At this time, I would like to turn the conference over to Brian Logan. Mr. Logan, please go ahead.
Good morning and welcome to our Q4 earnings call. Earlier today, we released our 4th quarter sales and earnings, income statement, balance sheet, store opening and closing summary 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. Today's earnings call is being recorded and the replay may be accessed through the Internet at abercrombie.com under the Investors section.
The call is scheduled for 1 hour. Joining me today are Mike Jeffries and Jonathan Ramstrom. 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. In addition, in our press release this morning, we announced that the company has converted to the cost method of accounting for inventory. We will discuss the background to and impact of this change later in these prepared remarks.
In general, our comments for the Q4 and full year 2012 results are based on the retail method of accounting to be consistent with the basis in which we gave our guidance coming into the quarter. Also as a reminder, the fiscal 2012 retailer calendar includes a 53rd week and therefore 4th quarter and full year comparable sales are compared to the respective 14 week and 53 week periods ended February 4, 2012. Finally, effective with the 4th quarter results, we are moving to reporting our primary comparable sales metric inclusive of direct to consumer sales. We believe this change is appropriate now that we have a more established comparable store excuse me, comparable sales base for our international direct to consumer operations. For comparison purposes, we are also continuing to provide comp store sales excluding direct to consumer.
We will now begin the call with a few remarks from Mike followed by a review of the financial performance for the quarter from Jonathan and me. After our prepared comments, we will be available to take your questions for as long as time permits. With that, I will turn the call over to Mike.
Good morning, everyone. We are very pleased with our results for the Q4. Our sales were in line with our guidance coming into the quarter and our earnings exceeded expectations due to a very strong gross margin performance along with continued tight expense control. Excluding impairment charges, our adjusted diluted earnings per share for the year was $3.22 under the retail method. Total sales for the quarter were up 11%.
Total comparable sales including direct to consumer sales were down 1% with the U. S. Flat and international down 3%. Despite a challenging U. S.
Retail environment over the holiday period, our core U. S. Chain store plus USDTC comparable metric remained positive as reflected in the chart in our investor presentation. Our international comparable sales represented a further sequential improvement in the trend with growth remaining very strong in direct to consumer. This trend improvement was most notable in Hollister, where we had positive comp store in Scandinavia, Belgium, Spain, Hong Kong and China.
Importantly, we saw a significant sequential improvement in our sales trend in the U. K. Despite that economy dipping back into negative growth. Overall, international sales represented 1 third of our business for the quarter. If international business in U.
S. Stores is included, the figure is closer to 40%. While international comparable sales have been negative for the past several quarters, we are encouraged by the improving trend and by the diversification benefits of our increasingly global presence. Turning to gross margin. Our strong performance for the quarter reflected a significant year over year benefit from lower product cost, but also a moderated promotional stance during the high volume holiday shopping periods and the effect of generally lower levels of clearance inventory.
We also saw good sell through in key categories such as outerwear and jeans. On a full year basis, we achieved overall sales growth of 8% and had a 3rd success of year of healthy year over year growth in sales and adjusted earnings per share. We also generated strong free cash flow for the year and ended the year with our balance sheet in great shape after having returned about $380,000,000 to shareholders during the year through share repurchases and dividends. Beyond the numbers, I'm extremely optimistic that we are well positioned to make continued significant progress over the next few years. Our brands remain incredibly strong and resonate on a global level.
On the front line of our business, our stores organization does a world class job of presenting those brands to the world and running stores like no one else. And we are well positioned to reap the benefits from all the investments we have made in systems over the past couple of years, including a new merchandise planning system, the conversion to cost method for inventory and our DTC investments. Speaking of DTC, our business this year achieved total sales of 7 $100,000,000 versus $290,000,000 just 3 years ago. We now have an international DTC business doing around $230,000,000 in volume at very high margins and growing rapidly. We have made great progress on DTC, but still see major opportunity ahead of us.
Most importantly, our strengths as a company are underpinned by an extremely talented team of associates and our ability as a team to focus on achieving our goals. But while all of that is unquestionably true, it is also true that our profitability is not where it needs to be. We have made progress in our operating margins over the past couple of years, but they are still well below historical levels. And that is despite the benefit of our highly profitable international business. So this clearly represents a major opportunity for company.
And we believe this opportunity lies in 2 specific areas. 1st, revisiting our operating model and identifying processes and identifying processes and investments we make in our business that may have had a return at one point in time, but no longer due today. These are complex issues to address. They involve cross functional impacts and they involve re examining things that have become a core part of how we do business. With regard to this initiative, we have established a cross functional team led by 2 senior leaders and supported by a team of other senior associates with a mandate to perform a detailed review of opportunities to simplify processes, to eliminate low value added components of our model, corporate priority and we believe there is a very significant opportunity.
