Q2 2023 Abercrombie & Fitch Co Earnings Call

Good morning. Thank you.

Good day and welcome to Abercrombie and Fitch's second quarter fiscal year 2023 earnings call. Today's conference is being recorded. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session.

To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. At this time, I would like to turn the conference over to Mo Gupta. Please go ahead. Welcome this Russo. Welcome Mo.

Thank you. Good morning and welcome to our second quarter 2023 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer, and Scott Lopesky, Chief Financial Officer and Chief Operating Officer.

Earlier this morning we issued our second quarter earnings release which is available on our website at corporate.abracrombie.com under the investors section. Also available on our website is an investor presentation.

Please keep in mind that we will make certain forward-looking statements on the call. These statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today.

These factors and uncertainties are discussed in our reports and filings with the Securities and Exchange Commission.

In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and reconciliations of GAAP to adjusted non-GAAP financial measures are included in the release and investor presentation issued earlier this morning. Finally, references to Abercrombie brands include our Abercrombie & Fitch and Abercrombie Kids brands for sale at

Thanks, Mo. Good morning everyone and thank you for joining us today as we discuss our second quarter results.

It was a very busy summer for our global brands, and I am pleased to report we delivered both net sales and operating margin above the outlook ranges we provided on our call in late May.

Total net sales grew 16% in Q2.

showing improvement across regions, brands, and channels.

Abercrombie brands continue their strong momentum, delivering a net sales increase of 26%.

While Housderbrands made an important return to net sales growth this quarter, with a year-over-year increase of 8 percent.

This Hollister return is a result of the comprehensive work the team has done to get closer to our team customer and evolve the assortment over the past year.

Looking across the company, I am also proud of how we grew, which included both higher unit selling and higher AUR, showing strong product acceptance and value perception.

Our sales growth produced meaningful operating leverage and when combined with year-over-year growth profit rate improvement, delivered a second quarter operating margin of 9.6%, a significant expansion from a roughly break-even quarter last year.

Chase is definitely back and it continues to help us accomplish our strategic goal of keeping inventory tight and current with total inventory finishing 30% lower than second quarter 2022.

In what continues to be a dynamic macro environment, our second quarter and first half results show our playbook is working and the customer is choosing our brands.

In response, we are raising our full year sales and operating margin outlook, which Scott will expand on shortly.

Diving into some brand color.

Abercrombie brands continue to impress and push to new heights, marking the highest second quarter sales for the brand since 2011 and the tenth consecutive quarter of sales growth.

The 26% sales growth in the quarter was on top of 5% growth in the second quarter of 2022, exceeding our expectations.

We've also seen sales growth continue for Abercrombie brands into early August .

As we share in our call in May, a deep understanding of our customer allows us to present a compelling assortment to an authentic brand, voice, and experience.

These elements work together to help form long-lasting relationships with our customers.

We saw balance in how Abercrombie-Rams grew in the second quarter. Units in AUR were both positive, global traffic and conversion improved, and all the regions, channels and genders positively contributed to sales growth.

Both men and women posted double-digit sales growth in Q2.

In women's, we continue to see strength in pants and dresses as our customers look for outfits to get them through their workday to their weekend getaway.

On the men's side, we saw strength in knit tops and pants, all versatile, and all-season products to outfit them for their everyday lives.

The current position of the Abercrombie & Fitch brand is a result of years of deep transformational work and focus on executing our playbook to modernize the brand and get back to growth.

It was an especially proud moment for me last month when we opened our new Abercrombie store on 5th Avenue in New York City.

The updated store design, the range of products, and the omnichannel experience truly showcase the evolution and strength of the brand and demonstrate who we are today.

We are happy to bring our updated brand expression to Fifth Avenue and we look forward to opening more stores around the world in the months to come.

Our second quarter milestones continue with Hollister Brands, where we return to growth with an 8% sales improvement over last year.

exceeding our internal expectations in a challenging environment for our team customer. We see this quarter as a key proof point, validating months of work by our team to evolve the brand positioning and the assortment.

Consistent with the first quarter, we drove a healthier, more profitable business with gross profit rate improvement on higher AUR and lower freight costs and significantly lower year-over-year inventory levels, down more than total company average.

