At this time, I would like to turn the conference over to Mr. Eric Cerny. Mr.
Cerny, please go ahead.
Good morning, and welcome to our Q3 earnings call. Earlier this morning, we released our Q3 sales and earnings balance sheet, income statement, store opening and closing summary and an updated financial history. Please feel free to reference these materials available on our Web site. Also available on our Web site 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 Internet 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 1 hour. We will begin the call with a few brief remarks from Mike, followed by a review of the financial performance for the quarter from Jonathan Ramston. After our prepared comments, we will be available to take your questions for as long as time permits. Please limit yourself to one question so that we can speak with as many callers as possible.
As a reminder, the after tax operating results of rule for 2,009 and prior periods are now included in discontinued operations and income statement and related comparisons to prior
year, therefore, generally exclude rule. Now, I'll turn the call over to Mike.
Thank you, generally exclude rule. Now, I'll turn the call over
to Mike. Good morning, everyone.
Thank you for joining us. Jonathan will talk to the specifics of the quarter in
a moment, but simply put, we are pleased with our performance against our objectives for the quarter and remain very excited about the opportunities the quarter and remain very excited about the opportunities ahead of us across all areas of our business. Our domestic business has continued to improve. Our international results are outstanding and our direct to consumer business is posting very strong growth. We will share more details coming into 2011, but I want to take a few minutes to recap where we stand on our key roadmap objectives to achieve an operating margin of 15% or better our goal for fiscal 2012. As you recall, these include improvements in domestic productivity, including store closures returning gross margin to historical levels driving Gilly Hicks.
I will start with what appears today to be the most challenging of these objectives, returning our gross margin to historical levels of around 67%. We feel good about the elements of this objective that are under our control, namely benefiting from a growing international components of our business international component of our business and turning the corner on domestic AURs. However, cost pressures from raw materials and labor costs have only increased as we have gone through the year and transportation costs remain at very high levels. We think it is possible that some of these factors such as cotton costs may abate somewhat, but that is not something we can count on. We expect to make progress on gross margin in the first half of twenty eleven overall.
However, for receipts later in the season, costs are escalating significantly and visibility beyond that is limited. Aside from the gross margin objective, we are positive about the other components of our roadmap objectives. On domestic productivity, our objective is to be at 85% or better of 2,007 productivity by 2012. We've made solid progress on that this year to date with some strengthening as the year has gone on and the domestic closures scheduled for this year and next will help. Beyond that, we will need mid single digit increases in same store sales in each of the next 2 years.
We intend to achieve this by continuing to provide an assortment that is trend right, premium quality and offers a healthy balance of fashion and basic heritage items. Over the last year, we have become much better at how we deliver fashion right assortments with attractive price points and we'll continue to improve on this process as we push for sales improvement. Moving to our international business, we crossed a milestone this quarter with the opening of our first Hollister stores in Spain, 1 in Madrid and 1 in Barcelona. Both are running ahead of projections. We also opened our 2nd Hollister store in Germany in Oberhausen and early signs are that this will reaffirm the very strong response we saw to our first opening in Germany last year.
Meanwhile, our U. K. Hollister stores comped double digits for the quarter and our Italian business got even stronger. Looking forward, we need to accelerate our Hollister expansion in 20 11 2012 beyond the 20 stores we will open this year and are putting a huge amount of effort into making that happen. The focus is equally strong on A and F flagship opportunities The focus is equally strong on A and F flagship opportunities and in both cases, we expect to give more concrete guidance coming into 2011.
We are also looking very hard at the pipeline further out to make sure we are fully capitalizing on the opportunity ahead of us. Turning to direct to consumer, our business is up 40% year to date with both international and domestic up strongly. The direct to consumer business now represents around 10% of our business and we continue to believe strongly in the growth opportunity it offers. Over the course of this year, we have made or will be making many different investments in our direct to consumer business, including headcount. Additionally, we have launched mobile sites, added on figure key looks, improved the shop ability of our sites, are adding much stronger analytic capabilities and are experimenting with paid search and other initiatives.