We are engaging an outside consulting firm to support us on this project and we expect to have completed the diagnostic phase of the project by the end of the Q1 and be in a position to better quantify the opportunity at that point. The second initiative relates to average unit retail. We have launched another cross functional team to identify ways to increase our AUR, particularly in our U. S. Stores and U.
S. DTC. This team is also being led by a dedicated senior level leader. Making progress on AUR will help our gross margins and also contribute to expense leverage. Overall, if we could make meaningful progress on these initiatives, we believe it is a realistic goal to drive our operating margin back to at least the low teens over the next few years.
However, no benefit from either of these two initiatives is assumed in our outlook for 2013. Beyond these initiatives, our focus remains on the strategic initiatives we outlined back in August of last year with regard to merchandising, inventory productivity, insight and intelligence, customer engagement, optimizing expense in AUC and U. S. Store closures. We believe
We believe our
merchandising strategies are already
paying off in what you have commented that you've seen in our assortments. This includes increased vendor collaboration to leverage the expertise of our of our supply chain partners during the product development cycle. With regard to insight and intelligence, we are now engaged in our 1st global market research study. Our goal is to better understand our customers' our goal is to better understand our customers' perceptions of us as well as our key competitors. Geographically, the scope includes North America, Western Europe and Asia.
Regarding customer engagement, more than 1,500,000 new customers have joined our club programs since their launch in the Q3, which is in addition to the 3,500,000 previously existing customer contacts that we brought into the club who are also eligible to receive member benefits. Our overall CRM file now contains over 10,000,000 contacts. From a social media perspective, we have also now exceeded the 10,000,000 fan milestone on Facebook for Hollister. And for the 2nd year in a row, Hollister was a top 5 non paid trending topic on Twitter during Black Friday. Through continued focus on our key strategic initiatives, including the 2 cross functional initiatives I discussed a moment ago, we are confident that we can drive significant and sustainable improvements in our performance.
Coming back to 2013, while we anticipate a slow first quarter due to a number of top line pressures, we anticipate another year of earnings growth in line with our long term goal of annual EPS growth of 15% or slightly better. With that, I'll hand the call over to Jonathan, but I'll be available to take your questions later.
Thanks, Mike, and good morning, everyone. Brian will talk in more detail about the retail to cost conversion in a few minutes, but I'd like to say that we are very pleased to be making this change. We believe the cost method better aligns with our focus on realized selling margin. It is already giving us much better visibility and drill down capability into our merchandise plans. The conversion resulted in an increase in diluted EPS for 2011 and a reduction for 2012, which is primarily due to markdowns taken on very high carryover inventory at the end of 2011.
In general, on a forward looking basis, we do not expect the change to be significant to reported EPS. Brian will go into more detail on this in a moment. Moving on to the numbers. To reiterate what Mike just said, we are very pleased with our results for the quarter. The company's net sales increased 11% to $1,469,000,000 Total U.
S. Sales including DTC increased 1% and international sales including DTC were up 34%. Total DTC sales including shipping and handling were up 26%. Including direct to consumer, comp sales were down 1% last year comprising comp store sales down 4% and comp DTC sales up 17%. Within the quarter, comparable sales were stronger in November January.
Gross margin for the quarter under the retail method improved 9 20 basis points year over year, reflecting a significant year over year benefit from lower product cost and much lower carryover fall inventory. In addition, gross margin benefited from a moderated promotional stance during the high volume holiday shopping periods and the effect of generally lower levels of clearance On an adjusted non GAAP basis, operating expense as a percent of sales for the quarter was approximately 180 basis points higher than last year, driven primarily by the deleveraging effect of negative comp store sales, higher direct to consumer expense and higher MGAAP store sales, higher direct to consumer expense and higher MG and A expense, including incentive and other compensation expense. Operating income for the quarter on the retail method and on an adjusted non GAAP basis was $281,000,000 versus $149,000,000 a year ago. And operating margin increased 7.90 basis points to 19.1%. Our GAAP results for the quarter included an impairment charge GAAP results for the quarter included an impairment charge of approximately $7,000,000 related to 17 stores.
All of these stores are domestic stores and excluding 1 Gilly Hicks store opened 4 years ago or more. Diluted earnings per share for the quarter under the retail method on an adjusted non GAAP basis were 2.21 dollars versus $1.12 for the prior year and represented our strongest 4th quarter performance since 2007. Turning to the balance sheet. We ended the quarter with total inventory under the retail method down 36% versus year ago and inventory under the cost method down 37%. Under both methods, we had a significant benefit from lower fall carryover inventory and lower inventory in transit as well as a significant year over year AUC benefit.
