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A&F Rides Digital, Fewer Markdowns to Banner Quarter

Lower inventory levels translating to fewer promotions and higher digital sales helped Abercrombie & Fitch Co. Inc. post its best third quarter operating income since 2012.

In a Nutshell: The company is staying laser focused on what it can control, and maintaining flexibility to respond to holiday needs and possible coronavirus impacts in the weeks ahead.

“Results were fueled by 43 percent year-over-year digital sales growth and sequential sales improvements in our global store base. Updated product and marketing resonated with existing and new customers across brands and regions. Combined with a focused inventory management strategy, we expanded gross profit rate significantly while continuing to tightly manage expenses, leading to operating margin improvements over last year,” Fran Horowitz, CEO, said, adding that the company also “delivered out best third quarter operating income in eight years.”

The company also disclosed it will complete early exits on four additional flagship locations by the end of January, which is in addition to the three announced earlier due to natural lease expirations. The company has been repositioning its store network from larger format, tourist-dependent flagship locations to smaller, omni-enabled stores catering to local customers. Of the four locations having early exits, the Düsseldorf flagship closed in the third quarter, while the London, Munich and Paris flagships will close by the end of January. The Brussels, Madrid and Fukuoka flagships will close in early January due to natural lease expirations.

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“With these seven closures, we should end the year with eight operating flagships down from 15 at the beginning of the year. These actions align with our multiyear strategy of reducing dependence on tourist-driven locations to reposition within key markets and deliver a better omnichannel experience to our local customer,” the CEO said.

In a conference call with Wall Street analysts on Tuesday, Horowitz said that the stores the company is exiting only contribute about 1 percent to total revenues, and had a “20 percent drag to comps.” Closing the stores “removed $85 million in lease liabilities from our balance sheets,” she said, adding that although the stores were being shuttered, “We remain committed to the markets they operate in.”

The company continues its ongoing review of store locations, and has about 60 percent of store leases up for renewal over the next two years. Horowitz emphasized that the company still believes in stores, but that they must be in the right locations and size to meet the current store-network vision for future growth.

The CEO also said that efforts by the company’s supply chain team has enabled the Abercrombie to keep up with the rise in digital sales. The company also has added additional carriers to meet the customer demand expected over the holiday season.

“We are focused on controlling what we can control and responding to what we cannot,” Horowitz said of the upcoming holiday season. And while the company is encouraged by quarter-to-date trends, she reminded analysts that it is still early, with the largest sales weeks still ahead against a backdrop of Covid uncertainty. With the key technology and supply chain investments the company has made, Horowitz emphasized, “The company is better positioned today than it was coming into this pandemic.”

Net Sales: For the quarter ended Oct. 31, net sales fell 5.1 percent to $819.7 million from $863.5 million.

By brand, net sales for Hollister fell 7 percent to $476.7 million, while its core Abercrombie brand sales were down 2 percent to $343.0 million. By region, sales in the U.S. fell 4 percent to $557.8 million. In the Europe, Middle East and Africa region, sales dipped 1 percent to $190.2 million. In Asia Pacific, sales dropped 22 percent to $43.6 million, and in other international locations, decreased 12 percent to $28.0 million.

The company ended the quarter with inventories of $546 million, down 8 percent compared with the year-ago period that ended Nov. 2, 2019.

Horowitz said the sales decline of 5 percent for the quarter was better-than-expected per the 15 percent guidance in the second quarter. The performance was helped by reduced promotions in the quarter, which helped margins, despite store closures of 80 percent in California, one of the company’s largest markets. Those closures contributed to part of the sales decline at Hollister, which also saw slower sales in August due to the delayed back-to-school selling season. Sales began picking up in September and October as California reopened, the CEO said, adding that the brand saw its best third quarter gross margin rate since 2008.

Hollister’s Gilly Hicks intimates brand also saw double-digit sales growth in the quarter. Bralettes and cozy fleece were top categories. “There’s significant white space that we see for Gilly, [and we are] allocating additional resources to accelerate growth,” Horowitz said, adding that at some point she sees stand-alone Gilly Hicks-branded stores in its future.

At its core Abercrombie brand, the CEO said women’s saw double-digit sales growth, helped by strength in denim, knit tops and bottoms, fleece, sweaters and skirts. Men’s saw growth in its 96-hour assortment, such as the travel jogger. Abercrombie kids also saw strength in September and October, which helped to partially offset a slow August.

A highlight in the quarter was the company’s record third-quarter digital sales, which jumped 43 percent to $382 million and provided the “highest digital growth margin in eight years,” she said.

For the nine months, net sales fell 17.8 percent to $2 billion from $2.44 billion. The decline in sales includes the periods earlier this year when stores were dark due to Covid-19 mandates.

Earnings: Net income jumped to $42.3 million, or 66 cents a diluted share, from $6.5 million, or 10 cents, in the year-ago quarter.

Wall Street was expecting adjusted diluted earnings per share of zero cents on revenues of $739.36 million.

The company ended the quarter with cash and cash equivalents of $813 million. Liquidity, including cash and equivalents and borrowing available under its asset-based revolving facility totaled $1.2 billion.

On the conference call, chief financial officer Scott Lipesky said sales could be down five to ten percent from current trends for the fourth quarter, based on some unknowns such as a change in customer demand and the possibility of renewed store closures due to a rise in Covid infections. He also said he’s not sure when the stores that are currently closed again in Europe due to the resurgence of Covid might be able to reopen.

CEO’s Take: “We are encouraged by quarter-to-date results, including ongoing strong digital demand, with our customers responding favorably to new product and messaging. However, this is tempered by uncertainty regarding the potential for increased Covid-related store restrictions and our expectation for elevated shipping, handling and freight costs. As we approach the peak holiday selling period, inventories remain well-controlled and we have thoughtful plans in place to help us adapt to changing business conditions,” Horowitz said. “As we have done since the start of the pandemic, we will utilize our proven playbooks to remain agile and provide the best omnichannel experience for our customers.”