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Abercrombie & Fitch (NYSE:ANF)

Q4 2011 Earnings Call

February 16, 2011 8:30 am ET

Executives

Jonathan Ramsden - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Director

Eric Cerny - Manager of Investor Relations

Michael Jeffries - Chairman, Chief Executive Officer and Member of Executive Committee

Analysts

Dana Telsey - Telsey Advisory Group

Lizabeth Dunn - FBR Capital Markets & Co.

Samantha Panella - Raymond James & Associates

Jeff Black - Citigroup Inc

Richard Jaffe - Stifel, Nicolaus & Co., Inc.

Robin Murchison - SunTrust Robinson Humphrey Capital Markets

Christine Chen - Needham & Company, LLC

Randal Konik - Jefferies & Company, Inc.

Stacy Pak - Prudential

Linda Tsai - MKM Partners LLC

Adrienne Tennant - Janney Montgomery Scott LLC

Eric Beder - Brean Murray, Carret & Co., LLC

Betty Chen - Wedbush Securities Inc.

Paul Lejuez - Credit Suisse

Michelle Tan - Goldman Sachs Group Inc.

Robert Samuels - JP Morgan

Marni Shapiro - The Retail Tracker

Jeffrey Klinefelter - Piper Jaffray Companies

Jennifer Black - Jennifer Black & Associates

Kimberly Greenberger - Morgan Stanley

Evren Kopelman - Wells Fargo Securities, LLC

Laura Champine - Cowen and Company, LLC

Lorraine Hutchinson - BofA Merrill Lynch

Edward Yruma - KeyBanc Capital Markets Inc.

Janet Kloppenburg - JJK Research

Operator

Good day, and welcome to the Abercrombie & Fitch Fourth Quarter Earnings Results Conference Call. [Operator Instructions] At this time, I'd like to turn the conference over to Mr. Eric Cerny. Mr. Cerny, please go ahead.

Eric Cerny

Thank you. Good morning, and welcome to our fourth quarter earnings call. Earlier this morning, we released our fourth 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. 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 one 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 Ramsden. 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 Ruehl for 2009 and prior periods are now included in discontinued operations, and income statement and related comparisons to prior year, therefore, generally exclude Ruehl.

Before I turn the call over to Mike, I would like to remind everyone that we will be hosting an Investor Day on Tuesday, April 5, at our campus in New Albany, Ohio. Today we'll begin with registration at 9:00 and conclude by 2:30 p.m. You can find more information regarding the day as well as registration details by viewing our Investor Relations website. We look forward to your visit and hope that many of you will be able to attend. Now, to Mike.

Michael Jeffries

Good morning, everyone. Thank you for joining us today. 2010 was a year in which we exceeded our objectives in terms of sales, operating income and earnings per share. We did this while continuing to invest for the future and to build our organization to capitalize on the huge opportunities we see ahead.

With regard to the top line, in 2010, we achieved Domestic same-store sales growth of 7% and total Domestic growth of 10% including Direct-to-Consumer. This was driven in part by a more aggressive promotional stance, but more important, as those of you who visit our stores know, by a compelling assortment and by stores that looked great. It is also worth noting that our Domestic business continued to get stronger throughout the year.

Our International business was up 79% for the year. We were off our initial goal of 30 international Hollister openings for the year, but the very strong volume of the stores we did open compensated for this. Across Europe, our business is extremely strong. Our U.K. Hollister stores comped well above the overall company rate in 2010. Our four German Hollister stores are running at more than double their initial projected volumes and the three Spanish stores are more than 50% higher.

Meanwhile, we have continued to gain momentum in Italy, with our three stores now running close to the U.K. in average store volume. Just over two years after we opened our first Hollister store in Europe, we now have a business that is annualizing at over $300 million.

Turning to A&F. While Tokyo has trended lower, our three major international flagship stores in London, Milan and Tokyo are now annualizing well above the $200 million we talked about a year ago.

In Direct-to-Consumer, we had total growth of 41% for the year, with strong growth in both our Domestic and International business. We added significant resources to our Direct-to-Consumer group during the year, improved the shopability of our sites and continue to add new country-specific sites. And the Gilly Hicks made very solid progress, posting comps of close to 40% for the year and initiating a new 5,000 square foot store in the U.S. as well as our first international opening in London in November.

Taking all of these things into account, while there are certainly challenges ahead, we feel very confident in the momentum of our business and the global power of our iconic brands.

Turning to 2011, I want to take a moment to talk about our roadmap objectives. Starting with gross margin, there is no doubt that sourcing costs are the biggest headwind we face. When we last spoke in November, I mentioned that we were seeing increased costs for the late-spring-season receipts. That pressure has continued to increase. And as we sit here today, we are anticipating double-digit cost increases for the fall 2011 season.

