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

Thank you. Good morning, and welcome to our third quarter 2021 earnings call. Joining me today are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our third quarter earnings release, which is available on our website at corporate.abercrombie.com under the Investors section. Also available on our website is an investor presentation. Please keep in mind that 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 and investor presentation issued earlier this morning. We will also be providing financial comparisons to the corresponding periods of fiscal 2020 and 2019, where applicable. And due to temporary COVID-driven store closures last year, we will not be disclosing comparable sales. With that, I will turn the call over to Fran.

Thanks, Pam. Good morning, and thank you for joining us today. I am excited to share our third quarter results, which benefited from a strong back-to-school -- and discuss the fourth quarter, which is off to a good start. But first, I'd like to begin with a thank you to our global team as well as our partners. Together, we actively navigated factory closures and transportation delays, reduced our promotions and markdowns, managed expenses and made strategic investments across marketing, technology and fulfillment to drive our business forward. Due to that hard work and our ongoing commitment to delivering against our key strategic pillars, including: fleet optimization, digital and omnichannel enhancements, a faster concept-to-customer life cycle and improved customer engagement, we delivered our best third quarter operating profit and margin in close to a decade. Total sales rose 10% to last year and were up 5% to Q3 2019, and we achieved our highest Q3 sales since 2014 despite industry-wide supply chain constraints and the removal of 1.1 million gross square feet from our store base last year. Our largest and most established market, the U.S., outperformed with sales up 17% on a 1 year and 12% on a 2-year basis. It was wonderful to have more kids return to school and have social activities resume for our kid, teen and millennial customer. We executed well against the back-to-school and fall calendar, providing seasonally appropriate newness and outfitting options. With compelling interpretations of the latest fashion trends, including wider leg silhouettes, vegan leather and seamless body suits, all while maintaining the quality, fit and value that we have become known for. Our customers were highly engaged, as illustrated by our average basket size and last customer rate of return, both of which improved in the double-digit percent range. In addition,…

Thanks, Fran, and good morning. In the third quarter, we delivered strong results across brands and across the P&L. Our profitability continued to benefit from the transformative moves we made in our operating model and expense structure last year as the shift to digital accelerated. For Q3, total net sales were $905 million, up 10% to last year and up 5% to pre-pandemic levels. While transportation delays increased during the quarter, our teams were able to maximize the inventory on hand to deliver sales above our expectations. Store sales rose 11% on a 1-year basis and were down 20% on a 2-year basis. At the same time, total digital sales increased 8% compared to last year and grew 55% from 2019, representing 46% of total sales this quarter compared to 31% in 2019. By brand, net sales increased 10% for Hollister, which includes Gilly Hicks and Social Tourist, and 12% for Abercrombie, which includes kids. As compared to Q3 2019, net sales increased 1% for Hollister and 10% for Abercrombie. By region, we continued to see strong results in the U.S. with net sales up 17% and 12% on a 1- and 2-year basis, respectively, despite having roughly 140 fewer stores and over 20% less square footage in our U.S. store base as compared to Q3 2019. In the U.S., Hollister was up 17% to 2020 and up 7% to 2019, while Abercrombie was up 19% and 18%, respectively. Outside of the U.S., we continue to see a slower recovery with EMEA down 6% to last year and 7% to Q3 2019. Our business was strongest in our largest European market, the U.K., where we experienced sequential sales improvements. The U.K. customer has responded well to product and has embraced our latest A&F location on Regent Street, which opened in…

[Operator Instructions] We'll take our first question from Paul Lejuez with Citi Group.

Curious, within that gross margin guidance for the fourth quarter, what are your AURs assumptions? And how does that compare to AURs in the third quarter? And maybe if you can also kind of run through the freight pressure that you're expecting in 4Q versus 3Q?

Sure, Paul, I'll grab that one. So yes, the gross margin for Q4, we'll see a little bit accelerated pressure versus what we saw in Q3. Number one, it's just a larger quarter. So we have more units flowing through. And we'll also see more of that Vietnam reopening pressure where we're putting a lot of that product on air to get it here by the holiday peak. So in the outlook for Q4, we're calling it flat to 2019. Q3 was up about 360 basis points to 2019. And getting back to the AUR question, we believe that we can get the AUR on lower markdowns and promotions to offset that $75 million headwind in Q4. Our product has resonated well coming into the quarter from October, and we're seeing that here in the November time period. So feel confident that we can offset that headwind in here in Q4.

