Abercrombie & Fitch Co. (ANF) Earnings Call Transcript & Summary

All right. Thanks. Welcome, everybody, to A&F's presentation at ICR. I'm Paul Lejuez. Happy to be here for this virtual fireside chat with Abercrombie & Fitch's CEO, Fran Horowitz; and CFO, Scott Lipesky. Guys, we all -- most of us saw the press release, but maybe some of us didn't. So maybe we can kick things off and start with some opening comments from you, Fran, to maybe set the stage, share a little bit more color of what you experienced this holiday.

We lost Fran's camera real quick. So we'll fix that. But go ahead. We can hear you.

You can hear me? Okay. So thanks, Paul. Good morning, everyone. Happy New Year. And I certainly wish we were together in person. I've got some opening remarks I'm going to read, so I won't be looking directly at the camera. We're working through all the technology here. So just excuse me for that upfront. So last night, we put out a press release updating our fourth quarter and full year outlook. For those of you who have not had a chance to review it, we reiterated that we expect to achieve a 9% to 10% operating margin for fiscal 2021, representing our highest rate in over 10 years. This compares to non-GAAP adjusted operating margin of 2.3% in fiscal 2019 and 1.7% in fiscal 2020. Let me tell you, hitting that operating margin is truly a reflection of all the transformative work that we have done over the last several years. A big shout out to our global teams for making that happen. For those of you who are listening but maybe a little bit less familiar with the story, since 2019 -- I'm just going to recap a few of those accomplishments. So we reduced our global square footage by about 20%, closing a total of 160 stores, including 9 flagships, from year-end fiscal '19 through Q3 '21. We grew our digital penetration to roughly 50% of revenues from 1/3. We have gotten closer to our customers than ever before, further refining and differentiating the Abercrombie and Hollister brands. Abercrombie is squarely focused on the post-collegiate millennial and their lifestyle, while Hollister caters to the teen. Importantly, response from both new and existing customers to updated product, voice and experience has been overwhelmingly positive. Marketing, of course, goes hand in hand with product, and we have also reinvented our campaigns with a focus on digital and social in particular. We've built teams on the ground in London and Shanghai to get closer to our local customers in those regions. We relaunched our intimates brand, Gilly Hicks, which we continue to view as a primary growth vehicle, with the purpose of bringing our customers to their happy place. In conjunction, we also introduced our first stand-alone Gilly location after closing them in 2014. The store has been very well received, and I can't wait for you to come to Columbus to visit. It's a great first step in the next phase of Gilly's growth. Gosh, what else? We introduced our fifth brand, Social Tourist, and we had consistent AUR and gross margin expansion on reduced promotions and markdowns. So much positive change over the past few years, and I could not be prouder. Now turning to the fourth quarter results. Q4 sales and inventory receipts started out strong, and it looks like it will end strong, too, based on recent trends. However, holiday was weaker than expected as units that were slated to arrive in December did not clear through the ports in the time frame we had anticipated. This was beyond our control and resulted in a miss of sales during the peak selling period. Beyond those delayed units, we also experienced renewed COVID-related restrictions globally. Taking these factors together, Q4 sales are now expected to be flat to down 2% to 2019 levels versus our prior outlook for up 3% to 5% and are expected to be up 4% to 6% to last year. So to be clear, because I know everyone is just trying to figure this out as I'm speaking, if those units arrived as planned, we believe that we would have met our previous outlook. The product that we had been waiting for have been selling quite well when we had it in stock in late Q3 and early Q4. We had a lot of momentum in the last time we spoke with you heading into December, getting received and having great reception to our fall and winter product. But as receipts slowed, we just did not have the inventory to keep up with demand. Throughout the quarter, we did continue to execute our planned promotional cadence. We reduced the depth and breadth of markdowns and promotions and are on track to achieve our prior gross margin rate outlook of approximately flat to 2019 levels, which assumes we offset nearly 650 basis points of freight cost pressure. Wow. Post-holiday, as products had arrived and set, sales have accelerated. And we are utilizing various strategies to mitigate markdown risk. And while what happened in December was obviously not ideal, we have taken proactive steps to limit future impacts as we operate in this new normal. So I know I went through a lot, but it's worth repeating. We have truly reinvented ourselves over the past several years. Scott and I, along with our senior leadership team, are excited about the future. The foundation is firmly in place, and we are positioned for global growth across each of our brands. With that, Paul, we are happy to take questions. So let's get started.