In response to this, we do expect to increase our tickets and our gross margin rate will also benefit from the continued growth of our International business. However, there is significant uncertainty about how these different effects will balance out in terms of their impact on our overall gross margin beyond the spring season. One thing we will continue to do is to take a long-term approach. Among other things, that means that we will not sacrifice quality to achieve cost reductions.

Turning to our other roadmap objectives. We have spoken in the past about a mid-single-digit same-store sales objective for 2011 and 2012. We continue to believe this is realistic. We are looking to accelerate the pace of international Hollister openings to approximately 30 to 40 this year. These will include our first Hollister stores in mainland China and Hong Kong. We will open a total of six A&F flagships this year, a combination of our full flagship stores and the smaller Tier 1 flagship format we have used in Copenhagen.

In addition to our previously announced Paris and Madrid openings, these openings will include Düsseldorf, Brussels, Dublin, and Singapore. In total, we are projecting annualized volume of around $200 million for these six flagship openings.

We continue to target high growth rates for our Direct-to-Consumer business, which in 2011 will continue to benefit from multiple investments we are making in this business as well as from our growing international presence. We are also looking to sustain the strong growth we have seen in Gilly Hicks.

Finally, on expenses, we continue to challenge all areas of our business to find efficiencies while at the same time, we continue to invest in our long-term growth.

With that, I'll hand the call over to Jonathan, but will be available to answer your questions at the end of these comments. Jonathan?

Jonathan Ramsden

Thank you, Mike, and good morning, everyone. I'll start with a quick recap of our results for the quarter and fiscal year and then go on to make some comments about 2011.

For the fourth quarter, the company's net sales increased 23% to $1.15 billion, while comp store sales increased 13%. Our gross margin rate for the quarter was 63.6%, approximately in line with last year's gross margin rate of 63.5%. Our operating income for the quarter was $144.7 million. This included pretax charges of $48.4 million associated with store-related impairment charges and $4 million associated with the closure of 56 domestic stores during the quarter. A summary of our operating expenses can be found on Page 8 in the investor presentation.

MG&A expense for the quarter was $106.4 million, up 15% versus last year's expense of $92.4 million. MG&A for the quarter included equity and incentive comp of $17.8 million versus $10.4 million last year. MG&A for the quarter also included approximately $5.5 million of charges not anticipated at the beginning of the quarter related to an increase in legal reserves, a write-off on the trade-in of our fractional aircraft ownership to reduce our operating costs going forward, and some software write-offs.

Stores and distribution expense of approximately $485 million for the quarter included the $52.4 million of impairment in store closure charges that were referred to a moment ago. Excluding those charges, store occupancy costs were approximately $168 million. All other stores and distribution costs represented 23.1% of sales, modestly below the 23.6% of sales they represented last year, and included approximately $4 million of additional depreciation related to our DC consolidation, which I will come back to in a moment.

For the year as a whole, excluding the net effect of impairment charges and store closure charges, we achieved approximately 320 basis points of operating margin improvement, which was ahead of our roadmap objective for the year. Growth in the four wall contribution of international stores was the greatest driver of this improvement, with DTC and domestic store productivity also making significant contributions. These contributions were partially offset by growth in non-four wall expenses, including MG&A, store management and support, and DC costs. The impact of Gilly Hicks was not significant to the year-over-year change in margin.

Turning to the balance sheet. We ended the quarter with total inventory of costs up 24% versus a year ago, or up 22% excluding in-transit. Inventory days on hand at the end of the quarter were comparable with the low points over the past five years.

Looking forward, we expect inventory on hand, excluding in-transit, to be flat in dollar terms at the end of the spring season. We ended the year with $826 million in cash and equivalents compared to $670 million at the comparable point last year.

During the quarter, we repurchased approximately 913,000 shares at an aggregate cost of approximately $47 million, bringing our total repurchases for the year to a little under 1.6 million shares. Going forward, we expect to continue share buybacks within the parameters outlined on our last earnings call.

Turning to 2011, our focus is to continue making progress on our key roadmap objectives. Domestically, as Mike said, our objective is to maintain the mid-single-digit comp improvement we achieved in 2010, including for the first quarter. In addition, we continue to expect approximately 50 store closures by the end of 2011.

Internationally, we expect to accelerate our rate of store openings for both A&F and Hollister and this should continue to drive significant operating margin improvement. We expect DTC to continue to make a meaningful contribution to our overall margin improvement. We are also planning for continued strong growth from Gilly Hicks, although we expect the operating margin effect from Gilly Hicks will have minimal impact on our overall operating margin through 2012.

Last, we continue to focus on maintaining tight control of expenses, including our non-four wall expenses. This includes keeping our home office headcount flattish and continuing to identify opportunities to gain greater cost efficiency such as with our DC consolidation. So more specific guidance on 2011 is included on Page 15 and 16 of our Investor Presentation.

