Abercrombie & Fitch Co.
Q2 2022 Earnings Call Transcript

Published: 25 Aug 2022

[Operator:]

Good day, and welcome to the Abercrombie & Fitch Second Quarter Fiscal Year 2022 Earnings Call. Today's conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Pam Quintiliano. Please go ahead.

[Pam Quintiliano:]

Thank you. Good morning. And welcome to our second quarter 2022 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our second 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 any forward-looking statements made on the call are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today. A detailed discussion of these factors and uncertainties contained in company's 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 a reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning. With that, I will turn the call over to Fran.

[Fran Horowitz:]

Good morning. And thank you for joining us today to discuss our second quarter results. Before I get started, I would like to take a moment to thank our global teams for continuing to bring your best each and every day. So it's been a couple of months since our Investor Day and during that time, the retail landscape has continued to evolve rapidly. We're now in year three, of one of the most dynamic environments that I have experienced in my 30-plus-year career in retail. The work we have done over the last several years to improve our enterprise-wide agility has enabled us to take decisive action to navigate near-term challenges while remaining focused on executing to our long-term goals. At our June Investor Day, we provided our 2025 long-term targets and introduced our always forward plan which is centered around the successful execution of three strategic principles

[Scott Lipesky:]

Thanks, Fran, and good morning. For the second quarter, we delivered net sales of $805 million, down 7% to last year on a reported basis and down 4% on a constant currency basis. Sales were below our expectation for a low single-digit decline as the as the Hollister business softened quarter progressed. By brand, net sales at Abercrombie, which includes kids, rose 5% compared to 2021 on a reported basis and 7% on a constant currency basis, largely in line with internal expectations. Hollister, which includes Gilly Hicks and Social Tourist, declined 15% or 12% on a constant currency basis, reflecting mounting macro pressures on its core consumer, a shift in shopping behaviors versus last year and lower demand for core back-to-school categories. This compares to prior year growth of 30% and 20% for Abercrombie and Hollister, respectively. By region, net sales decreased 4% in the U.S. and declined 14% internationally or 5% on a constant currency basis. By region, EMEA was down 13% on a reported basis and 4% on a constant currency basis, and APAC was down 33% on a reported basis and 25% on a constant currency basis. In EMEA, strength in the U.K. and Middle East was offset by softness in Western Europe. In China, we experienced COVID-related pressures throughout the quarter but have seen a nice trend change as the country has reopened and mostly stayed open. Our gross profit rate was 57.9% versus 65.2% last year. Key drivers of the year-over-year change were the adverse impact of exchange rates of 30 basis points and higher product costs of 750 basis points. Relative to our expectations, FX was slightly worse than anticipated, while product cost pressure was in line. These impacts were partially offset by higher AUR driven by the Abercrombie adult brands. Looking to back half of this year, we are modeling freight rates to remain relatively steady with Q2 levels. We expect to see freight flip to a tailwind as we anniversary elevated air rates and air usage due to Vietnam closures last year. This will be offset by rising product costs as we continue to see higher commodity costs flow through COGS this fall. We are encouraged by recent trends across rate and commodities giving us cautious optimism that this year will be the peak and that we will begin to realize benefits in fiscal 2023. Moving on to inventories. We ended the quarter with inventory up 70% to last year, 92% of which is current. As Fran mentioned, our Q2 '21 total inventory at cost was the lowest in over a decade, and on-hand inventory, the lowest since mid-2000s as we saw shipping times lengthen and experienced significant delays from the Vietnam shutdowns. Overall, our inventory is current, and we intend to keep it that way. We are keeping a close eye on Hollister inventory. Based on the greater-than-expected falloff and trend in Q2, we've chased areas of strength, reduced receipts on slower moving categories and put plans in place to bulk and hold certain items. We will utilize markdowns as necessary to ensure the remaining inventory turns appropriately. Looking ahead, we expect to see total year-over-year inventory growth moderate in Q3 and approach 2021 levels in Q4 as we lap all late receipts from last year. I'll now cover the rest of our Q2 results on an adjusted non-GAAP basis. We excluded $2 million and $1 million of pretax asset impairment charges for this year and last year, respectively. Q2 operating expense, excluding other operating income, was $465 million compared to $450 million last year driven by inflation and higher digital fulfillment expense, partially offset by lower incentive-based compensation. On digital fulfillment, we have seen temporary cost inefficiencies as we ramp up our new West Coast distribution center. We expect these inefficiencies to moderate in Q3. We are breakeven on the operating income line compared to operating income of $116 million last year. For tax, we recognized a tax expense on a pretax loss due to our inability to obtain a tax benefit for certain losses incurred outside the U.S. Net loss per share was $0.30 compared to net income per diluted share of $1.70 last year. Our balance sheet remained strong. We ended the quarter with cash of $370 million and liquidity of $729 million. During the quarter, we repurchased 1 million shares for approximately $18 million. At quarter end, we had 49.5 million shares outstanding, down 21% from the start of 2021 and with approximately 240 million remaining under our previously authorized share repurchase program. We remain committed to putting excess cash to work and expect shareholder returns to focus on share repurchases, pending liquidity levels, market conditions, share price arability to accelerate investments in the business. Turning to investments. We continue to expect fiscal '22 CapEx of approximately $150 million, with about half supporting digital and technology and half supporting stores and maintenance. We continue to expect to be a net store opener this year with approximately 60 new stores globally weighted towards the back half. This year, we have approximately 250 leases up for renewal, which gives us great flexibility to react the macro environment. We expect to close around 30 locations this year, pending negotiations with our landlord partners. I'll finish up with our thoughts on the remainder of the year. In our updated outlook, which replaces all previous full year guidance, we assume inflation related pressure on consumer demand continues and that freight rates remain at current levels through year-end. For the full year, we are planning as follows