We ended the quarter with approximately $646,000,000 in cash and cash equivalents, including our undrawn credit and term loan facilities. This equated to total pro form a liquidity of $1,146,000,000 as of February 2, 20 13. Yesterday, we elected to draw down the full $150,000,000 from the term loan and this cash will therefore be available to supplement our operating cash flow in funding our 2013 capital allocation priorities. For 2012 as a whole, we generated approximately $345,000,000 of free cash flow, which was net of capital expenditures of 340,000,000 dollars We repurchased 7,500,000 shares during the year at an average cost under $43 including 1,200,000 shares purchased during the Q4. We ended the quarter
with 78,400,000 shares outstanding. With regard to
our expectations for fiscal 20 With regard to our expectations for fiscal 2013, we are projecting full year diluted EPS of approximately $3.35 to $3.45 This would represent another year of healthy earnings growth against the restated cost method adjusted EPS of $2.90 for 20.12. This projection includes an assumption of approximately flat overall comp sales, including direct to consumer, with slightly negative comp store sales. It assumes gross margin rate improvement compared to fiscal 2012 gross margin rate of 62.4% under the cost method, somewhat offset by expense deleverage due to negative comp store sales and higher DTC expense. The projection also assumes a full year tax rate approximately in line with prior year and a full year diluted weighted average share count of approximately 81,300,000 shares, which does not include the effect of any potential share repurchases during the year. With regard to the Q1 of fiscal 2013, we are anticipating some significant headwinds on the top line due to much lower levels of fall carryover inventory compared to last year on top of a difficult macroeconomic environment.
However, we anticipate a significant improvement in the gross margin rate. Based on the above, we are projecting a slight loss per diluted share for the quarter versus a restated loss of $0.25 per diluted share for the Q1 of last year. This projection assumes high single digit negative comparable sales for the quarter. We expect comparable sales to improve significantly in the Q2 as the Q1 headwinds that I mentioned a moment ago diminish and we pick up tailwinds as we anniversary inventory flow issues that adversely affected us last year during the Q2 of last year. With regard to real estate plans for the year, we expect to open A and F flagship locations in Seoul and Shanghai as well as approximately 20 international Hollister stores.
These will include our 1st Hollister store in the Middle East as a result of a now fully executed joint venture agreement with Majid Al Futayim Fashion. Our first stores in the region will be in Dubai, but we anticipate expansion to Abu Dhabi, Kuwait and Qatar in the next couple of years. In addition, during 2013, we will open our first stores in the Southern Hemisphere in Australia and enter Japan with Hollister. We expect capital expenditures of around $200,000,000 for the year with estimated pre opening costs of around $30,000,000 for the year. During fiscal 2012, we closed 47 stores and we expect to close approximately 40 to 50 U.
S. Stores in 2013, primarily through natural lease expirations at the end of the year. Our capital allocation philosophy remains to be highly disciplined in allocating capital to where it will derive the greatest return on a risk adjusted basis. After allocating capital to new stores and other internal projects to provide superior returns, we continue to expect to return excess cash to shareholders. The chart on Page 16 of the investor presentation illustrates our capital allocation for the past several years.
Finally, I would like to echo Mike's comments about our optimism coming into 2013. There will certainly be challenges during the year, particularly in the Q1, but we are going to be highly focused on the 2 initiatives Mike talked about and expect that these will lead to sustainable and meaningful improvements in our operating margin and return on invested capital. We will talk more about this on our next earnings call. Before handing the call over to Brian, I would like to take a moment to welcome a new member of our finance team. Sanjay Singh has recently joined us from Procter and Gamble, where he was most recently the Finance Director of Global Beauty Care.
In his over 20 years with P&G, Sanjay spent much of his time in Asia, including roles based in China, Japan and Korea. Among other responsibilities, Sanjay will be overseeing our long term financial and strategic planning process and many of you will likely meet him in that context. With that, I'm going to hand over to Brian to provide some more details on the retail to cost conversion and to add some more color on our results for the
quarter and fiscal year. Thanks, Jonathan. I will start by taking a few minutes to discuss the retail to cost conversion. In addition to my comments, please refer to the change in method of accounting for inventory Q and A included as an appendix in our investor presentation. During the Q4, we changed our method of accounting for inventory from the retail method to the weighted average cost method.
This was enabled by a systems conversion project that has been underway for some time, but which was completed during the quarter. Under the former retail method, a cost to retail relationship was established at the item level based upon weighted average cost and initial retail selling price. When the retail selling price of an item was permanently reduced, the company reduced the value of its inventory and recorded a charge to cost of goods sold, so as to maintain the already established cost to retail relationship. For example, if a permanent markdown was taken to reduce the retail selling price of an item by 10%, the book value of inventory on hand would also be reduced by 10% with a corresponding charge to cost of goods sold. In addition, the value of inventory on hand at the end of a reporting period was reduced and charged to cost of goods sold by recording a valuation reserve that represented future a future anticipated permanent reductions in retail selling price.