We have also invested in country specific websites in each of the countries where we currently have store locations. On expenses, we are maintaining a strong focus on validating ROI and our visibility to that has been enhanced by a new budgeting and reporting system in place for our current budget cycle as well as continuing improvements in our capability. Finally, turning to Gilly Hicks. Our like stores are comping in the 40s year to date, on track with our productivity goals. We are looking forward to our 1st U.
K. Opening on Saturday, November 27 in London. If anyone happens to be in London over Thanksgiving weekend, hopefully, you'll notice some buzz around that. In summary, these are very exciting times for us. There is a huge amount of work to be done to execute our plans, but we have a very clear view of what we need to do.
And I know that we have the team in place to get it done, a team obsessed with enhancing our iconic brands. With that, I hand the call over to Jonathan.
Thank you, Mike, and good morning, everyone. Our results for the quarter are summarized on Page 3 of Q3 were up 18% to $886,000,000 including a comp store sales increase of 7%. These results were very close to what we had planned coming into the quarter. Our DTC business was up 32% for the quarter. Our international sales were up 87% for the quarter and represented 18.5% of total sales.
Our gross margin rate for the quarter was 63 point 7%, down 40 basis points versus last year. This was slightly better than we had anticipated as a result of a currency benefit and lower freight costs than originally budgeted. We now expect a similar level of erosion in the 4th quarter and that the gross margin rate for the season as a whole will therefore be slightly below our prior expectations. A summary of operating expenses is included on Page 7 of the investor presentation. Overall, operating expenses for the quarter came in somewhat lower than anticipated at the beginning of the quarter.
Store occupancy costs were $165,000,000 lower than expected due to lower depreciation charges. We anticipate 4th quarter store occupancy costs to be in the high 160s, excluding costs associated with store closures and potential impairment charges resulting from our annual review of store related assets. All other stores and distribution expenses were approximately $220,000,000 or 24.8 percent of sales for the quarter. For the Q4, we anticipate a continued modest leverage benefit in these expenses versus last year. MG and A for the quarter was $103,000,000 up 17% to last year.
This was at the higher end of the mid teen percentage growth we anticipated at the beginning of the quarter, primarily due to higher incentive comp. MG and A for the quarter included total equity and incentive comp of $15,600,000 compared to $300,000 last year, accounting for approximately 600 basis points of the increase. The impact of an insurance recovery in the prior year accounted for approximately another 300 basis points of the increase. For the Q4, we expect MG A to be up slightly above the Q3 in dollar terms. Operating margin for the quarter was 8.8% and represented a 2 50 basis points improvement over last year.
The tax rate for the quarter was 35.6% compared to a benefit of 4.7% for the Q3 of 2,009. The 2,009 rate was favorably impacted by a true up in the year to date rate. On a full year basis for 20 10, we now expect the effective rate to be around 35%. Net income for the quarter was $0.56 per diluted share. Turning to inventory.
Total inventory at quarter end was up 47% at cost versus last year or up 43 percent excluding inventory in transit. This was in line with our expectations at the beginning of the quarter. We expect the year over year inventory increase to moderate towards a closer alignment with sales at the end of the year. We remain comfortable with our inventory levels, which we believe are appropriate to drive the business. We ended the quarter with approximately $618,000,000 in cash and cash equivalents and outstanding borrowings and letters of credit of approximately $68,000,000 During the quarter, we purchased 669,000 shares under the company's existing share buyback authorizations at a total cost of $29,200,000 Going forward, we expect this share buyback program to continue subject to performance expense and tax rate expectations is included on Page 11 of the investor presentation.
Our store opening plans for the year are on track with the guidance previously given and reflected on Pages 1213 of our investor presentation. With regard to closures, we now expect 2010 store closures to be slightly above the previous figure of 60 planned closures. As previously indicated, we will record additional charges in the Q4 associated with these closures. This concludes our prepared comments section of the call. We are now available to take your questions.
Please limit yourself to one question so that we can speak with as many callers as possible. I think If everyone has had a chance, we will be happy to take follow-up questions. Thank you.
We'll now take our first question from Evron Kopelman out of Wells Fargo.