With clean current inventory, we control the promotional calendar and reduce discounts in the second quarter, further supporting gross profit rate expansion from last year.

On the product, which was developed using months of research and testing, second quarter selling was driven by customer response to a more balanced assortment. We saw strong conversion in women from purposeful distortions to dresses, non-dentum bottoms and seasonal tops.

While on men's, we also saw progress across tops and non-denim bottoms. We entered the second half with our assortment tightly aligned with our team's needs to represent who they are becoming, and we are fully in chase mode across genders to quickly deliver more of what's working. Beyond the assortment, we're also bringing an updated brand voice to Hollister, highlighting changes in the product while continuing to use social media to present...

We know the team customers deeply connected through digital, but the store experience is just as important, if not more so for this customer. As we've shared previously, about two thirds of Hollister's 2022 sales were in store and the store channel was an area of strength for us in the second quarter.

As we look to fall, we're happy to see sales growth continue for Hollister Brands into early August . We've seen nice traffic and conversion improvements across channels that tell us the customer is ready to shop and we believe we are well positioned to engage with them.

We're optimistic that we can deliver sales growth for the remainder of the year, and that growth is embedded in our updated outlook.

Shifting to our regional performance, we saw the strongest Q2 results in the Americas with 19% sales growth.

Outside the Americas, both regions contributed to second quarter sales, delivering 4% growth in EMEA.

and 18% growth in APAC.

Both brands also saw sales growth across regions, an important milestone we were targeting for 2023.

At Amaya and APAC, we benefited from the product evolution and distortion of both Hollister and Abercrombie brands.

We've organized around a regional operating model that provides better support for our local customer, and through the first half, our regional team has made sizable resets to our foundation in terms of pricing, promotions, along with depth and timing of seasonal inventory.

We believe this regional operating model is a key growth enabler moving forward. We have achieved so much this quarter and first half of 2023, and believe our results demonstrate strong execution in a highly dynamic macro environment, as we remain close to the customer and deliver relentless, strong, and effective results.

deliver relevant assortments for their lifestyle needs, they continue to choose our brands. We delivered growth and profit expansion while balancing inventory and making the strategic investments we believe are critical to achieve our always forward plan and position the company for long term success.

I'll now turn it up to Scott to give you some additional detail on the quarter and our updated financial outlook for 2023. Thanks, Fran. One item to note before I speak to the second quarter in our updated full year outlook. During the second quarter of 2023, we've evolved our operating model and structured a better leverage in the knowledge and experience of our regional teams to enable global growth.

With these moves, our segment reporting will shift to be geographically focused on three regions, the Americas, EMEA, and APAC. Our second quarter 10Q will show additional disclosures in our financial statement footnotes.

Now on to second quarter results. We delivered a strong quarter on the top line with total net sales of 935 million, up 16% to last year.

Comparable sales for the quarter were up 13%.

We saw year-over-year sales gains improve each month as the second quarter progressed, driving results above the expectations we shared in May.

On a regional basis, the Americas led the way with 19% growth.

We saw sales inflect to the positive in EMEA with 4% growth over last year. In APAC, we continue to benefit from the China reopening delivering 18% growth.

Looking at the brands Abercrombie brands delivered 26% growth and Hollister brands grew 8% off the second quarter of 2022 where we saw the team market and our performance take a step back.

For Abercrombie Brands, growth was consistent across genders while the women's business led the way in Hollister Brands.

Moving on to gross profit, our rate for the quarter was 62.5% compared to 57.9% in 2022.

there were several key drivers of the 460 basis point improvement.

First, we saw approximately 400 basis points contribution from better than expected AUR, driven by a higher mix of Abercrombie business to the total, lower promotional activity, and some ticket benefits in Abercrombie.

Second, we saw a freight benefit of approximately 340 basis points.

Finally, these benefits were offset by higher cotton costs, impacting the rate by around 180 basis points, and 60 basis points from adverse impact from foreign currency.

The net benefit from freight and cotton for Q2 was approximately 160 basis points in line with the expectations going into the quarter and consistent with our full year estimated benefit of approximately 250 basis points.

The supply chain is in a good place with freight costs, shipping times, and performance significantly better than last year. With a functioning supply chain, we can once again run the business the way we would like, leveraging Chase to read and react and drive inventory receipts.