Under the cost method, the company does not reduce the value of its inventory or recognize any impact of permanent reductions to the retail selling price and cost of goods sold unless the company expects to sell the merchandise below original costs, in which case the inventory will be reduced to the expected selling price. Using the same example I gave a moment ago under the cost method, inventory book value would not be reduced and there would be no charge to cost of goods sold unless the reduction in selling price dropped below cost and then inventory value would only be reduced to the new selling price. As a result of these differences in accounting for permanent markdowns in ending inventory, the conversion to the cost method had a number of impacts on the company's financial statements, including increasing the value of inventory and creating timing differences in cost of goods sold. For example, in the Q4 of fiscal 2011, EPS under the retail method was 0 point cost method due to elevated levels of markdowns taken on very high fall carryover inventory levels under the retail method. Conversely, in fiscal 2012, we ended the year with much lower carryover inventories levels, which required fewer markdowns and a lower markdown reserve than a year ago under the retail method.
This resulted in EPS for the Q4 of fiscal 2012 under the retail method being $0.20 greater than under the cost method. Had we had normalized carryover levels at the end of fiscal 2011, we would not have seen such a significant divergence between the retail and cost method results in fiscal 2011 and fiscal 2012. Additionally, operating income among our 3 operating segments, U. S. Stores, international stores and DTC, as well as our other category was impacted by the conversion.
Under the retail method, the other category included charges associated with permanent markdowns taken on merchandise held in the distribution centers. Under the cost method, the segment that ultimately sells the merchandise now bears the full cost of inventory markdowns. This effect is most significant for the DTC segment due to its role in clearing end of season under the cost method. The company believes the new methodology is preferable as it better aligns with the company's operational focus on realized selling margin and improves the comparability of our financial results with those of its competitors. The change was effective as of February 2, 2013 and was applied retrospectively to fiscal 2011 and fiscal 2010.
The company has included in its release this morning a schedule of restated consolidated statements of income for fiscal 2011 and fiscal 2010 along with restated quarterly consolidated statements of income beginning with the Q1 of fiscal 2011. In connection with this change, the company's annual 10 ks filing will be reported on the cost method with prior year figures restated accordingly. The company determined that it would be impractical to restate fiscal years 2,009 prior. Coming back to the quarter, as reported, 4th quarter comp sales were down 1% with comp store sales down 4% and comp direct to consumer sales up 17%. By brand, comp sales were flat for Abercrombie and Fitch, up 4% for Abercrombie Kids and down 2% for Hollister.
Across the brands, male performed better than female. The gross profit rate for the Q4 under the retail method was 65.3%, 9 20 basis points better than last year's Q4 gross profit rate, reflecting a significant year over year benefit from lower product costs and the effect of reduced markdowns in ending inventory from lower levels of clearance inventory. The gross profit rate for the 4th quarter under the cost method was 63.4%, 390 basis points better than last year's restated 4th quarter gross profit rate, primarily driven by lower product costs. Stores and distribution expense for the quarter was 700 excuse me, was 5.77 $577,000,000 or 39.3 percent as a percentage of net sales. Store and distribution expense for the quarter included charges for impairments of $7,400,000 Excluding the effect of these charges, the stores and distribution expense rate for the quarter was 38.8% compared to 37.7% last year excluding impairment, asset write down, store closure and lease exit charges.
The increase in stores and distribution expense rate was primarily the result of deleveraging negative comparable store sales and higher direct to consumer expense. MG and A for the quarter was $22,000,000 versus $112,000,000 last year. Last year's Q4 included $10,000,000 in charges related to legal settlements. The increase in MG and A expense was due increases in incentive and other compensation related expenses, marketing, IT and other expenses. We reported other operating income of $13,700,000 for the 4th quarter, which included income of $4,800,000 related to business interruption insurance recoveries associated with Superstorm Sandy.
Last year, we reported other operating expense of $7,600,000 for the Q4, which included a charge of $13,400,000 related to the company's holdings of auction rate securities. The tax rate for the year was 35.4%. Details of international Hollister store openings for the quarter are included on page 20 of the investor presentation. At the end of the quarter, we operated 285 Abercrombie and Fitch stores, 150 kids stores, 589 Hollister stores and 27 Gilly Hicks stores. This concludes our prepared comments.
We are now available to take your questions. Thank you.
Thank you very much.
Congratulations on a great quarter.
Thank you, Betty.
Thanks, Betty.
I was wondering, Jonathan, if you can talk a little bit or Mike about the guidance for Q1 comps of down high single digit. I think you mentioned in your prepared remarks some impact maybe from macro conditions as well as the inventory flow. Is it also based upon some of the trends you're seeing now in February? And also why we should expect that to increase significantly in the Q2? And that would be really helpful.
Thanks.
Let me take a stab at this. We went have come into the Q1, knowing that we have tailwinds primarily from the lack of cold weather inventory that we had on hand last year. We are anticipating sales losses due to that through the middle of March. We were also very concerned about macroeconomic situation coming into the Q1. 2nd quarter, we see that we won't have the same problem in terms of liquidating carryover merchandise.
However, we also see that we will be in better position versus last year. If you'll remember, we had a real problem with flowing newness into the stores. We also think that the cannibalization effect is diminishing in Europe. So Q1 is really going to be a margin opportunity. We believe that for the reasons I just mentioned, Q2 we'll see a resumption of healthier sales levels.