[Operator:]

[Operator Instructions] Our first question today comes from Dana Telsey of the Telsey Advisory Group.

[Dana Telsey:]

Good morning, everyone. What a changed environment. As you think about the inventory levels - I hope you can hear me. As you think about the inventory levels and the positioning as we go through the balance of the year, how are you planning for in-transit units on hand and product costs? And how will it differ by brand in certainly this promotional environment? Thank you.

[Fran Horowitz:]

Hi, Dana, good morning. I'll kick that one off. So it is really important for everyone to understand where we are with our inventory levels. So to begin with, 92% of our inventory is current, and we define current inventory by goods that are long life, goods that are early but actually have not even been set yet as well current goods. Now if you take the 70% ahead of last year and you break it down, half of that, to your question, is in transit. So $140 million or 130% more than last year because we are anniversarying from last year, probably our lowest inventory levels in over a decade. Everyone managed through all of the supply chain pressures from last year. But additionally, we had 40% of our goods coming out of Vietnam last year. At this point last year, those factories were all closed during -- due to COVID. Now if you take the balance of the 70 points, you take 28 of them, which is our on-hand units, and then 8, which are production costs. So it's very important to really break down and understand how -- why we are, where we are. We disappointed our customer last year in the back half. We were not able to get goods. In fact, we started receiving goods still after Christmas last year. So I hope that helps. don't know, Scott, if there's anything else that you like add.

[Scott Lipesky:]

So yes, looking forward, we expect Q2 here on a year-over-year growth basis to be the peak. We'll moderate in Q3 and then we will moderate significantly in Q4 as we lap like Fran has finish with all those late receipts from Vietnam last year. As a reminder, we were receiving goods holiday goods into the last week of January, and we are not going to do that this year. So we'll see good moderation in inventory as that go through the back half.

[Dana Telsey:]

Thank you.

[Operator:]

Our next question comes from Corey Tarlowe of Jefferies.

[Corey Tarlowe:]

Hi, good morning. Thank for taking my questions. Fran, first, I think we called out in the release that you've seen a little bit of an improvement so far in back-to-school. Maybe can you talk a little bit more about what you're seeing there? Any trends either at Hollister or ANF. And then specifically maybe some merchandise that's resonating really well with the consumer right now? And then, Scott, as it relates to the promotional environment, what have you embedded in your outlook from a markdown perspective as we look throughout the back half?