Great. Thank you. Thanks for the overview, Fran. Much appreciated. Maybe can you talk about the performance by brand during the holiday period and into January? You mentioned, I think, that Hollister and Gilly were a little bit more impacted by the later delivery. So anything you can walk us through by brand? And also you said January picked up. Are you seeing that more at one brand versus another?

Yes. So we're not going through the by brand performance today specifically to the quarter. What I'll tell you is that what we're seeing is what we've seen all year. So we've seen the U.S. outperforming international. COVID restrictions are really impacting us very differently around the world, even around the country. So we are seeing that specifically to Hollister. We did have many goods. We've talked about this before. We've had many goods that were caught up in Vietnam factory closures. We have a little bit more of an outsized production in Vietnam for Hollister girls as well as Gilly. So we're managing through a bit of that from an inventory perspective, but all inventory driven. But overall, Paul, expecting to see the same as we've been tracking for the year. Scott, anything you want to add to it?

Got it. And the promotional environment, you said that gross margin was going to come in line with plan. This is despite some inventory delays. Maybe walk through that dynamic, why there is no additional gross margin pressure. And anything that you can help us understand what's going on, on the gross margin line because obviously it came in, in line with your expectations.

Which is pretty exciting, right? That's a pretty nice accomplishment. In 2019, we've got 650 basis points of freight pressure and still being able to maintain those numbers. That is simply driven by a product, voice and experience lining up and our product resonating, getting significant AUR growth out of our product. We learned very specifically during COVID how to realign our inventory. Tight controls on inventory are driving supply and demand much more in line to driving these margin rates. So we're thrilled to be able to see these results.

Got it. Helpful. And were there any changes in terms of what products sold best during this holiday season versus what you had been experiencing prior? Are there any specific categories that you wish you had more of this season or any that fell short of plan? And I guess as we think about that, let's think about that through the lens of did anything fall short of plan because of an actual demand issue as opposed to a supply chain issue?

Yes. So what we saw resonating for the third quarter and the beginning of the fourth quarter continues to be what we're seeing resonate currently. So we saw -- and we've had a denim business all year that's been terrific. Third quarter, in fact, we broke a company record in denim sales. Our denim business has continued to be successful. I would say, Paul, any place that we were low on inventory, it was simply because of the inability to deliver it. So a great example of that is outerwear. We usually dominate them all in the fourth quarter for outerwear. And many of the outerwear units that we really were expecting to have when we had our call prior were caught up on a ship. I know we talked about it earlier this morning, but to give a little bit example of how things were managed to the best of our ability, and then you just end up in a situation sometimes where things are just simply out of your control, here's a great example. You have a ship that leaves Southeast Asia that has berthing rights at a U.S. port. And by the time the ship gets here, the U.S. port has changed hands, and that ship is no longer accepted at that particular port. I mean who knew we would be talking about this at ICR, that the CEO will be talking about this in general? But the reason I'm bringing up this very specific example is that's a great way to show you that our team did everything that they could to mitigate the circumstance all year. They were terrific at getting product here. Sometimes things just end up out of your control. So with that said, we worked on different things and now hopefully, again, to continue to mitigate that as we head into the future, but those are some examples where it was really very inventory specifically driven.

Got it. Very, very helpful. And is Omicron having an impact on your business from a traffic perspective? Are you seeing it show up in weaker store traffic? Has it caused any staffing issues? How are you able to kind of manage through any of those Omicron-related issues?

