Good day, and welcome to the Abercrombie & Fitch Third Quarter of Fiscal Year 2022 Earnings Call. This conference is being recorded. At this time, I'd like to hand the call over to Kate Wagner. Please go ahead, ma'am.

Thank you. Good morning, and welcome to our third quarter 2022 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 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 reports and filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and reconciliations of GAAP to adjusted non-GAAP financial measures are included in the release and investor presentation issued earlier this morning. With that, I will turn the call over to Fran.

Good morning, and thank you for joining us today. Before we dive in, I'd like to thank our global team for their ongoing resiliency and focus on executing our long-term goals as we navigate a dynamic global macroeconomic environment. Against a challenging backdrop, our Q3 results beat our expectations on the top and bottom line with Abercrombie sales up 10% and Hollister showing sequential sales improvement and adjusted operating margin coming in 200 basis points higher than our expectations. We're excited about our positioning going into the holiday season, continued momentum in Abercrombie, and inventories are healthy with the year-over-year change cut in half from our peak last quarter. I'm encouraged by the trajectory of our business, and I'm confident that the steps we've taken throughout the year will put us in a position to win in Q4 and beyond. On to our Q3 results. While our global consumer continues to see significant inflation across our day-to-day lives, we were pleased to see our business improve off the second quarter, delivering flat sales in 2021 on a constant currency basis. Throughout the quarter, we continued to execute against the key pillars outlined in our Investor Day, focused brand growth, an enterprise-wide digital evolution, and operating with financial discipline. These pillars give us confidence in our approach to the holiday season, which we will enter with healthy inventory levels, momentum in our key merchandising initiatives, and a consumer that is engaging with us across channels. Starting with focused brand growth, we saw sales trends improve across brands compared to Q2. However, Abercrombie continued to significantly outperform Hollister as the bifurcation of the sales and gross margin performance continued in the third quarter. For the third quarter, total company net sales declined 3% compared to 2021. And as I mentioned, we were flat on a constant currency basis. For Abercrombie brands, which includes kids, we saw third quarter net sales grow 10% or 13% on a constant currency basis, led by ongoing strength in Abercrombie adults. Importantly, third quarter sales for Abercrombie Brands were up over 20% compared to the pre-pandemic level of 2019, even as we have reduced store square footage by around 40%. During the third quarter, we saw momentum continue in Abercrombie Adult as our customers transitioned to fall. Our assortments continue to evolve as we aspire to outfit our customers from the gym to the office to happy hour and beyond. We saw strong traffic across channels and AUR growth versus 2021, leading adults to achieve its best Q3 sales since 2014 and its highest Q3 AUR since 2004. I am so proud to see this team continue to push boundaries on products and marketing and deliver some of the strongest sales results in our industry. On product, performance for our women's assortment remains very strong, delivering the highest Q3 sales level since 2007. The strength was driven by our best-ever Q3 sales in jeans, dresses, and pants, as we continue to build our best dressed guest franchise and chase into key trends across bottoms categories. And after seeing some green shoots in men's in Q2, we saw growth in Q3 with strength across key top categories as well as outerwear. While the overall size of men's lags behind women's, we are optimistic about the growth opportunity ahead. Across men's and women's, we are well positioned for the holiday and are energized about the emerging spring trends we will deliver in early 2023. On the marketing front, our team continues to deliver. We were thrilled to be recognized with the Performance Marketing Strategy of the Year award by LTK, which is the world's largest influencer and creator commerce platform. The Abercrombie brand was also named to the Brands that Matter list by a SaaS company for effectively leading with purpose, inspiring conversation, and communicating our values through all of our work with the Trevor Project, Steve Fund, and communities. Kudos to our team for their passion around these projects and for all their hard work in ensuring successful partnerships. Moving on to Abercrombie Kids. As discussed last quarter, kids had a soft start to the back-to-school season, but we saw sequential improvement as we moved through the quarter. We saw the best performance in our super soft sweatshirts and sweatpants. Turning to Hollister, which includes Gilly Hicks and Social Tourist, we saw selling trends improve slightly compared to Q2. Third quarter sales declined 12% or 9% on a constant currency basis. Consistent with Q2, we check closely to apparel store traffic in the U.S., but we saw lower conversion basket size compared to 2021 as we lapped the lingering effects of stimulus last year and our customers dealt with significant inflation this year. As we worked through the remaining back-to-school period into September and October, we continue to see our customers shift spend towards tops and out of bottoms as compared to 2021. We are pleased to see stronger performance in higher fashion special occasion items like women's dresses and men's woven shirts. We're looking at these categories as leading indicators of our ability to improve conversion and have chased into related categories in the past few months. We are seeing nice performance in our women's tops business and will work to spread the success to other categories. Building out in Hollister, while key apparel space has seen softness in the