incentive comp of $10.8 million versus $17.8 million last year. On an adjusted basis, MG&A for the full year was up 6.6%. Sourcing and distribution expense of $602.1 million for the quarter included $82.7 million of store-related asset impairment and write-downs and store closure and lease exit charges of $19 million. Excluding the applicable elements of those charges, store occupancy costs were approximately $181 million, and all other stores and distribution costs represented 24% of sales, slightly above the 23% of sales they represented last year as a result of less top-line leverage than anticipated.

For the year as a whole, excluding the charges we have called out, we achieved approximately 260 basis points. Turning to the balance sheet, we ended the quarter with total inventory at cost up 48%, or up 41% excluding in transit. By component, most of the increase is attributable to spring and basic inventory, as reflected in the chart on page 12 of the investor presentation. During the quarter, we repurchased approximately 2 million shares at an aggregate cost of $98 million, bringing our full-year share repurchases to approximately 3.5 million shares at an aggregate cost of almost $200 million, as reflected on page 13. We ended the quarter with $583.5 million in cash and cash equivalents compared to $826.4 million at the comparable point last year.

This number reflects buybacks and dividends of approximately $257.6 million in the past 12 months and the paydown of $45 million in revolver debt. At the end of the fourth quarter, we changed our intent regarding our auction rate security portfolio, which resulted in an other than temporary impairment charge of $13.4 million during the quarter. We opened four flagships and 14 Hollister stores during the quarter. This was one less Hollister opening than planned due to a delayed opening date for one store, which will now open in March. Details of store openings for the quarter are included on pages 15 and 16 of the investor presentation. Coming back to the charges we have taken during the quarter, these included the following: charges of $68 million associated with the impairment of long-lived assets related to 76 U.S.

chain stores, one Canadian store, as well as the Fukuoka and Hollister Soho flagships, and $0.6 million associated with write-downs related to the reconfiguration of the Fukuoka, Ginza, and Hollister flagships, Hollister Soho flagships, and a small write-off related to a canceled flagship project. In the event we complete the closure of the Fukuoka store, we are likely to incur additional charges. A charge of $19 million related to store closures and lease exits. During the quarter, we closed 26 stores other than through natural lease expirations and also accrued for terminations of certain other leases where we have not opened a store. A charge of $10 million relating to an adjustment to legal reserves in connection with legal settlements during the quarter. Last, a charge of $13.4 million relating to auction rate securities, as reviewed a moment ago.

The 2012 EPS effect of real estate charges and store closures during the quarter will be approximately $0.10 to $0.15. This excludes potential transfer of sales volumes from closed stores to other stores or to DTC. Turning to 2012, the key assumptions underlying our EPS guidance of diluted EPS of $3.50 to $3.75 are shown on pages 7 and 18 of the investor presentation. Mike referred to our plans for 2012 store openings a moment ago. Relative to our original expectation of close to 20 flagships by the end of 2012, we have deferred two locations, and two other planned openings have moved into 2013, including Seoul, which we confirmed today.

Coming back to store closures, in addition to the 135 stores we have closed in the past two years, we have identified approximately another 180 stores for closure by 2015 based on current performance, which would bring our total closures to over 300 stores. We expect total capital expenditures for 2012 to be approximately $400 million. Turning to the first quarter, we expect continued significant gross margin erosion of around 400 to 500 basis points for the quarter due to high year-over-year AUC comparisons in a submersional environment. We expect expenses to be approximately flat as a percentage of sales. Gross margins should begin to stabilize during the second quarter and be up significantly in the back half of the year. This concludes our prepared comments section of the call, and we are now available to take your questions. Thank you.

Speaker 5

Thank you. Ladies and gentlemen, the question and answer session will be conducted electronically. To ask your question, please press the star key followed by the digit one on your touch-tone keypad. Please limit yourself to one question. Again, that's star one for questions, and we'll now pause to assemble the queue. Our first question will come from Randy Konik with Jefferies.

Speaker 2

Block, when you play that.

Hey, can you hear me?

Yes.

Speaker 10

Hey, Randy.