Our inventory for the quarter was down 30% to last year and both brands and all regions are leveraging our chase capabilities.

We continue to expect to finish the third quarter with inventories lower than last year. At year end, we expect to be flat to down to last year.

Operating expense, excluding other operating income, was $497 million compared to adjusted operating expense of $465 million last year.

We had no exclusions this year and excluded $2 million of pre-tax asset impairment charges last year.

The year-over-year expense increase was driven by inflation, investments in digital technology, and higher incentive-based compensation.

With higher than expected sales, we saw improved expense leverage in the quarter, with operating expense representing 53.2% of sales this year compared to 58% last year.

Operating income was $90 million compared to approximately break even last year.

Operating income exceeded our expectations, driven by the combination of higher sales, a better than expected gross profit rate, and improved expense leverage.

Net income per diluted share was $1.10 compared to an adjusted net loss per share of 30 cents last year. On the balance sheet we ended the quarter with cash of $617 million and liquidity of $974 million.

For the first half of 2023, we had operating cash flow of approximately $216 million and capital expenditures of approximately $90 million.

We ended the second quarter with 759 stores.

Based on the first half results and a solid start to August for both Abercrombie and Hollister brands we are increasing our Foyer Outlook. This updated Foyer Outlook replaces all previous guidance.

For the full year, we expect net sales growth of around 10% from the 2022 level of approximately 3.7 billion.

This is up to our previous outlook of up 2 to 4% due to outperformance in the second quarter and our current expectations for the second half.

We continue to expect the 53rd week to contribute approximately 45M dollars to fiscal 2023.

For stores, we expect approximately 35 new stores, 20 combined remodels and rate sizes, and 30 closures. For operating margin, we expect to be in the range of 8 to 9%, up from our previous outlook of 5 to 6%, with the increase driven by higher expectations for gross profit rate expansion on higher AR and improved expense leverage on higher sales. We continue to expect a net benefit from freight and cotton of approximately 250 basis points for the full year. We expect an effective tax rate in the low to mid 30s compared to our previous expectation of high 30s due to higher expected profitability levels. And we continue to expect capex of approximately 160 million. For the third quarter of 2023, we expect net sales to be up low double digits compared to fiscal third quarter 2022 level of 880 million. Embedded in the outlook is the assumption that we see year over year growth across regions and brands, with Abercrombie brands continuing to outperform Hollister brands. The outlook also assumes that total sales growth compared to 2021 remains consistent with the trend we saw in the first and second quarter. For operating margin, we expect to be in a range of 8 to 10% compared to an adjusted operating margin of 2.4% last year.

And with that, operator, we're ready for questions. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. The first question comes from Corey Tarlow with Jeffries. Your line is open. Great. Thanks so much for taking the question. I wanted to start with the really impressive momentum that you've seen at Abercrombie. What maybe surprised you to the upside as you thought about?

So yes, it's so exciting to see the momentum continue with A&F. As a reminder, it's our 10th consecutive quarter of growth. And it really is the culmination of years of hard work. The playbook is working. We've talked about it before, but we are no longer a jeans and t-shirt brand. We certainly are a lifestyle brand today. And what's driving this win is several categories. I mean, the pants is a newer business for us. We have a great franchise going there. Our dress business continues, our YPB franchise. Really exciting is that the men's business is also now comping very, very nicely. It's exciting to see him back and noticing our business as well. WE Olivia

Back to school, specifically any trends that we're seeing, the good news is that the bottoms business is more than denim. We came out of Q2 last year really kind of focused on our assortment. The team got to work and there are a lot of things happening from cargo pants to knit bottoms to wider jean legs. So that's what we're seeing in the current business. Inventory once that trend fell off there in Q2. So that's where we're focused.

the color and best of luck.

Thanks.

Please stand by for the next question.

The next question comes from Dana Telsey with Telsey Advisory Group. Your line is open. Your line is open.

Hi Fran and Scott. Congratulations on a terrific quarter. This year you're achieving that operating margin basically of around 8% or so. And when I think about the 2025 target, the target for the operating margin was right around 8%.

So this year, eight to nine, obviously, and the 2025 target was 8%. How much of what you have now is sticky, so could that 8% 2025 target have the opportunity to reach the long-term target of 10% as we go on this journey? Thank you.

