Abercrombie & Fitch Company

Please stand by, we're about to begin. Good day and welcome to the Abercrombie & Fitch second quarter fiscal year 2020 earnings call. Today's conference is being recorded. If you have a question at any time during today's conference, you may signal us by pressing star 1 on your touch tone phone. We will open the call to take your questions at the end of the presentation. We ask that you limit yourself to one question during the question and answer session. Thank you. At this time, I'm going to turn the conference over to Pam Quintiliano. Please go ahead.

Thank you. Good morning and welcome to our second quarter 2020 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.abercromby.com under the investor 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 is contained in the company's filing to the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and 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. Good morning, everyone. I hope you and your loved ones are healthy and safe. Before discussing second quarter results, I would like to start by thanking our global teams and partners. Despite the unique challenges they've all faced, they've continued to team up, build up, and get it done. From our DC store and home office associates to our vendor partners around the world, together we've continued to successfully navigate this unprecedented period of uncertainty. I am so proud and humbled to be a part of this amazing organization. Due to the hard work, patience, ingenuity, and perseverance of our team, We have been able to quickly read and react to changing customer demands while fortifying our position for the future. Our total Q2 company revenues were down 17% as compared to last year. Throughout the quarter, we remained nimble. We utilized our lean and agile inventory management strategy while authentically speaking to our customer and providing them with relevant products that aligned with their lifestyle needs. Our customers responded favorably, with our gross profit rate expanding 140 basis points, fueled by lower promotions and clearance and improved AUR. We also tightly managed expenses, leading to operating expense leverage and our best Q2 operating income in six years. With an unwavering focus on maintaining strong liquidity, we generated $187 million of operating cash flow, ending the quarter with $767 million of cash and equivalents and approximately $1.1 billion of liquidity. This empowered us to make quick and strategic near-term decisions while continuing to fund critical long-term investments for future growth. Over the last several years, we've strengthened our foundation as it executed events of key transformation initiatives, including reducing square footage and updating our in-store experiences, investing in digital army channel capabilities, increasing the speed and efficiency of our supply chain, and continuing to evolve brand positioning while improving customer engagement. The significant progress we made leading into the pandemic on our transformation initiatives, including investments in systems, processes, and talent, have been key differentiators in our ability to strategically pivot our entire organization. Our solid foundation has enabled us to thoughtfully engage with our customer as they continue to deal with COVID-19 and the physical, mental, and social challenges associated with it. At the same time, they've also been responding to calls for social justice and struggling with the uncertainty of what back to school or back to work will look like this fall. Throughout, we have stayed close to our customers, pivoting and adapting our product, marketing, messaging, and inventory to align with their changing realities. When we last spoke in May, we were encouraged by our Q1 and Q2 results and were planning Q2 in the back half conservatively. At that time, we had roughly 50% of our global store base open, with stores operating at 70% productivity and digital continuing to show impressive growth. As this quarter progressed and restrictions eased, we opened more stores. At the end of the quarter, roughly 90% of our global base was open, which is consistent with where we are today. Although open, we are operating at reduced hours in many of our global locations. Similar to Q1, stores have continued to experience year-over-year declines in traffic, partially offset by improved conversion. As we continue to open and at times re-close select stores, the safety and well-being of our customers, associates, and communities has remained a top priority. We've continued to fluidly ship inventory by channel, We've also expanded fulfillment options by adding curbside pickup, which is available across roughly 80% of our U.S. store base by the end of the quarter. Scott will provide more detail on our reopen store performance trends. With stores reopening, our digital business has remained strong. For the quarter, digital sales grew 56% to $386 million, with robust double-digit gains in each month on improved traffic, conversion, and AUR. Combined total visits to our website and highly rated apps rose over 25%, with app visits alone rising approximately 50% in the quarter. We spoke directly to our customer about COVID-19, as well as the social issues they were facing. Our honest dialogue, combined with relevant products, resulted in strong digital growth across brands every month of the quarter. We achieved record Q2 digital sales. Abercrombie, excuse me, we achieved record Q2 digital sales. Abercrombie