Abercrombie & Fitch Co. (NYSE:ANF) Q3 2023 Earnings Call Transcript

Abercrombie & Fitch Co. (NYSE:ANF) Q3 2023 Earnings Call Transcript November 21, 2023

Abercrombie & Fitch Co. beats earnings expectations. Reported EPS is $1.83, expectations were $1.07.

Operator: Good day, ladies and gentlemen, and welcome to the Abercrombie & Fitch Third Quarter Fiscal Year 2023 Earnings Call. Today’s conference is being recorded. [Operator Instructions]. At this time, I would now like to turn the call over to Mo Gupta. Please go ahead.

Mohit Gupta: Thank you. Good morning, and welcome to our third quarter 2023 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer and Chief Operating Officer. Earlier this morning, we issued our third quarter earnings release, which is available on our website at corporate.abercrombie.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 today 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 Abercrombie & Fitch and Abercrombie kids and references to Hollister brands include Hollister, Gilly Hicks and Social Tourists. With that, I will turn the call over to Fran.

Fran Horowitz : Thanks, Mo, for joining us. We are excited to report outstanding third quarter results, which is a testament to our global team delivering on our goal to our customers’ needs at each brand. We continue to build on momentum from Q2, with sequential acceleration in both sales growth and profitability. On the top line, growth trends were strong throughout the third quarter, driving sales results above our expectations. For the quarter, net sales increased 20% with growth across all regions, brands and direct selling channels, including both stores and digital. We also exceeded expectations on the bottom line with a 13.1% operating margin, driven by 570 basis points of gross profit rate expansion and operating expense leverage on higher sales.

The 13.1% operating margin was an expansion of over 1,100 basis points compared to third quarter 2022. For the year-to-date period, net sales were up 13% to last year with an operating margin of 9.3% over 900 basis points better than 2022 through the third quarter. These results show the powerful response from our customers as we continue to execute on our playbook. I am so impressed with what our team has delivered, pushing boundaries and challenging ourselves to grow while staying close to our customers and remaining agile. As we enter the fourth quarter, we are poised to continue this momentum with our brands and regions strategically positioned to win. As such, we are raising our sales and operating margin expectations for 2023 and capping off a significant year of improved growth and profitability for the company.

I’m proud to share it with a strong quarter across our brand portfolio and the time we’ve spent reinvigorating Hollister brands is resonating with our customer. With a refreshed brand aesthetic and evolved assortment, Hollister brands achieved 11% growth for the third quarter, showing nice progress as we comp a disappointing 2022 back-to-school season and what remains a dynamic team apparel environment. Hollister delivered growth in all regions showing balance as we further localize our assortment experience. We continue to prioritize driving a healthier business in Q3 improving the gross profit and low rate — on lower freight costs and higher AUR from lower promotions, consistent with the first half of the year. As we enter the peak holiday season, our inventory is in a significantly better place compared to last year, giving us the opportunity to be strategic with promotions.

Turning to product wins. The Hollister women’s business continues to lead the way for the brand growing nicely and showing balance as tops, bottoms and dresses all helped drive sales improvement to last year. As we discussed last quarter, we entered back-to-school with purposeful distortions to dresses non-denim bottoms and select top categories all of which did well for the balance of the quarter. Importantly, we have used these learnings to chase into winners for the holiday season. The overall men’s trend was similar to the second quarter with solid performance in non-denim bottoms, fleece and sweaters all of which were areas of focus for newness as we rebuilt the assortment. This holiday season, as team customers head to them all, we’ll be ready to meet them with an evolved assortment.

We expect to complement the in-store business with increased digital marketing, particularly on social channels, where our teams are spending the abundance of their time. Although it’s early, we’re pleased with Hollister’s brands throughout to the fourth quarter and remain on the path to deliver growth for 2023, a key point for progress for the brand. Moving to Abercrombie brands. Wow, the team delivered their 11th consecutive quarter of sales growth with an impressive 30% sales increase year-over-year. We continue to find new ways to win with our target audience, resulting in great balance and consistency in addition to growth acceleration. Similar to Q2, we saw growth in units, AUR, genders, regions in both stores and digital direct channels.