[Fran Horowitz:]

Corey, so yes, a couple of things. We'll start with Abercrombie. It's an exciting that second quarter really continuing to grow and see some nice AUR growth in the Abercrombie brand. And as we headed into the third quarter, continuing to see those key categories still resonating such as jeans and dresses. In Hollister, there was a significant shift in this consumer, greater than we have honestly seen and a quick, quick shift out of bottoms and into tops during Q2 and dresses particularly. This customer has really pressed on inflation and what they have can spend their money on. We're seeing the consumer come in and be very judicious on their spending. As we got into August, though, he and she started buying more tops maybe perhaps to go with some of those bottoms that they are waiting to buy on. So what we're seeing is a consumer shift much quicker in Hollister than we saw in Abercrombie. But what's resonating, I would say, number one, our dresses. Q2, we saw the best Q2 ever in Hollister dresses as well as Abercrombie, some exciting things happening and shifting consumer behavior.

[Scott Lipesky:]

All right. Let me grab the promo piece. So as we went through Q2, once we saw the Hollister business soften a little bit, like many others, we've heard that kind of back of June into July, we saw the same exact trend here, specifically in the Hollister business. Once we saw that, we turned on some markdowns and promotions, kept that inventory current and kept it turning. At the same time, we have reduced receipts for holiday and beyond. So we feel good about the right-sized level of the receipt by for Hollister, for holiday and beyond. So what we're going to focus on as we go through Q3 is just keeping that back-to-school inventory turning part of our reduction in the operating margin outlook is reflecting a little bit of margin pressure there in the Hollister business to keep that inventory turning, but feel good as we get to Q4 and beyond that we have rightsized that inventory level.

[Corey Tarlowe:]

Great. Thank you very much. Best of luck.

[Fran Horowitz:]

Thanks.

[Operator:]

And we can go to Paul Lejuez of Citi.

[Kelly Crago:]

Hi, this is Kelly on for Paul. Thanks for taking our questions. I'm just curious if maybe we could take a step back and just talk a little bit more about the Hollister brand. I know that certainly inflation is having an impact. It does seem like Holster has been underperforming for a while. So is there anything -- any diagnosis you have of the brand? Or are there changes that need to be made to potentially reposition the brand? And then also just on Europe, that did underperform. Is that mainly in the Hollister business? And just any color there because we have heard from others that Europe has actually been strong. So just curious of your thoughts there. Thanks.

[Fran Horowitz:]

Hi, Kelly I'll kick off with Hollister. So as you recall, just a couple of months ago, we had our Investor Day, and we talked about our OEs Forward Plan. And within that, we've discussed Hollister, which is the past four years, Hollister in the U.S. saw a 4% CAGR growth. So it continued to really resonate with that with the team. We did see a significant falloff for Q2, and we think part of that is macro. This consumer who is on the lower end of the income scale is definitely feeling a lot of pressure from inflation but there's part of it that, of course, we own and have to inspect and continually look through our business and really understand what's happening. So we saw a shift from bottoms to tops as I mentioned a little bit earlier, and the team got to work. They really got to work on the receipt. They made sure that those trending categories are in line for fourth quarter. We have a very agile and flexible supply chain here, and we can react to what's happening in the business. So we're into what we can control, and we are confident in the future of Hollister.

[Scott Lipesky:]

Let's grab the EMEA side. Second question. And what I would say with EMEA is it's bifurcating. We've seen great results in the U.K. more recently. We talked about that last quarter. We've also seen strong results in the Middle East. Where we haven't seen as strong results are in our next two biggest countries, so Germany and France. So while we're excited about the results we're seeing in U.K. and Middle East, we do have opportunity in Germany and France. And our teams are focused on that and we'll be looking to address that as we go forward Q3 into Q4. We are committed to EMEA long term. It is our second largest region, and we do have opportunity there as we go forward and we will address.

[Kelly Crago:]

Got it. Just to clarify, is that - that's mainly on the Hollister brand, where we're seeing that weakness? Or is it kind of across the board?