Hey, good morning. Thank you. My question is about the when we look at the delta between the sales and comp growth and it's about 11 points this quarter. How should we think about that going forward, especially as the more and more international stores enter the comp base? Can you give us some color or help in terms of how we think about how that impacts comps?
I assume positively given some of the numbers you gave for the Hollister UK stores comps, but how should we think about the delta? Thank you.
Good morning, Avren. I guess, I understand that people externally focus on that metric. It's one that we don't particularly focus on internally. I think what we have seen over the past few months is some volatility in that spread caused by
different seasonality in the DTC business
and in the seasonality in the DTC business and in the European business, which follows a slightly different seasonal path than our U. S. Business. I think going forward, it's hard for us to be too specific about what that spread is going to be. I think if you because you've got a lot of things moving in and out of it with comp base.
So it's typically something we haven't given guidance on in the past. But I think your best way of getting there is to model in the volume of the stores that are opening during the quarter and some assumption about DTC and that will lead you to a spread expectation for the quarter.
Our next question comes from Jeff Klinefelter out of Piper Jaffray.
Hi, yes. Thank you. Congratulations everyone on a good quarter. It's on the international stores. Mike and or Jonathan, if you could just address the Hollister's seem to be opening very, very well, Continental European markets.
Could you compare or contrast those openings with your experience in the UK? And then also, just with respect to the international business, how should we think about sort of the profit margins on a fully loaded basis? Is there a certain scale you have to achieve per country in order to get to that point of maximum contribution? Thank you.
I'll start the answer by saying we're just very pleased, as I said, with the openings in Spain. They're exceeding our projections very handily. The German second German store continues to be really a strong volume store. I think it's tough to say how do they open or have they opened versus UK. They're all opening very well and very well versus projection.
And clearly at volume levels that are multiples of the Hollister stores in the U. S. With that, I'll turn it over to Jonathan.
Hey, Jeff. I think as you know from what we've said in the past, we target a 4 wall operating margin
for all new international stores of at least
30%. And generally speaking, country unique country costs associated with each new country we go into, unique country costs associated with each new country we go into. So as we think about the plan going forward, we do have to look at the total store count potential in each country and look at that in the context of those country specific costs to make sure the overall country margin is still at an acceptable level. So that's broadly how we look at it.
We'll go next to Randall Konik with Jefferies and Company. Hi, Randy.
This is actually Scott Robinson with Mirage Capital. A couple of questions or actually one question. Can you provide some color on your e commerce vision going forward? And how do you plan to sell marketing services through your website?
The second didn't quite hear the second bit.
Can you provide some color on your e commerce vision going forward? And what how do you plan to take advantage of this enormous opportunity in 2011 to sell more goods and services via your website to allow customers to have a better shopping experience?
Well, I think as Mike said on the call, we think DTC is a huge opportunity for us going forward. We've been making a lot of investments in it over the course of this year, some of which Mike enumerated a minute ago. There are other things we have in the pipeline. So we certainly think it's great growth opportunity for us and it should be highly accretive growth even net of some of the incremental investments we need to make in building that business. I think in terms of specifics for 2011 of what we're going to be selling, I don't think there's anything additional we can add on that.
We'll go next to Janet Kloppenburg with JJK Research.
Hi, everybody. Congratulations. Nice quarter. I had a couple of questions on the gross margin. First, Jonathan, you went quickly as over why the gross margin for the Q4 would be down.
I didn't fully understand that. I was expecting it perhaps to be flat to slightly up. And secondly, Michael, if you could talk a little bit about the cotton price pressure for the second half. I was wondering if the impact of a higher number of international stores, which I believe generate a premium margin could help to offset some of the higher sourcing costs? Thanks so much.
Hey, Janet. Good morning. On the first bit, I think our prior guidance for the whole season was that gross margin would be flat to slightly down for the season. What we're saying is we're going to be a little bit below that, but only slightly for the season as a whole as we currently see it. So there was a little bit of a shift between Q3 and Q4.
