011101 A&F Boosts Sales but Faces Higher Supply Costs · Abercrombie & Fitch finally conceded to lowering prices in order to boost sales during 4Q10. However, its recovery could be

A&F Boosts Sales But Faces Higher Supply Costs

321 Pacific Ave. San Francisco, CA 94111 | www.blueshiftideas.com

FOLLOW-UP REPORT

January 6, 2011 Companies: AEO, ANF, ARO, BKE, GPS, JCG, STO:HMB, TGT, WMT

David Franklin, [email protected] 415.364.3780

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Summary of Findings Abercrombie & Fitch finally conceded to lowering prices in order to boost sales during 4Q10. However, its recovery could

be challenged by a return to higher prices.

A&F caters to college-age youth interested in a casual, understated style that is more about image than design. It is starting to attract even younger consumers as well. The premium-priced trendsetter remains at or near the top of the market, but copycats are undermining its status as a leader.

A&F’s Holl ister, with its colorful California styling, caters to high school students and serves as a customer pipeline for A&F.

H&M Hennes & Mauritz AB (STO:HMB) and Forever 21 Inc. are the most popular and trendiest retailers in the youth apparel market, noted for high fashion and low prices.

Retailers currently offer little difference in styling, making price the primary driver of consumer purchases. The youth apparel market is moving from baggy, torn garments to a more tailored look.

A cotton shortage and harder business conditions in China could undo retailers’ sales momentum from the holidays. Supplier orders from A&F and Hollister are flat year to year, but fabric prices have doubled and likely will result in higher garment prices by the spring.

Background Abercrombie & Fitch Co. (ANF), a leader in the teen apparel market, appears to have experienced a 3Q10 sales increase and is expected to continue to perform well through the holiday sales season following two years of declines and market share losses. Still, the company faces stiff competition in the teen apparel market and pricing’s growing importance among teens. INITIAL DATA Silos: Suppliers (3), retail experts (3), store personnel (4), competitors’ store personnel (3), and customers (3) Additional Sources: Industry publications and news sources (3)

Silo 1) SUPPLIERS Senior account manager for a denim manufacturer and supplier to key retail stores

This source said A&F targets college-age consumers while its Hollister stores cater to teens and creates a built-in pipeline of A&F customers. Abercrombie recovered from its 2008–2009 slumps by dropping prices during the recent holiday season. The brand—more about image than quality—remains strong but could undo its recent improvements if it were to reinstate higher prices. Retailers have promised not to increase prices, but the source said price hikes are inevitable because of a cotton shortage, the increasing cost of labor and transportation in China, and drastically low cotton inventories. The source expects stability in January and February but a bad retail year overall.

Research Question:

Where does Abercrombie & Fitch fit in the teen apparel landscape?

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“Their customers are college kids. Their other store, Hollister, is geared to the high school kids. They are afraid to change so they can’t get out of the college thing, but I don’t think they want to. They are trying to stay with the same thing and then, through Hollister, catch the next wave. The Gap [Inc./GPS] made that mistake 10 years ago when they targeted the 20 to 30 year olds. They aged with them and there was no next wave.”

“Abercrombie wants to stay in the college market, and they do a lot of promotions on campuses around the country. The appeal is there as long as they produce a fresh, free look. Abercrombie is about the feel. The appeal is the brand and the image. The product is important, but at this point everyone has the same product. It’s not as if their customers go from store to store comparing the quality of the denim. They go into the store because it’s Abercrombie & Fitch. The image they convey is the sense of being 20 years old and free. The product is the same—the T-shirts and the jeans and the jackets. There’s no magic there. It really is about the brand. Their goal is to catch the next wave. What hurts them is their price. A few years ago they made a decision never to come down on price. That’s when you saw sales drop. Since September 2010, their same-store sales dropped about 22%. Everyone dropped, but Gap only lost 2%. I’ve seen the recent [A&F] numbers for October and November, and they are positive and up each month.”

“Abercrombie is still in the running and in front although there are some newer players coming up like [The] Buckle [Inc./BKE]. [A&F was] not near the top a year ago, but they seem to be back. You may view Aéropostale [Inc./ARO] as a competitor, but they don’t really sell jeans. They sell polo shirts and T-shirts. Gap isn’t a competitor because they sell at a different price point. Abercrombie is really in between the two, and that helps them. They really compete with Guess [Inc./GES] jeans, American Eagle [Outfitters Inc./AEO] and every other guy that sells [branded] jeans. Levi [Strauss & Co.] is a big competitor and they have made a big comeback although they are privately held. Who is No. 1? I have no idea.”

“They were the trendsetters up until about 2008. But now everyone is the same, and they have the same merchandise. Nothing is new. They created a strong brand, but it is diluted and not as important as before. So far, they have not come out with a strategy to change things.”

“[A&F] had a rough year last year because they were trying to stick to their guns on pricing. Their policy is no rebates. They do one to two sales a year, and that has hurt them because everyone else dropped prices. But they decided this year to go big in December, and everything I’ve seen on their latest figures looks good.”

“They did bring the price down the end of this year, but I don’t know if they want to continue. A lot will depend on the reaction and the economy. 2010 left an opening for them to use rebates, but it’s not a long-term strategy. They just used it to get out of the gutter.”

“The jeggings thing is on life support. It did what it had to do. It appealed to a very ethnic, young crowd.” “Abercrombie orders were not good this year, but that was true for everyone. The cotton shortage could really

change things. Retailers have said they don’t want to raise prices in 2011, but the fabric suppliers are raising their prices 35% to 40% to offset the problem. China had bad crops this year. Pakistan had floods. The U.S. had one of the smallest crops ever. China bought up a lot of the U.S. cotton, pushing up prices. It’s a dollar higher. Last week the price was at $1.52 a pound, and the suppliers add points to that. The yarn guys buy it at $1.52 and may add 20¢ a pound.”

“There was a big conference in New York with all the retailers talking about what’s to come in 2011 because all the prices have gone up, not just the price of cotton. The labor costs in China have increased. The transportation costs have increased. People who were paying $2.78 a yard for a premium fabric are paying $4.78 a yard because $2 more have been added to cover the costs. Several of the retailers were in a panic.”