Within the year, as we have indicated in the past, we do not expect our rate of margin improvement to be linear and in particular, due to timing factors we expect the second quarter to be challenging. Overall, as we look to our roadmap goal of a 15% operating margin in 2012, we do not believe it is realistic to expect that our gross margin will return to its peak level of around 67% by that point. However, if we are able to hold our gross margin approximately flat in 2011 and make some progress in 2012, we believe the overall operating margin goal remains achievable. As Mike said earlier, however, our visibility on gross margin beyond the spring season is limited at this point.

I want to make a few comments about our plans to consolidate our DC facilities here in New Albany. As many of you are aware, we currently operate two DCs, one serving a&f kids and our global DTC business for all brands and the other serving Hollister and Gilly Hicks. Going forward, we plan to consolidate into a single DC, which should, in turn, facilitate a sale of our second DC and result in reduced distribution costs upon completion by mid-2012. We expect to incur approximately $26 million in CapEx associated with the consolidation, of which approximately $19 million will be incurred in 2011.

From an accounting standpoint, the consolidation is expected to result in accelerated depreciation of the existing DC to building and equipment of $28 million or slightly higher, of which $4 million was recognized in the fourth quarter and approximately $4 million per quarter is expected to be recognized in 2011. During our Investor Day in April, we will offer a tour and detailed presentation on these plans.

In total, fiscal 2011 total capital expenditures are expected to be approximately $300 million, predominantly related to new stores, store refreshes and remodels.

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. After everyone has had a chance, we will be happy to take follow-up questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Michelle Tan with Goldman Sachs.

Michelle Tan - Goldman Sachs Group Inc.

Mike, I was wondering if you could give us a little bit more color on how you're thinking about taking up ticket. Is it across the board or varied by geography? What's the magnitude? And if the consumer accepts it, what are the implications for second half IMU?

Michael Jeffries

Well, I think Michelle, that's the question of the day. We know we have to pass the cost increases. The question is, how much? And you're right in terms of where. Clearly, we have more opportunity to pass the increases on in our International business than our Domestic business. So the answer is, we know we are going to be increasing ticket prices. We have to. We're comfortable that we can pass some of these increases on to the customer. We're not comfortable with how much.

Operator

Your next question comes from Evren Kopelman with Wells Fargo Securities.

Evren Kopelman - Wells Fargo Securities, LLC

As a follow-up to that question, can you talk a little bit about how you're planning inventory units for the second half? Obviously, it's hard to know the demand elasticity, but as you think about the unit for the U.S. versus International business, do you have an opportunity to move units? Or is it, “Once it's in a country, it's there”?

Jonathan Ramsden

I guess it says the overall question about units. I don’t think we really want to get into that for the fall season. We've given guidance on inventory dollars at the end of spring season, but I don't think we want to get into any more specifics beyond that. To your question about whether we could move inventory units back-and-forth between the U.S. and Europe, it's easier to move it from the U.S. to Europe. There are some tax limitations on our ability to bring them back from Europe to the U.S.

Operator

Your next question comes from Jeff Klinefelter with Piper Jaffray.

Jeffrey Klinefelter - Piper Jaffray Companies

I want to maybe clarify, Jonathan, that the Hollister stores -- any sense out of that 30 to 40, how many of those would be Asia versus Europe? And then also those flagship Abercrombie's Tier 1 versus traditional, any sense for number? I just wanted to clarify that. And then in terms of the four-wall trends out of International, it's pretty encouraging, the profitability. Is there any other detail you can give us in terms of how those are measuring up versus Domestic?

Jonathan Ramsden

Yes, I mean, on the 30 to 40, Jeff, they do skew very heavily towards Europe, so they're predominantly Europe. And as we've said, they're predominantly in the back half of the year, which is one of the factors that's impacting the second quarter because some of the preopening charges that are hitting that quarter. In terms of the six A&Fs, as we said on the call, in aggregate, we're projecting annualized volume of around $200 million for those six stores in total. They are typically sort of -- Düsseldorf, Singapore and Paris will be more in that sort of larger flagship category. Brussels, Dublin will be probably more in the sort of Copenhagen, Fukuoka mold. But obviously all those things are on a continuum so it's difficult to be too precise, but that might be broadly how you could think about them. And then I think the third part of your question was four-wall profitability. As you know, our core metric when we sign up for a new store is that we want to hit that 30% four-wall margin, at least, so if we're doing significantly better than the volumes we protected in those stores, that is taking those of four-wall margins higher than that. So I think that gives you some indication of what we're seeing, and that's why International growth was the most significant driver of our margin improvement year-over-year.

Operator

Your next question is from Janet Kloppenburg with JJK Research.

Janet Kloppenburg - JJK Research

Michael, I was wondering if you could talk a little bit about perhaps some opportunity for IMU benefit in the back half of 2011 through shallower promotions. Product is getting stronger across the board, and I'm wondering if you're seeing an opportunity, with the economy improving, for perhaps promotions to be less steep or less broad than they were in this past season. And Jonathan, just a quick question on the $1.38 that was reported, exclusive of impairment charges. Was that legal charge of $0.04 per share included in that $1.38 or excluded?