Our next question will come from Randy Konik with Jefferies.
Hey, great. Thanks a lot. Jonathan, can you give us a little perspective on just what you saw in the international business during the quarter in terms of maybe traffic or regional perspective? And just remind us what were the compares we're going to face up against in international going forward? And then just lastly, any update on how you're thinking about from a planning what you're working on from a planning and allocation perspective with regards to the inventory?
It is nice to see that the fall carryover is down. And should we expect these carryover levels to continue to moderate as we go forward through the year and beyond? Thanks.
Hey, Randy. Sure. I mean on the first point, we saw a sequential improvement in the trend everywhere pretty much in Europe. I don't think there was any there were any exceptions to that. And we saw the 2 year trend pick up a bit in the stores.
And obviously, we had very strong direct to consumer growth. So the overall comp for international, as we said, was down a little bit. In Europe, it was actually slightly better than that given the strong direct to consumer growth we saw in Europe. In terms of compares, we do get a more of a tailwind coming into Q2. We did see a step down in the international business from Q1 to Q2 of last year.
So that's one of the tailwinds winds that will help us from a comp standpoint in Q2. In terms of inventory levels, we expect them to be down year over year at the end of Q1 and Q2 on a dollar basis. We haven't given guidance for the back half of the year at this point.
Next we'll hear from Barbara Wyckoff, CLSA.
Hi, guys. Hi, Barbara.
Good morning, Barbara.
Hi. How are the U. S. Stores that don't serve tourists doing now that the other teen retailers are sort of forging their own identity? And then just as a follow-up, can you talk about the learnings in the stores in the countries in Asia?
And then lastly, as things have stabilized or starting to stabilize in Europe, are there any stores that you would not open today if you could make that decision again?
Would you repeat the first part of the question Barbara? I'm a little
Okay. Of the U. S. Stores that don't serve tourists, how are they doing now that your prior direct competitors are sort of dancing to their own thing, they forge their own identity
and they're not copying you?
We call those the promotional stores, which have no tourist business. And we're pleased with how they're doing. The trend clearly improved during the year. And I think you're right that we are all in kind of different zones. And those stores in the U.
S. Did better than the stores that were tourist related, which relates to the weakness in the international business versus the U. S. Jonathan, do you want to talk about the second part of the question?
Sure. Yes, Barbara, I think on the second point, we've always said there are probably 1 or 2 maybe 3 stores in Europe that if we had our time again, we might not open. Frankly, one of the ones we've talked about in the past has had a dramatic improvement over the last few months. So I think we wouldn't really include it in that category anymore today. So there's probably 1 or 2 at this point that we would not have opened if we were doing it over again.
Next we'll hear from Janet Kloppenburg, JJK Research.
Good morning, everyone. Congratulations.
Hi, Janet.
Hi, Michael. A couple of questions, particularly on the guidance. I think what you're saying is that your clearance inventory is down significantly, so you're forfeiting a lot of business because of that. Perhaps you could talk a little bit about full price selling trends and what you're seeing there and if there's encouragement if there are encouraging signs there both domestically and internationally. Also in the Q3 you gave us a breakdown in the U.
S. Of the flagship comp versus the branch comp. I was wondering Jonathan, if you could talk a little bit about that? And Michael, do you think the macroeconomic situation in the United States has worsened from the Q4 to the Q1? And is that affecting is that also affecting comps here in the month of February?
If you could talk a little bit about February trends that would help because we've been hearing that it's tough this month. And I think there's a lot of reasons behind that, but I'd love to hear more. Thank you.
Okay. We can't comment on current quarter business. We haven't and we won't. I will comment on regular price selling. I think we have lots of good news within regular price selling.
And I believe that we are taking advantage of the merchandise initiatives in terms of more current fashion. I think you're seeing that in our assortments and you will see it on an ongoing basis. The floor set that we did this week, I thought was new, different. The floor set we're going to do March week 1 is going to be more newness March week 3 more newness. So I am encouraged by how new fashion is selling.
Now we can go from there to Jonathan.
Jan, on the second part of the question, flagship of tourist stores in the U. S. Did come negatively better than the international rate and they did sequentially improve from Q3 to Q4.
Thank you, Janet.
Next is Marni Shapiro, The Retail Tracker.
Hey, guys. Congratulations on a good quarter. Yes, your stores don't have very much inventory in them at all. Thinking about throwing a party in one of them. I was curious about dovetailing on what Janet was asking about the new merchandise.
It seems that the inventory you're bringing in of the new product is you're not bringing in much of it and it's turning very quickly. So as we move into March and later in the season, is the assumption that you'll increase the percentage, the buys behind that fashion? Clearly, the denim will remain a core part of your buy. But what I'm seeing is a lot of what you have in fashion that is selling, you're buying so few units that it's turning too quickly. And I'm curious how as we march the season, how that's going to change?