[Scott Lipesky:]

Across the board, Hollister is more highly penetrated into the EMEA region, but it's a similar trend across the board, both brands strongest in the U.K. and Middle East and then seeing softness in Germany and France.

[Kelly Crago:]

Got it. Thanks guys.

[Operator:]

[Operator Instructions] Our next question comes from Janet Joseph Kloppenburg of JJK Research.

[Janet Kloppenburg:]

Hi, everybody. Can you hear me?

[Fran Horowitz:]

Yes. Good morning, Jen.

[Janet Kloppenburg:]

Hi Fran, hi Scott. I just wanted to dig a little bit deeper on this change in preference at Hollister and maybe get your views, plan on what's going on in denim and if things have slowed in that category. And then, Scott, if you could talk a little bit about the outlook for inventory at the end of the year and how you're planning it go forward, given the trends at Hollister. Thanks so much. Also Fran love to hear about denim trends at A&F as well. Thank you.

[Fran Horowitz:]

Okay. Let's face it all the way back up to the top here, Jen. So the shift that we saw in Hollister, as you know, back-to-school is traditionally a strong bottoms business, and we did see a very quick, very significant shift. Bottoms have been trending quite some time. The past three years, the consumer does have a lot of those newer fashion bottoms in their closet. And there were occasions have shifted a bit. So dresses were, as we mentioned, a record for us for Q2, super exciting. As we headed into August, what we saw in Hollister girls tops, we saw a nice shift in the trend. She's really responding to the tops that we're giving her. And with a limited amount of money to spend, they are making very judicious decisions. These decisions would be short term. We could see the bottoms open up as we -- as the weather changes and we head into the back half of the third quarter. But with the information that we have today, we had to put our outlook based on what we currently know. A&F, we continue to see growth in that brand and in jeans. And the opportunity there is that consumer is actually going back to work and continuing on this 96-hour exciting weekend that we always talk about and their wearing occasions have shifted as well. So the offices have gotten more casual. They're going back to the office. They're wearing some of our fashion and dressed up denim to go back to the office in. So two, the customers are diverging. The brands are divergent. We're seeing different behavior between the two.

[Scott Lipesky:]

Okay Janet, [indiscernible] for the plan go forward. So we will - the year-over-year growth rate will peak here in Q2, will moderate in Q3, and we'll get close to last year levels, 2021 levels as we get to Q4. At that point, we'll be lapping all of those late receipts from last year. In transit will be down, units on hand will get pretty close to last year as we lap if received. As we think about 2023, we are thinking about that today. As the business softened specifically in Hollister there in Q2 and that June, July time period, we have reduced have reduced receipts for Q4, receipts for Q1 and Q2 of the next year. In the spring season because we want to get our brand to the chase mode. It's something that we talk about internally a lot. There is capacity out there. You've seen across the industry, many people taking out receipts for the back half and planning conservatively. So we are doing the same thing. So we feel good about our inventory plans for Hollister specifically, Q4 and into Q1 of next year. We will chase if we need to. And there, like I said, there is capacity out there to do that.

[Janet Kloppenburg:]

Thank you.

[Fran Horowitz:]

Thanks Janet.

[Operator:]

And we can go to Mauricio Serna of UBS Technology.

[Mauricio Serna:]

Hi, good morning. Thanks for taking my questions. I guess I wanted to talk a little bit about freight. I mean, what are you thinking in terms of the potential for recovery of freight costs that you have experienced, the pressures that you've experienced over the last year, how much do you see that could be like permanent? And how much do you think you can recover probably next year? And maybe if you could talk a little bit about the monthly sales progression you saw throughout the quarter and how that exit rate compares to July, particularly? Thank you.