Hey, Dana, great question and it's nice sitting here today in the middle of the year to put that 8 to 9% out there for the full year. When we zoom, zoom out and look back at 2022. we had a lot of assumptions. It was pretty tumultuous time back in 2022. We set these targets and we needed to get some freight and cotton back into the mix and we weren't sure how quickly that would come.

Obviously, we've seen freight come back in pretty quickly as that market really has come back in almost to 2019 levels. And as we think about cotton, that's something in the future for us. So sitting here today, we feel good. We're growing the business. We are getting the cost back into the business and we're starting to leverage that OPEX, which is really exciting. What do you, what do you see as the future for the business effectively stepping into distributors' P Ravens of Soon

All key parts of the formula to get us to that 2025 number. We're not going to talk about 2024 and 2025 at this point. A lot of water to go under the bridge here this year. But we want to make these changes sticky. We want freight to be sticky. That's a little out of our control. Hopefully cotton is next. Fran, we talked a little bit about AURs a second ago. But coming to this year, we both talked a lot about holding those AURs, maybe growing them a little bit.

Puts us in a really nice position long term from a gross margin perspective. So we've been able to do that. We've been able to grow those gross margins, so sitting here today, we feel good about those targets still and again, nice to put that 8 to 9 out for this year.

Got it. And then Fran, just on Hollister, with the improvement in Hollister, I think it was the first positive sales since the fourth quarter of 21 or whatever.

what are you seeing there? How do you think of the progression to holiday? And just overall how's back-to-school trending? Thank you.

So, you know, I'm very excited and very proud of the team on what we're seeing. So, last Q2, to your point, we saw, you know, a significant step back for ourselves and many of the other teen retailers. We really took an introspection and said, is it us? Is it macro? And where we landed was that we owned a lot of where we were.

The team got to work and I would say got back to being closer to their customer and really understood how to evolve their assortments. You know, the best news that Scott mentioned, you know, supply chain is back and one of the best tools that we have is chase and reading reacting. And that's what the team has been up to all year.

So our assortment for back to school are very evolved, they're also very known, which is a great thing for us.

Our expectation as we head into the back half is to continue to see growth in Hollister.

Thank you. Congratulations. Thanks, Dana. Thanks, Dana.

Please stand by for the next question.

The next question comes from Matthew Boss with JP Morgan. Your line is open.

Great thanks and congrats on a really nice quarter.

Thanks, Matt. So Fran, given the magnitude of the performance at Abercrombie that you continue to see, I guess, could you just speak to what you see driving the sustained momentum of this brand and help us to think about market share, new customer acquisition, and then just relative to a year ago?

Maybe Scott, could you speak to the supply chain broadly, inventory levels into the back half, and just your ability to chase trends across both concepts this year relative to the same time last year?

So I'll kick this one off. So it is very exciting and I like your word, magnitude. It's nice to see this momentum continue and grow for that matter. You know, it is the 10th consecutive quarter of growth that we have seen and the consumer is really responding to what we're doing. You know, we're no longer a jeans and t-shirt business. We really have expanded into a lot of new categories.

that extension of categories. We have in women's a pant franchise called Sloan. It's all over TikTok. Women are loving that pant. We're offering it in many different fabrics and iterations. Our dress business has become a real destination. We have a best dressed guest collection that continues to grow year over year. She's coming to us for those important wearing occasions now from all of her social things that she's out and out.

Your question is about Chase. This Abercrombie business is very chaseable now with the supply chain where it is. We've got a very strong sourcing and supply team where they're very agile. They work with the teams every week, respond to the business and can chase into what's working. Yeah, and on the supply chain, Matt, so happy with where we are at supply chain, kind of start at the factories. You know, the France point, we are able to chase. There's capacity out there in the factories, which is.

are better than they have been in years. Timing is better, fulfillment rates are better, and then even when you get on the ground here in the US, there's been some really good activity with a lot of the union settling, whether it was rail, most recently with UPS, West Coast ports, so a lot of good news, but just equal stability, hopefully, in the supply chain, if we have stability, that means we can chase.

And that's how we want to run the business. So very happy with where we sit today. Congrats again, best of luck. Thanks. Please stand by for the next question.