Adults, Kids, Hollister, and Gilly Hooks all hit new highs, with record digital sales buying over two-thirds of our categories, including many of our must-win, must-grow classifications. As a reminder, we had a meaningful digital business entering this year. The channel accounted for roughly a third of our revenues at over a billion dollars in fiscal 2019. We have solid global platforms and distribution center infrastructure in place, which has enabled us to keep up with strong digital demand. Both brands had high digital engagement and strong growth rates in the quarter, benefiting from lists and awareness. At Hollister, our focus on assortment architecture continued to pay off, with our must-haves and top 30 items outperforming. Our customers find a wealth of patterns, ombre and florals, across genders. And while loungewear remains popular, including sleeves and sweats, fashion content also resonated. I'm especially proud of our performance in girls' denim shorts, a highly competitive category where we were predominantly full price. On the guy side, must-have multi-pack tees, graphic swim, and lounge shorts were strong. Needless to say, I am extremely encouraged by our Q2 performance in Hollister. It is our biggest brand, representing roughly 50% of our annual revenues in 2019, and we remain confident in the global growth opportunity that lies ahead. At Gilly Hicks, we experienced double-digit sales growth, with over 100% growth in the digital channel. Our customers continue to embrace our new active collection, Gilly Go, as well as our company lounge and Intimates offerings. While still early in its life cycle, we are excited about the global white space of Gilly as we continue to offer products that focuses on our teen customers and their lifestyle needs. With improved assortments of Hollister and Gilly Hicks, we shifted messaging away from promotions and into storytelling. We had a clear and well-defined product and brand stories across channels that authentically spoke to our customers. We also focused on topics they care about the most with an emphasis on pride and mental health, two causes we champion. Our Proud of You Pride campaign in support of equality and diversity is well received. As the quarter is closing, we launched our Back to School Done campaign featuring TikTok stars Charlie and Dixie D'Amelio. We are thrilled to have Charlie and Dixie as part of the Hollister team. They truly align with our customer and the causes they support, including anti-bullying and equality. And for those of you who are not on TikTok, Charlie is the most followed person on the platform with over 82 million followers and Sister Dixie has almost 36 million. They're popular across social media with roughly 27 million and 17 million followers respectfully on Instagram. For Back to School, they partnered in our Hollister Denim Lab with fellow influencer and one of our first Hollister brand ambassadors, Noah Pugliano, and one of our customers' favorite celebrities, Bill Nye. testing fits and styles to arrive at unique product recommendations. In addition, Charlie created the hashtag more happy than advanced challenge. As of Monday, the campaign had 5 billion views worldwide and 1.2 million video submissions. Since its launch, we've experienced improved traffic and new to file metrics. And our partnership with Charlie and Dixie does not end with back to school. So stay tuned for additional stories and collaborations throughout the remainder of the year. I also encourage you to tune into Hollister's Volume On series, where we have members of the Team BIPOC community take over Hollister's Instagram to have honest dialogues about current events that are impacting their lives. While there's a lot to be excited about at Hollister, Abbott Crombie has not been standing still. Our AMS women's business has multiple categories with double-digit, on each channel sales growth, including shorts, knit tops, skirts, and swims. Men's new product acceptance is also strong, with double digital growth in tees, shorts, jeans, and our signature fragrance, beer. For both genders, our soft AF line, which is one of our key line-driving collections, continued to resonate. In addition, our annual prize collection was well-received. At Abercrombie Kids, performance continued to be driven by our summer essentials, including shorts and slim. Out of poverty adults and kids, second quarter marketing campaigns are typically about summer and all of its fun celebrations. But the current environment required quick and creative thinking and some heartfelt conversations in order to properly show up for our customers. An example of this is our Pride campaign. Our messaging was celebratory, but with the rise of protests weeks before its launch, the team pivoted to highlight the role of the BIPOC community in the fight for LGBTQIA plus equality. We were authentic, supportive, and part of the conversation and had an overwhelmingly positive response. Pride is important for many of our customers across France. In support of Pride, together with our customers, we have donated over $4 million combined to GLSEN and the Trevor Project, two important organizations that we work closely with, that work closely with the LGBTQIA plus community. I'd also like to congratulate the Abitami Marketing Team for being a recipient of the Silver Halo Awards of Corporate Social Initiatives and Crowd Marketing. I can't wait to see what our marketing team continues to accomplish, especially with our recently