Michael Jeffries

Let me answer the first part of the question, Janet. I would hope that we will be able to have promotions that are less deep and fewer of them. We're hoping that our markdown dollars are more efficient. And I would say we absolutely would like to go there. Beyond that, I can't be more specific.

Jonathan Ramsden

The second part of your question, the only thing that is added back in the $1.38 is the impairment charge and then the store exit charges of around $4 million. So the $5.5 million I referred to in MG&A is not added back in that number nor is the DC depreciation of $4 million, which is included in that $1.38.

Operator

Your next question will come from Stacy Pak with Barclays Capital.

Stacy Pak - Prudential

I guess, one follow-up question on the pricing. Mike, are you thinking that you will actually raise prices domestically versus have less markdowns? And then can you comment internationally what you did in response to the VAT tax increase? Did you take prices up there? And are you seeing any impact from that? And then Jonathan, I was hoping you could clarify Q2 a little bit. I mean, you alluded to higher preopenings from the later store openings in the year, but I would think also your gross margin would be better in Q2, given the rising costs in the back half. So can you just clarify what you're seeing in Q2 a little bit?

Michael Jeffries

I'm going to let Jonathan handle all those answers.

Jonathan Ramsden

Let me start with Q2 then. What we're calling out -- and we've spoke to this, I think, several times in the past -- is that as we continue to make progress with our operating margin, it's not necessarily going to be even by quarter. I think the point of the comment we're making was simply that the second quarter within the year is the one where that impact is the most significant. And that's primarily because we have heavy skew towards our store openings later in the year, so we have big preopening rent, other preopening costs starting to come into play in Q2 before we start to get the volume benefit from those, and that starts to turn around at the back half of the year as the volume comes on stream. With regard to gross margin, we haven't been specific about how that's going to break out by quarter. We do expect approximately flattish for the season, as a whole. The cost is certainly escalating in the second quarter and the question of when we take our tickets up and start to see that benefit could create a little bit of a timing disconnect, which may also impact the second quarter relative to the other quarters in the year.

Stacy Pak - Prudential

And the VAT tax?

Jonathan Ramsden

We made a number of ticket adjustments in the U.K. in particular, and that's one of the factors that's been taken into account in what we've done there and will continue to do.

Stacy Pak - Prudential

And no negative reaction, I assume.

Jonathan Ramsden

I mean, our U.K. results have obviously been very strong. We haven't called that out, anything other than what we've spoken to you for 2010 as a whole. But we’re obviously very happy with our U.K. business.

Operator

Your next question is from Randy Konik with Jefferies.

Randal Konik - Jefferies & Company, Inc.

I guess, Jonathan or Mike, just want to focus on domestic store base here, obviously, on the store close. Do you think that, after the 50 store closures in 2011, we’re done? And is there any type of color you can give us on how bad these stores are from -- or below the average store are from a sales-productivity preferred-margin basis, just so we can get a sense of how much these stores have been weighing on the product profitability of the company? And as these stores are closed, do we get closer and closer to that 75% of peak productivity you’re focused on for domestic market?

Jonathan Ramsden

I guess with regard to closures, we do expect that we'll continue to do closures post 2011. We haven't given specific numbers on that, but as we go through the year and get closer to thinking about 2012, I think we will start to talk more specifically about this. But as we spoke during the past, there was a fairly significant number of stores, around 200 or so, that were in negative territory. We've dealt with a decent chunk of those. Some of those have got a little bit better, but some of those expirations fall out beyond the 2010, 2011 time frame. So, we do expect that we'll be continuing closures. I don't think we're ready yet for the specific number on what that will be in 2012 and 2013, but I think we'll do that relatively soon. In terms of how bad, we spoke about -- the class of 2010 closure is averaging about $1 million of volume, yet for 2011 we'll give more specifics on that, going forward, but it's probably not going to be dramatically different to that. And then the primary driver of the negative contribution is just the absolute low level of volume as opposed to occupancy. But we'll start to give a little bit more color on that, going forward. I think in the overall scheme of things, as we've said in the past, the impact of closures relative the domestic store productivity increases for existing stores is much less. So the primary driver of getting back to that 85% or a little better is going to be the same-store sales in the stores we have open, not the ones we're closing.

Randal Konik - Jefferies & Company, Inc.

If I may, is there any type of target you think you can get to, from a long-term operating margin standpoint, that you're now targeting for the Domestic business versus the prior peak of around 20%? Is there anything we can kind of look at there?

Jonathan Ramsden

We're working very hard at the moment on our long-term plan. Well, first of all, we're rolling forward our three-year plan to add in 2013, and then we're working on our long-term plan out beyond that. And I think we'll start to get more color on that, probably some extent at the Investor Day in April as we go through the year and as we get to clearer visibility and more comfort with where those plans are going to take us.