We're not talking about major shifts, by the way, a couple of tenths for a couple of different things. So I think as we've cautioned in the past, our core intra quarter guidance during the quarter is less precise than our viewpoint for the season as a whole. And we're slightly off what we thought for the season. And then there was a
bit of shift between the quarters in our gross margin expectations. The second part of your question, I'll answer the latter first and that is that our international stores do offer us the opportunity for enhanced rate, but also to enhance the total quality level of our offerings. And I'd like to make 2 points with regard to the cotton prices. Obviously, they've escalated. They're clearly a problem, but we're not going to overtalk on this problem because of our perspective.
And Janet, you understand this, our long term objective in the business, which is our perspective is long term. And we've always believed that some problems could be opportunities. We're looking at this this way. We think lots of people are going to take a lot out of their product at this time. We're not.
We're going to use this opportunity to enhance the product offering and we can get paid for it, particularly in international locations. The second point I'd like to make and maybe this is the strongest point I'd like to make is that our perspective is long term and our relationship with our factories, our vendors is a long term relationship. And I couldn't stress more strongly how grateful we are to them that they have held our hands during this time, been fair with us in terms of what's happening with cotton prices and other increases. But I think they know that we're there for them for the long term as they have been there for us and will be there for us because they are as obsessive as we about creating beautiful products at fair prices.
We'll go next to John Morris with BMO Capital.
Congratulations too on a great start to the back half here. Jonathan, just following up there on that gross margin question. Can you just clarify for me why the shift between Q3 and Q4? What's going on there? And then as you look out to the back half of twenty eleven, besides cotton potentially being a difficult cost component?
Are there other cost pressures that you are referring to? And can you just kind of give us a little bit more color on that?
Sure, John. Good morning. Yes, I guess in Q3, as we said a few minutes ago, we'd expected gross margin to come in a little lower. It got better partly because of currency, which helped over the latter part of the quarter. And also we our budget our freight costs came in a little lower than budgeted.
In the Q4, we've added some markdowns, which is incrementally lowering the gross margin rate modestly. But I think I want to caveat all of that by saying these are not major shifts in the gross margin rate. These are relatively minor. And if you look at the season as a whole, we're pretty close to where we thought we were going to be. And as I said a second ago, the sort of split split between the quarter, less of a focus for us than looking at the overall season.
So I think I'd just like to caveat all of that with those 2 riders. I guess with regards to back half of twenty 11, I think we and other people have talked about labor costs continuing to be an issue beyond cotton costs, and Mike alluded to that earlier on. As Mike said, we think there is some possibility that cotton costs may abate, labor costs, the rate of growth may change over time, but directionally they're likely to continue heading upwards.
We'll go next to Liz Dunn with FBR.
Hi, good morning. I had a question on inventory. I see that in the presentation materials on your website, you've added a chart with inventory days, which is really helpful to provide some historical context. But I think last quarter, you sort of broke down how much was attributable to some buckets. Could you tell us specifically how much supports the new store openings and the direct to consumer business or if not specifically some context around that?
Hey, Liz. Yes, I don't think we can tell you specifically, but certainly with the international store openings in the Q4 that does create a need for additional inventory. And as we roll through year end, all those stores coming on stream in the Q4 will continue to add to a factor of causing an overall increase in inventory levels as well as continuing to support DTC growth. So aside from the sort of underlying comp business, those factors are both causing inventory to be running at somewhat higher levels. But overall, I think the key point is that we're comfortable with where we are.
We expect the year over year increase to moderate as we come out of the year and as we're lapping more normalized levels from the prior year.
We'll go next to Dana Telsey with Telsey Advisory Group.
Good morning, everyone.
Good morning, Dana.
Hi. You've been trying different promotional or marketing messages throughout the quarter and even throughout the past 2 quarters. What are you finding is working? Does it work differently in Hollister or in Abercrombie in both domestically and overseas, particularly in the Hollister Mall stores at all? And as you think about the AUR trends, which were down around 11%, how do you see that progressing into next year?
Thank you.