So 2 -- so yes, so there's no question that Omicron has affected us. And we have a global fleet, and Omicron is being responded to from a government perspective very broadly around the world. There are some states here in the United States that are not even acknowledging it all the way to the extreme of a country like Germany where, candidly, if you don't have either a vaccine -- proof of vaccine or a negative test the day you want to shop, you can't enter the mall. So think about how incredibly broad all of those restrictions are and things. So from that perspective, it's been challenging. From our perspective, we have, fortunately, a little bit of a benefit by having several brands. So in a mall where we have several brands and we have a staffing issue because we have one store perhaps that gets caught up with COVID, we can borrow staff from the other stores, and that has helped us out tremendously. In fact, we really have not had any stores, a couple here or there, closed because of it. What we have done is reduce hours, which I believe many of our competitors have done. As I walked through the mall, I've seen many stores closed during different times to make sure that they have enough staff to cover at least like the key times. But overall, our distribution centers around the world, a very proud moment. We've not closed those. Health and safety has been #1 top of mind, but with all the opportunities that we put in there to protect people, we've not had to close. So long story short, we're seeing it, we're feeling it, but we're managing it and controlling what we can control at this point.

Got it. Fran, maybe I'll give you a break and move over to Scott for a second. On the freight side, Scott, still on track for, I think, the $75 million of incremental freight in 4Q. Any signs of improvement? Anything you can share about expectations for the first half? How much of that $75 million is driven by mix of air versus boat versus just the higher cost of each? Anything you could share on the breakdown there and how you're thinking about '22?

[indiscernible] in a long time. So appreciate that. Now still on track for the $75 million here in Q4, and it's really coming from a few different places. One, the ocean rates, everyone sees the ocean rates rising. The air rates are also rising. And then our air mix has risen here in Q4 as we've tried to dig out of that, that Vietnam shutdown that happened kind of late summer into early fall. So still on track for the $75 million. Not a lot to say as we go into 2022 yet. We'll focus a little more on that in Q4, obviously. But the freight rates are high, and they will likely remain high. Now I'm optimistic as we go through next year and the supply and demand starts to equalize a little bit after the world kind of reopened here the last 12 months that we'll start to see some benefit there and maybe a little bit of a tailwind in the freight rates go forward. But lots to learn every day as we look at these rates.

Got it. And I'll stick with you, Scott. Planned repo for $125 million in the fourth quarter, which I think puts you at around $350 million for the year. So it's about 15% of your market cap. Can you talk about what you project for cash at year-end? How much do you think you need? What else might you do with all the money other than continue to buy back stock? I think you've got some debt that's callable this year. Can you just talk about the amount of cash and use of cash just given you've had a pretty aggressive share repurchase activity this year?

The cash balance has been a real asset for us, no pun intended. As we came into COVID, we had a very strong financial position. We've actually bolstered that with doing a high-yield bond as we got right in the throes of COVID back in 2020. And it really put us in a position as a company to invest through COVID and to focus on the business through COVID versus focusing on the balance sheet and liquidity. So coming into this year, as we saw a lot of the hard work that we did in 2020 show through in the P&L and the profitability, we have amped up our repurchasing. Like you said, $350 million to $370 million is what we're projecting this year, around 15% plus of our market cap. So definitely not insignificant. And all the while, we have the liquidity to invest in our business. As we think about going forward, we want to continue to buy back shares. We want to continue to leverage our balance sheet. We do have excess cash. We've talked to our investors about that, and we're starting to work that down. This year specifically, on top of the buyback of around $350 million, we put about $100 million to work, deleveraging the balance sheet, prepaid a long-term lease for a store that we closed, got a nice discount. And we also bought back in some of that high-yield bond for around $40 million. So close to $450 million of cash that we put to work outside of operations. And we're just -- we'll likely show a cash balance at year-end a little bit lower than last year, and that's fine. We've told our investors we're going to work that cash balance down. Looking forward, like you said, we do have a non-call 2 provision expiring here early kind of first half of 2022. Haven't been definitive on what we're going to do with that, but we'll definitely talk about that on our year-end call. But it gives us a nice opportunity to pull down some high-rate debt.