On the assortment, both men’s and women’s posted double-digit sales growth in the quarter. Looking at women’s Q3 marks the 13th consecutive quarter of double-digit sales growth. I’ve been impressed with how our teams have continued to build on strong franchises across tops, bottoms and dresses. For men’s, Q3 marked our fifth consecutive quarter of growth, an important milestone we strongly come at the beginning of our growth path in Q3 2022. Following our successful playbook for women’s, we are building into franchises in the central lease and its while driving newness across jeans and pants. I’m excited about our cold weather assortments in both genders across sweaters, fleece and outerwear as we approach holiday. Abercrombie continues to find compelling ways to connect with customers through unique collaborations and brand experiences.

For example, our recent collections with Influencer Kathleen Post and Harlan’s Fashion Road designer into cold Benfield have driven engagement with new and current customers particularly on social media and our digital shopping platforms. On an in-person experience, we continue to see traction in our neighborhood stores, and we were thrilled to open 4 additional locations in the quarter, including Soho in New York, Brickell Street in Miami, King Street in Charleston and Harvard East in Baltimore. We have and will continue to use our digital and store experiences in concert to drive a seamless customer experience. Looking forward to the fourth quarter, Abercrombie brands has had a great start to November, continuing at historic 2023, and we’re confident our customers will love what we have for them this holiday season.

Moving to regional performance. As we discussed last quarter, we are seeing positive results from our evolved regional operating model, which provides better support for our local teams and a greatly improved customer experience. Each region delivered growth in the quarter also building on second quarter sales increases. On a comparable sales basis, the Americas grew 16% in Q3. EMEA grew 15% and APAC grew 32%. And the localization efforts our EMEA and APAC teams have made key updates to our assortments, pricing and forced cadence as we have moved through 2023, contributing to our sales performance in those regions. In EMEA, our teams also localized marketing content and prioritize spend in our 2 largest markets, the U.K. and Germany, where we are seeing outsized positive results compared to the rest of Europe.

We’ve seen similar progress from our APAC team as well. As you know, Singles Day is an important retail holiday for us in the region, and the team tailored promotions and product positioning, leading to a nice increase in sales this year. There is more work ahead, but our improved trends give me the confidence that we are focused on the right aspects of the customer experience and that we can continue to recoup lost volume over the past few years following the COVID pandemic. Before I turn it over to Scott, I want to share a few additional — for the upcoming testing holiday period. Fourth quarter is off to an encouraging start, and we’re ready and focus to compete with the large volumes ahead of us. Our teams have worked hard to align our product and promotional messaging to set us up for successful holiday across brands.

With strong brand positioning and highly product strategies in place for each brand, we are accelerating our marketing investment in the fourth quarter to capitalize on heavier traffic and drive customer acquisition and retention. While the macro environment remains challenging and uncertain, we have proven that we can deliver growth across brands and regions if we stay focus on our customer and execute our playbook. I’m so proud of our teams have achieved so far, and we expect to finish 2023 showing the strength of our customer relationships in addition to sales growth and profitability. I’d like to thank all global associates for making this happen through their unrelenting customer focus and unwavering commitment to our always forward plan.

We all look forward to continuing momentum in the important holiday period and sharing our full year accomplishments with you soon. With that, I’ll hand it over to Scott.

Scott Lipesky : Thanks, Fran. I’ll start with adding my thanks and congrats to our global team for delivering a strong third quarter. We drove net sales, gross profit rate and operating margin above our expectations while continuing to manage inventory tightly. For the quarter, total net sales of $1.056 billion were up 20% to last year with growth across brands and regions. Comparable sales for the quarter were up 16% with both stores and digital contributing. The 400 basis point spread between comps and total sales was primarily driven by net new store activity. As a whole, our new stores have exceeded our expectations and are expected to deliver productivity per square foot at a rate than double the stores we closed last year and will close this year.

On a regional basis, our growth was more balanced in the quarter compared to recent past. Better balance was driven by an acceleration outside the Americas. By region, net sales grew 22% in the Americas, 14% in EMEA and 13% in APAC. On a comp basis, sales grew 16% in the Americas, 15% in EMEA and 32% in APAC. In our EMEA and APAC regions, we have seen a good response to localization efforts made this year, including product and inventory distortions, pricing adjustments and timing of product drops. On a brand basis, Abercrombie brands delivered another great quarter of growth at 30%, while Hollister brands grew 11%. On a comp basis, Abercrombie grew 26% and Hollister grew 7%. Similar to the second quarter, Abercrombie brand’s growth was consistent across genders, while the women’s business drove the growth in Hollister brands.

