Abercrombie & Fitch Co /De/ Q2 FY2024 Earnings Call

Good day and thank you for standing by. Welcome to the Abercrombie & Fitch Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mohit Gupta. Please go ahead.

Thank you. Good morning and welcome to our Second Quarter 2024 Earnings Call. Joining me today on the call are Fran Horowitz, Chief Executive Officer, and Scott Lipesky, Chief Financial Officer and Chief Operating Officer. Earlier this morning we issued our second quarter earnings release, which is available on our website at corporate.abercrombie.com, under the Investor section. Also available on our website is an Investor Presentation. Please keep in mind that we will make certain forward-looking statements on the call. These statements are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today. These factors and uncertainties are discussed in our reports and filings with the Securities and Exchange Commission. In addition, we'll 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 the Investor Presentation issued earlier this morning. Finally, references to Abercrombie brands include our Abercrombie & Fitch and Abercrombie Kids brands, and references to Hollister brands include our Hollister and Gilly Hicks brands. With that, I will turn the call over to Fran.

Thanks, Mo, and thank you all for joining us this morning. I am incredibly proud to report our financial results exceeded the expectations we provided in May and set second quarter company records for both net sales and operating profit. We delivered strong second quarter net sales growth of 21%, reaching $1.1 billion with an operating margin of 15.5%. We achieved these outstanding results while also funding long-term growth priorities across regions and brands. After a historic success in the first half, our teams are energized and we've entered the second half ready to deliver for our global customers. I am thrilled with our start to August and we are raising our full year sales growth and profitability expectations. For more context, in 2024, we've set out to demonstrate sustainable profitable growth on top of a defining fiscal year result in 2023. I'm so proud of how we're showing up for our customer and we are clearly seeing them respond. In addition to record second quarter sales, this was our seventh consecutive quarter of net sales growth in a dynamic, often uncertain consumer environment which underlines the strength of our brands, our team, and our playbook. We work every day to satisfy new and returning customers' needs across product voice and experience. I believe our global brand portfolio is as strong as it's ever been. Combined with an agile modern supply chain and a culture of financial discipline, we believe we have all the pieces in place to deliver on our goals across a variety of macro environments. Sharing a bit more detail on Q2, I want to call out a consistent theme we've demonstrated over the last five quarters. We are delivering strong top-line results while also maintaining balance in how we're growing. Our second quarter sales growth was broad-based, fueled by expansion across regions, brands and genders. We also saw growth in both units and average unit retail, consistent with the past five quarters. There's balance in our product too, with growth across key categories, as our teams are delivering lifestyle assortments with increasing relevance to our local customers. On the gross profit line, we saw 240 basis points of rate expansion compared to last year. This was driven by higher average unit retail and improved product costs, partially offset by higher freight costs. We also delivered operating leverage in the quarter while funding important marketing, digital, technology, and people investments to support our long-term aspirations. All this great work led to operating income of $176 million for the quarter, nearly double the second quarter result from the prior year. Continuing the theme of balance, we delivered growth across regions in the second quarter. The Americas continued to lead the way with 23% net sales growth, consistent with the first quarter. The Americas grew across markets with nice increases in traffic across direct selling channels. In EMEA, putting aside a pandemic-related sales rebound in early 2022, we demonstrated growth on growth for the first time in over 10 years, delivering 16% growth on top of 4% in the second quarter of 2023. Customers in both the UK and Germany continue to respond to the localized assortments and we're engaging with them to increase marketing and brand presence. Finally, APAC grew 3% in the quarter on comparable sales growth of 21%, where we continue to be led by our focus markets of China and Japan, as we engage that customer in new and different ways. We are energized to see the progress we've made to localize our playbook across regions this quarter, but we know there's more runway ahead of us. On to the brands. Abercrombie brands had another outstanding quarter with net sales growth of 26% on top of 26% growth in the second quarter of 2023. Balance growth continued in men's and women's and across categories, with seasonal shorts, swims, skirts, and dresses performing well. We also saw balanced growth in both average unit retail and units, as well as new and existing customers. As a follow-up to our highlights in the first quarter, the wedding shop continued to contribute nicely and has proven to be a great assortment extension. The reaction from customers has exceeded our expectations and we have now entered the men's side with some suiting options to complement our dresses. We continue to prioritize customer acquisition in Abercrombie, funding effective marketing campaigns across digital and social channels. We are excited to enter the back half with more customer activations planned. In the US, we released our latest NFL collection, further expanding on what has been a great partnership. Related to the collection, we have a number of exciting social and digital campaigns planned throughout the season to drive engagement. It's just one example of how Abercrombie Brands is working to win with both new and current customers in the second half of the year. Moving on to Hollister brands, we continue to build momentum. Net sales growth of 17% exceeded our expectations and accelerated sequentially from 12% growth in Q1. Importantly, the balance continues from the first quarter with both men's and women's growing, as well as expansion of both unit sales and average unit retail, the latter driven by lower promotions. On the product side, women’s saw balanced growth across categories with particular strengths in skirts and dresses. In men's, we saw shorts and graphic tees contribute to the growth. With the additional week of Back-to-School selling in the second quarter, we were pleased to see consistent growth trends and I'm very happy with how Back-to-School is going for us so far. With great product, our goal now is to amplify the brand. On top of new store locations and refreshed store experiences, we're investing in incremental marketing to increase engagement and reintroduce Hollister brands to our target audience. This increased marketing investment spans across digital and social channels, as well as through authentic real-life experiences and activations. One example is our Feel Good Fest, which is a concert and festival put on in partnership with high schools across the country. More recently, as back-to-school and fall school sports have kicked off, we launched the Hollister Collegiate Graphic Shop. The collection of quality basics including crew neck sweatshirts, hoodies, and tees, touting vintage inspired university logos and graphics represents more than 30 universities across the United States. Hollister Brands is building nice momentum and we believe product collections like this can help bring new customers into the brand. As we reflect on our team's success and strong second quarter results, I'm as confident as ever in our global growth potential and our ability to make continued progress on growth and profitability in 2024, as reflected in our increased expectation for sales and operating margin. As we enter the back half, our team remains on offense while looking forward to the holiday season, and I'm thrilled with what we've seen in the third quarter so far. Looking further out, with a strong family of brands, a proven playbook and an evolving regional operating model, I believe our relationship with the customer continues to improve and we all see tremendous opportunity ahead. We continue to further strengthen all aspects of the customer journey, developing a consistent, enduring business that can grow and succeed even in these dynamic and often uncertain times. A huge thank you to our associates around the world whose hard work, dedication, and support of our customer have put us well on our way to sustainable, profitable growth in 2024. And with that, I'll hand it over to Scott.