I think, Dana, there's a limit obviously to what we could say about what our plans are for the next couple of months. I think what we have said, and Mike spoke to it earlier on, is that we see domestic AURs turning the corner coming into 2011 and being in positive territory. But I think, as we've said in the past, I mean, the month to month patent may not be linear. And I think we obviously can't say too much about our specific plans for the balance of this season in particular.
One addition, Dane, and that's it. We do not promote in our international stores at all.
We'll go next to Kimberly Greenberger with Morgan Stanley.
Great. Thank you. Good morning. I was wondering, Michael, if you can talk about how far out you've secured product and how much visibility you have as to pricing in the first half of the year? And when you talk about costs escalating meaningfully, could you help us understand the magnitude on that?
That would be helpful. Thanks.
I can't tell you the magnitude. I can say that for Q1, we are committed to AUCs that are about
even
to last year. And we are seeing pressure on the second half of summer deliveries and back to school. I can't give you an order of magnitude.
We'll go next to Marni Shapiro with the Retail Tracker.
Congratulations. The scores look great. And I hate to harp on the whole pricing, but if we could just think about it in terms of 2 buckets within sourcing and pricing, it seems to me you've been a lot less promotional. And if the increase in pricing in the back half of the year is what I'm hearing, shouldn't you be able to, with your brand, offset that with better promotions that maybe aren't as deep and with fewer markdowns as I've seen over the last couple of weeks and maybe a month or so?
Marta, are you talking about the back half of 10 or back half of 11%?
Back half, well, sort of middle of 11% and into back to school in 11%. 11%. It seems to me that you have strong enough brands and I've watched you pull the lever back on the promotions the last couple of weeks months, suggesting that maybe there's a little more wiggle room for you guys than some other players out there?
Well, I mean, Manny, overall, I mean, we clearly have felt that we're getting better at how we execute some of those initiatives. We do have the benefit of the international mix coming into play more and more as we go forward. And I think if cost pressures remain very significant, then we're going to keep an open mind to pricing generally, although we certainly haven't made any decisions on that. But I think all of those factors we continue to look at.
By the way, I misspoke because we do promote in Canada, but that's treated by us as much as North America, but we don't promote internationally other than Canada.
We'll go next to Michelle Tan with Goldman Sachs.
Hey, Jonathan, I was wondering if
you could give us any more color on how you think about the minimum cash cushion that you want to maintain as you look at buyback going forward from here? Is there a dollar level per quarter or annually that you're thinking about?
Hey, Michelle. Yes, I think there are sort of 2 guardrails in how we think about this. We're always going to want to maintain a healthy net cash cushion, which we define as our cash on hand less anything we've got drawn down on the revolver and any letters of credit we have outstanding against the revolver. I think historically, we used to talk about a $300,000,000 cash cushion. Going forward, I think we're thinking more in terms of a $350,000,000 net cash cushion.
So cash on hand, less outstanding revolver drawdowns and LCs. So we would never want to be below around $350,000,000 is our current thinking. So that's kind of one guardrail. I think on the other end, we've seen our share count creep up over the last couple of years due to equity plan issuances. And I think going forward, we would at a minimum look to offset those equity plan share issuances with buybacks.
So they're really the kind of 2 guardrails. Where we end up between those 2 guardrails will be a function of how we're feeling about business, how we see our cash flow requirements in general going forward, market conditions obviously and potentially other factors, but we would expect to be somewhere within that range. So with the sort of floor being as of today that we would never go below a €350,000,000 net cash cushion. That isn't to say that we're going to be at that level. It's just that would be the sort of guardrail of the lower end.
We'll go next to Christine Chen with Needham and Company.
I wanted to piggyback off of the inventory question. Maybe another way to look at it, I mean, you're up against the down 30 something, but what's the breakout between other merchandise that has less fashion risk versus the fashion product? And how much of that inventory is finished goods versus maybe work in process, I. E. Material that you might have bought that you can make into whatever you want to kind of mitigate the sourcing cost increases?
And then if you could just talk about rollout of Geely next year since it's doing so well? Thank you.