Got it. Helpful. Maybe just shifting over to Fran again. Fran, how should we think about the trajectory of each of the brands? And as you look out to 2022, what kind of gets you excited? And then I guess also, how do you think about lapping the stimulus benefit in the first quarter? Have you quantified that at all? Just curious about your outlook by brand for '22.

You hit the sweet spot. I would love to talk about it. Not -- it's hard to me I can't see who is or is not participating in this call. So just to give a quick little brief history, when I first joined 7-plus years ago, Scott and I got on this journey together through all of that. We really had to make a decision whether or not we had 1 brand or 2. I mean I walked the mall, like any good merchant, prior to taking this position and realized that the brands have just become one. Other than the price point and the graphs across the top, you couldn't tell the difference between the brands. We have done a fantastic job creating a brand position for both brands that are resonating with that core demographic, Hollister as a quintessential teen brand and Abercrombie as a quintessential 20-something young millennial brand. And we've seen momentum, particularly in Abercrombie. I mean I will -- that's a personal high moment for me. We've had some starts and stops in trying to get that brand moving again, and the brand love and the reception that we are seeing to that brand today online and social media is really -- it's fantastic. So my expectation is that trajectory is going to continue into 2022 for both brands. We also have our growth brand, Gilly, opened up our first freestanding recently in Columbus, Ohio, which has been really well received. We launched that brand, added guides, have Gilly Go active within there and loungewear, some really exciting things. We have our kids brand. We also have our Social Tourist, our digitally led brand, Social Tourist, which we have partnered with 2 of the largest influencers that are out there today on TikTok. So I'm thrilled to see what's happening. Regarding stimulus, it's -- for us, it's a tough question to answer. Do we love when the consumer has more money in their pocket to spend? No doubt. But we don't -- it's difficult for us to quantify how much of that drives. As we head into the first part of next year, we have wage inflation. We have strong employment. So our expectation is that we'll see momentum in the consumer continue.

Got it. That is very, very helpful. Can you maybe talk about store growth for next year? We've seen you, I think, open your new Gilly stores. There's one this past year. What's the plan in terms of the growth of that concept but even just thinking across the portfolio of all your brands? And then maybe also tie that in, just if you can give us an update. Flagship closings have been part of the story for some time. Maybe just give us an update on where we are on the selection front.

Let's start big picture. So big picture, you know, Paul, we've been on this journey of closing stores for quite some time and declared very publicly in April of 2018 at our last Investor Day that our goal and our biggest lever to drive our profitability was by optimizing our global store fleet, and we have done an excellent job at doing that. We probably had a nice acceleration doing that through COVID, and we're able to close some of those stores sooner than we had anticipated. But getting the right store, right location, right economics is something I talk about quite frequently. To be a leading digital omnichannel brand, you have to have stores. I mean it's just -- that's just what it is. It is the magic between digital and stores that equal omni, and that is what our consumer continues to respond to and resonate to. Every sale -- 90% of every sale starts with research done on a consumer's phone, whether that's initiated and completed on the phone or within store, that is the world today that we're living in. So we have no finish line when it comes to opening and closing stores. This year, specifically, we will be about flat, open and close. Next year, our expectation, honestly, is to be net openers because we still have an opportunity around the world to either reposition. To your point on flagships, in a city where we've closed a flagship, we can open up 3 or 4 more local stores so we can work on getting that local consumer. So our real estate team -- and working through our fleet is an iterative process and one that really, really never comes to an end. Gilly specifically, I think that's the last part of the question. We're excited about what we're seeing. We also had an opportunity to rebrand all of our side by side, which is something that we had gone out with an initiative a couple of years ago. So we have side by side next to the Hollister stores in many malls around the world. We rebranded those to equal and match what we branded in our stand-alone stores, so that's an opportunity for us. So on the fourth quarter call, we can talk a little bit more about what '22 looks like. But overall, stores matter, and we're continuing on that journey.