Great, thank you. To echo Fran, we were very pleased with the first half of the year. Our teams continue to execute at a high level across the business, managing the day-to-day while continuing to make progress in our long-term investment plan. Getting into the results for the second quarter, we delivered record net sales of $1.13 billion, up 21% compared to last year, with growth across regions and brands. Similar to the first quarter, this is the first time in the history of the company we've delivered over $1 billion in net sales in a fiscal second quarter. On a reported basis, we saw a 320 basis point benefit from the calendar shift from the 53rd week in 2023, consistent with our expectations. Comparable sales grew 18%, representing the fifth consecutive quarter of double-digit comp sales growth in both the stores and digital direct selling channels. On a regional basis, we again delivered growth across regions. Net sales grew 23% in the Americas, 16% in EMEA, and 3% in APAC. On a comp basis, sales grew 18% in the Americas, 17% in EMEA, and 21% in APAC. In the Americas, similar to last quarter, we saw balanced growth across markets. In EMEA, the UK and Germany continued to lead the way, and we've now delivered year-over-year growth for five consecutive quarters in the region. In APAC, we saw a large spread from comps to net sales growth, which was primarily driven by foreign currency and net store closures. From a brand perspective, Abercrombie brands delivered strong growth with net sales up 26% to last year, while Hollister brands growth accelerated to 17% as our customers responded favorably to our assortments and our marketing. On a comp basis, Abercrombie grew 21% and Hollister grew 15%. For gross profit, we delivered a rate of 64.9% for the quarter, up 240 basis points compared to the 62.5% rate in 2023. We saw year-over-year benefits from lower cotton costs, as well as a benefit from lower promotions across brands on well-controlled inventories and strong product acceptance. These benefits were partially offset by higher freight costs. We ended the quarter with inventory up 9% to last year, with all brands in a clean position entering the fall season. Moving on to expenses, operating expense excluding other operating income was $561 million for the quarter, compared to operating expense of $497 million last year. We continued to drive operating expense leverage with operating expenses as a percent of sales of 49.4% and improvement of 380 basis points compared to last year. We saw similar themes to the first quarter in terms of year-over-year operating expense growth, with higher variable expenses on sales growth, as well as inflation and increased investments in marketing, digital and technology, and people. For marketing, second quarter expense was in-line with expectations, finishing at around 4.5% of sales. Operating income was a record $176 million or 15.5% of sales compared to operating income of $90 million or 9.6% of sales last year. Net income per diluted share was $2.50, up from $1.10 last year. EBITDA totaled $215 million, or 19% of sales, compared to EBITDA of $126 million, or 14% of sales last year. On the balance sheet, we ended the quarter with cash and equivalents of $738 million and liquidity of approximately $1.2 billion. We delivered operating cash flow of roughly $165 million and had $43 million of capital expenditures. We repurchased $15 million worth of shares, ending the quarter with $202 million remaining on our current share repurchase authorization. During the quarter, we fully redeemed the senior secured notes at par value with cash on hand, ending the quarter with no funded debt. We also amended and extended our asset-based credit facility. The maximum size of the credit facility was increased from $400 million to $500 million, inclusive of the new $100 million European sub-facility. Moving forward, with the redemption of the senior secured notes behind us, we expect to prioritize share repurchases to put excess cash to work in the back half, subject to business performance, share price, and market conditions. At a minimum, we expect to buy back shares to offset net dilution from stock compensation. On the store fleets, we ended the quarter with 757 stores. For the first half of the year, we opened 18 new stores, remodeled or right-sized 30 stores, and closed 26 stores. New and remodeled store performance has exceeded our expectations, and we are excited to deliver many new store experiences in the weeks and months to come. For the full year, we expect to deliver approximately 60 new stores, 60 remodeled and right-sized, and 40 closures. Shifting to our expectations for the rest of fiscal 2024, we've had a strong start to the year delivering record net sales in the first half and the momentum has continued in the first few weeks of the third quarter. For the third quarter, we expect net sales to be at low double digits compared to the third quarter 2023 level of $1.06 billion, including a year-over-year headwind of around $10 million or 90 basis points due to the calendar shift from the 53rd week in 2023. We expect growth across regions and brands and minimal impact from foreign currency. We expect operating margin to be in the range of 13% to 14% compared to 13.1% in 2023. We expect the gross profit rate to be consistent with 2023. Now that we are through the majority of the cotton benefit, and we expect to see year-over-year freight pressure in the quarter. We also plan to continue investing in our brands and infrastructure, which we expect will moderate potential operating expense leverage, keeping expected operating margins around 2023 levels. And we expect an effective tax rate in the mid-20s. For the full year, we now expect net sales growth in the range of 12% to 13% up from the 2023 level of approximately $4.3 billion, an increase in the previous outlook of up around 10%. This outlook continues to include an adverse impact of around $50 million from the loss of the 53rd week in 2023. We've included a table in the press release to provide more detail on expected sales and comparative growth impacts by quarter and for the full year. For operating margin, we expect to be in the range of 14% to 15%, increasing the high ends compared to our prior outlook. We continue to expect the year-over-year improvement to be driven by gross profit rate expansion from the combination of lower cotton costs and higher average unit retails on lower promotions and clearance selling, slightly offset by higher freight costs. We also continue to expect full-year expense leverage while executing our agile funding process to find ways to accelerate investments in the business in the months to come. We expect an effective tax rate in the mid-20s and capital expenditures of approximately $170 million. To finish up, we are very happy with how our teams are executing across the business. We delivered record financial results in the first half, improved our balance sheet with the elimination of funded debt, and continued to invest in our brands and infrastructure. We look forward to executing our plans in the back half to deliver sustainable, profitable growth this year. Operator, we are now ready for questions.