Speaker 2

Hey, how are you? If we back out the near term for a second, I think you made some really good points around the long-term story here. If you think about the April 5th analyst meeting and we thought about the $7 billion roughly of revenue targets over the long term, you talked about the Hollister stores or some of the Abercrombie stores, the volumes are annualizing above that pro forma or that run rate you kind of targeted at the analyst meeting. Do you still feel about nine months later, still feel very good about that $7 billion target? If anything has changed around that, both from a top line or margin standpoint, what would it be? Thanks.

Speaker 10

Yeah, Randy, fundamentally, we still feel good about it. The updated roadmap we reviewed with the board yesterday came in a little lower than that, but that was almost entirely attributable to more U.S. store closures, which is accretive to the bottom line. In terms of the international components of that and the direct-to-consumer components, they're absolutely on track.

Speaker 5

Our next question.

Speaker 2

Greg, can you hear me?

Speaker 10

Thank you, Randy.

Speaker 5

Our next question comes from Janet Kloppenburg with JJK Research.

Speaker 10

Good morning, Janet.

Speaker 9

Good morning, everyone. Jonathan and Mike, I'm looking at page eight of the packet you provided us today, where we see the U.S. margin down about 350 basis points. What I'm wondering about is if you could help us understand how that looked through the first nine months of the year and how much erosion there was in the fourth quarter, and just the magnitude of the improvement you expect in the U.S. business in fiscal 2012. Thanks so much.

Speaker 10

I'll let Jonathan answer that question. I think page eight is a very interesting page, and maybe the international stores are more interesting than the U.S. Let's let Jonathan answer that.

Speaker 9

It is and shows the value of that growth strategy, Michael. I think, you know, we have a lot of U.S. stores closing as we go forward. I'm just wondering how we should be thinking about the margin in the U.S. business.

Speaker 10

Sure, Janet. Yeah, I mean, in terms of the U.S. stores, the effect in the fourth quarter, as we said in the prepared comments, was more pronounced than you see for the full year. A lot of that was that we weren't able to get the AURs up as we thought we would in the fourth quarter to offset some of that mix effect in AUC. We got this big markdown reserve effect at the end of the quarter, which particularly impacts those U.S. stores. We've talked about planning for flat comp store sales going forward. We've talked about having average unit costs be down for the year next year. We're being conservative on AUR. We're not expecting a dramatic improvement in U.S. store margins, but we would expect some in 2012. We expect international and direct to continue delivering very high incremental margins per this chart.

Speaker 8

We think those are conservative assumptions, flat AUR and flat sales.

Speaker 10

Did that answer your question, Janet?

Speaker 9

I think I'm just wondering about the store closings in the U.S. because you gave us that your 250 top stores in the U.S. had much higher margins than the entire store base. As we close more stores, I thought there may be a natural lift that we should be thinking about in the U.S.

Speaker 10

Yeah, we'll continue to get it. We said $0.10 to $0.15 from the closures and other charges we took in Q4. We'll continue as we close more stores in future years to get, you know, a few cents per year as we close those stores. That excludes the transfer, and it also excludes our belief that by closing more of these lower-tier underperforming stores, we'll be able to lift up the entire brand, particularly Abercrombie & Fitch. There's an intangible, unquantifiable benefit of that that isn't baked into that analysis at this point.

Speaker 9

Should we be thinking that the international margins could move higher in fiscal 2012?

Speaker 10

I think we'll be very pleased to continue getting the margins we're getting currently.

Speaker 9

Okay, thanks so much. Good luck.

Speaker 10

Thank you, Janet.

Speaker 9

Yeah.

Speaker 5

Next, we'll hear from Lorraine Hutchinson with Bank of America.

Speaker 6

Thank you. Good morning. I was just looking for a little bit more clarity on your inventory trends as the year progresses. I'm seeing inventory excluding in transit up 41% when you're looking for a flat comp this year. I guess, can you just talk a little bit about how you guys AUC the trend as the year goes by, and then what your expectations are for AURs going forward?