You are absolutely correct that we're turning it quickly. We planned on turning it quickly. We will increase the inventory levels through deeper buys. The inventory levels through deeper buys as we proceed through the quarter. We'll be very happy with where we are from an inventory level perspective in Q2.
That's one of the reasons for my optimism about Q2 becoming very much better than Q1. But your question and your observation is a good one, But it's really based on the good news, which is we're turning through this new fashion very quickly.
Liz Dunn with Macquarie has our next question.
Hi. Thanks for taking my question. I guess, first just a clarification on the guidance. If you had not made this accounting change, would the rate of EPS growth be similar that you're forecasting for 2013? And then also I was just wondering about your decision to draw down on the debt.
Can we assume that that will be used for repurchases? Thanks.
Elyse, on the first part, had we stayed on the retail method, we would have expected that the guidance would have been broadly comparable to what we're guiding to on the cost method. I think part of that is the fact that Brian described in his comments of that benefit we had in the Q1 of 2012 from markdowns that were taken in 2,000 in the Q4 of 2011 on that high fall carryover inventory. So broadly speaking, as we said, with normalized
inventory levels, we would expect that the results
on a retail and we would expect that the results on the retail and cost method would not significantly diverge. So the guidance would have been broadly similar, although obviously it's somewhat academic at this point and it would depend on what assumptions we made about markdown reserves at the end of 2012. In terms of the synergy drawdown on the debt that was part of the arrangement for adjusting the facility. That will add to the capital we have available for repurchases or for other capital allocation priorities during the year.
Next, we'll turn to Lorraine Hutchinson, Bank of America Merrill Lynch.
Thank you. Good morning. How are you thinking about the long term store count in Asia? And are there any lessons learned in Europe that you've applied to the rollout over there?
Lorraine, that's a great question. It's something we have not yet at this point put a specific external goal on where we see store count or volume going. It's something that we're focusing a lot on internally. We're going through a comprehensive review of our long term strategic plan, which we'll be working on over the next few months. And as part of that, we're doing a very deep dive into Asia.
Now we have a basis there of having opened quite a few stores. We're looking at
the real estate opportunity, productivity levels, where
we can be with the direct productivity levels, where we can be with the direct business relative to the stores, what marketing efforts we need to support the growth in different markets and it does vary by market. So we're in the midst of diving into that as well as frankly beyond Asia or other parts of the world such as the Middle East, the Southern Hemisphere. So at this point, we're not ready or able to give a specific outlook for Asia, but we're getting closer to being able to do that. I think in terms of lessons applied from Europe, clearly Europe's been a huge success for us. So I don't think there are a lot of negative lessons we would take out of that.
We'll certainly be conscious of the cannibalization point as we open up in Asia. I don't think there are any other sort of significant learnings that we would apply. I think Asia having said all of that is very different to Europe and we need to be mindful of that as we enter into in the region.
I think I'd like to add that we're continuing to gain optimism about Asia. And let's just go through the reasons. In China, we're comping positively at Raffles City in Shanghai and XC in Shenzhen. And we expect to comp positively at Galleria in Beijing when it enters the comp base. We recently opened our 4th Hollister store in China.
We believe that the Shanghai flagship will be important to the development of the brand awareness in China. Hong Kong remains a really bright spot. Festival Walk remains strong even after opening Hyacinth and Petters Street and is comping positively. Festival Walk and Hyacinth are 2 of our highest performing Hollister stores in the world. And in addition, Petter Street is obviously doing major volume.
We're enthusiastic about Korea. We opened our 2nd Hollister store in Seoul a couple of weeks ago. And we're excited about Japan with the introduction of the Hollister brand there. So we think Asia is going to be a major opportunity for us and we're off to a very good start.
Kimberly Greenberger with Morgan Stanley has a question.
Okay, great. Thank you. Good morning. Mike, I'm wondering if you can share some of your strategic thinking behind this change in accounting methodology. It strikes me that it's not simply just a change in accounting methodology, but you're looking to drive different organizational behavior.
And I'm wondering if you can talk about anything you've seen so far. And what do you think the medium and long term financial benefits of this sort of new way of thinking, new way of running the organization are likely to be?
I'll let Jonathan have a stab at that.
Well, let me just give a couple of high level observations on that Kimberly. I think historically on the retail method our focus was on IMU and our systems were oriented towards IMU. And to some degree as merchandise moved through the cycle, we lost visibility on the original historic cost of the merchandise and therefore had limited visibility on the selling margin. So given the evolution of our business model, given the complexity of our business model and the multiple different channels we operate in and the different economics of those channels, a very different story to where we were 4 or 5 years ago. Being able to focus on selling margin is extremely helpful in how we look at the business across channels and within channels.
And the systems conversion we've gone through gives us much greater ability to drill down into the numbers and to understand what's rolling up into the overall plans as opposed to having to have done a lot of that stuff outside of the system for the past couple of years while we've been working through this system conversion project. So high level that's how I would characterize it.
