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Abercrombie Caught Flat-Footed by Demand for Curvy Jeans in Q3

Abercrombie & Fitch Co. just missed Wall Street’s third-quarter estimates, undermined by exit costs for flagship store leases and related asset impairment charges, a miss in top-line sales due to insufficient inventory in some categories and lower international sales due to political turmoil overseas.

In a Nutshell: Abercrombie suffered some self-inflicted wounds, like underestimating demand for the curvy jeans it launched in the quarter or Hollister Co. brand tops that “sold through too quickly and we didn’t buy aggressively enough,” CEO Fran Horowitz said in a telephone interview Tuesday following the company’s conference call to investors.

Still, Abercrombie and Hollister combined helped the company post its ninth positive consecutive quarterly comparable sales in the U.S. market, and the 11th for the Hollister brand.

The company is in the process of setting local bases overseas, with London to oversee Europe, Middle East and Africa and Shanghai for Asia Pacific and China. According to Horowitz, the global merchant team at the company’s headquarters in Columbus, Ohio, will maintain the current global operating model to ensure a brand-focused cohesive across all regions.

Horowitz pointed to the back-to-school season at Hollister as an example of how local teams will operate. “In the U.S., it starts in July, but in Europe, it’s after September,” she explained. “Instead of setting up back-to-school in Europe at the same time as in the U.S., it will be set up later and will [include] swim, shorts and real-wear product [during July through September].”

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International sales were hurt by Brexit in the U.K., the firm’s largest international market, and by protests across Europe and Asia, with the latter hurt by intermittent store closures in Hong Kong, Horowitz said on the conference call. The company remains confident in the fundamentals of its international business and ability to grow sales in Europe and Asia, she added.

Intimates brand Gilly Hicks continues to resonate with consumers and Abercrombie is devoting resources to support its growth, she said.

Horowitz said Abercrombie has evolved its real estate strategy, and has leveraged the bankruptcies to date by opening “shorter term leases” to test locations as the company refines its store base. “Fifty percent of the U.S. leases are up for renewal,” she said, which will allow the company to maintain flexibility to adjust its fleet size next year.

The company recently opened a new combined Abercrombie adult and kids store in Westfield London, its largest shopping destination site in Europe. Horowitz said the Abercrombie flagship on Manhattan’s Fifth Ave., where the lease is up for renewal, will move a few blocks away to a smaller Hollister location, which is half the size of the Abercrombie site and “will better represent the brand.”

A new Hollister store on 34th Street in Manhattan is test demanding in the area and “is on track to be one of the top performing locations in our fleet,” Horowitz said. The company plans to retrofit Hollister stores and prune the square footage at Abercrombie locations, she said.

A Perfect Storm of Factors Contributed to Abercrombie's Q3 Miss
A look inside the Abercrombie store in Westfield London, complete with a mobile area for shoppers near its entrance. Courtesy Photo

The company has diversified its sourcing throughout Southeast Asia, particularly in Cambodia and Vietnam, Scott D. Lipesky, senior vice president and chief financial officer, told Sourcing Journal in a telephone interview.

“We’ve been with most of our current vendors, who have migrated out of China over the years, so we’ve not had to sacrifice quality or speed. When dealing with vendors, we just send the [purchase order] to another factory,” he said of how Abercrombie works around tariffs. The company did not bring in additional goods early ahead of the tariff increase in September that impacted apparel imports from China, he added.

Although Abercrombie saw little tariff impact in the third quarter, the fourth quarter is expected to see more significant fallout, Lipesky said in the Wall Street conference call, emphasizing that the company did not raise ticket prices in response to new duties. In 2020, Abercrombie plans to shave a few percentage points off the 16 percent rate of China-sourced goods—and that’s already a notable drop from 25 percent last year.

“We’ll keep an eye on ticket prices as we get into spring,” Lipesky said.

Net Sales: For the quarter ended Nov. 2, net sales inched up 0.3 percent to $863.5 million from $861.2 million. The company said comparable sales were flat versus up 3 percent in the year-ago period.

While both Abercrombie and Hollister posted positive U.S. comps in the quarter, up 3 percent combined on top of the 6 percent gain last year, it was offset by international comps of down 8 percent against the negative 3 percent posted last year.

By brand, Hollister sales were flat at $515 million and down 2 percent in comparable sales. Abercrombie was up 1 percent to $348.7 million and up 3 percent in comparable sales. By region, U.S. sales were up 4 percent to $583.6 million, with comps up 3 percent. International sales were down 6 percent to $279.9 million, with comps down 8 percent.

Horowitz noted during the conference call that the unseasonably warmer temperatures in September hurt outerwear sales, although that has picked up at the tail end of the third quarter and heading into the start of the fourth quarter as the weather turned colder.

Earnings: Net income fell 73 percent to $6.5 million, or 10 cents a diluted share, from $23.9 million, or 35 cents, a year ago. On an adjusted basis, earnings per share was 23 cents for the quarter.

Wall Street was expecting adjusted diluted EPS of 24 cents for the quarter on revenues of $868.4 million.

In the quarter the company recorded an impact of $285,000 from flagship store exit costs and $12.6 million in related asset-impairment charges.

For the fourth quarter, net sales are projected to be flat to up 2 percent, with comparable sales in the same range. For fiscal 2019, net sales were guided to the range of flat to up 1 percent, again with comparable sales in the same range for the full year. The company said net sales guidance is expected to be driven by comparable sales and net new store contribution, partially offset by an adverse impact from changes in foreign currency exchange rates.

On the subject of tariffs, the company said guidance for fourth quarter and full year includes the current 25 percent tariff rate for Tranche 3 items and the starting rate of 15 percent for Tranche 4 items. “These tariffs are expected to have a direct adverse impact on cost of merchandise and gross profit of approximately $4 million and $5 million in the fourth quarter and the full year, respectively, and did not have a significant impact on third-quarter results,” the company said.

CEO’s Take: According to Horowitz, “Continued U.S. momentum was offset by challenges across several of our key international markets as well as a complicated global operating environment, which weighed on overall results. Despite these challenges, we ended the quarter with a balanced inventory position and have seen good response to our new assortments as weather has turned more seasonal, giving us confidence in our product and messaging for the important holiday period.

“While we are focused on the upcoming holiday season, we also continue to make progress against our long-term transformation initiatives including: delivering 34 new store experiences, keeping us on track for our goal of 85 for the year; continuing the global rollout of omni capabilities and new payment options; and building out customer and product-facing teams in the EMEA and APAC regions,” she added.