“Most retailers have extremely low inventories. Last year they didn’t produce, and Abercrombie, Aéropostale and others managed their inventories. Some put the brakes on in April because they didn’t know what the holidays would bring. Gap called in December and said, ‘We only have 2,000 units left and we’re feeding 140 stores.’ So our sales are good.”

The appeal is the brand and the image. The product is important, but at this point everyone has the same product. … They do one to two sales a year, and that has hurt them because everyone else dropped prices. But they decided this year to go big in December, and everything I ’ve seen on their latest f igures looks good. … but it ’s not a long-term strategy. They just used it to get out of the gutter.

Senior Account Manager Denim Manufacturer & Supplier

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“If you want anything cotton, you should buy before February of this year because the prices are going to go up. The retailers say there won’t be any price hikes, but the pendulum has to come back. Something’s got to give. If they keep the same prices, their sales will go down and the stockholders won’t be happy. If the price goes up from $39.99 to $49.99, there’s a chance consumers won’t buy. My forecast for 2011 is scary even though everyone says the economy should come back. It doesn’t look good for Abercrombie or anyone else. The next two months should be OK, but if cotton prices stay the same something’s got to give. Prices have to go up. That’s why retailers made such a big push for the holidays. They know what’s coming. Inventories are down drastically. They will have to replace some of it, but it will be way more expensive. We’ve gotten our orders for January, February and March from Gap and they have not changed [year to year], but we raised our price by $1.25 and they are still buying. The orders all are the same so Q1 numbers-wise for us looks good.”

“It’s not so much a mess as there are a lot of unknowns for 2011. I am more pessimistic for 2011 in my industry. I don’t see it as a good year. In 2012, there will be a new crop and maybe some farmers will move away from soybeans and grow cotton.”

“The choice will be up to the retailers. They say they don’t want to raise prices. They are trying to squeeze us, but everyone has the same [shortage] problem and they will see us increase prices by 35%. The retail dilemma will be whether to raise their prices. They will have to, and there will be no explanation. With food prices, the consumers know why the prices went up. But it’s not as if [the news media] will run stories on the cotton shortage in China and how it will increase the price of denim/fabric. But [consumers] will see it and feel it.”

“The consumers don’t remember that last year a pair of jeans [at Gap] was, say, $49.99, and suddenly it is $59.99. So they may go to Kohl’s [Corp./KSS] where they were paying $29.99. ... Everyone is waiting for the other guy to do it. But believe me, someone will have to do it.”

North American representative for a large supplier of denim, cotton and khaki fabric

This source said A&F’s position as a trendsetter for teens is being undermined by pricing pressure from competitors and from copycats diluting the brand. A&F’s business has improved slowly but has not recovered completely from a slump a year earlier. H&M is doing very well while A&F, Aéropostale and American Eagle are battling each other. Retailers will have to manage price hikes from suppliers because fabric availability will be tight in 2011. The problem could affect margins and retail pricing.

“Abercrombie has generally been seen as a trendsetter, but they have created a look that’s become similar to other brands that have copied them and it has diluted their brand. They specialize in everyday youth clothing. If they want to be a trendsetter again, they will have to do something else, but we have not seen that from them. The battle with them started about a year and a half ago when competitors like Aéropostale and American Eagle started to put pricing pressure on them. [A&F] did not lower their price.”

“H&M is doing very well. J. CREW [GROUP INC./JCG] in its particular segment is doing well. The slow or stagnant retailers are Abercrombie, Aéropostale and American Eagle, but it is mostly because they are fighting against one another for customers. Abercrombie is doing a little better this year. Last year they had negative comps. They are not back completely, but they are coming back slowly.”

“Abercrombie was negative [in 2009] because of the economy and their price point was higher than American Eagle and Aéropostale. American Eagle is chasing them like crazy; they are opening stores. They just put a store in SoHo, right across the street from Abercrombie.”

“The holiday has been positive for all retailers. Spring and summer are our smaller season for denim, and we have already had our orders and

If cotton prices stay the same something’s got to give. Prices have to go up. That’s why retailers made such a big push for the holidays. They know what’s coming. Inventories are down drastically.

Senior Account Manager Denim Manufacturer & Supplier

Abercrombie has generally been seen as a trendsetter, but they have created a look that’s become similar to other brands that have copied them and it has diluted their brand. … If they want to be a trendsetter again, they wil l have to do something else, but we have not seen that from them.

Representative Denim, Cotton and Khaki Supplier

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will be shipping for spring. The orders for 2011 were normal, no different from last year.” “The current trends are for lightweight fabrics, and flared legs are popular in a few of the brands, at least that is

what I’m seeing in the premium Los Angeles brands. Our assets have been buying more and ordering more [for holiday and winter lines]. The problem is cotton prices. They have gone from 60¢ a pound to $1.70 a pound. The increase is due to a bad crop in China, flooding in Pakistan and a short supply from the previous season. It does not necessarily mean there is a shortage, but assets have to pay a higher price, which makes it difficult for them to adjust sales and production prices. They may have to do more shaving with their margins.”

“Because fabric prices have gone up by a dollar a yard, the buyers are not focused particularly on style or design. Right now they are just trying to figure out how they can get the price point they are looking for. Price, not design or style, is driving the order and sales patterns. This is not usual.”

Sales and marketing manager at a U.S. mil l that makes spun yarn for texti les/garments

The source said A&F sets trends for youth apparel and remains at or near the top of the branded retail heap. The price of cotton has more retailers seeking new polyester blends, recycled fibers and wool. A&F’s merchandize strategy—changing product every six to eight weeks—is well suited to benefit from supply shortages and manufacturing shifts in Asia. Retailers’ orders overall, which dipped 20% in 2009, recovered in 2010. The success of holiday sales will drive orders for 2011.

“Abercrombie & Fitch appeal to junior high and high school. They have managed to stay ahead of it, which is tough to do. Abercrombie does not do the same thing over and over. They change their offerings every six to eight weeks. They don’t have to have continuity, so they are set up well for shipments. They do have a couple of standards, some tops and T-shirts for the juniors market. But you do not go into to Abercrombie to buy staples. You go to buy what is trendy. They have been successful as a trendsetter, but you have to stay on top of that game. They seem to have stayed on top of it for now.”