Operator

Your next question will come from Christine Chen with Needham & Company.

Christine Chen - Needham & Company, LLC

Wondering if you could maybe talk about your thought process in leading in China and Hong Kong with Hollister rather than Abercrombie. And I'm curious where in Hong Kong the Hollister store might be. Is it going to be flagship? Is it a mall-based store? If you could just talk about that a little bit.

Michael Jeffries

I think we can. The first store in Hong Kong is a Hollister, mall-based store. It's in the Festival Walk center. We probably would have liked to have led with an A&F flagship and we simply weren't able to make a deal quickly enough. We're working very hard on that, but we think that Hollister in Hong Kong and China will be a mall-based business.

Christine Chen - Needham & Company, LLC

And do you worry about the counterfeiting of your brand over there?

Michael Jeffries

Constantly.

Christine Chen - Needham & Company, LLC

So what are you going to do about it? I mean, I guess it's flattery but...

Michael Jeffries

Well, we have a wonderful team in place and they've been working on the counterfeiting there for quite a few years. We're very aware of what it is, probably where it's going. In fact, we're told that having bricks-and-mortar in these countries will, in fact, improve that rather than take it the other way. We're hopeful but fearful.

Operator

Your next question is from Paul Lejuez with Nomura.

Paul Lejuez - Credit Suisse

Can you talk a little bit about the timing of the A&F flagships? When should we expect -- the four that you announced today, when should we expect those to open? And then you've spoken a little bit about the second quarter pressure from preopening. Can you maybe talk about when these stores, either flagship or international Hollister locations -- how long does it take? When do they become profitable to the P&L? Is it day one? Can you maybe just talk about that timeline?

Michael Jeffries

I'll give you the opening and Jonathan can take you from there. Paris is May; Madrid is third quarter; Düsseldorf, Brussels, Singapore and Dublin are all fourth quarter. Their actual dates on those are not going to be more specific than the quarter.

Jonathan Ramsden

Well, on the second part of your question, we expect all of our stores to be profitable from the day the doors open. The issue is, prior to that actual opening, we're typically paying and booking rent expense for five months or more for Hollister store and up to a year or more in some cases for an A&F flagship store. So we have that expense even though we don't have any sales volume. And then we also, as we get closer to the opening of the store, we have to start hiring managers. If it's a new international store, we have expats that go over typically from U.S. to open the stores initially. They have to go through language training and they can be in-country for several months prior to the opening of a store, particularly a flagship. So all of the costs sit there prior to opening, but the day we open we fully expect all of our stores to be operating about 30% or better margin at that point.

Operator

Your next question comes from Betty Chen with Wedbush Securities.

Betty Chen - Wedbush Securities Inc.

I was wondering if you can speak a little bit more about the Direct-to-Consumer business. It grew by a significant amount in the fourth quarter and throughout 2010. I believe, Mike, you mentioned that you've been making multiple investments and also looking into more company-specific sites. Can you talk a little bit more about the investments you might make in 2011 and sort of what sort of progress that we can look from that channel throughout this year?

Michael Jeffries

I'm going to turn that over to Jonathan.

Jonathan Ramsden

I think the reference was to country-specific sites rather than company-specific sites. Basically, our model continues to be that once we open the store in a new country, we open up a country-specific DTC site as well. So that it obviously helps with -- the opening of the store helps with awareness, and we typically see a lift in volume on DTC once we have a store presence in a country. In terms of the incremental investments, I think we'd identified, a year or so ago, a lot of areas where we had the opportunity to invest and to drive the DTC business further. Many of those have not come into play yet. I don't think we want to talk too specifically about what they are in 2011, but we feel we made good progress. But one of the reasons we feel optimistic about the progress we can make in '11 and '12 is that we know there are several potentially significant things that we've not yet activated, but we'll be doing over the coming months. Just to mention one, we are redesigning our sites and you're going to see all of that coming live, but there are many other things that we're working on which we think will be meaningful to the business.

Operator

Your next question is from Dana Telsey with Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

As you see product trends, Mike, in terms of the newness that you're defining and how it's moving along, where are you in the progress towards newness both on Mens and Womens? And what do you see happening going further? And then just wanted clarification on inventory. How do you see it trending in units and in dollars, whether it’s for the first quarter or the first half?

Michael Jeffries

The answer to the first question, Dana, is that we're very much on track. We're getting on track in terms of looking to what's next -- looking for what's next that is appropriate for our business -- and then going through a rigorous testing process before we make major statements, which I think you can see in our stores is how we look today. So I think that it's a very astute question because it is the process, and I think we're doing better and better at that in both Womens and Mens. And clearly, the Womens business has, in the fourth quarter, outperformed the Mens business, which was still strong. So we're very pleased with our progress and process.