Speaker 10

Yeah, Lorraine, first of all, we did have more inventory at the end of the quarter than we planned. That's also reflected in that full carryover comment we made earlier on. If you look at it, most of the rest is spring and basic, and part of that is just timing of receipts, including partly in the intrinsic, even in the base. Clearly, while we're projecting flat same-store sales, our overall sales are going to be obviously well above that. We see inventory being up by a more moderated amount, by a moderated level at the end of Q1, and then much more moderated at the end of Q2. Partly, it's just timing as we work through the season. In terms of the AUC trend, I think we've long said that the first quarter was a very tough comparison.

As you recall, last year, AUCs were significantly down for us in Q1. We're lapping that, and Q1 is really the last quarter where we get the full impact of that cotton spike. Q2, it starts to even out more, and it's really then with the back-to-school receipts and balance of the fall season receipts that we really see that significant year-over-year decline in AUC.

Speaker 8

I think that term significant is very important.

Speaker 5

Next, we'll hear from Evelyn Kopelman with Wells Fargo.

Speaker 6

Hey, guys. I just wanted to quickly ask about maybe what are your thoughts on the promotional strategy going forward in the U.S.? I know, you know, in Q3, you thought it was a little bit too heavy, and Q4 fell short of your expectations. How are you thinking about that going forward? Thank you.

Speaker 8

We are in a highly promotional environment in the U.S. We would hope that would abate. We have to almost play it month by month, week by week. That's our strategy.

Speaker 5

Next, we'll hear from Michelle Tan with Goldman Sachs.

Speaker 6

Great, thanks. Hey, guys.

Speaker 10

Yeah.

Speaker 6

Two quick questions on expenses. One, it looks like in the detail you gave, pre-opening expense was $59 million in 2010. I think you guys have talked about a $100 million number for 2012. Is that still the right number, and are the components comparable to the $59 million that you did for 2011? Secondly, on your expectation for not leveraging expenses in Q1, but then seeing leverage for the full year, is the difference because of the timing of how expenses flow in through the year, or is there a difference in kind of how you're thinking about the sales cadence between the first half and the second half?

Speaker 10

I guess on the first part, Michelle, the store pre-opening costs of $59 million for 2011. That includes rent, we called out in the past, plus other pre-opening costs for new store openings. We talked about $100 million in the middle of last year, and we said at the time we were working to get that down. That number has come down pretty significantly relative to that $100 million. It will be north of the $60 million, but probably more in the $70 million range for 2012. Obviously, that's still a function of store openings in 2013, which started to impact late in 2012. That would be our best estimate at this point.

It's come down partly because of the impact of timings, partly because we moved out a couple of those flagships, but also because we've been, as we said back in the middle of last year, we were going to work very hard to get that number down. We've been successful in doing that. The number we're at in 2012 will likely be the peak based on the ongoing store opening plans that Mike spoke to a moment ago. We would expect in dollar terms that to remain relatively stable after that, and therefore we would get leverage benefits from it going forward. In terms of the Q1 OpEx, not getting any leverage in Q1 versus the balance year, there's a few different factors going into that in terms of the timings of some investments we're making in the first half of the year.

We continue to have the DC depreciation, for example, in the first half of the year. In the back half of the year, we not only have that, but we also have the benefit of the consolidation having occurred and the reduction in cost per unit we get from that. That's one example. There are some investments we're making that are skewed more to the front of the year in the DTC area, and we get more of the benefit of those from a sales standpoint later in the year. There are some other things of that nature.

Speaker 5

Next, we'll hear from Liz Dunn with Macquarie.

Speaker 6

Hi, good morning. Thanks for taking my call. Can you hear me okay?

Speaker 8

Yes, good morning, Liz.

Speaker 6

Good morning. Just one point of clarification on the future store openings. It looked like the impairment had a significant number of Hollister stores, and it doesn't seem like in the past Hollister has been a big portion of the store closures. Will it be a big portion of the store closures going forward? What's your posture on promotions internationally going forward?

Speaker 10

I guess on the first part, we have had some Hollister impairments in the past, but the closures have and will continue to skew more towards Abercrombie & Fitch and Kids than Hollister.

