Good day, and welcome to the Abercrombie & Fitch Second Quarter Fiscal Year 2021 Earnings Call. Today's conference is being recorded. [Operator Instructions] And at this time, I would like to turn the conference over to Pam Quintiliano. Please go ahead, ma'am.

Thank you. Good morning, and welcome to our second quarter 2021 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 is contained in the company's filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures. 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.

Good morning. I am excited to be here today to share our recent results and provide insights into the start of our back-to-school season. We entered Q2 well positioned to realize ongoing benefits from the work that we had done heading into and during the pandemic. This included growing our digital channel, which carries a higher 4-wall operating margin than stores; rightsizing our store fleet; expanding our digital and technology teams; adding to our vendor and regional carrier networks; and investing in marketing with an emphasis on digital and social. Throughout the late spring and summer, our customers took advantage of the warm weather and an increase in social activities. We were there for all their outfitting needs. Product acceptance was strong across brands, continuing momentum from the past several quarters. Once again, we reduced markdowns and promotions, tightly managed inventories and made strategic investments across marketing, technology and fulfillment to support near- and long-term growth. Our proven playbook worked, and we achieved our best second quarter operating income and operating margin since 2008. Before I turn to results, just a quick PSA. As we continue to lap significant impact from COVID, we'll be providing comparisons to both second quarter 2020 and 2019 where applicable. And due to temporary COVID-driven store closures last year, we do not plan to disclose comparable sales. Second quarter total sales rose 24% to last year, and we were up 3% compared to Q2 2019. Our largest market, the U.S., led with sales up 31% on a 1-year and 11% on a 2-year basis. Results speak to customer retention and spend and to new customers discovering our brands. By channel, total global store sales rose 55% from last year and were down 20% from 2019. I'm very proud of our stores' performance, which was achieved…

Thanks, Fran, and good morning, everyone. As Fran mentioned, we will be providing comparisons to both second quarter 2020 and 2019, where applicable, and will not be disclosing comparable sales. Turning to our results. In the second quarter, we delivered total net sales of $865 million, up 24% to last year. On a 2-year basis, sales were up 3%. We ended the quarter with all of our 733 stores open. This compares to 92% of our base open at the end of the first quarter. As of yesterday, all stores remain open. Store sales rose 55% on a 1-year basis and were down 20% on a 2-year basis. We recouped a significant amount of lost sales due to COVID-driven store closures last year. At the same time, total digital sales dollars remained steady compared to last year and grew 52% to Q2 2019, representing 44% of total sales this quarter. By brand, net sales increased 20% for Hollister, which includes Gilly Hicks and Social Tourist, and 30% for Abercrombie, which includes kids. As compared to Q2 2019, net sales increased 2% for Hollister and 4% for Abercrombie. By region, net sales in the U.S. were up 31% and 11% on a 1- and 2-year basis, respectively, despite having roughly 129 fewer stores and over 22% less square footage in our U.S. store base as compared to Q2 2019. In EMEA, sales rose 11% on a 1-year basis, but were down 5% on a 2-year basis. Customers responded well to localized product, voice and experience, which allowed us to reduce promotions in region. We were pleased with results in light of permanent store closures and ongoing COVID-related restrictions. Since Q2 2019, we have closed 17 stores, including 8 flagships, as we continue to reposition to a smaller and wider store network…

[Operator Instructions] We will begin with Paul Lejuez with Citi.

Fran, I wonder if you could talk a little bit more about the Gilly Hicks brand and just how you're thinking about that brand in '22, how big it can be for you guys, both near term and long term. Also curious what you're seeing on the promotional environment as you begin in back-to-school, what you expect for the second half. And then, Scott, I think you still have some pricey debt. Just curious how you're thinking about what to do as far as using cash and whether use it to pay down debt, buy back more stock.

Paul, would love to talk about Gilly. What an exciting quarter for Gilly. We're building off momentum that we were already feeling in Gilly. The team has been hard at work building that brand over the past couple of years, and we had an opportunity to really get close to the customer, understand that this is the most stressed out generation, this Gen Z generation, and to come up with a brand purpose that really helps them find their happy place has been just a huge win. The brand is resonating. The product is resonating. We opened up a freestanding store as a test and learn in Easton just a couple of weeks ago that has been really well received. We also took some of those assets and used them on our side-by-sides around the world, about 20 of them, and have seen a nice pickup from that as well. Adding this gender-inclusive and size-inclusive to it has just been an all-around win. We are excited about where we're headed, and we have not declared as part of the Hollister number today. I think your second question was the promotional environment for the second half. We are thrilled with the progress that we have made. I think you have been on this journey with us for quite some time. And being able to actually reduce our promotions to the extent that we have thus far this year has been just a huge win for us. We are holding our inventory tight. As we've said, that's the one of the biggest learnings coming out of COVID, and we intend to remain there. So the back half is more promotional than the first half. We will continue to monitor the situation, but we expect to continue to make progress.