Jonathan Ramsden

Dana, on the second part of your question, as we said on the comments a few minutes ago, we expect inventory dollars to be approximately flat at the end of the spring season. We typically manage inventory on a seasonal basis and focus less on the quarter end, which can be subject to some fairly significant timing effects. But as of this point, we would probably expect the first quarter to be up modestly versus last year, but to be back flat in dollar terms at the end of the second quarter. But again, we think the end-of-season position is really the most significant piece to focus on.

Operator

Your next question is from Edward Yruma with KeyBanc.

Edward Yruma - KeyBanc Capital Markets Inc.

First, now that you've made some tweaks to the box size of Gilly Hicks, how do you feel about, kind of, its performance and the longer-term rollout potential? And second, more housekeeping, how do we think about the potential accounting head for the LTIP?

Michael Jeffries

Jonathan?

Jonathan Ramsden

On the LTIP, Ed, it's entirely a function of the number of shares we have available in our plans relative to the share obligations that we have. Frankly, it's rather complex to explain, and I'd probably take up the rest of the call if I try to do it in any level of detail. But essentially, it's a function of the stock price. The stock price gets to certain levels that requires a greater number of shares to settle outstanding awards and triggers additional awards. At a certain point, those obligations could become greater than the remaining number of shares we have available in the plans. So there is a reasonable likelihood that we will put up a long-term incentive plan at this year's Annual Meeting and if that goes through, that will obviously alleviate that problem, hopefully, fairly significantly. The consequences of that issue not being alleviated and ultimately running out of shares would be that we would have to start to mark-to-market certain share awards on the expectation that they would need to be settled in cash. So it would create some quarter-to-quarter earnings volatility because we will need to mark the awards to market each quarter based on the stock price. If we ever get into that scenario, we'll certainly give people the data to understand the impact of that quarter-to-quarter, but obviously, we're hopeful that, that situation doesn't arise because we will be able to get a long-term incentive approved that makes the issue moot.

Michael Jeffries

I'll comment on the Gilly Hicks question. We feel very positive about the new size, the 5,000 square foot Gilly Hicks prototype, and are very, very optimistic about the long-term potential of this brand.

Operator

Your next question is from Eric Beder with Brean Murray.

Eric Beder - Brean Murray, Carret & Co., LLC

Your International issue is about 20%. What are you looking at for next year in terms of that? When do you think -- or do you believe that you could be over 50% of your sales internationally, going forward?

Jonathan Ramsden

Eric, we said in the past that we expect to be around 30% in 2012. I think that's another one of those pieces of data -- as we give a more longer-term outlook at the Investor Day, we'll give an updated view on that. But as of today, that probably remains pretty close to what we expect in 2012. Where it goes beyond 2012, I think we'll give more color on as we go forward. We certainly expect and strongly believe that there is a huge growth opportunity internationally and we don’t see that dwindling or losing steam anytime soon.

Operator

Your next question is from Robin Murchison with SunTrust.

Robin Murchison - SunTrust Robinson Humphrey Capital Markets

Previously, in terms of AUR, you've indicated -- and congratulations by the way on the significant improvement in the fourth quarter -- but, so going forward, I think you've indicated that we should continue to expect sequential improvement. I wanted to get an update on that, and then also if you could update us on the U.K. distribution center.

Michael Jeffries

I don't think we've said more than we anticipate the AUR being positive this spring. And I think that's all we can say at this moment about that.

Jonathan Ramsden

I think it will turn positive in the fall, as well as in overall terms.

Michael Jeffries

Right. Clearly.

Jonathan Ramsden

On the U.K. DC, we have a Netherlands DC, Robin, which serves as our European business. So that regimen has been in place for I guess about two years now. We had a five-year original deal with TNT [TNT Fashion], which is our third-party distribution function in the Netherlands. So we don't have anything significant in the U.K. at this point. And that distribution center in the Netherlands is servicing today all of our European business, as well as the two Japanese stores. Certainly on the agenda is the possibility that we'll have an Asian distribution center, probably a similar outsourced arrangement sometime fairly soon.

Operator

Your next question is from Lorraine Hutchinson with Bank of America.

Lorraine Hutchinson - BofA Merrill Lynch

You mentioned Tokyo sales trending down. Can you just talk about why you think that is, and then implications for the overall business in Japan?

Michael Jeffries

Let me take a stab at that. We're not completely sure. Ginza is doing a healthy volume, but it's not what we anticipated. I have to emphasize that it is a very healthy volume, but we did not make our opening goal, which was very aggressive. We're not completely sure, but we're continuing to work through the dynamics of that business. We're actually very cautious on Japan now. We do not have any more Japanese deals in pipeline and we'll take it slowly.

Operator

Your next question is from Laura Champine with Cowen and Company.

Laura Champine - Cowen and Company, LLC

I'm wondering if you're looking at the potential for taking costs out in product, whether that means using less cotton or moving to other countries. I'm noticing, for example, your spring wovens looked a little lighter. I don't know if that's a style decision or if that's an effort to take cost out of the product.