Got it, Scott. And I think you mentioned the shift in marketing. Can you just maybe run through kind of what shifted out of 3Q and into 4Q?

Yes. As we learned more about the inventory flows in Q3, we made a decision to move some of that marketing into Q4. So we shifted a small chunk of our marketing out of Q3 into Q4 to better align with those flows. So as Fran mentioned, we're loving what our teams are doing on social, and we're going to continue to fuel those efforts. We love the response that we're getting at each of our brands. We called out Abercrombie and we'll see some great things on Snap and TikTok this week. So we're going to continue to fuel those efforts. That should help us here in Q4, but it's also going to give us a nice setup heading into 2022.

Yes. And the important thing -- just to add one last thing to that, Paul. As we are seeing a different flow of our inventory this quarter, which is kind of exciting and lots of things to learn from it, that marketing will help notify the customer that we're going to surprise and delight them all the way from Black Friday through Christmas with new deliveries and fresh new product.

Next, we'll go to Jay Sole with UBS.

Great. I'm just wondering if you can give us an update on denim? You mentioned some -- that denim was really strong. You mentioned some styles that were non-skinny denim that really were working. But I mean, where do you think we are in this denim resurgence? I mean is this sort of like the peak of it? I mean do you think it can last another quarter? Could it last another year or 2? How do you think about it?

Jay, I would love to talk about denim. It is on fire. We just reported our highest denim quarter in history, which is across all the brands and genders. I mean it's super exciting. There are so many things happening in denim. It's hard to even pin them down. But between -- to your point, between wider legs, the lighter washes, he's adopting them, she's adopting them. This kind of a trend in denim has legs, no pun intended, but it is going to last quite some time. I mean, if you look at what happened with the skinny jean, that trend went on for a decade. And we are just at the beginning of this trend. We've been seeing such positive response to the consumer. And he and she both need newness in their wardrobe. So we expect it to continue for quite some time.

Got it. Okay. If I can just ask one more, about the buyback. With the authorization that's out there and where the stock price is, I mean, do you feel like now is a good time with the margins that really bounced back so far, it's a good time to buy back a lot of stock? Or do you feel maybe a little bit cautious heading into next year with tough comparison, lapping stimulus and all that, that maybe it's better to hold on to that cash for now?

Yes, Jay, we have fundamentally changed this business. It started back with COVID last year in the middle of the year and the expense we were able to take out of the business. And then store occupancy that we removed in the back half. So our goal has been for years to reset the profitability of this company, and we have done that. So we are bullish on the stock, as you can imagine, on the company. So we have repurchased about $235 million so far this year. We expect to continue that here in Q4. And as we mentioned, our Board put a new authorization for $500 million out there. We're in a great position to have the balance sheet to be able to do it. With higher profitability levels, we're generating more cash, and we continue to put that cash to work in the business and for shareholders.

All right. Next, we'll go to Susan Anderson with B. Riley.

Nice job on the quarter. I was wondering if maybe you could talk about your thoughts on your term EBIT margin goals as much as you can. I know you're doing your Analyst Day next year. But just wondering how much of the margin gains seen this year is sustainable longer term? And is there still more opportunity to drive that EBIT margin over the next couple of years?

Sure, Susan. I'll kick this one off, and then Fran can chime in. But our goal back in 2017 was to take our 2017 margin of 3% and double that to 6%. We're going to about triple that and more this year if we deliver on our Q4 outlook. So it feels good here at Abercrombie to be talking about operating margins in the 9% to 10% range. And we're not going to talk too much about the long term, but we believe that a lot of these gains are sustainable. And getting back to what I just mentioned, it's about this fundamental shift in our operating model. This acceleration of digital has been good. We have done a great job cleaning up our store fleet. A lot of those stores that were too big, whether it's a chain store in a mall or a store in a flagship. So pulling down that occupancy has given us better profitability and also the ability to invest in marketing efforts as we become more of a digital business. So we like where the business is set up from an expense perspective, and we believe that these gains are sustainable.