“I would categorize Abercrombie as a place youth go for trends and they will continue to do so. I would rank them at the top or close to the top [among retail competitors]. Abercrombie is one that helps set styles. I think Abercrombie tends to influence mainstream fashion. You have got to go to Abercrombie because they change their [merchandise] so frequently, it’s hard for competitors to keep up. Even Wal-Mart [Stores Inc./WMT] can’t compete because their business model is based on competing through repetition. J. Crew seems to be doing well. I have seen some of their financials, and they have revamped quickly. But the truth is, there are too many [brand] stores with similar product. You have to figure that only those with strong balance sheets will survive.”

“Everyone went into 2010 feeling cautiously optimistic. It started out good from the mill standpoint. The pipeline was almost dry in 2009, and in 2010 they filled up the pipeline. This holiday season seems to have had a pretty good sales outcome. If that is the case, 2011 will be a little more optimistic and a little less cautious. The outcome of holiday sales will be a big determining factor for 2011. Most people want to forget 2009. When you look at the internal data, you have to compare orders and shipments to 2008. Most felt the 2009 orders were down 20% [compared with 2008]. In 2010 we recovered the loss and are back up 20% to where we were in 2008. It’s not unlike the stock market.”

“One trend we are seeing is the increasing use of synthetic fibers and the use of easy-care fabric. The price of cotton is a lot more than it was a year ago—up by about a $1 a pound—so one thing we are seeing is a change in the mix. Instead of garments with a 60-40 blend of cotton to polyester we are seeing more 60-40 polyester to cotton. There is more emphasis on performance fibers and fabric. Under Armour [Inc./UA] started a lot of that trend based on the concept that something can look good and still be functional. There has been in increase demand for polyester. Ten years ago we sold almost no polyester, and now it’s one of the larger items we produce and sell.”

“There also is a trend and ability to run a recycled product. Most of the manufacturers and retailers are trending toward creating post-consumer recycled polyester. Several of the name brands are leading the trend. The material is made from recycled plastic bottles. The bottles are washed and then they are chipped into flax and

One trend we are seeing is the increasing use of synthetic f ibers and the use of easy-care fabric. The price of cotton is a lot more than it was a year ago—up by about a $1 a pound—so one thing we are seeing is a change in the mix. Instead of garments with a 60-40 blend of cotton to polyester we are seeing more 60-40 polyester to cotton.

Sales & Marketing Manager U.S. Yarn & Textiles Garments Mill

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the flax is turned into yarn. Most of the retailers want these recycled fabric garments. They are typically more affordable than the fancier garments. All of them are looking for that special product that’s recycled.”

“Fleece continues to be a popular fiber. We also have seen a rise in the demand for wool. Wool is a natural fiber and renewable, so we are seeing more wool and polyester. Canada and Europe have been big users of wool, and we are seeing more of it in the U.S. Lots of retailers are looking for natural fibers and recycled fibers. I don’t think the natural fiber trend has legs, but the use of recycled fiber has tremendous potential.”

“The cost of doing business in China has gone up in terms of labor and transportation and raw material. They fueled that because they bought up the world’s supply of cotton. Demand exceeded supply, and that pushed the price up.”

2) INDUSTRY EXPERTS Owner fashion/style consultancy, fashion author, professor and designer

This source said A&F sells an image rather than fashion or style. The company caters to tweens through Hollister and teens and college-age consumers through Abercrombie. It neither leads nor follows, offering styles that are basic and casual. The fashion market is saturated with similar styles but may be poised to return to higher-end garments with unique features. She predicted flat year-to-year sales for this holiday season.

“Abercrombie & Fitch has a definite niche that caters to teens and tweens. It’s more about the California lifestyle image than about fashion. That’s what they sell—not so much clothing and style but the image. That’s why you always see a huge line of people waiting to get into the store, and they all are tourists.”

“I do see them more as a leader than a follower, but they are not leading others. They do their own thing. The fashion is very basic, a lot of jeans. It’s the Gap with a better fit and higher price. Hollister is a lower-priced label and a younger label. Abercrombie & Fitch targets high school and college-age kids. Hollister is more for junior high students. In a way, Hollister grooms the kids to go on to Abercrombie, and I think most kids know they are related.”

“There is so much saturation in the fashion industry. Abercrombie wants to target those with money. People who have money want to spend it on styles that do not look like everything else. H&M copies the designer brands but at cheaper prices and with less durable quality. I believe we are going to go back to quality and unique style. Right now the market is oversaturated and people buy too much of the same thing that doesn’t last. I think things will change and people will look for higher-end, good-quality fashion. But what the saturation and sameness did was it brought fashion to the mass market.”

“I don’t know about material pricing, but there has been way too much inventory. Think of all the stores and all the malls and all the outlets with all the same goods. If the price of cotton is too high, consumers can go a different way. There are other options like hemp, soy and polyesters. I know the retailers don’t want to raise prices even if suppliers raise prices. The markup in denim is huge, and there’s no way people are going to pay more for jeans. It will be up to the retailers and manufacturers to deal with the cotton shortage and prices. Are they going to be loyal to themselves, or are they going to be loyal to the customers? The problems will start when the stockholders complain that they are not making the same amount of money as before.”

“In the stores, I don’t see people buying as much. They are buying smaller quantities and fewer pieces. We now have so much casual wear and contemporary separates. What’s missing is the outfit and the put-together look like they used to have in coordinated sportswear. What’s out there are a lot of single items, and that leaves the consumer with the job of having to put it all together. There is a void in coordinating outfits that make it easier for the consumer.”

“In New York, people seem confused. And when people in New York are confused about fashion, what does that say about Middle America? We have to help people with their fashion and make it clear: This top goes with this skirt and coordinates with these pants. Right now it feels as if everyone has got the same look.”

Right now the market is oversaturated and people buy too much of the same thing that doesn’t last. I think things wil l change and people wil l look for higher-end, good-quality fashion.

Fashion Author, Professor & Designer

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“Sales in New York this holiday were OK. We had bad weather that kept people from going shopping, and we have not seen the usual crowds. I think things are about the same as last year, and I don’t know if retailers will do any better than last year.”

“Overall, whether you are Abercrombie or the Gap, everyone is feeling their way through this. People got very excited when the economy was good. They built megastores and everyone built out. Now, there is just so much you can do with all that real estate. If Abercrombie is opening and closing stores, it relates more to creating a balance.”

“They are trying to figure out where the consumers are. ... Keep in mind that the teens and tweens are not necessarily only online. They want to get out and see things and be seen and get away from their parents. They want to be in these fantasy settings the retailers have built for them.”