All right. I'll grab the third piece here on cash usage. Yes, year-to-date, we have put some cash to use. We put about $250 million of our cash to use $135 million in share repurchases and around $110 million to delever the balance sheet. Back in Q1, just as a reminder, we paid about $65 million to settle a multiyear obligation related to our SoHo Hollister store. And then we bought back in some of that pricey debt that you mentioned there, Paul, in the second quarter here for about $45 million. So as we think about that debt in the future, first good opportunity there is we have a non-call provision on that debt. That comes up here in 2022. I can't believe it's happening already, sneaking up on us. So that's then our first decision point there will be. So in the meantime, it makes sense for us to buy a little bit of that in here in Q2. So more to come there as we get into first quarter of next year. As we look forward to the back half and cash usage, I mentioned that we're going to be focusing on share repurchases, pending stock price and the ability to invest in the business.

Next, we will hear from Susan Anderson with B. Riley.

Nice job on the quarter. I guess, just to touch on the gross margin, I think you mentioned the highest since '09. And if you look back historically, it looks like it's been even higher in the upper 60s. So I'm just curious if you think there's more room there and how confident you are in maintaining that margin level as we look forward. And then just for third quarter, it looks like you're expecting gross margin to be a bit below second quarter. Is that really just all increased freight costs?

Susan, it's Scott. I'll grab this one. So yes, thinking about gross margin, yes, highest since 2009. Extremely pleased with the progress we've made in pulling back on promotions. Obviously, we learned a ton through COVID on inventory levels, and just the product acceptance has been great, and a huge thanks to our merchant and design teams. Thinking about the past, I don't think we'll get back to our peak. The business was very different back in 2006 and 2007 than it is today, but we are making great progress on that gross margin. Thinking about -- let's see, the second part of the question was...

The third quarter gross margin expectation versus second, yes.

Yes, third quarter gross margin. Yes, to bring it back to the third quarter, yes. So we are seeing the increased freights coming into us on the third quarter. So it started to build here in the first half. Some of that gets booked up in your inventory, and then we'll start to flow that through here in the third quarter. So it will be a little bit down there versus Q2, but the great thing is we're still talking about 300 basis points up versus 2019, and that's baking in 300 to 400 basis points of pressure from, hopefully, transitory freight inflation that will hopefully sort itself out in the future. But we'll see when that happens. So really pleased with the progress on gross margins.

We'll now move to a question from Jay Sole with UBS.

Great. Fran, you mentioned that there's lots of newness in denim, and lots of styles are working for both women's and men's. Can you give us a sense of what you think this fashion trend has meant for the growth rate for the category? So in other words, if before the pandemic it was growing at 1%, do you think it's growing at 5% now, 10% now? And secondly, do you think that growth rate can persist for a few more quarters?

Jay, so what an exciting time for denim. It doesn't happen very often where our industry sees such an incredible trend happening. So the newness in denim, skinny jeans, we'll just start there. They've been around for a decade. So to talk about all of this newness in denim, we see a long, long runway. And there's so many things happening between the leg openings, the high-rise, the low-rise because of the '90s influence. I mean, I could just -- I could go on and on and on about all the exciting things that are happening, and what's great is that they're happening across brands and they're happening across genders. So our expectation is that we expect to see this newness continuing well into the future.

Got it. And then maybe you talked about increasing some marketing expenses, which sort of implies that you really like how the Hollister and Abercrombie & Fitch and also Social Tourist and all the different things, Gilly Hicks, you're doing with brands are positioned. But specifically on Hollister and Abercrombie, given all the work that you've put in over the last 5 years to reposition these brands, what are the KPIs that you're looking at that tell you that these brands really are where you want to be and are ready to be really invested in a big way to continue to increase the engagement you're already seeing with consumers?