Yes. And the only thing I would add to that is the sustainability is driven by the transformation of this company. And this company is a very different company than it was just a few years ago. And the fact that our brands are firing on all cylinders and that their brands are just resonating, getting that product voice and experience right really is a proof point to the delivery that we're going to do for third quarter and the future that Scott just discussed.

Great. And then if I could add one follow-up. Just curious what you're expecting out of the international business for fourth quarter? Are you expecting similar trends as we saw in the third quarter? It sounds like U.K. things are resonating there as things opened up. I know parts of -- other parts of Europe, we're starting to see that shut down. And then Asia, obviously still having some issues.

Yes. You nailed it. We do expect the trends to continue heading into fourth quarter. We expect the strong performance in the U.S. to continue. First 3 quarters of the year, we've had double-digit growth off of 2019 in the U.S., and that's with less -- 140 less stores than we had in 2019. So great progress there. And the U.K. is our strongest country, which is good, because it's our largest country outside of the U.S. And I would say the environment in the U.K. is the most similar to what's happening here in the U.S. So we're excited to see some of those other countries in Western Europe to open up. You saw Austria in the news recently. We have a handful of stores in Austria. So those stores will be closed for about 20 days here. But in the meantime, as we're looking at that European and APAC business, we're going to continue to leverage that strength in the U.S.

And we believe in the long-term growth of both the APAC and the EMEA regions. In fact, we just recently opened up a new store on Regent Street for Abercrombie, which we're already seeing nice response to, and that store is very much the prototype of our go-forward. It's a smaller location, much less expensive build out and yet the customer experience is really resonating. So we're excited about the opportunities in both EMEA and APAC.

Next question comes from Dana Telsey with Telsey Advisory Group.

As you think about the occupancy expense leverage from the reset, where are you in that? How do you see that progressing through 2022? And are there any stores that you thought you would close that maybe whether sales pick up or more favorable lease negotiations is helping you keep that?

Dana, we made great progress last year. We got through a significant amount of those oversized Abercrombies within the mall as well as a big chunk of those flagships. Looking at this year, we're going to be around flat on store accounts. A lot of that progress was made last year. We'll be around flat this year. And we do expect, as we go into next year and beyond, we'll likely be net store openers. But the good thing is we're going to continue to reposition our fleet globally, whether it's the U.S. or international and make sure that we're getting rid of some of those larger-sized stores and replacing those with smaller stores -- more of those omnichannel stores that we've been talking about. So as we do that, even as net openers of stores, our goal is to keep our square footage relatively flat or just increasing slightly in the years to come to keep that occupancy where it is today.

And just one quick follow-up, on price. Where are you in terms of raising prices? Is it across categories? How much is it? And how do you see the promotional environment? How you're planning it for 2022?

So I'm very proud, Dana, to tell you that we actually have not raised our prices this year nor do we plan to for the fourth quarter. What we've been able to do is really reduce our promotions. And what we referenced as discounted ticket has been we've made considerable progress in that. We have been working on that for a long time. To see 6 consecutive quarters of AUR growth is really a testament to all that work and how it's coming together. I think the second part of your question was Q4 2022?

How do you see 2022? Yes.

2022, we'll discuss in our fourth quarter call. Obviously, we're looking at things like inflation and the opportunities that are out there. We haven't made any commitments to that yet. So we will get back to you on the fourth quarter call for that one.

[Operator Instructions] We'll next go to Janet Kloppenburg with JJK Research Associates.

Congrats on a good quarter. Scott, I got on a little late. I think you said that there was $75 million in freight pressure in the fourth quarter. Did you say what that's compared to versus the third quarter? And I was wondering if you -- I know you're guiding to a flat gross margin on a 2-year basis. I was wondering if you expected AUR trends to continue to improve a 3Q's rate? Or if you thought that maybe that would moderate because of us being in holiday and promotions perhaps picking up? And as you look into next year, I was wondering how you felt in -- for the first quarter and the second quarter about freight headwinds? Some of the companies that I'm talking to think that they'll be higher -- that they'll be higher than the fourth quarter sequentially. Others like Urban last night felt that there'd be some relief. If you could help there, it would be great.