“I have a feeling it will be OK in 2011. Everything is on sale now, and the retailers want to get rid of the merchandise for the new lines. I think people will be ready to buy into the fantasy again in the spring.”

Consumer research psychologist and professor of psychology and marketing

This source said A&F took too long to adjust its styles and prices during the recession, allowing competitors to take a portion of its customer base. The loss continues as teen consumers have altered their approach to shopping, seeking the Abercrombie look but at lower prices at Target Corp. (TGT), Kohl’s and Forever 21.

“Abercrombie was cool, coveted, just exclusive enough to be desirable by the target demographic. They had it all.”

“With the recession, Abercrombie took so long to get that teen marketing changed. They looked like they lacked compassion and they left the door open to other teen retailers to steal customers.”

“They still have a good product and the sex appeal for teens. They’ll recover, but they’ll never be the same as before because they let their competition in.”

“Others mimic their style but have a lower price point.” “Teens are not stupid. They think about this stuff more than adults. If

they can get the same look for less, they don’t care who sets the style. They want the look, not the label.”

“In the recession, people learned a new way of shopping. There is no longer a stigma about buying less expensive brands as long as it looks cool.”

“I can’t believe how often Target comes up with teens. Kohl’s is up there, and I keep hearing about Forever 21 as having the same look as Abercrombie for one-tenth of the price.”

Marketing associate high-end denim manufacturer with a celebrity fashion CEO

This source said A&F caters to a niche teen market through its clean, casual apparel. The company is neither a leader nor a follower but retains its image. Teen retailers setting the trend include H&M, Forever 21 and Industria de Diseño Textil’s ZARA.

“Abercrombie is very specific, and I wouldn’t consider it either trendsetting or on trend. They cater to a very specific look and style in the teen sector. The garments are higher priced than some of its teen competitors. The perceived quality is higher than some of the lower-priced competitors though.”

“The Abercrombie style fits into the fashion landscape as casual clothing catering to a specific group in the teen market.”

“We are geared more toward the contemporary market, but we have a footing in the younger sector as well but on the higher price point. There we are seeing a trending toward wider-leg bottoms in denim and nondenim fabrics. We are also seeing a trending toward trouser-style ankle-length pants in lighter weights. For color, we are seeing light denim make a resurgence.”

“Customers are purchasing at a similar rate as they used to with our product. We don’t believe that people are willing to compromise in the area of premium denim. They may be looking for a deal and holding back on shoes and tops, but they don’t seem to be doing so on denim. It’s a wardrobe staple and has become more acceptable over the years, making it even more of a value.”

With the recession, Abercrombie took so long to get that teen marketing changed. … They left the door open to other teen retailers to steal customers. … They’l l recover, but they’l l never be the same as before because they let their competit ion in.

Consumer Research Psychologist & Professor

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“Department stores and major boutiques mark down our inventory seasonally as they always have to clear out for newer items they are moving in. We keep an exclusive amount of inventory in our own stores because we are in a position to handpick what goes in there. We keep that stock very fresh, and we also stock with exclusive items that you can’t find in our other retailers.”

“The retailers that are the most trendsetting are [Arcadia Group’s] Topshop, Cusp [owned by Newton Holding’s Neiman Marcus], Intermix, Kitson and Urban Outfitters [Inc./URBN]. Most on trend are for teen shops are H&M, Forever 21 and Zara.”

3) A&F AND HOLLISTER STORE PERSONNEL A&F assistant manager, Chicago

This source said A&F’s market traditionally has been college-age consumers but increasingly has attracted more teens. Hollister targets and markets to tweens, who also shop at American Eagle and Aéropostale. A&F is more preppy while Hollister is more beach style. A&F is viewed as a trendsetter in styles and store layout. The popular plaid look reportedly originated at A&F and continues to be very popular. Jeggings are selling well and appear to be an emerging trend among teen girls. The Fierce cologne is a top-selling men’s fragrance. Large fragrance displays were located near the registers and in the middle of the store.

“Our target market is 18 to 22, but we are seeing more high school kids than college kids buying our clothes. Abercrombie Kids is geared toward ages 8 to 16. Hollister is same brand as us, and they are in between, going for ages 14 to 18. Hollister’s image is Southern California, more beachy, and we are more the preppy type. Hollister is targeting the younger crowd. Hollister is not as trendy as Forever 21, but it’s also not boring. I would say American Eagle Outfitters and Aéropostale are more geared toward and sell more to the middle school crowd.”

“We set the standard for what the other retailers are doing. We do this through our marketing, how our stores are laid out and the design of our clothes. Others follow our lead.”

“Right now jeans and our fragrance are our biggest sellers. Fierce is the No. 1 selling fragrance for men in the country right now. It’s what you smell when you walk in the store.”

“An emerging trend for girls is definitely jeggings—leggings that look like jeans. They like them because they are really comfortable. Plaid is also really, really hot. We had the plaid look going first; then others copied the look. Both the guys and the girls like the plaids. They like to wear them with dark jeans. The store I just came from has been selling out of our plaid shirts like crazy. The fitted plaid is in now.”

Reporter Observation: The store was visited during midday on Wednesday, Dec. 15, and appeared to be emulating a club, with low lighting and loud dance music. The only customers were a middle-aged couple and a man in his 20s; all there were Caucasian. The four sales associates were restyling mannequins or folding clothes. The clothing’s colors were more muted than items at Hollister but were very similar in styling, including jeans, hoodies, flannels, short skirts, oxfords and leggings. The shelves had plenty of inventory and sizes. Men’s pants were available in sizes 28 to 36 while shirt and jacket sizes ranged from S to XL. Women’s pant sizes were 00 to 12 while tops ranged from XS to L. We found approximately 35% to 40% of A&F’s inventory being discounted but more than 50% of items on sale at Hollister.

Holl ister assistant manager, Chicago

This source said Hollister is more appealing than A&F to teenagers. Hollister targets those ages 13 to 18 and offers smaller sizing than usual. A&F’s target is college-age consumers. Teens continue to purchase the classics such as jeans, T-shirts, hoodies and leggings. Hollister stocks the classics but makes small updates to styling. Fitted plaids have been doing well for a few years and are expected to keep selling. Although Hollister and A&F offer similar styling, Hollister’s prices are more affordable.