Michael Jeffries

Well, let me answer the second part of the question. We have not taken any weight out of that fabric. We continue to source as efficiently as we can in terms of new potential countries. We look to be as efficient as we can be in terms of cost. We're saying we're not taking quality out of the product and we're really not, but there's some tricks to the product that we can do that will not take quality out of the product, but will cost a little less. We have the opportunity to do that more in the Hollister brand, actually, than the Abercrombie & Fitch brand.

Operator

Your next question is from Richard Jaffe with Stifel, Nicolaus.

Richard Jaffe - Stifel, Nicolaus & Co., Inc.

Mike, a philosophical question. As costs rise or are anticipated to rise in the second half, obviously you can't do much about it other than trying your best to source effectively. How do you feel about sharing some of that cost increase with the consumer versus swallowing some of that cost increase in the form of depressed margin and hope to manage the business more efficiently? How does it weigh in your mind?

Michael Jeffries

Well, that weighs on our minds all the time, but I think the answer to the question, Richard, is that a portion of these cost increases have to be passed on because they are pretty steep. So “We will be increasing our prices” is the answer to the question. Order of magnitude, I cannot tell you at this moment.

Operator

Your next question is from Kimberly Greenberger from Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

Mike, I'm wondering, as you look into the second half of the year, how you're thinking about the trade-off between the pricing architecture at Hollister versus A&F? And are you expecting any slowdown in your comp momentum as you begin to raise price? Or do you just expect that the trade-off between the higher AUR and perhaps slightly fewer units will be net neutral and you'll be able to maintain your momentum? Just how are you thinking about managing through this process?

Michael Jeffries

I think the answer is that we're doing it very carefully and taking a stance that is almost week-by-week. What's happening as we're raising prices? What's the reaction? What's the reaction by brand? I wish I could give you a roadmap at this point, but I can't. And I would doubt that anybody really can. And I think the point of this tension is that it has to be managed carefully and really on a week-by-week basis. And those businesses that can do that, I think will make their way through this. Those that can't, I think they're big problems.

Operator

Your next question is from Robert Samuels with Phoenix Partners.

Robert Samuels - JP Morgan

Jonathan, can you just discuss briefly just your views on cash and your minimum cash cushion that you like to maintain. And you bought back a little more stock this quarter. Would you think about being more aggressive with your buyback, going forward?

Jonathan Ramsden

Robert, yes, I think we basically going to operate within those two guardrails that we talked about on the last earnings call. At the lower end, we want to maintain always a very healthy net cash cushion, which we've articulated as being around that $350 million figure at the trough point of the cycle, which is -- clearly January is not the trough point of the cycle. On the other end of the spectrum, we want to, at least, be offsetting equity planned share issuances, so the overall share count stays flat. Where we end up between those two points, I think is going to be a function of market conditions, how we're feeling about business in general. But they would be the two guardrails, which I think hopefully gives people some sense of how to model that out for 2011.

Operator

Your next question is from Jeff Black from Citi.

Jeff Black - Citigroup Inc

I guess on the pricing front, it sounds like you're experimenting with taking some prices up. But do you have any clear evidence that you will, in fact, be able to raise price at the U.S. divisions? And then Jonathan, I know you said you don't want to talk about the second half but regarding units, can we assume that units are down in the U.S? I mean obviously, your plan, obviously there's big print on international that is going to drive the overall picture higher, but U.S.-specific, can we expect units to be down?

Michael Jeffries

Let me answer the first part of the question. And the only evidence we have is that we do have momentum in our business, in the U.S. business. So that gives us comfort that we can do so.

Jonathan Ramsden

Yes, on the second part of the question, Jeff, I mean, part of the reason why we can't be too specific is that it's not fully baked for the full season, and we're still working very hard on the full season on costing, on projecting out comps by quarter. So we're still working through that. I think overall, we said we expect AURs to be up and that will certainly be a contributor to the comp improvement. In terms of figuring out what that mean in terms of units, obviously, the AUR component increase offsets some of the comp increase in terms of what it means for units, but I don't think at this point we're ready to be more specific than that for the fall season.

Operator

Your next question is from Marni Shapiro with The Retail Tracker.

Marni Shapiro - The Retail Tracker

One, I do want to follow-up on the pricing question. It seems to me in walking your stores, you have been playing around with the pricing for the last little while, but especially since spring has set, and I'm curious if you can talk a little bit about that? And if you found any difference between -- historically your Hollister pricing in kids have been very similar. And I've noticed recently some of those have kind of played around. I've noticed you put items on the floor, and I'll call it swim as an easy example, that you've not taken the price down at all since last year and it's cold and already selling. So if you could just talk a little bit -- I know everybody's very concerned about the pricing, but it seems to me you've already started playing with it and if you've seen any positive results that you have visibility. And how is it playing out in Europe, most importantly? Do you have more ability to raise pricing there? And how do you manage the markdown from the backside of that in Europe?