Speaker 8

Let me answer the second part of the question, international promotions. First, I'd like to circle back and answer the first question about promotions. Promotions are not our priority. Our priority here is to continue to focus on high-quality, trend-right merchandise and differentiated store experience. I keep saying that. Promotions are a way of life in the U.S. We do not promote internationally. We had clearance events in the end-of-season clearance events in Hollister and a few flagships. We have decided going forward that it's probably right to have an end-of-season clearance in Hollister, which would be the end of the spring season and the end of the fall season, only as clearance and not to do them in flagships. There is no promotional strategy for this business internationally.

Speaker 5

Next, we'll hear from Stacy Pack with Barclays Capital.

Speaker 6

Hey, a couple of questions. Jonathan, I was hoping maybe you could quantify the reduction you're expecting in AUC sequentially in Q1 from Q4, understanding it's not down year over year, and then how much it should be down in the second half. Jonathan, can you tell us the two or three things that are under your control that Abercrombie & Fitch Co. can do to get the domestic operating margin up to, you know, a mid or high single digit go forward? For you, Mike, given the number of domestic stores that there are, what is the vision for the domestic business? When you think about international growth, how are you balancing, you know, direct versus flag? I mean, does direct ultimately take over? How are you kind of thinking about that longer term?

Speaker 10

Jonathan, hi, Stacy. Starting with the AUC, the Q4 and Q1 AUC on a like-for-like basis, it's similar. There's less of a mix effect in Q1 because, you know, a lot of the mix effect in Q4 was that winter product, which skewed somewhat upwards. The overall like-for-like AUC component in Q1 year over year is comparable. Second quarter, that's the case up until we start to get back-to-school receipts in, and then we start to see it turn the opposite way, and we'll have significant year-over-year declines. We haven't been specific on that, but certainly into the double digits beyond that point.

Speaker 8

Let me respond to your question about vision for the A&F chain. I have to respond to that as where we're going worldwide. Clearly, flagship stores are clearly profitable. We'll continue to grow them at the rate of three to five a year. The direct business is doing very well, and we'll continue to grow at a very big rate. We've established for the total business a goal of $1 billion in direct, and A&F is a good part of that. U.S. stores, obviously a smaller base in better malls, play to the quality level of the A&F business around the world. That's the vision for the brand and the stores. I think it's very consistent in terms of quality, taste, aspiration.

Speaker 10

I guess on the last bit, Stacia, about international direct versus flagship, I guess we don't look at them as being, you know, mutually exclusive in any way. I think they support each other. As we planned the flag, as we've seen, when we spoke about it in the fourth quarter, our direct business was very strong in Europe, and that was across brands. The increasing store rollout, I think, supports the awareness and familiarity and supports the direct business, and that's certainly what we've been seeing. I think a key point in there is that we've long said that we're not going to get overstored, and Mike alluded to that again, internationally. We'll have a more optimal balance between and direct internationally than we have here at this point.

Speaker 5

Next, we'll hear from Christine Chen with Needham & Company.

Speaker 6

Thank you. I was wondering, again, I wanted to focus on the store productivity in the U.S. I think you know you had given metrics in the past that store productivity domestically could be 90% or greater of $0.7. I assume in this environment that's off the table. I guess how are you thinking of it from a productivity perspective since you are benefiting from the lift from the store closures? Thank you.

Speaker 10

Hey, Christine. We've said we're modeling based on flat likes for 2012. Certainly, that won't take us to that 85% to 90% of productivity that we've talked about in the past. We're hopeful that we could do better than that, but that's what we're assuming at this point based on the current trend. It's a slightly better trend in the domestic business than international, but it still wouldn't get us, based on what we're currently modeling, to that range we've talked about in the past.

Speaker 5

Next, we'll hear from Dana Telsey with Telsey Advisory Group.

Speaker 6

Good morning, everyone. Can you talk a little bit about CapEx and how you're seeing it break down by bucket in terms of the spend? Mike, as you think about the product, how do you see the product evolving and whether it's for guys or girls, pricing going forward? Do you see it changing either for back-to-school and pricing versus margin? Thank you.