“Holiday sales are up. We are doing well. Better than last year. Don’t really know numbers.” “We have plenty of inventory and stock. We’re not running low on any product or sizes. We audit daily to make

sure sizes are out. We did have an allocation issue, which seems to be solved now. We used to sometimes have a lag; it could be pretty slow, but now it is pretty good. We get restocked a lot faster and better now.”

“We appeal to the teenager crowd from 13 to 18 year olds and into college. Generally, our target is ages 16 to 20, but we do have younger customers too. Our sizes run a little smaller than usual. Abercrombie’s crowd is

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more 18- to 25-year-olds, and their sizes are smaller too but not as small as ours. Abercrombie’s style is reflected in Hollister. We have the same styles as they do, like the plaids, but our clothing costs less. Our quality is cheaper than Abercrombie, but so are our clothes.”

“Our look is kind of classic style. We are owned by the same people as Abercrombie, so our looks are kind of similar. We have lots of clothes that have come out in prior years; we just put a new twist on it each season. I am referring to classics like jeans and hoodies—stuff that everyone always buys. For the most part, we carry the same items every year; we just change it a little to make it fresh. Also, at this store, girls’ fleece pants do really well.”

“We have been pushing the plaids for two years now. They have been doing well so far, and it looks like it might continue to perform well. I don’t know what corporate will do. It’s hard to say, but the plaid push has been working. Associates wear plaids with dark denim.”

Reporter Observation: Blueshift visited this store midday on Wednesday, Dec. 15. Rather than having window displays, this outdoor mall store placed mannequins on each side of the main door. A surfboard stating “Surf Hollister, California 1922” was on display inside the store. Music was played at a fairly loud volume. Three customers were in line at the registers while four others were browsing. A mother and her teenage son had an American Eagle bag. A 30-something woman had a Nordstrom Inc. (JWN) bag while another woman with her teenage daughter was carrying a Gap bag. The remaining two customers were middle-aged women shopping together. All customers were Caucasian. The four employees on the floor were organizing clothes, working on mannequins or running the registers. The clothes were very colorful, including the plaid versions. The shelves had plenty of inventory and sizes. Men’s pant sizes ranged from 28 to 36 while shirts and jackets were available in S to XL. Women’s pants ranged from sizes 0 to 11, and tops were in sizes XS to L. Well over half of the merchandise was on sale and included all types of clothing. Many items carried the “Hollister” logo.

A&F store associate, Los Angeles area

This source said A&F’s target market is 18- to 29-year-olds while Hollister focuses on consumers ages 14 to 18. A&F’s strength is its frequent updates on classic clothes. Sales for November and December were ahead year to year. This source expects strong 1Q11 sales because of a new line being released in February.

“Sales in both December and November were higher than they were a year ago, and we think the next quarter will be strong because we’ll have the new line in by February.

“Right now we are preparing for a February arrival of our spring preview, so we don’t have any of the newer items in. But what we will be seeing is a little bit more selection on colors and styles on tops.”

“Abercrombie’s age range is between 18 and 29 or so, mostly college. Hollister is more about the 14- to 18-year-olds.

“Abercrombie offers a distinct style that other stores do not. We have a brand that is easily identified and very popular with teen markets. Hollister’s role is really an extension of that brand; only the colors of the items at Hollister are all much brighter, and the prices are slightly lower.”

“We aren’t trying to be Forever 21. We see that as ‘fast’ casual clothing, with a lot of turnover. We have a line of solid staples like jeans and jackets and classic shirts for men that have staying power.”

“The biggest trends I’m seeing are skinny jeans and flannels for guys, with some variation on that for girls. I get customers who will shop for tops at Forever 21 but come here for the jeans because they know the quality is reliable.”

“Our inventory is full, but we are selling because everything in the entire store is 40% this week. We are probably going to sell out on jackets and hoodies in certain colors.”

We appeal to the teenager crowd from 13 to 18 year olds and into college. Generally, our target is ages 16 to 20, but we do have younger customers too. Our sizes run a l itt le smaller than usual. Abercrombie’s crowd is more 18- to 25-year-olds, and their sizes are smaller too but not as small as ours.

Assistant Manager, Hollister Chicago-area

Right now we are preparing for a February arrival of our spring preview, so we don’t have any of the newer items in. But what we wil l be seeing is a l itt le bit more selection on colors and styles on tops.

Store Associate, A&F Los Angeles-area

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“I guess every retailer has to wind up with some items at the end of the season that didn’t do as well as anticipated. We have a few sweaters, mostly in whites, that are moving a little slow, but really everything in the store is popular.”

Reporter Observation: Blueshift’s visit took place on a Wednesday, Dec. 29, at 2:30 p.m. and lasted for 25 minutes. The store was doing a brisk business as the entire inventory was 40% off. Several staff members were actively involved with customers or folding or arranging inventory. The store seemed very well-stocked but lacked the post-holiday sales rush. The store duplicated displays in different rooms and offered a living room-type setting area for shoppers. Most shoppers were between ages 18 and 30, female, and without parents. Flannel shirts and hoodies seemed to garner the greatest interest, possibly because of the rainy weather. Most customers appeared to be buying only a few items. A few customers had bags from J. Crew and Target.

A&F store associate, New Jersey

This associate for a regular Abercrombie & Fitch store said pre- and post-holiday sales were strong, but she could not offer a year-to-year comparison as she did not work at this store a year ago. Jeggings and cardigans were popular, and a lot of people were buying the Fierce cologne. Customers appeared to be college-age or adults buying for children. This source said many customers come in carrying bags from H&M and Forever 21, where she does a lot of her own shopping because of price. She reported no problems with inventory or sizing.

“The customers are usually younger, around 20, or they are with their parents, or the parents are buying for their kids. But I just helped a woman who was in her 40s shop for herself, so you never know. She bought jeans and a few shirts.”

“Christmas sales have been really good, and you can see there are lots of people in the store now. Look at that checkout line.”

“Everything was 30% off; then two weeks ago it went to 40% off. I don’t know if they are extending the sale because of the snow we had or not. Not even our manager knows when the sale will end, but we think it will be through next week for sure.”

“One of our biggest sellers in the cologne we spray in the store and on the clothes. It’s the men’s Fierce, but even the women like it and buy it. The other hot items are the jeans and jeggings, and cardigans. Those are the fashion trends for teens.”