back-to-school season, we continue to look inward at opportunities to improve the business. From an organizational perspective, towards the end of the second quarter, we made several key personnel moves at the senior levels of our Hollister merchandising team. We have also shifted ownership of Hollister marketing to Carey Krug, who has been our Head of Abercrombie marketing for the past four years where she has built a great team and is instrumental in driving the amazing A&F turnaround. Carey has moved into a new role as Chief Marketing Officer and is now responsible for marketing strategy and creative across all brands. We look forward to seeing Carey build on the work our Hollister team has done over the past few years. From an operational perspective, we are continuing with the inventory actions discussed, which includes adjusting forward receipt plans in terms of total level and by category. With these adjustments, we are determined to improve Hollister's performance in the quarters to come. At Gilly Hicks, as we continue to build awareness around the active lifestyle brand, we took a big step forward in opening additional freestanding stores. As of today, we have 14 freestanding Gilly stores with 11 in the U.S. and 3 in EMEA. The team and I are excited to bring our updated positioning and product offering to our global customers as we continue to test and learn. Outside of Gilly, we continue to support our brand growth principle with new store openings across our brands. We opened 19 stores in the quarter and continued to track towards opening around 60 for the full year, which will make us a net store opener for the first time in more than a decade. It's been great to see our brands deliver the updated experience in new centers as well as reenter key locations we exited over the past few years. For the year, we expect to open 18 Abercrombie Adult stores, 24 Hollister stores, 15 Gilly Hicks stores, and 3 kids' stores. For Abercrombie Adult, our customer has responded well to the new store concept we launched last quarter that features elevated fixtures and furnishings. The styled space is dedicated to key merchandising categories and updated fitting rooms with customizable lighting. Financially, our new Abercrombie stores are delivering 60% higher sales per square foot compared to the average Abercrombie Adult store. For Hollister, we are excited to start rolling out our Revolve store concept this quarter. The new format creates an optimistic and welcoming environment that is omni-focused and complements our digital shopping experience. The open concept interior is designed to be agile and adaptable, allowing for merchandising flexibility. Across all brands, we remain disciplined in our real estate approach with the new stores checking each acquired box: the right size, the right location, and the right economics. Shifting to inventory, the year-over-year inventory trend is playing out as planned with inventory growth moderating in Q3 after a peak in Q2. We ended the quarter with inventory up 36% compared to 2021 as we made good progress selling through summer and back-to-school inventory at Hollister. Consistent with last quarter, 92% of our inventory was current, defined as fall and holiday product, new goods that haven't been set for longer-life items. As we move through Q4, we expect year-over-year inventory growth to moderate further, and we are planning to be relatively flat to 2021 by year-end as we fully anniversary the late receipts we experienced last year. Turning to our second strategic principle, enterprise-wide digital revolution. During the quarter, we delivered Share2Pay, a new way for Hollister customers to pay on the mobile app. Share2Pay was completely developed in-house, and I'm so proud of our internal team, many of whom we've hired over the past 18 months as we add talent to accelerate our digital revolution. This first-of-its-kind payment solution is based on the need we saw among our customers to eliminate a key barrier to conversion. The feature allows our Hollister customers to easily share their digital shopping bag with their parent, for example, to complete the purchase, as many don't have access to credit cards to transact digitally. The early response has been positive as Share2Pay transactions are showing higher conversion and basket size than the average. We'll continue to get feedback and evolve this technology with the goal of finding more use cases beyond Hollister. This feature is one example of the work our teams are doing to support our digital evolution, which is necessary to grow our digital business off a 2021 base of roughly $1.7 billion. In addition to rolling out customer-facing technology, we also made progress on multiyear technology modernization efforts in areas like merchandising and data, which will enable us to be smarter and faster in the future. A huge thanks to our team, and I can't wait to see what's next. For our third strategic principle, operating with financial discipline, we are focused on managing controllable expenses in the third quarter. We currently manage headcount and adjusted marketing to better match demand patterns. As discussed last quarter, we reduced inventory buys for holiday and to ensure all brands are in a position to chase receipts in strong-performing categories. Despite the challenging macro backdrop, we remain cautiously optimistic as the holiday season ramps up in a big way this weekend. Quarter-to-date, sales are running consistent with Q3 levels. Across brands, I am pleased with our assortments, and we've seen good early reads in cold-weather categories. Also, much different than last year, we have the inventory on hand for our customers this year due to our efforts to deliver inventory earlier than normal to mitigate potential supply chain delays. While our teams are working to deliver a great holiday, we also remain laser-focused on the long term. As we move through Q4 and into 2023, we expect to continue to leverage our strong balance sheet to fund the multiyear strategic investments necessary to execute our Always Forward plan.