Hey, Christine. I guess, on the inventory question, first of all, most of it is finished goods. There is the inventory in transit component, which accounted for percentage of the increase, but we stripped out inventory in transit in the chart that's in the presentation. I think as we said on the prior earnings call, we've never historically had issues with inventory and we feel very comfortable about the inventory position we have. And we think we need the inventory levels we have to drive the business.
So we're comfortable with where we are. And I think in a historical context, the chart we have in the presentation illustrates that we are not out of line with where we've historically been at this stage in
the year. The second part of the question, Christine, I'll take rollout of Gilly. We're obviously very pleased with the results. We're very pleased with the 5,000 square foot store that we opened in Roseville and we're going to see how we do in London on 27. We're not in a position to make an announcement on anything other than that at this point.
But thanks for the question.
We'll go next to Brian Tunic with JPMorgan.
Thanks. Good morning, guys.
Good morning, Brian.
Hey, just two quick ones. First, are you guys reiterating your mid single digit comp guidance for the fall season? And then as we try to get some more thoughts around the store closings for 2011, can you give us some idea whether it's occupancy or stores and distribution? What kind of number can we expect to lower for next year based on the store closings?
I guess, Brian, on the first point, we've said, I think what you're alluding to is we've said we bought to a mid single digit comp for the fall season. We haven't specifically updated that, but clearly our results for the Q3 were consistent with that buying assumption for the season and we haven't spoken to anything subsequent to that. On store closings in '11, we'd originally said 110 over 1011, few of those are pulling forward into 10, but we'd still expect to be in the 40 to 50 range in 'eleven. The primary reason why those stores are unprofitable is low volume, which does tend to result in very high, first of all, low gross margin rates. So closing those stores helps with the gross margin and then high occupancy costs as a percentage of sales in some cases, although not all.
So I think you're generally going to see and then clearly because we have to still stack them to minimum levels, those variable expense items tend to run as a high percentage of sales. So I think you're going to see the impact on gross margin and then in both components of stores and distribution expenses from a leverage benefit. But also keep in mind that we're talking about 67 or so stores this year and another sort of 40 to 50 next year. So you have to keep it in that overall context.
We'll go next to Paul Lejuez with Nomura Securities.
Hey, thanks guys. Just a couple more questions on the store closings. I know you haven't closed many yet this year, but I'm wondering if you've looked to see if nearby stores are getting a bump from those stores closing. Also, how many of the stores are at lease expiration, the ones that you plan to close this year? And then last, is there any near term negative impact on the gross margin line in 4Q as you clear merchandise and closing those stores?
Thanks.
Hey, Paul. I guess on the first question, it's something we will be looking at as we close these stores. But as you say, we've only closed a few so far, but we'll certainly be tracking what happens as we close the balance through the next couple of months to see what happens in terms of transfer business and also by the way be trying to do some things to help that process as we close the stores. There will probably be some modest incremental markdowns associated with store closures, but not particularly significant in the overall scheme. And the vast majority of the stores that are closing are by way of natural lease expirations this year, maybe not the vast majority, but certainly the majority.
There are a few buyouts and early closures included in the total.
We'll go next to Robert Samuels with Phoenix Partners.
Hi, good morning, guys. Could you just elaborate a little bit more on the international Hollister stores and what differences you're seeing if any by location and country?
By location, the business is pretty uniformly strong. The one thing I can say that's interesting about our business is that I think as many of you have noticed, more and more of our stores are requiring crowd control.
We'll go next to Dorothy Lachner with Kerrison Company.
I wanted to come back for a second just to the product cost issue because obviously over the last year you've been working really hard to get your average unit cost down. And I'm wondering if there's more room to go there. In other words, are there certain things that will help you in 2011 offset things like the increasing cotton prices and so forth?
I think the answer to that, Dorothy, is very smart to note how hard we have worked at that. We will continue to do those things that will help us with AUC. And those things involve
purchasing
better at cross branding of fabric and bundling of like items and we'll continue to do that and that should give us benefits. But we do have headwind in terms of cotton and labor terms of cotton and labor prices.
We'll go next to Richard Jaffe with Stifel Nicolaus.