Speaker 10

Hi Dana. I'll tell you the CapEx piece. I guess the drivers of that are, you know, obviously store count, also store opening timings, including openings in 2013, which have an impact at the end of 2012. We also had some CapEx cash expenditures that rolled over from 2011 into 2012 in terms of when the cash went out the door and the rolls into that CapEx line. A couple of other significant things there. We continue to have some CapEx as we complete the DC consolidation. We have some fairly significant IT-related investments in the DTC and DC area, including a new order management system, which there was a press release out a couple of weeks ago on that that we have going in for DTC this year. We have a new planning system we're putting in place over the course of the year, various other investments in DTC.

That is up fairly significantly on a year-over-year basis. The rest of it is really just the store count and cadence from a timing standpoint.

Speaker 8

To go to the second and third question, Dana, I see the product evolving very nicely. I think you can see that in the stores as of last weekend, what we stand for in each brand. The pricing is an issue that we look at on an ongoing basis. We believe we got a little bit high in Abercrombie & Fitch, particularly in flagship, and the differential between Hollister and Abercrombie & Fitch is probably too great. We see some retail price reductions happening in the Abercrombie & Fitch brand. Effect on margin, we think we are going to be able to manage that on an ongoing basis as we're benefited from AUC reduction. Next question. Thanks, Dana.

Speaker 5

Adrienne Tennant is next. Please go ahead.

Speaker 0

Good morning. Mike, I had a question. I was in the Fifth Avenue store yesterday, and the color palette is probably the best that I've seen across the teen landscape, very bright, compelling. My question was.

Speaker 10

Thank you.

Speaker 0

You're welcome. My question was that I'm not seeing that in the non-flagship stores. As you said, you just sort of landed it last weekend. Is there an intended delay into the regular U.S. chain, or is there something going on there? Jonathan, can you just give us the initial price points internationally for Q3 and Q4 so we can sort of understand extracting the markdowns? The AUR was up about 15% Q3 internationally, up 5% in the fourth quarter. Just trying to figure out how much of that is due to the promotional activity at the end of the ball season. Thank you very much.

Speaker 8

Let me answer the first question. I believe that the chain stores do reflect the flagship stores in terms of bright color. Take a look again and keep looking as the season progresses.

Speaker 10

Hey, Adriana. On the second point, I'm not sure the numbers you were quoting, I'm not sure where you're getting those from specifically, but if you look at our tickets, they were up pretty significantly in the international stores, starting from early September onwards. They were fully in, again, sort of well into the double digits. In terms of the actual tickets, the sale events we ran in January did moderate that to some degree, particularly in Hollister, but that was only January. It was only one month out of the season significantly. In terms of looking forward, we talked about the ticket moderation in the spring, particularly in Abercrombie & Fitch.

Speaker 5

Next, we'll hear from Kimberly Greenberger with Morgan Stanley.

Speaker 6

Oh, great. Thank you. Good morning. I was wondering, Jonathan, if you could address the flexibility in your expense base, and is there an appetite or an ability to cut back on various SG&A expenses if your comps remain flat or perhaps turn negative? I was just wondering if you could clarify something I think you mentioned in your prepared remarks. Did you say you took impairment charges on European stores? Why would that be? Thanks.

Speaker 10

The answer is no on that one, Kimberly. We didn't take any impairment charge on the European stores. None of them are even, I think I can safely say, remotely close to that. There was one Canadian.

Speaker 8

Some Canadian.

Speaker 10

That we can talk to. In terms of flexibility in the expense base, I think the first point there is we're committed to investing in the areas of the business that we think are the growth opportunities, particularly DTC, particularly protecting the flagships, and not taking quality out of those and not investing for the future there. When you come back to the U.S. store base, we try to operate everything at a very consistent standard and with a very consistent model. That does place some restrictions on our ability to take cost out of that, but we continue to look at it. There are some changes we've implemented for 2012 that will reduce the expense base, and there are other projects that we're working through.

We have to protect the brand overall, so there are limits to what we can do in terms of taking cost out of stores that are underperforming. That ultimately goes back to the strategy being to close those stores rather than to operate them at a lower standard than the balance of the chains.

Speaker 5

Next, we'll hear from Anna Andreeva with JJK Research Associates.

Speaker 12

Hi, thanks. Good morning, guys.

Speaker 10

Morning.