Thanks, Fran, and good morning. For the third quarter, we delivered net sales of $880 million, down 3% from last year on a reported basis and flat on a constant currency basis. We saw foreign currency pressure accelerate in the quarter, driving an approximately 300 basis point adverse impact on sales. Sales results were above our expectations as we saw trends improve sequentially at both Abercrombie and Hollister. Net sales at Abercrombie, which includes kids, rose 10% compared to 2021 on a reported basis and 13% on a constant currency basis. This compares to reported and constant currency growth of 5% and 7%, respectively, for Abercrombie in Q2. Hollister, which includes Gilly Hicks and Social Tourist, declined 12% or 9% on a constant currency basis. This compares to reported and constant currency declines of 15% and 12%, respectively, for Hollister in Q2. By region, net sales increased 3% in the U.S. and declined 18% internationally or 8% on a constant currency basis. By region, EMEA was down 22% on a reported basis and 11% on a constant currency basis, and APAC was down 26% on a reported basis and 19% on a constant currency basis. In EMEA, our strongest performance was once again in the U.K. and the Middle East, and we continue to see softness in other key countries in Western Europe. Obviously, there are many unknowns in Europe this winter, so our focus is on controlling our inventory and expenses and quickly reacting to the environment. In China, our trend remained negative but improved significantly from Q2. Our gross profit rate was 59.2% compared to 63.7% last year. Key drivers of the year-over-year change were the adverse impact of exchange rates of 60 basis points and higher product costs of 370 basis points. On a constant currency basis, AUR was up slightly with Abercrombie higher than last year and Hollister lower than last year as we work through back-to-school inventory. On product costs, we are optimistic that the recent pullback in freight and cotton prices will stick. We expect to see freight flip to a tailwind in Q4 as we anniversary elevated air rates and air usage due to Vietnam closures last year and start to see lower ocean rates materialize in cost of goods sold. For cotton, we will continue to see year-over-year cost pressure in the fourth quarter. Looking ahead, assuming current prices hold, we expect to see a benefit from lower cotton prices starting in the back half of 2023. Moving on to inventory, we ended the quarter with inventory up 36% compared to last year, 92% of which was current. During the quarter, we made good progress clearing through Hollister back-to-school inventory that was bought at a level higher than trends. Looking to Q4 and beyond, Hollister inventory receipts have been reduced to match the summer and back-to-school trends. We continue to chase in key categories for Abercrombie. More recently, we have seen greater stability in the supply chain with transit times coming in better than our expectations. In total, we are targeting an inventory level relatively flat compared to last year by year-end. I'll now cover the rest of our Q3 results on an adjusted non-GAAP basis. We excluded $4 million and $7 million of pretax asset impairment charges for this year and last year, respectively. Q3 operating expense, excluding other operating income, was $501 million compared to $498 million last year. The increase was driven by inflation in higher digital fulfillment expenses, mostly offset by lower marketing, incentive-based compensation, and foreign currency. Operating income was approximately $21 million compared to operating income of $79 million last year. Changes in foreign currency adversely impacted operating income by approximately $8 million. Net income per diluted share was $0.01 compared to net income per diluted share of $0.86 last year. Changes in foreign currency adversely impacted EPS by approximately $0.10. Moving on to the balance sheet, we ended the quarter with cash of $257 million and liquidity of $617 million. We expect cash and liquidity to build nicely in Q4 as we sell through inventory during the holiday period. During the quarter, we repurchased 510,000 shares for approximately $8 million. At quarter end, we had 49 million shares outstanding, down around 20% from the start of 2021 with approximately $230 million remaining under our previously authorized share repurchase program. We also repurchased $8 million of senior secured notes at a slight discount to par value. We remain committed to putting excess cash to work, pending liquidity levels, market conditions, and our ability to accelerate investments in the business.