“People definitely buy an outfit. I rarely see people buy just one thing. I’d swear they buy up an entire display sometimes.”

“Hollister carries the same clothes and styles we do, but I don’t think they help or hurt our sales.” “I wear some Abercrombie & Fitch, but I still do a lot of shopping at Forever 21 and [The TJX Cos. Inc.’s/TJX]

Marshalls because they are cheaper and I like labels.” “As far as our competitors go, I see a lot of Forever 21 and H&M bags. There’s also a store here called

WHO.A.U—it stands for ‘Who Are You’—which is promoting a California look and carries more expensive clothes that look like ours [and] at the higher price range.”

Reporter Observation: Blueshift visited this store on Dec. 30 at 2:30 p.m. A total of 50 customers—mostly female and college- or middle-age—were in the store, with about 20 in checkout lines and 30 browsing. All ethnic groups were represented, and shoppers were carrying bags from Macy’s Inc. (M) and Forever 21. This mall has two A&F stores: a regular Abercrombie for those 14 years and older and Abercrombie Kids, for ages 7 to 14. The styles were roughly the same, but the stock was not identical. The two stores were separated by an unrelated shop, while a Hollister store was on the other side of the hall. The A&F was well stocked and relatively tidy and offered an additional 40% off everything in the store. The store had a steady stream of customers but did not have the mad post-holiday rush being enjoyed by some of its competitors in the mall. Several A&F customers in line had 10 or more new purchases. The hot item was the Addison down vest in multiple colors; several customers were buying more than one.

4) COMPETITORS’ STORE PERSONNEL Source tit le as it should appear in the report (e.g. CEO, IT Consulting Firm)

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This source said American Eagle has a solid position among teen shoppers even though its target demographic ranges from ages 13 to 25. Although American Eagle and A&F offer clothing very similar in style, A&F’s clothes are much more expensive. Hollister’s prices are somewhere in between the two brands. American Eagle offers more traditional styles for men and classic and trendy styles for women. Inventory has been good, and sizes have been plentiful. The customer base at American Eagle is 60% female, 40% male. American Eagle also offers a wider range of sizes than A&F.

“Our target customer is aged anywhere from 13 to 25, but teenagers are definitely are top customers. We have more female shoppers than males. I would say the ratio is 60% female customers, 40% male customers.”

“Our holiday sales are good. They are comparable and pretty equal to last year. Our inventories are good. We have plenty of stock and sizes available.

“Abercrombie is a lot more expensive than us, and it’s the same stuff. Our clothes are a lot more affordable. In terms of style, our men’s stuff is more classic—v-necks, cardigan sweaters, graphic tees. Our women’s items are a combination of classic stuff with some trendy styles mixed in.”

“Our hoodies always sell well, especially to teens. Jeans are always popular, too. We are the No. 1 jean retailer in the country. Everyone likes the way our jeans fit. They are comfortable and cheap, and they last forever. We are having a huge jean sale next week. Our basic outerwear and sweaters are also doing well, especially since winter hit. The teenagers really like the graphic tees and sweaters, too.”

Reporter Observation: The store was visited midweek on Dec. 15 from 2:30 to 3:00 p.m., during which at least 15 customers were present. The store was much busier than Hollister or A&F on the same day. The four salespeople were very busy at the registers and with helping customers. Customers were buying primarily sweaters and jeans. Men’s sizes ranged from 28 to 39 and S to XXL. Women’s ranged from 0 to 14 and XS to XL. Like Hollister, at least 50% of the merchandise was on sale at American Eagle. The store did not emphasize fragrances but carried more jewelry than A&F or Hollister. Also, this American Eagle store had a more open and traditional floor plan and was better lit.

Forever 21 sales clerk, Los Angeles area

A source said the store does very good business almost year-round, but the post-Christmas week had been brisk because of shoppers using gift cards. Trends are leaning toward blousy tops with leggings and jeggings and short boots rather than the conservative look of A&F. Bright colors, particularly purple and turquoise, are popular.

“We know prices at Abercrombie tend to drive customers to our store. I think we are on the mark when it comes to our large selections of styles. Abercrombie has good stuff but not enough of a variety.”

“Abercrombie is classic style, while we are a mix of romantic and punk and what’s trending now. We can offer more than 500 looks in our store while they have pretty much one or two fashion ideas to offer.”

“I don’t know what is popular at Abercrombie right now, but I guess usually what I see is a lot of Abercrombie hoodies.”

“The trends right now are pants and tops with short boots, bright-colored tops, and sweaters.” “We basically can appeal to anyone here because we have skimpy New Year’s Eve dresses, funky shirts, tops for

work and play, jeans, fashion shoes and casual boots.” “Teens definitely tend to shop for single items, like a top or a pair of jeans. They don’t usually buy mass-quantity

items. Their budgets are about $30, and that’s where we become so popular. We have the fashion items at a cost they can afford.”

Reporter Observation: The store visit took place on a Wednesday, Dec. 29, at 3:30 p.m. and lasted 20 minutes. Customers steadily streamed in, looking for mostly tops and accessories. Many were carrying Gap and Foot Locker Inc.(FL) bags. The store had several markdowns, including an accessories aisle with $3 and $1 items. Customers were mostly female between ages 17 and 25, shopping either alone or with a friend. This store carried no men’s clothing. Customers were buying single items.

Abercrombie is a lot more expensive than us, and it’s the same stuff. Our clothes are a lot more affordable.

Sales Associate, American Eagle Chicago-area

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Forever 21 assistant manager, New Jersey The source said A&F is a trend follower because of its limited product range while stores like Forever 21 and H&M are ahead because of their wider selections and better prices. A&F targets teens and does well because of its strong marketing rather than its product. This source was unaware that A&F owns Hollister, but said the two brands sell essentially the same styles at similar prices and that their close proximity in malls could help each other. Purchases were trending toward special occasion items, such as sequined tops and New Year’s dresses.

“I’d say Abercrombie & Fitch is a trend follower because there is nothing there you can’t get someplace else. Their marketing is just really good. They know just how to target teens, which is definitely their target audience.”

“Abercrombie & Fitch is everyday casual. There’s nothing special there, no product range—just ripped jeans, flannels, sweaters and hoodies.”