Thank you. Our first question comes from Dana Telsey with Telsey Advisory Group. Your line is open.

Hi. Good morning, everyone, and congratulations on the very nice results. Fran, if you think about the back-to-school selling season and the average unit retail growth, what have you seen in each brand, how does it differ by category? And then Scott, unpacking the operating margin guide for the third quarter of the 13% to 14%. I think the consensus had been a little bit higher. Is it the gross margin with the freight expenses or the reduction of the lower cotton costs? If you could just expand on that and unpack that a little bit more. Thank you.

Hey, Dana, good morning. Yes, super excited about our quarter and certainly for the first half of the year. I mean, outstanding to have a second quarter of $1 billion in sales and a balanced performance across brands, regions, and genders. Thrilled with back-to-school, both as we came out of the second quarter and how we started the third quarter. What we're seeing in back-to-school is a nice reaction. You know, the team got to work; it was actually two years ago this quarter when we took a step back a bit and had to really inspect what was going on with our back-to-school and our Hollister brand which we spent a lot of time rebuilding and rebranding. What we're seeing is continued average unit retail growth. Since 2019, we've had double-digit growth in actually both brands and excited to see what that's driven by, which, as you know, it comes down to product acceptance and financial control of our inventories. So we are seeing a balanced growth across brands and categories.

Hi Dana, it's Scott. I'll take over for Q3. We're coming off a fantastic first half, with record sales in both the first and second quarters, including a record operating income in Q2. Looking ahead to Q3, we're optimistic about an outlook of low double-digit growth on the top line compared to last year’s strong performance. As Fran mentioned, we have had a good start to the quarter, and we're pleased with the back-to-school season, as well as the positive trends from Hollister and Abercrombie. Regarding the P&L for Q3, we anticipate some impact from freight on the gross profit rate, but we expect some improvement in average unit retail this quarter. We'll aim to keep it stable overall. As for operating expenses, we will keep investing heavily in the business. In the short term, we're increasing our marketing efforts while also making significant long-term investments to strengthen our infrastructure and our brands. This may slightly moderate our operating expense leverage compared to recent quarters. We're really excited about our Q3 guidance and the full year, increasing our sales outlook and raising our operating margin target to 14% to 15%. These are truly exciting times for the company.