Turning to investments, we expect fiscal 2022 CapEx of approximately $170 million, up slightly from our previous outlook as we accelerate certain technology investments. In total, we expect half of our capital spend to be for digital and technology and half for stores and maintenance. We continue to expect to be a net store opener this year with approximately 60 new stores globally, with the majority in the U.S. We opened 31 stores through Q3, and the remaining 29 are set to open in Q4. We have approximately 220 leases up for renewal by year-end, and we continue to expect to close approximately 30 stores pending negotiations with our landlord partners. As we look to the remainder of the year, we assume inflation-related pressure on consumer demand continues and that our brand and regional performance will be relatively consistent with Q3, with Abercrombie outperforming Hollister and the U.S. outperforming international. Our updated outlook replaces all previous full-year guidance. For the full year, we are planning as follows: net sales will be down 2% to 3% compared to the 2021 level of approximately $3.7 billion, an increase to our previous outlook of down mid-single digits. Embedded in this outlook is an estimated adverse impact of approximately 250 basis points from foreign currency, slightly worse than our prior expectation. We expect operating margin in the range of 2% to 3%, with the lower end up slightly from our previous range of 1% to 3%, reflecting better-than-expected results in Q3. We continue to expect a total inflationary impact of around $250 million across product costs and operating costs compared to 2021.

For the fourth quarter, we are planning as follows: Net sales will be down 2% to 4% compared to the 2021 level of approximately $1.19 billion, consistent with the Q3 trends. Embedded in this outlook is an estimated adverse impact of approximately 300 basis points from foreign currency. For operating margin, we expect a level between 5% and 7%, and an effective tax rate in the mid- to high 40s as the rate remains sensitive to earnings levels by geography. As we manage through the holiday season, we are also keeping an eye on the long term. This year and next are pivotal years as we accelerate our digital revolution and evolve our omnichannel experience across brands. We are mindful of the macroeconomic environment and are managing expenses and inventory tightly with a goal to maximize cash flow to fund key investments. Looking to 2023, while we are closely monitoring consumer demand, we remain cautiously optimistic that we'll see significant relief on product costs and some stabilization of inflation across other key expense categories. We will learn a lot more in the months to come, and we'll discuss assumptions for 2023 on our Q4 earnings call.

Our first question comes from Dana Telsey from Telsey Advisory Group.

It's great to see the progress. Could you elaborate on the improvements you've been implementing at Hollister and your expectations for the brand's development moving forward, especially considering the recent personnel changes? Additionally, we've heard some insights about the trends as we move from October into November. How have your trends been as you exit the quarter into the current one? Lastly, Scott, you mentioned opportunities related to product costs. How do you view the supply chain situation in the first half of 2023 compared to the second half?

As you mentioned, we were pleased to see the sequential improvement from Q2 to Q3. In fact, we were pleased to see it in both of our brands. If you do take a step back, the Hollister customer, as we've talked about recently, has definitely been more impacted by inflation than our Abercrombie consumer seems to be at the moment. But we are controlling what we can control. The leadership changes came towards the end of Q2, and we got on those as soon as we started to see some opportunities hit us as back-to-school kicked off at the end of the last quarter. It's exciting to see our tops business is very strong. We chased into those. Our theory there when we talk to the consumer is that perhaps they can't buy a couple of pairs of jeans this year, but they want their outfits to look new, so they're putting new tops with those. We are determined to continue to see these improvements in the quarters to come, and the team is working very hard on adjusting inventories and really leaning into categories that are working. Let’s see question 2, October into November. Go ahead.