Speaker 12

I had a couple of questions. Just looking at the gross margin guidance for the year, you're guiding gross margins to be up significantly. I understand the AUC part of it, but I guess what's giving you the confidence that we could recoup this much gross margin in the back half, especially if the environment continues to be pretty promotional out there? That's my first question.

Speaker 10

Okay, yeah. I think the drivers of the margin improvement are AUC, you know, being down on a full-year basis and international mix, which, you know, inevitably pulls the margin up. The international gross margin is well above the company-wide gross margin. They're the two biggest drivers. We don't have a significant, really, any AUR benefit baked into improving that gross margin on a like-to-like basis.

Speaker 5

Next, we'll hear from Erica Moshmeier with Baird.

Speaker 6

Hi, thanks. Could you talk about just some of the factors that you saw in Q4? Kind of what parts of the disappointment you think were self-inflicted from an inventory or merchandising perspective, and how much you thought was from the external environment, be it weather or promotions for your competition? Thanks.

Speaker 8

Let me tackle that one. I think it was our difficulties were really primarily due to the extremely difficult environment. You just addressed the promotional activity in the U.S., the very warm weather, macro concerns in Europe. I think we can always do better from an assortment point of view, but I don't really believe we missed a lot of business because of that. I think the headline for the fourth quarter is the environment.

Speaker 5

Next, we'll hear from Barbara Weikoff with CLSA.

Speaker 7

Hi, everyone. Hi. Can you first talk about the kids' business? I'm intrigued you're adding kids to London Market and then a couple of German stores. Secondly, comment on the Abercrombie & Fitch Singapore store one month in.

Speaker 8

Kids' business is a business that we are excited about growing. We think the growth is going to come in flagship locations. As you know, Barbara, we have done extraordinarily well in kids in Milan. We've done well in Düsseldorf. We think the growth of the kids' business is a flagship concept. We are excited about being open in London in a very cool location. Singapore opening was very strong. I think the thing that we learned from Singapore is that we can operate well in different climate zones. That will help us go forward in how we're looking at the Southern Hemisphere. Thanks.

Speaker 5

Next, we'll hear from Jennifer Black with Citigroup Inc.

Speaker 3

Yeah. I guess one of our concerns has always been what happens to one of these flagships if we run into trouble, and it sounds like we have that in Japan. I think I heard you might be closing that store, Jonathan. What goes on in the dynamics behind that? I mean, can you find tenants that come in and rent at favorable rates? How long do you have to carry these stores before you close them? I know it's a Japan problem specifically, but if you could just address that with that store, that'd be helpful. Thanks.

Speaker 10

Okay, Jeff, just to be clear, we're talking about the Fukuoka store, not the Ginza store. There are no plans to close the Ginza store.

Speaker 8

Let me back up there, Jeff. We never should have gone into Fukuoka. That was a mistake in the first place. We're not talking about closing the Ginza store. I'm sorry.

Speaker 10

In Fukuoka, yeah, I mean, they are unique spaces, so we're trying to sublet it. It may take a while, but we're working on that. It's obviously a more complicated situation than when you're trying to get out of a mall-based space, but we're working hard at it.

Speaker 5

Next, we'll hear from Robin Murchison with SunTrust.

Speaker 4

Hi, thanks very much. Let me piggyback off of Jeff's question because I too had a question relative to that. Is there any thinking of shifting the size, the average size of your stores, either flagships or international stores? Thanks.

Speaker 10

I mean, certainly not the mall-based stores. The flagship stores already do vary quite a bit. We have several tiers for the flagship stores in terms of the square footage. When we open up in smaller markets, we tend to go with a smaller selling square footprint. They do vary quite a bit. Going forward, it'll be a mixture of some of the bigger footprints and some of the smaller footprints.

Speaker 8

The only store size adjustment we've made has been in the Gilly Hicks chain to go to a smaller format, which has been very successful. That's the only difference.

Speaker 5

Next, we'll hear from Paul Lejuez with Nomura.