“I wouldn’t say Abercrombie & Fitch are really our competitors, more H&M because we carry the same styles at similar prices. Only a small amount of our clothes are similar to Abercrombie, who I’d compare more to American Eagle.”

“I didn’t know [A&F and Hollister] were the same company, but the stores are always next to each other and it makes sense because the clothes are all the same. I don’t even see a difference in price, so I’d say they help each other.”

“I’ve been working at this mall since I was 16, and I’ve never seen it like this. I spent half an hour looking for a parking space. I came to work today thinking it would be an easy day for me, but it is insane. It is way busier now than it was before Christmas.”

“We added the men’s section about a year ago, and it is doing really well. We have also been working really hard on keeping the place picked up. Last year at this time it was trashed, clothes all over the floor.”

“[Customers] are buying outfits. If they try to buy one thing, we do what we can to make them buy more. But usually they buy more than one thing on their own.”

Reporter Observation: The visit took place on a Thursday, Dec. 30, at 3:30 p.m. At least 100 people were upstairs in the women’s, men’s and accessories sections while another 100 customers were downstairs on the “Latest Trends” floor. The checkout line on each floor was about 25 to 30 people deep. Dressing rooms had lines of 15 shoppers or more. Most customers were female but varied in age and ethnicity. The men’s section was busy but not crowded. The store was very well-stocked and surprisingly tidy given the crowd. It was also well-staffed; Blueshift’s reporter was approached several times with offers of assistance.

5) A&F CUSTOMERS 15-year-old gir l , Chicago

This source said Abercrombie & Fitch is very popular with all teenagers because it has the trendiest and most popular styles. She shops at both A&F and Hollister at least once a month and never has a problem finding her size or items to purchase. She has been shopping at A&F more frequently year to year as she believes the brand has become even more popular. She mainly purchases clothing items. She views price and the lack of markdowns on certain items as A&F’s biggest drawbacks. Although she lives in downtown Chicago, she shops at a large indoor suburban mall 45 minutes from her home. She goes on shopping trips with her mom, aunt and teenaged cousin. She is looking forward to turning 16 so she can work at either A&F or Hollister. Her mother has encouraged her to branch out to other stores and to other fashions aside from her usual sweatshirts and jeans. The source carried bags from both A&F and Hollister as well as from Delia’s Inc. (DLIA), a store suggested by her mother.

“I think teens consider Abercrombie to be real trendy. A lot of teens like it because it is popular and the clothes are very nice. I shop here more than I did a year ago because their clothes have gotten more popular and I really

I ’d say Abercrombie & Fitch is a trend follower because there is nothing there you can’t get someplace else. Their marketing is just really good. They know just how to target teens, which is definitely their target audience.

Assistant Manager, Forever 21 New Jersey-area

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like their styles. They have all the latest and popular styles. I never have a problem finding my size or colors I like. They always have clothes I want to buy.”

“I consider Hollister to be a follower of Abercrombie. They do have the exact same things with regards to clothes and styles, but Abercrombie is more popular with teens. All the kids like it.”

“The only bad thing about Abercrombie is their clothes are very expensive. For example, their coats are very high. One coat I really liked and wanted to buy was $150, and that is way too much for me. They also do not have enough sales. They do have sales, but they are not often enough and they are not on the clothes I like best. I would buy more clothes at Abercrombie if they were more affordable.”

“Today I spent $80. I bought a sweatshirt and some shirts. ... I usually spend around $50 when I am here, but I had some Christmas money with me today.”

“In the next six months, I will shop at both stores six or seven times. My mom tries to get me to shop at other stores, but I really like Abercrombie and Hollister. They are the most popular with my friends and me.”

“Other stores I like are Delia’s, New York & Company [Inc./NWY] and sometimes I go to [The] Wet Seal [Inc./WTSLA], but my favorites are Abercrombie and Hollister. I like Abercrombie the best.”

“I am excited to turn 16 so I can get a job at Abercrombie or Hollister. I really want to work at Abercrombie! I love fashion and have been waiting to work here!”

18-year-old female, Southern California

This college student and part-time retail clerk at Wet Seal said she rarely shops at A&F but received a gift certificate and wanted a new pair of jeans. She prefers Forever 21 and H&M because she finds their clothes more fashionable, less preppy and more reasonably priced.

“I honestly am not a huge fan of [A&F] because the clothes are too conservative. I don’t really go for the preppy look. ... I guess I’ve shopped here about four times in the last year. I used to shop at Hollister when I was about 13, but the clothes now are a little too young for me.”

“I guess Hollister is doing a good job taking care of that younger person, but I find the clothes too conservative. They have the same things as Abercrombie: way too much plaid, yellow and blue. I like poncho tops and funkier styles that I can dress up or accessorize. With Abercrombie stuff you pretty much have to wear what they sell as it is.”

“I’m looking for a new pair of jeans, but I might spend the gift certificate on something else because the jeans they have are not the right fit for me. I like the jeans from H&M better.”

“I don’t spend a lot when I shop, maybe $25 to $30 on a top or two. At Forever 21 that goes a long way.” “I don’t think most girls my age are into the Abercrombie look. They want to wear dark leggings with colorful,

flowery tops and sweaters. Their quality is probably pretty good, but I don’t think the fashion feels like what’s really trendy. The stuff looks the same as it always did.”

“Forever 21 is probably the best. H&M is right behind them. They have a huge selection of different looks, not just one store brand look. Also, the prices are much more reasonable. I just refuse to pay $60 for a hoodie when I can get the same thing at another store.”

“I probably won’t shop at Abercrombie much in the next year. I prefer Forever 21, H&M and the store I work at, Wet Seal.”

19-year-old male, New Jersey

The source recently began shopping at A&F but plans to shop there more often, “moving up” from Hollister. He said A&F targets consumers ages 18 to 22 and benefits from Hollister as Banana Republic benefits from Gap. The main difference between A&F and Hollister is quality. People who want to portray a certain image shop at A&F, but its clothes and styles are not very trendy. Fashion is moving toward more fitted clothes, a more European look. This source like the muscular cut and surfer look of A&F clothes.

I shop here more than I did a year ago because their clothes have gotten more popular and I really l ike their styles. … The only bad thing about Abercrombie is their clothes are very expensive. … They also do not have enough sales.