I'll grab that one. So similar trends to what we've been seeing across the industry. It sounds like it was pervasive across the industry. A little bit of softness there, late October, and maybe into the first week of November. Super warm in the Midwest and Northeast. And obviously, that's not optimal for selling cold weather products. I have seen those trends improve since, like others, which is exciting. We are seeing good early selling through our cold weather categories and outerwear fleece, and sweaters in the places where we need to win in Q4. So happy with the results there, the early results in those categories. On product cost opportunities as we look to next year, the great thing to see these costs coming back in, significant reductions in freight through the ocean and air as well as seeing the cotton prices stabilize here and down pretty significantly year-over-year. Obviously, it's going to take a little bit longer to see that cotton flow through. So first half of next year, cotton will be pressure, and then we'll start to see the benefits in the second half of next year. Optimistic that we'll see the freight benefit throughout the entire year, assuming those ocean costs stay where they are. So good news coming, hopefully, on the product cost front.

Our next question comes from Corey Tarlowe from Jefferies.

Congrats on the progress here. So Fran, maybe if you could just start talking a little bit about how you feel about the health of the inventory going into the holiday. It sounds like a lot of the inventory is current, and there are lots of stores, and they seem to look really good. So maybe just talk a little bit about the assortment and the health of the inventory into the holiday here. And then I have a follow-up.

Yes, inventory has been a major focus this year. We've addressed it each quarter, and we started the year with a strategy to optimize our inventory for the most critical quarter. Last year, we faced challenges due to closures in Vietnam and various supply chain issues, and we were determined not to disappoint our customers again. Currently, our inventory is at about 36%, which is half of what it was last quarter. That inventory is mostly current, at 92%. We made significant adjustments as we began to see consumer responses to our products in the second quarter. We're satisfied with the status of our inventory by category and brand, and we expect to be flat by the end of the year, aligning with our strategic goal. I believe you have a follow-up question.

Great. Yes, could you just talk about how you think about the promotional environment as we head into holiday? It seems like people have been talking about more promotions that are expected to see ahead. Could you maybe just talk about how that is baked into the guide? And then, Scott, how you bridge that 5% to 7% operating margin, maybe some of the puts and takes for the Q4 that are associated with that.

Sure. This week is significant for the quarter, as it is the most promotional time of the year. Our promotional strategy is based on what is effective for us, rather than on the actions of other retailers. I am proud to say that our promotions are much lower than they were before the pandemic and consistent with last year's levels. We are already seeing positive sales from certain categories, particularly those related to cold weather. We are well-positioned to compete, and I am eager to be in the malls this weekend to experience the consumer excitement.

As we consider the promotional landscape in relation to the operating margin, we anticipate Abercrombie's average unit retail prices will rise again. They showed a solid increase in the third quarter, while Hollister's prices declined as we continued to manage our back-to-school inventory, which had been purchased earlier in the year before a downward trend began around June. We expect this trend to persist in the fourth quarter, with Abercrombie's prices going up and Hollister's slightly down as we address clearance inventory. When we look at achieving a 5% to 7% operating margin, it's worth noting that we are approaching last year's freight levels, although we will remain below 2021 standards. Gross margin will likely continue to face year-over-year pressure, despite freight providing a positive impact in the fourth quarter, as cotton costs will largely offset that benefit in our profits and loss statement. There are no significant changes in the average cost of goods sold. We aim to keep other operating expenses stable compared to last year. Therefore, for the fourth quarter, it will primarily be a story about margins as we navigate the promotional atmosphere. As Fran mentioned, we aim to end the year with inventory levels comparable to last year, ensuring a smooth transition into 2023. Moreover, we are optimistic about the outlook for product costs and anticipate reaping benefits throughout 2023.

Paul Lejuez from Citi.

This is Kelly Crago on behalf of Paul. I wanted to follow up on your promotional activities. It seems that the Hollister brand is becoming more promotional compared to last year. I'm also curious about how the Average Unit Retail (AUR) compares to 2019. Conversely, A&F has been less promotional year-over-year, leading to increased AURs, which I assume are higher than those seen in 2019.