Speaker 1

Hey, thanks, guys. A couple of questions. I'm wondering if you took mix out of the equation, what the AUC and AUR would have been in Q4 if you are able to do that. Second, you guys gave the inventory breakdown by piece, the fall inventory in transit in spring. Wondering what the % changes were versus last year. Last, you guys gave the $10 million average on the international Hollister store. It's tough to get precisely to the new store productivity numbers, so just wondering how that $10 million has changed from when you started opening those stores to this past year's class. Thanks.

Speaker 10

I guess on the AUC piece, Paul, we haven't broken out the component of that plus 20 that was, you know, mix. I think in terms of the AUR, what we're saying is we didn't really get paid for that elevated mix, and that was really what a big factor in both the selling margin during the quarter and then the markdown reserve at the end of the quarter. The mix component was a reasonably significant component of that plus 20 overall AUC increase.

Speaker 8

I have to give you a little more color on the mix. We did make pretty big bets on cold weather gear here for furline garments, and we were not helped by the weather in that regard. That really did drive up mix from an AUC and an AUR perspective, and we clearly did not get paid for it.

Speaker 10

I'm just trying to go back to the second part of the question, which was.

Speaker 1

Each of those buckets?

Speaker 10

Sorry, Paul, say that again. I missed it.

Speaker 1

The % change in the pieces of the inventory increase. You gave the dollar increase for fall, for in transit, and spring basic, and I'm just wondering what the % change was in those categories.

Speaker 10

Oh, the fall was a much higher %. That was a pretty high % even after a significant markdown reserve. There is more full carryover increase. Spring is a more modest %. Certainly, you're still decent size in % terms. Again, that's more driven by the timing of receipts than by any other significant factor. On the $10 million average volume, I guess I don't really know how to answer that. We'd said $12 million at one point, but I think we'd always said that some of those early stores were going to be the real powerhouses like a White City and a Central Oberhaus. The $10 million we're at today, we feel very good about it, and it's very consistent with that long-term goal of a little over $8 million once we're fully built out in Europe.

As we've said, the stores we're opening are opening ahead of their approved volumes. Our approved volumes are what's tied to that $8 million objective.

Speaker 5

Next, we'll hear from Jennifer Black with Jennifer Black and Associates.

Speaker 4

Good morning.

Speaker 10

Hi.

Speaker 4

Hi. I wondered if you could talk a little bit about Gilly Hicks, and I think you have three international stores and how things went. I also wondered if you could talk about accessories as a category and discuss where you are in offering that women's mega fragrance. Thank you.

Speaker 8

Okay. Gilly Hicks first. We continue to be very excited about Gilly Hicks. We had very strong comps during the year and fourth quarter. As you say, we opened two stores in the fourth quarter in Europe, one in the UK, one in Germany. We're seeing very strong performance from these stores. Additionally, in Gilly Hicks, which is very interesting, very strong DTC growth. We're very encouraged about Gilly Hicks. The second part of your question, accessories. I think, as you know, accessories for us is a more limited category than for many others in that we don't sell costume jewelry and shoes and jokes. The categories we're in, we're seeing very strong growth at this point as a company. Fragrance, we introduced a new fragrance for Christmas, and it has been very successful, Perfume No. 1, with the little bubo.

It has not taken off as a Fierce, but we see we're going to see strong growth there. Not mega, but we're making progress in fragrance.

Speaker 5

Next, we'll go to Jeff Kleinfelter with Piper Jaffray.

Speaker 3

Yes, good morning, everyone.

Speaker 10

Hi, Jeff.

Speaker 8

Hey, Jeff.

Speaker 3

A couple of questions for you. Jonathan, just on the flagship business model, Jonathan and Mike, you know, there are a lot of questions out there clearly about the viability of that model, the profitability of that model. Could you just share a little bit more on a long-term basis? When you go in and pro forma one of these new flagships, you know, what sort of pattern of comp you bake into that pro forma, what sort of level of profitability you assume, and then what your variance of experience has been. I think that transparency would be really helpful for people on the call.

Mike, coming up on domestic, it seems like we're in a bit of a catch-22 here in that it's a promotional environment, and I think some feel like, you know, you're even setting the tempo to some extent, you know, within a certain portion of specialty retail. What does it take to actually gradually climb out of this cycle, in your opinion?