Moving on to gross profit. The gross profit rate for the quarter was 64.9%, up nicely compared to 59.2% in 2022. The 570 basis point rate improvement was driven by a few key factors. We saw approximately 250 basis points contribution from AUR growth driven by higher mix of Abercrombie business to the total and lower promotional activity enabled by lower inventory levels compared to last year. Next, we saw a freight benefit of approximately 200 basis points. And we saw a benefit of approximately 200 basis points from lower levels of inventory write-downs compared to last year. These benefits were offset by higher raw material costs of approximately 80 basis points. We expect slight raw material cost pressure in the fourth quarter of 2023, flipping to a benefit beginning in 2024.

Touching on the supply chain, we continue to see freight cost shipping times and performance at good levels. Entry was down 20% to last year at the end of the quarter, and we continue to chase across brands. As we look to year-end, we expect inventories to be down to last year. Our teams have done an amazing job building agility into our inventory decisions, and we are excited to see our customers respond to our holiday assortments. Taking a look at expenses. Total operating expense, excluding other operating income, was $546 million compared to adjusted operating expense of $501 million last year. We had no exclusions this year and excluded $4 million of pretax asset impairment charges last year. Year-over-year increase was driven by inflation, investments in digital and technology, higher incentive-based compensation and marketing.

Marketing dollars were higher than last year but were steady as a percent of sales. Strong sales growth, we expect — we delivered nice expense leverage in the quarter with operating expenses representing 51.7% of sales this year compared to 57.3% last year. Operating income was $138 million or 13.1% of sales compared to adjusted operating income of $21 million last year. Operating income exceeded our expectation, driven primarily by the strong flow-through of better-than-expected sales. Net income per diluted share was $1.83 compared to an adjusted net income per share of $0.01 last year. With strong earnings and inventory management in the quarter, we continue to strengthen the balance sheet. We ended the quarter with cash of $649 million and liquidity of approximately $1 billion.

During the quarter, we drove $134 million of operating cash flow. We repurchased $50 million of senior secured notes at par value for a total of $51 million and ended the quarter with $250 million of senior secured notes outstanding. Consistent with the past few years, we will continue to focus on debt and share repurchases as our primary means to put excess cash to work pending business performance, share price and our ability to increase investments in the business. For the first 9 months of 2023, we had operating cash flow of approximately $350 million and capital expenditures of approximately $129 million. We ended the third quarter with 765 stores. Shifting to our thoughts for the rest of 2023. As mentioned, we have had an encouraging start to the quarter, and we are excited about the opportunity ahead and as the majority of the volume is yet to come.

For the fourth quarter of 2023, we expect net sales to be up in low double digits compared to fiscal fourth quarter 2022 level of $1.2 billion. As a reminder, we have the 53rd peak this year, which we expect will add $45 million or 375 basis points of contribution to sales growth this quarter. We are assuming growth across regions and brands. We expect a minimal impact from foreign currency. For operating margin, we expect to be in the range of 12% to 14% compared to an adjusted operating margin of 7.7% last year, with the increase driven primarily by a higher gross profit rate on lower freight costs and higher AURs. For operating expense, we expect to see similar themes as we saw in Q3 with higher technology and incentive compensation expense as well as increased marketing.

For tax, we expect an effective rate of around 30%. Embedding the fourth quarter outlook in the full year, our updated full year outlook is for net sales growth of 12% to 14% from the ’22 level of approximately $3.7 billion. This is up to our previous outlook of growth of around 10% due to outperformance in the third quarter and our expectations for the fourth quarter. For stores, we now expect approximately 35 new stores, 20 combined remodels and right sizes and 35 closures. For operating margin, we expect to be around 10% for the year, up from our previous outlook in the range of 8% to 9%. We continue to expect a net benefit from freight and raw materials of approximately 250 basis points for the full year. We expect an effective tax rate in the low 30s compared to our previous expectation of low to mid-30s due to higher expected profitability levels and we continue to expect CapEx of approximately $160 million.

To finish up, we are pleased with the continued progress across regions and brands, giving us confidence that our playbook is working. While we are laser-focused on delivering a great holiday, we are confident in our path forward and are making progress on long-term strategic investments that will better enable speed, agility and a seamless omnichannel customer experience as part of our always forward plan. With that, operator, we are ready for questions.

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Q&A Session

Operator: [Operator Instructions] And our first question coming from the line of Dana Telsey with Telsey Advisory Group.