Yes, let me address that. When we talk about Hollister, we're maintaining a consistent promotional strategy compared to last year. Our Black Friday promotions have already begun, which is positive. Any additional promotions or pricing changes we might implement will primarily focus on reducing carryover inventory. Consequently, we anticipate a slight decline in Average Unit Retails on a constant currency basis. Unfortunately, foreign exchange continues to negatively impact our results in Q4, affecting the AUR. Looking back to 2019, we're actually pleased with our AURs, which are up across all brands. Even in Q3, despite increasing promotions to clear back-to-school inventory, Hollister's AURs remain higher than pre-pandemic levels in 2019, and Abercrombie has also seen significant improvements as we have fully developed that brand and its offerings. We're pleased with the AUR performance across all brands, even with recent promotional activities for Hollister. Regarding costs, we expect to see gross margins improving moving forward. As for Abercrombie, we have noticeably reduced our promotional activities year-over-year, which has resulted in remarkable momentum for the brand, allowing us to adjust our promotions in terms of both depth and frequency.

Got it. Secondly, regarding your comments on the trends so far this quarter, it seems you've noticed a slight slowdown in October, but trends have stabilized and may be improving as we approach the holiday season. The net change being down 2% to 4% aligns with what you've experienced in Q3. Is that what you are observing quarter-to-date? Also, I'm interested in how the comparisons will look as we progress through the quarter. Last year, Omicron was a challenge, and we believe there was some demand pull-forward during the holiday season then. How does the rest of the quarter appear in comparison year-over-year?

We'll start back with that one. So yes, I mean, our expectation, interestingly, for this holiday is that it probably would mirror more pre-pandemic. So last year and the year before, we saw a little bit more of a flattening demand throughout from Black Friday through the holidays. Prior to that, you used to see these big spikes on the most traffic days, which would be this Black Friday week through Giving Tuesday and then some of the key Saturdays. So we are expecting a little bit more of a cadence similar to pre-pandemic.

Yes, Kelly, like you kicked off with quarter-to-date trends consistent with Q3. So I feel good where we are. Yes, a couple of weeks in October, a little tough there at the end. These are small weeks in the quarter, same thing with November week 1. So back on track. Once the weather turned, we saw some great selling in those cold weather categories I mentioned earlier. So feel good sitting here today. And as we go through the quarter, we had light inventory last year. We have the inventory this year, and we're excited to compete as we go through the quarter.

Carla Casella, JPMorgan.

I wanted to ask you about the $8 million of bonds you repurchased in the quarter on the open market. What are your thoughts regarding your capital structure and whether you would consider calling those bonds, or when you might evaluate that structure?

Carla, yes, we bought back some bonds in the quarter, $8 million. We had done about $40 million in the middle of last year. So as we have excess cash, we look at the capital allocation stack. We increased capital investments. We've taken them from this year from $150 million to $170 million, so continuing to invest back in the business. Bought a little bit of stock back and bought the bonds back. When we think about our capital structure, we're comfortable holding the debt that we're holding. When we see opportunities like we have seen more recently where the debt trades below par, we can go in there and buy a little bit of that back in the open market, save a little bit of interest expense, nice cash payback going forward. So big picture, though, comfortable with the debt. And as we have excess cash, we'll continue to look at that capital allocation stack and see where we put the cash to work.

Okay, great. And then if I could just do one more question on the shipping costs. Can you just talk about freight rates and kind of where they peaked and where they are now relative to where you expect them to be in the next quarter and next year?

Yes. The peaks, I would say, happened probably earlier this year, and shipping costs are tough to pin down. There's indices all over the place. But when you don't shift from just the index point somewhere in China to maybe the West Coast, we ship from multiple countries in Southeast Asia. So there's no one index that I can just grab. But what I would say is they're down pretty significantly from the peak. And with the demand environment that we're seeing out there, a lot of retailers, including us, pulled back on Q4 receipts whenever the businesses fell off earlier this summer. So the demand environment is good. Hopefully, that's tilted back in favor of the retailers. We're seeing that come in the pricing and optimistic that, that will stick in Q4 and beyond.

Janet Kloppenburg, JJK Research Associates.

Congratulations on the impressive progress. Fran, I have a couple of quick clarifications. Are you indicating that you expect your promotions to remain flat for the fourth quarter, and were they higher year-over-year in the third quarter to help clear the Hollister product, while improving at A&F due to the AUR gain? That's my first question. My second question is about A&F men's. Should we be concerned about that? Additionally, as you look at Hollister assortments for the spring season, are you optimistic that we could see an improvement in Hollister's comparable store sales in the first half?