Speaker 10

Okay, Jeff, I'll tell you the first piece. I mean, I think you have to go back to that chart on page eight of the investor presentation. If you look at our overall business in Europe, which is essentially where we have the flagships at this point, it's extremely strong. We think there probably is some transfer between Abercrombie & Fitch and Hollister, but if you look at it in aggregate terms, it's growing fast, very high margin, a very healthy business when you add it all together. Those flagship stores are all operating at very high margins, even though in the case of London and Milan, they've come down quite a bit over the last six months or so. The four walls are still very strong there.

There may be some transfer with Hollister, there may be some DTC, but if we look at that overall European business, it's extremely strong in a very difficult environment.

Speaker 8

There is some transfer flagship to flagship. Those are the three elements.

Speaker 10

If you look at the comp trend for those stores, what we've seen with London and Milan is they opened well above their planned volumes and then comped very strongly. London had a brief period where it comped negatively in 2008, 2009, and then it came back again. Milan had consistently comped very strongly until the first year. Even though it's comped negative since then, it's still well above its original approved volume. I think we'll see what happens going forward with those stores. We're hopeful that trend will stabilize.

Speaker 8

I think the answer to your second question, Jeff, is that our focus needs to be, as it has been, on high-quality trend-right merchandise and great store experience. If we continue to concentrate on those things, we will pull out of this promotional merry-go-round at some point. I believe that. I just can't tell you when that's going to be, but our focus, being on the former rather than the latter, is going to take us there.

Speaker 5

Our next question comes from Brian Tunick with JPMorgan Chase & Co.

Speaker 11

Thanks. Good morning, guys. A couple of questions. I guess, Jonathan, can you maybe help us understand the DTC margins a little more here for the full-year basis? Was the decline for the full year based on really the Q4 and the clearance events? Can you talk about the inventory plans? Where are you thinking we're going to end spring or as we move through the second half as AUC comes down? Maybe, Mike, your comment that the top 200 U.S. stores have European margins. Can you maybe talk about the bottom part of the chain, sort of, what is the delta of what's happening in the store basis?

Speaker 10

Okay, Brian. On the DTC margin point, the erosion from 2011 to 2010, first of all, most of our business is still U.S. business. The same margin impacts that you see in the U.S. stores were felt in direct. We also made some fairly significant investments in 2011 that impacted the margin. We began to invest in certain marketing channels that we hadn't in the past and other things. That is really primarily what drove that. Overall, we're very comfortable with the margin in that range of 46% for the full year. Inventory plans, I think, as we said a moment ago, it'll be a moderated level of increase at the end of Q1 and then more significantly moderated at the end of the spring season, much more aligned with the sales trend at the end of the spring season.

Speaker 8

Top 250 compared to international store margins. I think you were asking, Brian, what does the bottom look like? Those are probably pretty flat-ish, but we've identified a number of those foreclosures to be more productive as a company.

Speaker 5

Next, we'll hear from Marni Shapiro with The Retail Tracker.

Speaker 12

Hey, guys.

Speaker 10

Hey, Marnie.

Speaker 12

From your mouth to God's ears, this promotional environment goes away. That's all I could say.

Speaker 10

Someday, Marni, someday.

Speaker 12

Someday, someday. Cashmere sweaters will be back to $200 the way they should be.

Speaker 10

Okay.

Speaker 12

Could you talk a little bit about a couple of quick questions. First of all, inventory-wise, did you see similar trends across the chains globally where fashion sold and you're really sitting with what I'm seeing, flannels and fur-lined sweatshirts and hoodies? If that's the case globally, is this what you see? Is this your carryover globally, or are there other pockets? As I think about your inventory going into 2012, are there any areas that you've distorted differently? I know most of 2011 you focused on trying to distort some of the fashion a little bit more. Could you talk about that thought process going into 2012?

Speaker 8

Okay. First part of the question, Marni, we had warm weather everywhere. Fur-lined hoodies and trimmed hoodies didn't meet our expectations anywhere. The second part of the question, pockets of inventory in 2012, where we're distorting? Yes, we are, but I don't think I can share that with you. I think the best thing to do is to walk into the stores and see what stands we're taking. It's for spring. It's clearly not for fur.