Thanks very much guys. And a follow on Hollister, given success in the European community, has your vision for Hollister expanded beyond that community? And are there things that you've learned in Europe that can be brought to United States?
Hey, Richard. Yes, we're certainly looking at countries outside of Europe for future Hollister expansion. I think we'll increase incrementally give more color on the specifics of that as we go forward. But certainly, we're looking beyond Europe both for A and F and for Hollister.
We'll go next to Lorraine Hutchinson with Bank of America Merrill Lynch.
Thank you. Good morning.
Good morning.
Just a question on the
real estate. As you try to accelerate the Hollister openings in 20112012, can you talk a little about the availability and pricing of the deals that you're getting and perhaps how many leases you've secured for next year at this stage? Jonathan,
do you want to Sure.
I think with regard to specifics on number of stores next year, we'll be more clear we'll be clear on that coming into We're still working through that, as Mike alluded to earlier, putting a lot of effort to getting that closed down. So we'll be more specific on numbers of 2011 openings in February. In terms of rents, frankly, they vary significantly from country to country. They're certainly in some like the UK or Germany running significantly higher per square foot than they do domestically, but that makes sense given the much higher volumes we see. I think the key point for us is that when we open a store, we focus on that 4 wall margin and that we can generate a sales volume that enables us to cover that rent and all the other expenses and still generate that 4 wall margin of 30% or hopefully better.
And that's really the single critical factor that we focus on in each of these new deals.
With a conservative sales estimate.
We'll go next to Linda Tsai with MKM Partners.
Yes, good morning. Your comments about the mid single digit increase over the next 2 years, what are the components of that? Specifically, how do you expect average unit retail to trend over the next few quarters?
Well, as we said, we see domestic AURs turning the corner coming into 2011. The increasing international component of the business helps from a mix standpoint as does the closures of underperforming high markdown domestic stores. I think beyond the first half of twenty eleven, certainly a component beyond that will be what we see continuing to happen on the cost front. But generally speaking, we expect to be in positive territory going forward on AURs and exactly how that plays out quarter by quarter. I think we'll see and give clearer guidance on as we go forward.
But overall, in terms of getting those mid single digit comps, the premise is certainly that AURs turn positive as opposed to continuing to decline.
We'll go next to Edward Yruma with KeyBanc.
Hi, thanks very much for taking my question. Can you talk a little bit about pricing you're seeing out of your competitors? And if in fact you're seeing competitive response to some of the more significant pricing actions
that you've taken over the past couple of months? Thank you.
We don't really look at the business that way, Ed. We've aggressively been driving our business. I can't really answer that question.
I think the only thing I
would add, Ed, or the only thing I
would say is that the strongest correlation we see is how we plan our own business, not with what others are doing. So and we saw that in the 3rd quarter. We were extremely close to what we planned for the business in terms of comps in particular. And that, I think we feel more and more comfortable going forward about our ability to have clearer visibility on the trend of business and that what we're planning is the single most important determinant of how we end each quarter.
We'll go next to Roxanne Meyer with UBS.
Great. Thank you. Good morning. Good morning. I'm wondering when you mentioned your long term gross margin goal of 67%, can you tell us what that assumes about where the U.
S. Business can get to over time? And then separately, can you just remind us if there's any average unit costing opportunities still in the Q4? Thank you.
I guess on the second part, there is we continue to get average unit cost benefit in the Q4 year over year. It's a little less than the Q3, which was less than the spring. So it's year over year, it's abating as we go through the year. In terms of the long term gross margin goal, to be at that level and in general to be back at that 15% operating margin level, domestic margins would be south of 15% with international margins being a good bit north of that. So we would not be back at our historic peaks for the domestic business, but by any means to be back at that overall 15% operating margin goal.
We'll go next to Jennifer Black with Jennifer Black and Associates.
Good morning and let me add my congratulations.
Thank you.
Your accessories look great and it looks like you've increased the penetration especially at the Abercrombie division. And I wondered if that's the case, what are your thoughts about it going forward? And then within accessories, can you talk a little bit about the fragrance business? I know that's a really big opportunity for you. Thanks a lot.