Dana Telsey : Congratulations on the very nice results. Nice to see the improvement in Hollister. And when you unpack the comps, men’s, women’s, what did you see in terms of performing any categories to note how is the difference between online and physical stores and how you’re thinking about promotions? How were they in the third quarter and plans for the fourth?

Fran Horowitz : Thanks, Dana. Good morning. So specifically, to Hollister. I mean it was really exciting to see our second quarter of consecutive growth, up 11%. Led by women’s again. So just like our — we saw it happen in Abercrombie, Women’s led the way there, too, and girls is leading the way for Hollister. What specifically worked for us, non-denim bottom that we’ve had an expansion in our bottoms category. They still love denim, but a lot of opportunities to a lot of other non-denim bottoms, which are happening actually in both the guys and the girl’s business. Categories to note, lots of exciting things, a very balanced assortment. Our inventories are very clean. I’m excited that we can hinder the fourth quarter with really fresh inventories and promotions.

As you know, the fourth quarter is certainly always the most promotional quarter of the year. We’re prepared to compete, but it is based on our own internal selling. What’s working, what’s not working. We work with the teams very closely during the fourth quarter to make sure that we’re agile and focusing those promotions specifically.

Scott Lipesky: Yes. Picking up the online versus stores, good balance across the total company for the quarter. Think about Hollister, a little tilted towards the store business in the quarter, which is great to see. We’ve opened some new stores throughout the year have done some remodels and rightsizes, and good to see that store traffic coming back. And that’s really on a global scale, which is very, very exciting.

Dana Telsey : Just one last item. Given that you’re hitting a 10% operating margin this year, is the 13% to 15% in the purview in the future? Or how do you think of the framework?

Scott Lipesky: Thanks, Dana. Yes. Very, very exciting to put a 10% outlook out there for the year. We started the year at 4% to 5%, and as the business has improved throughout the year, we’re looking out there 10% now. We’re not going to talk about 2024 today. We are very focused on delivering an amazing holiday, but super exciting to be putting a number out there 10% that we talked about last year in 2022, that 8% to 10% longer term. Excited to get here quickly.

Operator: And our next question coming from the line of Corey Tarlowe with Jefferies.

Corey Tarlowe : Great. So Fran, as it relates to the really impressive growth that you’ve seen at Abercrombie in the quarter. What are some things that surprised you as you think about the upside that was driven versus your original plan? And what were some items that really resonated with customers this quarter across products and geographies that really work for you and that you see working into the fourth quarter and the upcoming holiday season?

Fran Horowitz : Go ahead, Cory. So it’s super exciting to have just finished our 11th consecutive quarter of growth for Abercrombie brands is just such a big win for the company. Super excited and proud of the team of what they’ve been able to accomplish. What’s really terrific about that is it’s balanced growth. We saw balance across actually brand, the brand, the genders, the regions, the channels, I could keep going. So to have accomplished that was really, really terrific. We have a playbook. We are focused on delivering that product, voice and experience. It’s aligning really well for our consumer. And most excitingly, we built this business to run with speed and agility, and that’s what the team is doing this year, and they’ve really been able to test and react and learn about our assortment.

I’m excited for the fourth quarter. We’ve got a lot of known product in there that the consumer is already loving. And lastly, as you know, we’ve really expanded the addressable market for Abercrombie. And so we’re seeing the opportunity to have that customer from 20 to 40 shop with us as well as these expanded categories. So lots of exciting things happening.

Corey Tarlowe : Great. And then, Scott, on the gross margin that you saw in the quarter, close to 65%. That’s the highest we’ve seen in quite a while. So quite impressive as well. As you think of the drivers of that and as we look ahead, just qualitatively, is there any way to think about within that construct, what is perhaps sustainable going forward and what may come out just to get a sense for the puts and takes of the gross margin as we look ahead?

Scott Lipesky: Yes, great question. And this is something we’ve talked about a lot over the last couple of years really is the sustainability of the AUR. And what we always say is if we have great products and lean inventory, you have a great chance of delivering strong AURs. And that’s really what we’ve done. Last year, we had a little step back with the Hollister inventory as that business fell off pretty abruptly in Q2. But we’ve gotten through that, and each of the brands is in Chase. So what you’re seeing this year is another freight coming back in and normalizing, cotton getting kind of getting to the end of the tailwind and really strong AURs and a really great Abercrombie business that Fran just explained. So we want this margin to be sustainable. We’re working hard at that. And the pieces that we can control will be the inventory levels and great product, and we feel confident in that.