Jay, it's Scott, I'll grab this one. Yes. Loving where the brand positionings are for each of our brands, all 4 of them -- all 5 of them, including kids. So we're increasing marketing. This is the great position we have with a strong balance sheet, having that cash and seeing that expense savings across the store base, it's what we've been trying to do over the years is to move from more fixed into more variable, and marketing is our #1 variable cost, and we love to spend it. So the teams that we have built across our brands are just firing on all cylinders, like Fran said earlier. And we're going to give them more cash to fund that marketing. We love what's happening across social and across digital. We're finding great new partnerships. We're seeing TikTok explode. So we can put more money to work for all of our brands. And to drive those KPIs, we want new customers. We want to drive retention and so on and so forth. And that's what our teams have been executing on, and we appreciate that.

[Operator Instructions] We will now move to Matthew Boss with JPMorgan.

And congrats on the continued momentum.

Thank you.

So maybe relative to your second quarter net sales up 3% relative to 2019, what have you seen in August? Or how best to peg the continued momentum that you cited? And then, Scott, just on profitability, what are some of the puts and takes maybe as we think about the bottom line operating margin this year relative to maybe how best to think about it moving forward?

I'll kick off. So we are pleased with the momentum that we've seen heading into August. Back-to-school for the Hollister and the kids brand, because Abercrombie, we really called back to fall, so it's really focusing on the Hollister and kids from it. Back-to-school, we're seeing nice reception to the product. The early states, like Texas and Florida and Georgia, have seen a nice start to back-to-school. Our expectation is a nice, I guess, slow and steady wins the race, right? So we're looking for a longer season for back-to-school. In the past, we've always talked about these big peaks and valleys that we've seen throughout the country as the states peak. That's a bit different this year. The consumer was spending a lot more time in vacationing and then their social activities that they got back to. So we saw a lot more wear now selling, and now we're seeing them go into more wear forward selling. So excited about what we're seeing so far.

Yes. Matt, on the puts and takes for profitability, it comes down to really 3 levers for us. It's the store expenses, it's fulfillment and then it's marketing. And we've taken out a significant amount of occupancy coming into this year and through this year. We expect to make continued improvements in occupancy as we go forward. And whenever we close stores, reduce stores, we do see savings come through with other store expenses. On the fulfillment side, we've seen inflation there, and we've seen higher volumes. So we'll see how that plays out in the future, but that will offset some of those store savings somewhat. And then marketing is really where we want to accelerate our spend to grow the brand because I think what we've seen, more recently, specifically, is that when we can grow that top line and thinking about the plus 3 we just talked about to 2019, in Q2, we can see an amazing flow through. And we've seen great profitability here in the first half, and that's our goal going forward, is to continue to elevate that profitability, drive the top line and see that flow through.

We'll now move to a question from Janine Stichter with Jefferies.

I want to ask about the complexion of the sales guidance 2% to 4% versus 2019. Would you expect that the sales growth would start to improve in Europe and maybe a bit of a moderation in the U.S.? And then also just curious what you saw within the quarter in Europe as stores reopened. Interested in the cadence there.

Sure. Janine, I'll grab this one. So thinking about the 2% to 4%, go back in history a little bit, up 5-ish in Q1, up 3-ish in Q2. And so we're kind of right around that same range here in Q3. A couple of things happening here in Q3. We're hopeful and optimistic that Europe will slowly reopen. It's been slowly reopening. It certainly has lagged what's happening here in the U.S. So optimistic and kind of the vaccine rollout will continue, and people will start to get out a little bit more. On the other side of it is inventory challenges and supply chain challenges that we have seen. So inventory is kind of dribbling in here as we go through the quarter, and we expect to see a little bit of a hit there in Q3. Our in-stocks are not exactly where we want them to be, so we're doing everything in our power, and a huge thanks to our transportation teams to get our products here as quickly as possible. So those things are kind of balancing in, and it just keeps us right on track with where we've been for the first half.

Okay. Great. And then just on the gross margin, the 300 to 400 basis points of incremental freight, could you quantify what that was in either 2Q or the first half? Just curious how that -- just trying to get a sense of what the underlying merchandise margin improvement you're expecting in the back half versus what you saw in 2Q.

We didn't put in there. But I'd say in Q2, a couple of hundred basis points drag on gross margin from the freights. So a little bit of a growth here as we see that really start to flow through the inventory as those higher rates. We're bringing the product into spring and selling into fall, so it's been a drag. But the great thing is that underlying margin, how you -- merchandise margin, how you framed it is we're seeing great AURs, and we're seeing through the product acceptance and the inventory and the marketing. It's all working together to see great AURs to offset that cost pressure. And so that's our expectation here in Q3, and we'll update Q4 whenever we get there.

Now moving to a question from Janet Kloppenburg with JJK Research.

Can you hear me?

Yes.

Congratulations on a great quarter.

Thank you.