Michael Jeffries

There's a whole bunch of parts to this question. I think the first part of the question is answered the way -- it was to say that we look at this on a week-by-week basis and that's how this has to be, how the business has to be run today. I can't answer what has been successful, what hasn't. Clearly, we have an opportunity for increasing prices more in Europe than in the U.S.

Operator

Your next question is from Sam Panella with Raymond James.

Samantha Panella - Raymond James & Associates

Going back to the gross margin guidance and previously, I think you've said that averaging the cost would be about flat year-over-year in the first half. Any differences that you can call out between first quarter and second quarter? And then in terms of the gross margin expectation to be up in the first quarter, should we think about that similar to the magnitude that you're able to get in the fourth quarter? Or is there opportunity to do better than that?

Jonathan Ramsden

Yes, I think we had previously said roughly flat in the spring season. I think what come into play more and more is those later receipts in the season. We started to see the pressure that we're seeing throughout the fall season. And to the point earlier, the time of when we are fully able to react from a ticket standpoint may create a little bit of a disconnect in the second quarter. But implicit in us saying that we are expecting flat for the season and up in Q1 is, therefore, that there could be a little bit of gross margin erosion in Q2. I think beyond that, I'm not sure we can pass that any further at this point.

Operator

Your next question is from Adrienne Tennant with Janney Capital Market.

Adrienne Tennant - Janney Montgomery Scott LLC

My question is on a little bit more color on the magnitude of the cost inflation. You said double-digits. How far are you bought through at this current time? And I would expect that with cotton continuing to move up -- should we expect 10% in Q3-ish and maybe more toward the 15% range in the fourth quarter? Any more color on that would be great. And then I was sorry to hear about Fifth Ave. Can you give us an update on that, when will it be reopened if it isn't already?

Michael Jeffries

Yes, three parts to the question. Let me handle Fifth Avenue first. We are hoping to reopen next week. For those of you who didn't know, we had a fire in the store. There is smoke and water damage, but we are working very hard to reopen next week. The other part of the question was the magnitude of the inflation. We can't really say that at this point. We're grappling with this. We have bought our back-to-school assortments. We're still negotiating for Labor Day and on.

Operator

Your next question is from Jennifer Black with Jennifer Black and Associates.

Jennifer Black - Jennifer Black & Associates

I know the fragrance business is a big priority and I wondered if you feel like you're making headway as far as coming up with a counterpart to Fierce on the female side? And then any comments you have on your accessories business would be great.

Michael Jeffries

We've been working very hard on the female equivalent of Fierce. We have one that we will be introducing this Christmas and I hope it's going to be the equivalent of Fierce. If it is, then these calls will become a lot easier in the future.

Operator

Your next question comes from Liz Dunn with FBR.

Lizabeth Dunn - FBR Capital Markets & Co.

Just a clarification on the sales guidance in line with 2010. I mean, is it just fair to say, based on the visibility that you have to the first half or the first quarter, that the first quarter should be stronger than the rest of the year? And then I did a store tour last week and really got some great feedback on your inventory management through the fourth quarter. So first, congratulations on that. I think very few of us would have congratulated you on your inventory management heading into the season, so you clearly did a fabulous job. Can you talk a little bit more about your allocation strategies, because the District Manager we spoke with was quite complimentary on the inventory allocation that happened in the fourth quarter as it related to her stores?

Jonathan Ramsden

Let me just take the first one, Liz. We're saying that we're targeting a mid-single-digit comp for the full year, including for the first quarter, just to recap what we said earlier. I think one of the things we feel is that we've got a lot better at our ability to project and forecast our own business, as that as we've discussed in the past, the strongest correlation we typically see is how we plan our own business as opposed to what's happening elsewhere in the markets. So obviously, there's always some external factors that impact what the business is trending. But we feel, as we said that, that mid-single-digit comp is achievable for the year, including for the first quarter. In the second part of the question was first half of Q1. I think I probably dealt with that. On the allocation strategies, I'm not sure how much detail we can really go into on that. Obviously, it's a very complex area, so I'm not sure in the remaining couple of minutes we have we can really do justice to it.

Operator

Your last question will come from Linda Tsai with MKM Partners.

Linda Tsai - MKM Partners LLC

Could you just provide us with some intel on the customers that shop at the international Hollister and international Abercrombies? How similar are they to the customers you see shopping at the domestic stores?

Michael Jeffries

The answer is very similar in targeted age, income. I think A&F flagships have a broader customer in terms of age, and by broader I mean they skew older. There are older customers shopping in those stores than tend to shop in the domestic A&F stores. But part of that -- it's a little bit complicated because a lot of that shopping is for other people, so they're buying for younger people. But in terms of actual purchases, the flagships skew a little bit older.

Operator

That does conclude today's conference. We thank you for your participation.

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