A &F Customer, 15 Years Old Chicago-area

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“I just started shopping at Abercrombie and Fitch. This is my second time. I bought a sweater each time. But I’ll be shopping here a lot more now. I used to shop at Hollister a lot. I have a coat from there and some jeans. Now I’m moving up. The next thing I’m looking for from Abercrombie is a varsity jacket.”

“I plan to shop at Abercrombie whenever I go shopping, which is about two to three times per month. I like to spend around $100, less if I can.”

“Hollister to Abercrombie is like Gap to Banana Republic. Hollister helps Abercrombie because the clothes are similar but cheaper. That’s where the difference is: quality. It’s one of the reasons I’ll be shopping more at Abercrombie than Hollister now as I’m trying to change my image.”

“I’m changing my style from a baggy look to more tailored. I like my top half to be fitted, and I’m getting things tailored, like my jeans from the knee down. Kind of like a skinny jean, but not that tight all the way up. That way, I can tuck my jeans into my boots. I’m going for a clean look now instead of baggy.”

“I like Abercrombie’s current styles because their clothes fit different, a more muscular cut, more European.”

“I shop online a lot. [When I go to stores] I shop at H&M, Macy’s, Abercrombie, Hollister, [Polo] Ralph Lauren [Corp./RL] and [G-Star International BV’s] G-Star Raw. I’d say [G-Star is] coming up because they are unique. I have two pair of their jeans. They are expensive but not too popular yet, and I really like the cut. When I wear them, everyone asks what they are.”

“When I go to different colleges for parties and the other places I go, I’d say Ralph Lauren is what I see most [as the label to have]. As far as stores like Abercrombie go, people know if they want to look a certain way, they go there. But if they want to be trendy, they go to H&M or someplace else.”

“I live in Manhattan, but I come out to New Jersey to shop because the sales are better. When you live in the city you’re paying for [the stores’] high rents and the discounts aren’t that good. ... It takes me about 30 minutes to get to a bunch of different Jersey malls.”

Secondary Sources INDUSTRY PUBLICATIONS A Dec. 22 article in The Columbus Dispatch discussed takeover rumors surrounding A&F and the

company’s possible plans to change its state of incorporation from Delaware to Ohio. http://www.dispatch.com/live/content/business/stories/2010/12/22/abercrombie-may-shift-incorporation-to-ohio.html

“Abercrombie & Fitch wants to change its state of incorporation from Delaware to Ohio, a proposal made as the company has been the target of takeover rumors.”

“The reincorporation addresses ‘a number of corporate-governance matters in a manner that we believe appropriately protects and benefits the company and its stakeholders,’ the filing says.”

“Eleanor Bloxham, CEO of the Value Alliance and Corporate Governance Alliance, a Westerville consulting firm, said the filing seems to be based on two things: protecting against a takeover attempt and protecting directors against lawsuits.”

A Jan. 3 Women’s Wear Daily article reported that Abercrombie &

Fitch made a comeback this holiday season on several fronts, thanks to more appropriate pricing, promotions and better selection. However, concerns have surfaced regarding margin erosion based on discounts on everyday apparel. http://www.wwd.com/retail-news/holidays-winners-and-losers-at-retail-3410625#/article/retail-news/holidays-winners-and-losers-at-retail-3410625?page=2 (subscription required)

“Abercrombie & Fitch: The brand is coming back, reconnecting with customers in terms of products, promotions, social networking and e-

I used to shop at Holl ister a lot. … Now I’m moving up. … I plan to shop at Abercrombie whenever I go shopping, which is about two to three times per month.

A&F Customer, 19 Years Old New Jersey-area

The store has been marking down wear-now items, which wasn’t done in the past, but raising some questions on fourth-quarter margins.

Women’s Wear Daily Article

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commerce, after struggling for a long time with declining comparable store sales, stale product and pricing that wasn’t competitive. It’s now priced more appropriately with targeted promotions, there’s a wider range of fashion and the company is projecting a proactive, competitive image. The store has been marking down wear-now items, which wasn’t done in the past, but raising some questions on fourth-quarter margins. In addition, the international expansion is working, particularly with big-city flagships where more goods are sold at full price.”

Love to Know l isted Abercrombie & Fitch as No. 2 among the top 10 Web sites for shopping for teen

clothing. http://www.lovetoknow.com/top10/teen-clothing.html

“Whether it’s Humor Tees, scrubs or basics, teen dresses or whatever, Abercrombie has the stuff to get you juiced up looking sharp this season.”

Next Steps Blueshift wil l research Abercrombie & Fitch’s and Holl ister’s spring l ines to determine if the company wil l return to higher pricing or maintain the price adjustments made in fal l and winter 2010. We wil l monitor its competitors, including H&M and Forever 21, to see if they continue to gain market share. We wil l assess the cotton shortage and rising costs for material, labor and shipping, and gauge their effects on retailers, including A&F. Finally, we wil l look at A&F’s apparel selection and sizing to see if i t is expanding to meet more diverse customer tastes and larger sizes.

Additional research by Carolyn Marshall, Jacqueline Fox, Tina Strasser and Lindsay Gadsby. The Author(s) of this research report certify that all of the views expressed in the report accurately reflect their personal views about any and all of the subject securities and that no part of the Author(s) compensation was, is or will be, directly or indirectly, related to the specific recommendations or views in this report. The Author does not own securities in any of the aforementioned companies.

OTA Financial Group LP has a membership interest in Blueshift Research LLC. OTA LLC, an SEC registered broker dealer subsidiary of OTA Financial Group LP, has both market making and proprietary trading operations on several exchanges and alternative trading systems. The affiliated companies of the OTA Financial Group LP, including OTA LLC, its principals, employees or clients may have an interest in the securities discussed herein, in securities of other issuers in other industries, may provide bids and offers of the subject companies and may act as principal in connection with such transactions. Craig Gordon, the founder of Blueshift, has an investment in OTA Financial Group LP.

© 2011 Blueshift Research LLC. All rights reserved. This transmission was produced for the exclusive use of Blueshift Research LLC, and may not be reproduced or relied upon, in whole or in part, without Blueshift’s written consent. The information herein is not intended to be a complete analysis of every material fact in respect to any company or industry discussed. Blueshift Research is a trademarks owned by Blueshift Research LLC.

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011101 A&F Boosts Sales but Faces Higher Supply Costs · Abercrombie & Fitch finally conceded to lowering prices in order to boost sales during 4Q10. However, its recovery could be