Thanks, Jennifer. The fragrance business does offer us huge opportunity. As we've said, Fierce is currently this year, I think, going to be an $88,000,000 business and we don't have a female equivalent. So, if we could just come up with that, we'd have a lot of business. Regarding
to David Glick with Buckingham Research.
Good morning. Just a follow-up on Gilly Hicks. I know that it's premature to talk about the extent of the opportunity, but I was just curious, Mike, how you look at the U. S. Versus Europe, clearly U.
S. Potentially a bigger market, the competitive landscape seems a little more devoid of competition in Europe. And wondering if you see that as perhaps a faster
rollout in that region versus
the U. S? Rollout in that region versus the U. S?
David, I don't really know. We haven't opened a European store. We will at the end of this month. It is possible that Gilly has the same potential as Hollister in terms of worldwide locations, but we're taking it very easy. We're looking and we're looking at it
in a very hard way.
We'll go next to Robin Murchison with SunTrust.
Thanks very much. Congratulations, guys.
Thank you.
If you could just remind me please of the split this year air versus ocean and if you expect it to remain the same for the out year for next year? Thank you.
Hey, Robin. Air versus ocean has been down. We've been boating much more this year than we historically did. I'm not sure we've given specific percentages, but it's a relatively low percentage that's now coming in by air and that's one of the factors that's driven that increase in inventory in transit. I think going forward given where air rates are at, we'll be looking to stay close to that to the current mix.
There always be some, but we're seeking to continue to have most goods coming in by boat.
We'll go next to Stacy Pack with SP Research.
Hi, thanks. Versus Q3, it looks an awful lot easier. And your AUR was really nicely flat in October. So I'm still struggling to understand why the gross margin should be down equivalent to Q3. And am I right, your guidance is basically implying the Street needs to come down about $0.08 Am I in line there?
Certainly not. What we're saying specifically, I mean, I think everyone has their different models. A couple of points there, Stacy. Firstly, average unit costs, as I said a second ago, is moderating in terms of the year over year benefit we're getting in the 4th read too much into one month. So October AUR was pretty much flat, but we're not saying that any given month is indicative of what we're going to be seeing for the balance of the season.
So we do expect AURs to continue to be down in the Q4. And the reason why the gross margin is roughly equivalent is because the AUC is the benefit we're getting year over year is less than it was a year ago, as well as a couple of the minor factors year over year and some of the other gross margin components.
We'll go next to Adrienne Tennant with Janney Capital Markets.
Hi, Mike. Hi, Jonathan. It looks like
the strategy is really starting to
take shape. So congratulations on that.
Thank you.
My first question, Mike, is for you. Really, you sort of touched on the fact that the stores in Europe and Asia sort of performed similarly. Can you talk about the customer buying behavior? And with the test that you've had in Japan, does that sort of open the door for you to go into China? What would need to happen to sort of move to China and Hong Kong?
Thanks.
First answer is that our stores respond very
much the same
experience,
all of what we bring to the retail experience. I think the difference is there's just a different level of volume. So we offer the same experience in the U. S. As Europe.
We just are doing more business on a store by store basis in Europe on an average store basis in Europe than we are in the U. S. Today. The product breakdown in terms of what we sell by store, the percentage is basically the same. The second part of your question, what would it take for us to announce that we're going to China?
I think Jonathan has said we are making no announcements at this point. But we have very strong belief that what is happening in Hollister and A and F around the world can be duplicated in many places.
We'll go next to Linda McDonough with Waterloo Advisors.
Hi. Yes, I had two questions. I wondered if you could quantify the FX impact in the quarter and also the lower depreciation that you had mentioned?
Yes. Hey, Linda, the FX impact year over year for the quarter was slightly negative. I think less than one percent of sales adverse effect year over year. It was slightly better than we've budgeted based on where the rates moved from the beginning of the quarter. And the second part of the question was lower depreciation.
Yes, there were some assets that we thought would potentially go out of service during the quarter, which didn't and that was the primary reason for that reduction.
That conclude today's conference. Thank you everyone for your participation.