Yes. Just to add on, on the flagship. So a lot of the hard work is done on the flagships. We have a handful remaining. We expect those to expire through natural lease expirations. And really, the next phase for us is what Fran finished with, is filling in those markets. Closing a flagship doesn't mean we want to exit a city or leave a market. It means we want to reposition within that city and really plant more flags, not flagship, but flags of smaller stores around a city. And London is a good example. We opened a store for Abercrombie & Fitch on Regent Street, where we already have a Hollister store a few streets over from our Abercrombie or old Abercrombie flagship, smaller, cheaper, more modernized, more omni-enabled. And that's the path going forward. So now we're filling in the blanks around these cities.

Better traffic path on that one, for sure.

Got it. Scott, maybe talk to us about inventory management, how you look at '22, what you learned this year. How does it influence your planning for '22 from an inventory perspective?

Absolutely. One of the biggest takeaways from COVID is lean inventory management and the ability to do more with less. And so Fran and I preach that every day to our teams here at A&F, and we're not going to lose that discipline go forward. Now we're managing through. We just talked about inventory being part of the reason why we brought down our Q4 outlook. But big picture, we are going to manage inventory tightly at the company. We'll manage through the bumps in the road here with supply chain, and hopefully, that will start to level out here as we get into 2022. So we're doing things around the company like calling things earlier, diversifying ports, diversifying manufacturing, things that will help us manage through this supply chain disruption in the near term. But we are not going to lose that discipline around inventory. It puts us in the best position along with great products to deliver high AURs and good gross margins.

Got it. Thank you, Scott. Fran, if you could go back and do kind of one thing differently in 2021, if you could rewind back to the beginning of the year, and I guess Scott I'll ask the same question for you, what would it be if you could go back, turn back the clock a bit?

I have to tell you, Paul, I have nothing to put on that list. I could not be prouder of our team's execution on everything that we have done that's been in our control. We delivered on what we said we were going to do. And I'm thrilled and very proud of our '21 results.

All right. So Fran didn't take one. I'll take 2. I would have seen the Vietnam closure happening and done something differently, and I would have gotten...

You have a crystal ball. I don't.

I would have given berthing rights for that ship that Fran mentioned earlier that we didn't have. So yes, just seeing some of those unforeseen items is -- if we had to rewind the clock, that's what I wish we would have known because our inventory would have been a lot different coming into holidays than it ended up being.

I didn't realize the question was things that we control -- could control.

Yes. Got it. And just to go on the whole ship idea. Have you already received now everything? Are we back on the schedule of what you should be receiving in a timely manner? Has everything been pushed out? Are we going to be hearing about this again in the spring season with inventory getting pushed out later?

We're catching up on fall goods. Next couple of weeks, we feel like that will be cleaned up. And spring, we've started to move things around and feel better about spring. Each day that goes by, getting those -- that inventory flowing is the #1 goal. So we'll use some air if we need to, but we've started to call spring a lot earlier. And it's interesting on the point of some of these fall goods. We had spring goods that we cut and sold 2 months after some of these fall goods left the ports, and we received the spring earlier. And that just gets a little bit of the luck in the game of getting your inventory through some of these ports right now. But we're managing it tightly, and we feel confident right now in the spring.

And then, Fran, maybe just to close. We're just about at time here. Is it safe to say, like a big takeaway coming out of this holiday, that there's a supply problem much more than there is a demand problem and that's -- it's always better to have a supply problem than a demand problem? Is that an accurate statement? And just as you think about '22, are you excited about the demand positioning for the brands?

So 100%, we are clear that it is an inventory issue. That is what the challenge has been for the past x amount of weeks where we've seen that there's absolutely no doubt in our minds. Our brands are resonating. Our product, voice and experience have really been received very well by the consumer. As we mentioned, we've started to see the acceleration back now that the goods are getting here. So you summed it up for you, well, Paul. I appreciate it. But yes, there's no question in my mind that it is an inventory issue.

Great. Well, Fran and Scott, thank you for doing this today and look forward to a great '22.

All right. Thanks. Bye.

Thanks, Paul.