Janet, I'll address the first point briefly, and then Fran can elaborate. For Abercrombie in Q3, Hollister saw a decline as we adjusted pricing to clear back-to-school inventory. As we approach the holiday season, we expect our main promotions and the percentage of stores running promotions to remain consistent compared to last year. We have also adjusted the inventory purchases for Hollister for Q4 and beyond. Any additional markdowns in Q4 will primarily focus on Hollister's carryover inventory, and we will assess how that affects the selling mix in Q4. Now, I'll pass it on to Fran.

Sure. It was an exciting second quarter for men's as we noted some positive signs. In the third quarter, we actually experienced growth. We are optimistic that men's consumers are recognizing that Abercrombie is back, similar to the recognition that women's consumers have experienced for quite some time, and they are responding positively to strong categories, especially in our tops. Our outerwear business is performing well. Therefore, we are very encouraged by the progress in the men's business.

That's A&F?

A&F, exactly. Yes. And then for Hollister, it was great to see quite some improvement this quarter. Our expectation is to continue to see some sequential improvement. We're seeing good business on the top. As I mentioned, the consumer is looking to update their outfits. So they're buying a new top perhaps to go with their jeans. There's also a lot happening in non-denim bottoms. We've chased into categories like cargo pants, which the consumer responded to quite well during back-to-school. We didn't have enough, we've chased into those. So our expectation is to continue to see sequential improvement in Hollister quarter-by-quarter.

And do you expect a lag in Europe, Fran?

Yes. I mean, the international business has been challenging. There's a lot of uncertainty still in Europe. We are managing what we can in the short term, right? We're controlling our inventory. We are continuing to open up stores, and we do believe in the long-term opportunity there. So we'll have to see what the fourth quarter brings. It's been challenging.

Now I will take a question from Mauricio Serna from UBS.

Congratulations on the progress. Could you elaborate more on the performance of the categories across the two brands, particularly how denim has trended during the quarter? Additionally, could you discuss Europe and highlight where you are seeing some weaknesses in the market? Finally, regarding freight and the Q4 outlook, I recall there was a 370 basis point impact last year. Do you expect that to fully revert this quarter or will it happen more gradually?

Sure, let's revisit the performance in the denim category. We're noticing some differences across the brands. Abercrombie women's had another record quarter in denim, and Hollister's denim performance has improved sequentially. However, we're observing a shift in consumer preferences towards non-denim bottoms. In Abercrombie women's, we achieved record sales in pants, the best we've seen in over a decade. Hollister is also performing well with non-denim bottoms, particularly with cargo pants and similar items. We're adjusting our inventory to focus on these successful products and plan to continue this strategy.

All right. Let's sum up Europe, so pockets of weakness. Where we are seeing strength has been relatively consistent. We've seen it in the U.K. and we've seen it in the Middle East. And then kind of our next few countries, when you think about Germany, France, Italy, that's where we've seen the softness. Obviously, Germany has some significant uncertainty right now with the gas situation over the winter. So like Fran said a minute ago, we're just keeping our eyes on the region. We will control what we can control, keeping inventory lean, and we're just going to read and react as we go through the winter. On the freight side and thinking about the outlook. So yes, last year, we had about $75 million hit with freights when we had significant air usage, high air rates, high ocean rates coming in. We're going to get a big chunk of that back this year. You don't get all of it back. It's going to take a little bit of time for those lower rates to flow through the P&L. So again, hopefully, some good things coming there in 2023. But then some of that offset of the good pickup in freight year-over-year, we'll be seeing that cotton flow through in those higher rates. So we're kind of working through the inflation and the input costs. Freight hopefully have seen the peak, and we are on the good side of it. Cotton still, we've got to get through the peak there. And then hopefully, in the back half of 2023, we'll see some benefits coming in.

And as there are no further questions in the queue, I'd like to hand the call back over to Fran Horowitz for any additional or closing remarks. Over to you.

Just want to thank everyone for joining the call today and wishing you and your families a safe and happy holiday season.

Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect.