The company’s short-term outlook reflects its view of the sagging general economy and the ongoing challenges in the specialty retail sector.
However, Abercrombie & Fitch remains committed to its growth and investment strategy and over the Fall season. Internet sales, Canada stores, U.S. based tour stores, and the flagships in New York and London give every indication that this strategy with proven concepts will drive substantial long-term top-line and bottom line growth.
Key questions and answers from the second quarter fiscal 2008 earnings call conducted by Abercrombie & Fitch Co. (ANF) on August 15, 2008.
Jeffrey Klinefelter (Piper Jaffray):
On the system implementation plan, can you update us on how you are phasing that in through the merch organization in the back half of this year? And have you been testing it? Are you getting any feedback off of it in terms of turn changes or margin changes within your current business?
Kristen Blume: In terms of where we are from an implementation perspective, we’re not in the testing phases yet. It is a two-phased approach. Phase one is an April implementation of ’09, which includes all of the foundational components of the system, as well as purchase order functionality, so we anticipate great efficiencies there, from a workload perspective on the merchant side. That is the predominant factor in release one. Release two is September ’09 and what that includes is all of the financial components, stock ledger, perpetual inventory, etc.
That then eliminates all of our legacy systems at that point in time, so all the COBOL mainframe applications, everything that we will be running semi-parallel between release one and release two will be completely sunsetted at the September timeframe next year. Release one is in the design. We’re finalizing design and heading into the development phase, and for release two we are finalizing requirements. So we’ll continue to make progress there and update you.
Michael W. Kramer: We have some key merchants and some key planners that we have pulled out of the business that are 100% focused and dedicated to the development and implementation of this and they directly report back to the heads of those groups, so everybody is in communication and has impact in terms of this rollout. There will be no surprises at the end because of this fully being integrated with the business partners throughout the process.
Paul Lejeuz (Credit Suisse):
Can you break out some of the big pieces of MG&A and talk about the rate of growth on some of those pieces? Is there any opportunity to make some cuts there?
Mike Nuzzo: I think when you look at the MG&A, you want to think about it sequentially from Spring to Fall, and if you look at the estimate that we provided, this year our MG&A will be up about 7.5% from Fall to Spring. And this is actually lower than it’s been in the past two years. The previous year it was up about 10% and the year before that, I think it was up close to 13%.
But the elements are all the elements that you would think about as we get prepared for the international rollout. It includes the additional payroll for bringing on people and expertise. It includes depreciation related to the IT systems. It includes additional legal and consulting that will be essential for becoming fully capable of rolling out stores in multiple countries next year.
In terms of the ability to cut back on MG&A as we look out into the fall, there will be limited opportunities to do so, and we do our best to dig into the operations of this business and we have saved and generated savings in areas like travel, in samples, in marketing, and we will continue to make those efforts. We are clearly earmarking investments for 2009 to 2010 and our ability to cut back on those is not something that we want to do.
Janet Kloppenburg (JJK Research):
Should we then think that the rate of growth for the company in ’09 and ’10 may slow, as it has in ’08? Or do you think the revenue component from the flagships will help to offset some of this expense pressure? And secondly, it’s unusual for A&F to have inventories at the levels they are now and going forward if you are planning for comps to be down. Usually your inventories have been in line with your comp guidance. Can you explain that change in strategy?
Mike Nuzzo: We talked about the triggers that we have in place to help moderate the inventory and the planning systems here and the effort that we will put in to inventory management in the Fall, we are focused on ensuring that we come out of the Fall with no markdown or carry-over exposure.
Again, having worked through this system over the last couple of years, the tools that the planning team has to implement supply chain methodologies into the initial buys and the triggering processes that we have are better than they have ever been, so coming out of Fall, we will be as clean as we can be given the sales environment.
As far as the rate of growth question, we don’t really give a whole lot of information on 2009 and so on but we’ve got these flagships that we have outlined coming on board in 2009. I think we all understand both top line and bottom line opportunity that they provide to us, and also we have the Hollister U.K. stores opening in Fall. It would not be a surprise if we accelerate that as well and in late 2009 you see some additional Hollister chain stores come on board in Europe and the U.K. So absolutely on a top line basis, that will help our rate of growth as we get into next year.
Michael W. Kramer: Our rate of growth internationally will start to swing up to the latter part of 2009 into 2010, which will help offset that expense pressure. But going into 2009, it will not. In the absence of the economy turning around, going into 2009 is going to be tough for us but the latter part of 2009 with regard to the international hockey stick, we feel very confident about and that’s really a real big upside to us on a go-forward.
And then in terms of the inventory levels, keep in mind that last year there were some shifts in our inventory strategy going on at the end of last year and that’s why you see a little bit of a disconnect in terms of our growth.
Dana Cohen (Banc of America):
Just going back on the SG&A, the two pieces you are calling out, payroll as well as flagship expenses, are about twice the expenses you had in the first half. Should we just think that that is totally incremental or are there likely to be offsets as there were in the second quarter? And were there any other things other than payroll that resulted in the moderation in the expense dollars in the second quarter?
Mike Nuzzo: Let me start with the stores and distribution part of the P&L. First of all, the second quarter performance from an EPS standpoint was actually extremely good. We got benefit on the gross margin side but we also got some higher than what we would have expected benefit on the stores and distribution side, and a lot of that came from some effective management and a program that we had started in the fourth quarter, began to implement in the first quarter, and saw the full impact of in the second quarter, where we looked at within the payroll structure overnight hours, we looked at impact hours, we looked at the management structure of stores and saw a lot of savings that was generated from those areas.
We talk about the concept of leveraging on a flat to plus one comp. I think we still want to be of that mindset but clearly if you take into account the benefit that we got on the gross margin side and on the store side, we likely would have leveraged, excluding the incremental expense that we talk about, on a negative 1 comp, so it was a really strong accomplishment.
Going forward, we obviously assume that that programmatic change in the store side will continue into the fall. It is part of our fall guidance and, if you look at the fall guidance and if you look at where we are and what we’ve come out with the $3.40 to $3.45, a good way to think about it is if you look at our Spring performance, where we generated roughly comparable operating income dollars on a negative 4 comp, and if you take that model and you apply it to fall, the major difference between that and the guidance that we’ve provided is simply in the sales difference between a negative 4 comp and a negative 7 comp. If you take that sales difference and the fact that we’ve got some limited variable expense that we can take out of the stores and distribution line item, we are pretty fixed on our MG&A, as we talked about. We should anticipate a comparable other income and lower interest income. That I think will help you get to the earnings guidance that we provided for the fall.
Dana Telsey (Telsey Advisory Group):
Given the gross margin continues to be up around 130 basis points, how much of the improvement in gross margin is coming from London and the international stores? And as you look at the flagship stores, what opportunities in margin do you see in terms of their contribution relative to the whole? And just lastly on the Hollister business, any differences in how you are managing expenses at Hollister versus core Abercrombie?
Mike Nuzzo: On the gross margin side, you touched on one of the benefits that we’ve gotten, which is the international pricing. The second area of benefit is in the core retail pricing. We talked about the price increases that we have taken in denim and polos. We’ve taken some price increases in graphic tees, in shorts. And we will look to strategically take some price increases over the course of the Fall. So that, along with the international pricing, has been a benefit for us. As you look out into 2009, I can tell you that as we bring on more of these both flagship A&F stores and Hollister chain stores, the benefit to the IMU of that international pricing will increase.
And on the product pricing side, you will see an advantage as well. On the gross margin side we are paying special attention to is on the sourcing side. We have not seen product inflation as we’ve done our planning for the back half of 2008. We are starting to see some product inflation issues as we get into 2009 but what we will see in 2008 will be some inflationary pressures in the areas of transportation and logistics. So, we’ve got these two forces that are really helping us on the pricing side. We’ve got sourcing issues and on the markdown front, in terms of gross margin, I think it’s safe to say that our markdown level might be a little higher in Fall compared to last year than it was in the spring, but not significantly higher.
In terms of looking at the cost reduction with Hollister, we’ve always thought about running our businesses consistently in terms of staffing and the P&L structure, and so we are not taking any steps outside of the normal matrix and mechanisms in Hollister compared to the other brands.