I would reinforce that Kimberly. It's a way for us to have a better detailed view of the business, which is a complicated business today. I'm thrilled with what I'm seeing in our sessions. And I think I have said this, what we're uncovering in these sessions looking at the business this way. Big opportunity.
Our next question will come from Jeff Black with Avondale Partners.
Yes. Just staying on that topic and hi guys. Hi, Jeff. On the Mike you mentioned you're looking at processes and investments that had a high return that you're not getting that return out of now. Can we talk about what are some examples of what that might hit?
I mean, are you talking on the investment side about store concepts that might not be generating the return you thought? Are you talking about product investments that aren't generating the return or categories? And is that primarily domestic? Or does that also get to some of the international things you've been doing? Thanks.
Jeff, I'd rather not talk about this now because we have as I said, a team looking at everything we're doing. We said and I'll say again, we hope to bring more color to this conversation at the end of the quarter. But speaking to anything now I think would be premature.
Our next question will come from Brian Tuncay with JPMorgan.
Thanks. Good morning, guys.
Good morning, Brian.
Good morning, Brian.
I guess for maybe Mike, you've made some comments that you guys are looking for AUR opportunities in the U. S. And just curious about your comments or thoughts about AURs on the international side of the business. What do you think we're going to see over the next year or so from a price point perspective and maybe how that flow through to where you think international margins should come out? And maybe Jonathan on the capital allocation side, can you remind us sort of what's your minimum cash balance sort of view and how the partnership in the Middle East maybe how the economics might work for you versus all the company owned stores that you've opened before?
Thanks very much.
Okay. Let me go for the first part of the question. The AURs will over the year increase in the international stores. We and this is going to come through honestly ticketing a little higher in those stores. I think if we got too low, it did not impact the sales.
It probably impacted the sales negatively. So we have upside in AUR in the international stores. We'll start to see the benefit end of Q2 clearly in the fall. Before I turn it over to Jonathan, I'm going to be in Roosevelt Field on Saturday morning, if you're going to be around Brian or anybody.
Jonathan? Hey Brian, on the second part of the question, we've said in the past and remains the case that we won't have at any given point in time including at the trough of the cycle cash on hand of $350,000,000 So that's our lower guardrail in terms of what's available to fund repurchases or other capital priorities at any given point in time. In terms of the economics in the Middle East, on a 4 wall basis, we would view the model as being very similar to elsewhere in the world. Our partner there will be sharing in the capital investment and they will also be taking a return related to the investment they're making in those stores.
Steph Wissink with Piper Jaffray has a question.
Hi. Good morning, everyone. Thank you. Mike, if you could just share with us a little bit about how you're using or plan to use the CRM database, which is quite robust at this point to target your marketing or allocate your merchandise and even some of the things that you've mentioned around AURs, if you could just share with us a little bit of your intentions there? Thanks.
Jonathan? Sure. Steph, well, the good news at this point, we have a robust amount of data in the database, a lot of customer information. The next step, as we've described in the past, is to start leveraging that in terms of how we segment and ultimately personalized messaging to different groups of consumers. So we're getting closer to being able to make that a reality.
We've talked about it for a fairly long period of time as we've built up the programs. But with the back office system developments and the number of customers we now have in the database, that's much closer to being a reality. The other things we continue to look at is the overall content of the clubs and the programs, how we increase the front end engagement with the customers to make sure we keep the numbers growing in those clubs and they continue to be active participants in the clubs.
Our next question will come from Dana Telsey, Telsey Advisory Group.
Good morning, everyone, and congratulations. Hi. Product flow improvement and speed to market certainly has been a factor in your improved performance. Where are you relative to the goal? And does it differ by channel?
Does it differ by men's or women's? Or does it differ by domestic and international? Thank you.
Domestic and international would be the same. It is more important in female than in male. We are cautious about how much we're increasing our chase component of speed to market because there as I've said, there are some downsides to chase. But I think it's most apparent in the female portion of our business across the brands.
John Kernan with Cowen is next.
Hey, good morning guys. Thanks for taking my questions. Good morning, John. It looks like the a little bit of a follow-up to Brian Tuning's question. It looks like the international four wall margin was down about 600 basis points year over year.
The domestic four wall margin was up year over year for the full fiscal year. What is embedded in your guidance in terms of those two change in the full wall margin both internationally and domestically in 2013? Thanks.
Hey, John. Yes, in terms of the international margins, I mean, we continue to expect that they're going to remain at 30% or greater, which they were on both the retail and cost methods for 2012. We would expect to continue to make some progress on the U. S. Store margins.
And DTC, we would expect to remain now on the restated cost method in that kind of high-30s range in terms of an overall segment margin.
Lindsay Drucker Mann with Goldman Sachs has a question.