introduced social posts and video conversations on our adult channels, as well as our Kids Times crew series, both of which focus on racial equality and inclusivity. We continue to be extremely pleased with the ongoing evolution of our A&F adults and kids products and brand positioning, and I'm so excited about what the future holds. Throughout the quarter, we also continued our environmental, social, and governance work. At Hollister, we launched our online Progress Over Perfection sustainability campaign. By both brands, we continue to be encouraged by response to our spread-up partnership, which gives customers an incentive to receive gift cards for recycled clothing. Before I turn the call over to Scott, I'd like to take a minute to discuss the U.S. back-to-school season, which clearly looks very different this year. The COVID-19 spike has settled our key and early back-to-school markets, including California, Florida, and Texas. Delayed start to school across the country and many students beginning their studies virtually. We've experienced a slower start from years past with short traffic decelerating from July levels. In building our contingency planning, this was a scenario we considered and prepared for. Over the past several months, we've proactively bought inventories conservatively, shifted even more focus to where-now assortments, and re-cadenced our fall products and marketing flows. Quarter to date, our customers continue to respond favorably to new products. We've experienced improved year-over-year omni-conversion and digital has maintained strong double-digit growth. Recently, omni sales trends have improved as the anniversary of last year's peak back-to-school week and our customers received more clarity surrounding the timing of back-to-school and the mix between physical and virtual. Looking ahead, we are cautiously optimistic that the back of school selling season will extend into September and potentially October as school resumes throughout the country and the weather becomes more seasonal. For the quarter, we expect to recruit some but not all of the locked sales in August, which is historically our largest month. As such, we are planning Q3 sales trends to be consistent with Q2 in that down 15% to 20% range. With roughly 80% of our California store base still closed, our current trend is slightly behind that. Despite the challenging environment, I continue to believe in significant opportunities for our heritage grants and our growth vehicles both domestically and internationally. We have made difficult decisions this year to ensure that we are well positioned to come out of this period even stronger on the other side. As we approach year end, we have a chance to address roughly 25% of our leases that are up for renewal. As we continue to realize meaningful increases in our already deep digital penetration, this gives us the ongoing opportunity to level set our square footage and occupancy to a successful global omni-channel business required. We have a solid foundation, including a strong balance sheet, and will continue to leverage our financial flexibility to invest in the long term and further strengthen our position as a diversified global omni-channel retailer. And with that, I will turn the call over to Scott.

Thanks, Fran. I'd like to start by adding a huge thanks to our global teams and our vendor partners. I'm incredibly proud of how we navigated. We achieved our best second quarter operating income since 2014 and delivered $187 million of operating cash flow. Now on to Q2 results. Net sales of $698 million were down 17% as compared to last year. By brand, net sales declined 15% for Hollister, which includes Gilly Hicks, and 20% for Abercrombie, which includes Kidds. By region, net sales declined 16% in the U.S., 15% in EMEA, and 38% in APAC, our smallest region. Store traffic remained below last year, partially offset by improved conversion and 56% year-over-year digital growth. Looking specifically at reopened store performance, second quarter global store productivity was at roughly 70% of the prior year period. By month, May and June saw an acceleration in trends. We subsequently experienced a productivity decline in July, led by the U.S. Breaking down trends further by region, starting with our largest market, the U.S., second quarter store productivity was at 75% of last year, with 85% of our base open at quarter end. On average, our U.S. stores were unable to open for business for approximately one-third of the days in the quarter due to government and landlord-imposed restrictions on occupancy and hours of operation. We realized productivity improvements in the June that took a step back down in July with the resurgence of COVID in key early back-to-school markets, including the reclosing of roughly 80% of our stores in California and a delayed back-to-school start throughout most of the country. In EMEA, store productivity was at approximately 60% of last year. We ended the quarter with all but a few stores open, although the majority of our locations in our historically largest European market, the UK, did not open until mid-June. We do not believe back-to-school performance is reflective of assortment issues and have seen strong digital response to new products across brands. We've also experienced store productivity improvements over the past couple of weeks as students have had more visibility for the fall. We continue to believe that the back-to-school season will last longer than it has