Okay. Nice to hear from Janet. All right. Let's start with the first question. The freight pressure in Q3 was around 300 basis points. So if you do the math there, call it, $25 million, $30 million. $75 million, you did catch that, in Q4. So as you said, we expect to be flat on gross margin for the Q4 period. So yes, we assume that the AUR trends that we've seen throughout the first few quarters of the year here will continue into Q4 so that we can absorb that margin pressure here in Q4. Not a lot to say about 2022. There's still a lot to figure out here in Q4 as we finalize some of the air as we get the inventory in from Vietnam. So we'll see how much flows through here in Q4, and then we'll talk about the spring period. I do see -- I forget which companies you've mentioned, but I do think that freight will moderate at some point. I think we've seen some of the ocean rates coming down more recently in some of the indices that we look at. So more to come, a lot of variables and a lot of moving parts here heading into the spring.

Okay. And just one for Fran, if that's okay. It looks like this marketing investment is really paying off, Fran. And I'm wondering if you feel like you're at a level now that's appropriate? Or if you think continued investments would be -- give you a nice return like we've been seeing?

You're absolutely spot on. We are just thrilled with the results of our marketing. I think you remember when I first got here, we barely had a marketing department. And now we are industry-leading in both Abercrombie and Hollister. And the results and the innovation that we continue to see is just incredibly exciting. As we continue to see returns, we will continue to invest. Stay tuned for today. We are going to have a TikTok takeover. It's the most important social media platform that's out there, and we're going to own it for the most important week of the year. So we are thrilled with what the teams have been doing, and we will continue to monitor the investment relative to the return.

Next, we'll go to Mark Altschwager with Baird.

This is Sarah Goldberg on for Mark. I wanted to ask further on the recently launched same-day delivery across U.S. stores. What have been the early learnings there? And then how should we think about the longer-term impact of digital sales and margins versus other digital options, such as buy online, pickup in store or ship from store?

Sure. So listen, Sarah, we are a leading omnichannel retailer. And the most important thing that we do is listen to our customer, and they told us it same-day delivery was a very important option for them, just like last year when they told us that curbside was important for them. So we're continuing to evolve all of our optionality for our consumer. We've seen week-over-week gains in same-day delivery and a really nice early response to it.

And the impact on margins longer term, this specific offering will not have a material impact on those margins. Really, like Fran just mentioned, it's just another option for our consumer to engage with us. If they need something quick, they have that option. So really excited about that rollout this year.

It looks like we have one more question. And we'll take that from Marni Shapiro with Retail Tracker.

Congratulations. Two questions. First one is very important. When does the TikTok takeover start? Because you know I'm going to be on.

It starts today for both brands.

Excellent. And then could you talk a little bit about -- you've done some really interesting things on product drops very aligned to this generation, yet you've had to deal with all these product delays. Were any of the drops or new products and marketing that were supposed to hit for the fourth quarter, will they not hit in the fourth quarter? Are you able to repurpose some of this stuff into the first quarter? Were their product cancellations? Can you just talk a little bit about like, I guess, what kind of business you may have left on the table because of the product delays in Vietnam?

What's exciting, Marni, is that the team can pivot, honestly, on a moment, and that's the beauty of having obviously a digitally-driven business. So we do not believe -- we have not had any specific delays on special product drops. I'm possibly referring to one of the most exciting ones that we did for Q3, which was Bugha. Partnering with the Fortnite World Champ and having a product that's sold out within a very, very short period of time, was super exciting. But to the point being, we've not had to delay any of the drops because of these deliveries challenges.

That's fantastic. And then just one follow-up. Are you seeing both, at Abercrombie specifically, lapsed shoppers and new shoppers come back to the brand?

Yes, we are. Both. It's very exciting. I'm sure I know you're on social media all the time, but hearing all the customers talk and all the social chatter about how excited Abercrombie being back and all of the positive response about the brand has been just incredibly exciting.

Yes. It's been a very warm welcome. Best look for the holidays.

Thanks. Appreciate it, Marni.

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

I just want to thank everybody for joining us today. I hope you all have a great holiday season, and we look forward to catching up in the New Year.

And that does conclude today's conference. We thank everyone again for their participation.