Fran, I just wanted to ask about store productivity levels. One, if you could sort of discriminate between the U.S. and Europe in the second quarter. And second, as the e-com business continues to be pretty steady, how we should think about getting back to prepandemic productivity levels in the stores, particularly the mall-based stores. And Scott, in relation to the supply chain constraints and the transportation costs, it feels like it's getting a little bit worse. And I'm wondering how you think we should think about the fourth quarter and maybe the first quarter, too. Are you cautious there that things could actually worsen from 3Q? Or do you think -- and I understand these are just temporary headwinds, but I'm just trying to get the model right. What do you think that we could get some improvement as we move through the rest of the year and into next year?

Okay. So starting from the top, the productivity levels, yes, clearly, the U.S. currently are more productive than EMEA. We've seen continued restrictions across EMEA. And as Scott mentioned earlier, we're excited that we're starting to see some green shoots and a little bit more consistency in EMEA, but we had lots of COVID restrictions throughout the countries, particularly the U.K., which is our largest country throughout the whole second quarter. So productivity in the U.S. has been stronger, and we're actually very pleased with our U.S. performance being up 11% to prepandemic levels in total, we see as a big, big win. Your second question, let's see, digital is strong, getting back to -- I guess, so same answer. We are -- we continue to focus very closely on our leases, Janet, making sure that our stores are in the right location, the right economics and the right size. It's been a big, big initiative of ours since -- I mean, for years now, and we're continuing on that. We've closed 130 stores and took out 1 million square feet out of our base. We've got a lot of leases coming up in the back half, and we'll continue to stay focused on it. Hollister, just as the last step before I hand it over to Scott, we have -- most of our Hollister -- most of the stores in Europe are in our Hollister business. So with that, I'll hand it over to you.

Yes, I'll just -- I'll tag on a little bit to that last one there, Janet. When we think about the new normal, and when I say you think about store productivity and store traffic, some malls have regained that traffic from 2019, but a whole lot of malls haven't. And so we're -- I'd say back-to-school was kind of the first test of people coming back and really seeing how that store traffic looks versus 2019, and it was solid but definitely not back to those levels on average. So we'll get through a holiday season and understand that. So we're all still learning on what the productivity levels of these stores will be and where that traffic settles in. And to Fran's point, we have flexibility in our leases to make sure that we can either continue to shrink our stores to drive productivity that way, get rent deals that better fit the new sales level for that store and so on and so forth. On the supply chain constraints, yes, I'd say, right now, it's tough out there. All the articles you read are real, and we're all -- those of us on this side of the fence are living through it every day. So those costs are in our inventory. It hit us in Q2. It's going to hit us in Q3. It's going to hit us in Q4. I'd say the one thing that we're thinking about is just the reopening of Vietnam and getting those units in here September into early Q4, and there'll be some air that comes along with that. And as we think about the Q4 or the kind of the full year outlook that we put out there, we have that baked in there, but we'll see how it plays out. Out of our control at this point.

[Operator Instructions] We'll now move to Mark Altschwager with Baird.

This is Sarah Goldberg on for Mark. And congrats on the quarter. It's impressive to see the digital sales hold flat, despite significant strength in 2020. And I'm just curious how you're thinking about the sustainability of these digital trends moving forward and then maybe any further implications they would have on the fleet optimization program.

I'll start?

Go ahead.

Okay. Yes, I'll kick this one off, and Fran can chime in. But we're very happy with the digital sales hang up. That was one of our first big learnings coming through, as the world kind of reopened specifically here in the U.S. is what was going to happen to digital whenever the stores reopen. So with the fleet work that we did last year and the huge jump that we saw last year in digital sales because of the COVID-related closures, it was great to sustain that this year. And what I love from the finance perspective is to see that flow through and to see our difference, the P&L and operating model flow through to much greater profitability, with that sales mix being at 44% of digital versus back in '19 where it wasn't. So as we think about going forward, it does have an implication on the store fleet. I mean this business is about omnichannel now. We need to make sure we have the right-sized stores in the right locations to support a bigger digital halo within a certain market, and that's how we look at each market that we're entering. We want to maximize that omni business. So it absolutely has an implication, and we'll be thinking about that as we go into the back half of this year when we have those 240 leases up for renewal.

It looks like that's all the time we have for questions today. I will turn the call back over to Fran for any additional or closing remarks.

Thank you. Thank you for participating in our call today. I look forward to speaking with you in November when we report our third quarter results.

With that, ladies and gentlemen, this does conclude your conference for today. We do thank you for your participation. You may now disconnect.