Hey, thanks. Good morning, everyone. Good morning. Jonathan hey, there. So, Jonathan, I was hoping you could give some detail on what your AUCs as it relates to gross margin, what your AUCs were in the period and also your AURs and then what your outlook is for AUC specifically in the 1st and second quarter?
And then just on the inventory point, maybe you could to help us kind of understand how much money perhaps you left on the table by the inventory being so thin in the period. Any metrics you can give as far as what your average inventory was during holiday versus a normal run rate or any other way for us to quantify the impact of that?
Okay. I'll try to get through as much of that as I can, Lyn. AUC during the Q4 was down in the mid teens range. That was something we'd indicated. I think coming the quarter was broadly where we expected to be.
That's broadly in line with where we're going to be for Q1. We would still expect AUC to be down year over year in Q2. The question about how much dollars left on the table due thin inventory levels, that's a really tough question to answer. I think we are very happy with how we margined out during the quarter. Clearly, we had a very substantial gross margin rate improvement on both the retail and the cost methods.
I think we're happy with that. We're happy that we were able to be more promotional be less promotional. So I'm not sure if we were doing it all over again, we would have chosen to approach it any differently quite frankly. Average inventory versus holiday or run rates, I'm not sure that's something we can really get into frankly.
Our next question will come from Erica Maschmeyer, Robert W. Baird.
Thanks and congratulations. I just wanted to follow-up on your kind of early gut instincts on AUR and where you expect to be able to increase that in the U. S? And then I know last year you tried ticketing a bit higher internationally. How do you think you will go about it differently this time?
And then just one quick clarification, does your Q1 comp guidance include DTC?
Instincts on AUR, again, I'd really not like to get into detail because we have a wonderful team really investigating this. But we see that just low hanging fruit, our new systems will enable us to be pricing better by segment, by tier. There's an opportunity, immediate opportunity to how we are tiering fashion versus core by tier. There are lots of opportunities here, but again, let's save this conversation until this team comes up with its conclusions.
And Erika, yes, the Q1 guidance is total comparable sales.
Next is Adrienne Tannett, Janney Capital Markets.
Good morning. Let me add my congratulations.
Thank
you. Mike, so the spring trends, it seems like you're spot on there. I was wondering what you're welcome. You had said something about deeper buys entering the Q2. And I was just wondering if you meant more choice count or breadth or deeper key items?
And then secondarily, Jonathan, just so I understand this accounting change, it sounds like when markdowns are high, retail understates earnings. When they're lower, the retail method overstates the earnings. So this year, it would seem that the cost method would understate the earnings. And I'm just wondering when do we sort of normalize that and get that back so that overall earnings power of the company remains the same? So sorry if I'm not understanding that correctly.
Thank you.
Let me respond to the first part of the question. I think Marni got that exactly right. We need deeper buys not more breadth and you'll see that in
Q2. John? Adrian, on the second point, in terms of normalizing going forward as we said earlier, if we have normalized inventory levels at the beginning of a period and end of a period, there shouldn't be a significant divergence between the retail and cost method. So assuming at the end of 2013 our inventory levels are normal, then the EPS we would deliver under the cost method would not be significantly different what we would have delivered under the retail method is the short answer. I think we're anticipating there are going to be quite a few questions around this.
And certainly, we'll we have to talk to people 1 on 1 as we work through today and early next week in terms of follow-up calls. But that's probably the headline that's most helpful.
Our final question today will come from Anna Andreeva with FBR.
Great. Thanks so much and congrats to strong end to the year. Just Jonathan to double check, is there any impact from the change in accounting in the Q1? Just trying to understand if there's any of that headwind to get to your guidance for a slight loss. And I'm not sure if I missed this, but what were the 4 wall returns internationally in the 4Q?
I think you gave us the year on a cost basis, but what was it on the retail basis in the Q4? Thanks.
On the cost method, the international 4 wall was 33.8% in Q4. We're checking the retail figure. Importantly, the methodology we've changed to now includes all 3rd party sell off of excess merchandise in those margins. So that's actually a slightly more conservative way of presenting those international margins, but we think it's comparable with the U. S.
Stores. If you look at Q1, if you go to the very end of our investor presentation and you look at the restated cost method data for 2012, you'll see that, 1st of all, overall, our restated cost method basis EPS for 2012 Q1 was a loss of $0.25 And if you look at Q1 by segment, you'll see, for example, that U. S. Stores had a 7.9% 4 wall margin in the Q1 of 2012, which is obviously very low. And that reflected the fact that in the Q1 of last year, we were selling a lot of full carryover merchandise at significant markdowns.
The AURs were not always all that low because a lot of it was outerwear, for example. But the margin we were making on that carryover was extremely low. And therefore, when you restate Q1 on the method, the earnings per share goes down significantly from where it had been on the retail method. So relative to that Q1 restated loss of $0.25 we're anticipating significant year over year progress in EPS to come up without slight loss in Q1 of 2013. On the retail method in Q4 of last year, the international margin would have been in the range of 33% to 34%.