[Scott Lipesky:]

Let's start with freight. So we are cautiously optimistic about what we're seeing in the freight markets. Zooming into Abercrombie specifically, with the inventory issues we had coming out of Vietnam last year, we had a significant amount of air that we needed to use last Q3, Q4 and that -- those higher rates and that higher usage hit us in Q4 last year and even carried over into Q1 and a little bit into Q2 of 2022. So we expect at Abercrombie for freight to actually become a tailwind this year. That's been planned throughout the year. We expect to see that come in this year. When you zoom out and think about freight rates in general, optimistic again that what we are seeing in the ocean shipping market and the air market, those rates have been coming in. We're optimistic that they'll stay there and continue at least stay there and can maybe continue to come in, and then we'll see that start to flow through in 2023. So no forecast yet as we go into the future, but optimistic that we have hopefully seen the peak here. Next question on the monthly sales progression. I would say our progression specifically in Hollister, let's kind of split the two brands. Our Hollister progression is really the progression you've been hearing out in news at this point, fall-off in that June into July period. We just talked about seeing some nicer trends here more broadly over the last couple of weeks, seeing a little bit of week-over-week improvement. We're not assuming that, that's the start of a new trend. We're going to assume in our outlook that the trends that we've seen in Q2 are carrying forward for the back half of year. And we're assuming they're going to be out there until they change. Abercrombie on that side, I saw consistent strength as we went throughout the quarter in Q2. So excited to see the momentum continue in that brand. Plus 5% or plus 7% in the quarter on a constant currency basis with the Abercrombie adult brand actually being higher than that in kids bringing that down a little bit. So really optimistic that we'll continue to see that momentum continue in Abercrombie & Fitch.

[Mauricio Serna:]

Great. Thank you very much.

[Operator:]

Our next question comes from Marni Shapiro of The Retail Tracker.

[Marni Shapiro:]

Hi guys. I'm hoping -- I want to dive a little bit more into Hollister and then I have a quick customer file question. But in Hollister, it looks like -- or it sounds like the fashion is selling well where you have it. And I've noticed in the stores have some really exceptional fashion for back-to-school only it's a very small portion of the overall assortment. So I'm wondering if seeing that right. And it's as much a matter of this customer is under pressure as it is getting the balance right in the store. And then if you could just touch on at Abercrombie with the customer file. Are you seeing that continue to grow at Abercrombie? And are you getting the attention of the older Gen Z customers into the store as well, as well as just lapsed shoppers that maybe came back.

[Fran Horowitz:]

I'll kick off with the question on Hollister. Marni, so what we saw as an example in the second quarter, dresses were -- the best quarter we've ever seen in dresses for Hollister. So yes, the fashion to your point, is selling well and the consumer is responding to it, but they're very pressured right now. They have to be very judicious on what they're spending and how much they're buying. So we're continuing to monitor that, as Scott just went through on the receipt. And as we got into the third quarter, it is nice to see that our growth tops have really started to accelerate. So yes, to answer your question, seeing nice selling on the fashion, just a bigger shift out of bottoms than anticipated.

[Scott Lipesky:]

On the customer file, we continue to see growth in the Abercrombie & Fitch. Part of the comeback story of Abercrombie, we've pressed up our bets here in marketing for Abercrombie in the back half of last year. We're continuing to focus marketing this year even in light of what's happening more broadly in the industry, Abercrombie continues to be a standout, and we're going to continue protect investments in marketing to Abercrombie. We love the product, where the assortment is. We love where the brand positioning is and our goal was to get more people, eyes on that brand. And so while we're happy with continued customer and new brand customer growth, our new customers coming into the brand, we want to continue to accelerate that because we love the story we have.

[Marni Shapiro:]

Fantastic. Best of luck to back to school. I'll take the rest offline.

[Fran Horowitz:]

Thanks Marni.

[Operator:]

And as there are no further questions at this time, I would like to turn the conference back to Fran Horowitz for closing remarks.

[Fran Horowitz:]

Thank you, everyone, for joining the call today. Scott and I would also like to thank our Head of Investor Relations, Pam Quintiliano. Sadly, this is her last call with us as she'll be leaving Abercrombie & Fitch to pursue another opportunity, and we wish her the best of luck.

[Operator:]

Ladies and gentlemen, that concludes today's conference call. We thank you all for your participation, and you may now disconnect.