in the past as most schools have delayed their start dates, some well into September. Moving on, our gross profit rate of 60.7% was up 140 basis points the last year. This improvement was a result of higher AUR with promotional and clearance levels below last year. We entered Q3 with inventories current and down 7% to last year and are comfortable with our positioning. Our teams have done an amazing job managing the on-hand and on-order inventory. Over the past several years, we have made significant progress on improving the speed and agility of our product development calendar and lead times. This progress has enabled us to adapt quickly to changes in demand. As we look to the back half, we will continue to balance gross profit rates with sell-throughs. With uncertainty in the top line, we are conservatively managing inventories, fluidly shifting goods to a channel, optimizing our distribution center capacity for increased digital demand, and positioning the business to chase. And I'll cover the rest of our results on an adjusted non-GAAP basis. Excluded from our non-GAAP results this year are $8 million of asset impairment charges that we believe are principally attributable to COVID-19. These charges adversely impacted results by 15 cents. There were no exclusions last year. Operating expense excluding other operating income was $404 million as compared to $538 million last year, which included $45 million of flagship store exit charges, primarily related to our Hollister, SoHo location, which closed in Q2. Operating expense leveraged 610 basis points, with 530 basis points related to the adverse impact from flagship store exit charges last year. Storage and distribution expense decreased on a dollar basis, driven by a decline in store payroll and store occupancy, partially offset by increased shipping and handling expense on higher digital sales. Marketing general administrative expense was down on a dollar basis, primarily driven by reduced payroll, marketing, and other controllable costs. We remain focused on tightly managing expenses and finding areas for additional savings, but we will not starve the business. We anticipate that certain expenses will flex back up in the second half, including store payroll and variable store occupancy, assuming stores remain open. Overall, our goal remains consistent. Continue to reduce fixed non-customer facing costs to enable reinvestment in customer facing activities in our ongoing transformation initiatives. Operating income was $22 million compared to a loss of $39 million last year and included a $1 million benefit from FX. The effective tax rate was 1%, which was lower than last year as a result of changes in level and mix of projected pre-tax results in full year. Net income per diluted share was $0.23 compared to a loss of $0.48 last year or $0.46 on a cost and currency basis, with last year reflecting an adverse impact on flagship exit charges of approximately $0.50. Our balance sheet remains strong. We ended the quarter with cash and cash equivalents of $767 million and total liquidity of approximately $1.1 billion. We plan on holding higher than average cash balances to preserve flexibility in this uncertain environment. In July, we completed the issuance of $350 million of senior secured notes, which will mature in 2025. These proceeds were used to repay outstanding obligations under the existing term loan and ABL facilities, as well as towards related fees. The transaction extinguished our term loan facility, which was set to mature in 2021, improving our near-term liquidity position. We continue to see capital expenditures of approximately $100 million a year, with about half of that attributable to stores and the other half attributable to digital technology investments and maintenance needs. We still believe that stores matter and that they are an important part of the omnichannel brand experience, that they must be the right size and the right location with the right economics. To date, we have opened nine stores that meet that criteria, while closing 14 that have not. As we look at year-ends, we have over 200 leases coming due, which represents about a quarter of our store base. We will continue to hold conversations with our landlords to find a mutually beneficial and agreeable path forward. We will evaluate all options, whether it be remodeling or right-sizing, or walking away completely and closing stores. We are excited about the progress we have made on global store optimization and will have more to share in real estate as we move through the year. Lastly, our dividend and share repurchase programs remain suspended. Due to the heightened uncertainty in the marketplace, we are only providing a sales outlook at this time. For Q3, we are planning the business around a sales trend consistent with Q2. We are cautiously optimistic that the trend will improve, but we will manage expense and cash flow assuming it will not. We are confident in our marketing plans and assortment and have the ability to chase inventory if demand improves. Looking ahead, we remain confident in our ability to win as a global specialty retailer that caters to a broad customer demographic, from kids to post-collegiate adults. With continued progress on our transformation initiatives and our solid balance sheet, we are confident in our ability to thoughtfully pivot and strengthen the company no matter what obstacles may be thrown our way. With that, let's turn it over to the operator, ready for questions.