The next question comes from Marnie Shapiro with the retail tracker. Your line is open.

Marnie, your line is now open.

Sorry for that. Good morning guys. Congrats on an amazing quarter. The stores look fantastic. It's very exciting.

Can you touch a little bit on the marketing side of the business? Because Fran, you touched on the Sloan pan on TikTok. You guys are everywhere these days and it's impressive. Can you talk a little bit about what that spend should look like for the back half of the year? And are you getting new and lapsed shoppers back to the brands? I'm curious a little insights there.

Sure, hey good morning Marty. Yes, so as far as marketing goes, I'm really proud, I say this all the time, but we really, our marketing team is really leading in their, as you say, we're seeing us everywhere. So in Hollister, we've actually evolved our brand positioning very nicely and you're seeing that in back to school.

much more focused on the product and a very genuine reflection of who he and she is today for that team consumer. And marketing for Abercrombie right now, it's truly a machine. We're getting a lot of, there's a lot of customers out there that are speaking on our behalf and that's the best place to win today. The customer today, you know.

really responds better to their friends and their other customers than they do even to what we're putting out there. So lots of exciting things coming up for the back half. I'll let Scott speak to new and laps shoppers. Yes, on the spend, I'll start there. We're thinking about the first half. We were around flat year over year. That was up in Abercrombie down in Hollister. You know, we pulled back a little bit on Hollister as we were working.

Abercrombie. We've talked a lot you know over the last call it year as we've expanded this age group you know 22 to 40 let's call it that's a very large addressable market. So we're trying to reintroduce people to the brand you know they haven't been there for a while we're also introducing new customers to the brand that have never never shopped with us. So our team to France point has done an amazing job finding consumers out there. TikTok has helped.

to the fall season guys. Thanks Marty. Thanks Marty.

Please stand by for the next question. The next question comes from Mauricio Cerner with UBS. Your line is open.

Great, good morning. Thanks for taking the question and congratulations on the very strong results. Just wanted to see if you could share with us maybe the sales growth, you know, pretty impressive this quarter. Could you maybe break it down at a higher level between AUR growth and units? And also wanted to confirm for the store opening.

I think you mentioned 35 new stores and 30 closures. So, like, net is just like a five increase. Could you maybe talk about, like, where, like, that store opening, would that be more skewed towards Abercrombie or Hollister? Thank you. On the store side, we'll be tilted a little bit more towards the...

a little bit across brands, maybe a little bit tilted towards Hollister. So that's where we set net openers again and there's also 20 remodels and right sizes in there. So while that's not a new store, it's a new expression for our consumer. So we like that also. So when you add those kind of remodels and right sizes and the openings, we've got about 1255 new expressions coming for the consumer.

You know, units were down a little bit and that was purposeful and AUR was up. And then on Abercrombie, it's both. You know, it's growing units and it's growing AUR. So obviously, really like what we're seeing in the Abercrombie brand.

Got it. And if I just may follow up on the regional performance, you know, any commentary that you can provide on the EMEA? I mean, it's back to growth but still like relatively underperforming the other two regions maybe across the market. What are you seeing and do you expect that trend of U.S. delivering?

sorry, America delivering the strongest results in the second half to continue. Yeah, we'll continue to expect America's to outperform, and it's by far our biggest region, so that's a good thing. Whenever you think about the total company, we think about the inflection in EMEA for the second quarter. It was a good proof point for us. You know, we've talked a lot over the call at six to nine months about that Hollister assortment.

The evolution of that assortment and the balancing of that assortment we knew or we hoped I guess I should say that would help us outside of the US and we saw that in Europe and that was a good sign that we're making the right moves there in Hollister. And then in APAC obviously the smallest part of our business but continuing to see good trends there out of China and Hong Kong so our goal is to keep that momentum rolling.

Great, thanks so much. Please stand by for the next question.

The next question comes from Paul Luiz with Citi. Your line is open.

Thanks, guys. Scott, I think you said that—

Sales improved each month during the quarter. Curious if I heard that right, if that was at each brand, each region, maybe you could just clarify that comment. If you've seen further acceleration in August . Then curious about just performance in denim at both brands. I know you said non-denim bottoms, I think we're.