Thank you.

One moment for our next question. Our next question comes from Corey Tarlowe with Jefferies. Your line is open.

Great. Thanks and good morning everybody.

Good morning Corey.

On the growth at Abercrombie, one of the really impressive aspects of the momentum that you've seen is your permission to go into other categories. So you highlighted the wedding shop, you've expanded the NFL partnership, and I've seen a new merchandise in stores, and it looks awesome. And you even highlighted growth in swim, which is a category that I think has been pressured across many other retailers in the sector. So could you maybe just talk about how you think about the various growth vectors for the Abercrombie brand and which of those growth vectors do you think could be most sizable over time? And the other reason I ask that is because like the YPB brand, which you didn't mention in your prepared remarks, but I see that it seems to be doing fairly well in stores. So I'm curious how you think about ranking the various drivers of growth for Abercrombie as we look ahead?

Hi, Corey, okay. So let's break that down a little bit. Incredibly excited about the performance for Abercrombie. I mean to your point, 26% on 26%, growth on growth was super exciting to see. And that is being driven, as I say all the time, by staying close to the customer. I mean the team really spent a lot of time on customer insights and really understanding what matters to this consumer. The Wedding Shop is a great example; it beat our expectations again. We'll continue back into the fall season. As we've talked about, weddings are now two, three, four day occasions and they're all year round. The wedding season has really expanded well into the fall season. I'm glad you had a chance to go see that NFL collection. That is another great example. We started with the NFL, that partnership, about two years or three years ago, started small, and started to build. Now proud to carry all 32 teams and have added categories. Last year, we focused on fleece and t-shirts, and now you'll see sweaters and outerwear and hats, et cetera. So again, that's how we do it. We test, we learn, we continue to add categories and build on momentum. So as far as prioritizing, there are lots of exciting things happening out there. I guess you actually mentioned YPB as well. We are into our third year of growth in that category. Again, that was specifically asked for by our consumer, knowing that we could give them the right quality, the right product and the right fashion for them, and they've responded. So lots of exciting things happening and continuing into the back half.

Great. And then could you just highlight what you're seeing from a digital perspective? I do believe that channel is also margin accretive. So would just be curious to hear about the momentum that you are seeing there. It seems like that channel has done quite well based on what we are seeing in our alternative data.

Hi, Corey, yes. It's Scott, I'll grab this one. So digital has been doing well in double-digit comps we're seeing across channels. And really, I kind of take it back a couple of years ago between the strength of the brand, the strength of the assortment and really the teams we put in place on the digital side to improve that experience. Day in, day out, we are making investments in that experience across apps, across mobile web. And we are seeing that come through. So with great products, we are managing the inventory, and we have a great experience. It is really setting up our digital business to grow. So we are excited about the growth we've seen. We expect more growth in the future, and we are investing there and just excited about what we're seeing.

Great. Thank you very much.

One moment for our next question. Our next question comes from Matthew Boss with JPMorgan. Your line is open.

Thanks. And congrats on another nice quarter.

Thanks, Matt.

So Fran could you elaborate on the clear excitement across brands? I think you said three times on the call, how thrilled you were about August. And just category trends that you are seeing into early fall and back-to-school. I think then Scott, it would be helpful, just relative to the 14% to 15% operating margins this year, just how best to think about incremental margin expansion opportunities multi-year.

I'll kick off. So yes, to reiterate an outstanding second and first quarter, a great first half to the year. What we are most excited about is the fact that our growth is coming very balanced. So it's coming across brands, it is coming across regions, it's coming across genders. That's obviously what's enabled us to raise our full year outlook on sales growth and operating margin for the year. We are seeing a lot of consistency in categories. Tops are working, bottoms are working. We continue to have this incredibly growing dress business that's happening both in Abercrombie as well as in Hollister Girls. We are also seeing new categories working. We just added some suiting to complement the Wedding Shop for him. So when he goes with her on all these elongated wedding weekends, he can also dress in Abercrombie best dress guest outfitting. So lots happening. Back-to-school time, we are seeing nice excitement about denim. This low-rise baggy that we all called out here at Abercrombie, a couple of months ago and got after is working. So again, very balanced what we are seeing across brands, genders, regions, as well as categories.

Hi, I'll take the other part. We are aiming for operating margins of 14% to 15% this year, and I'm excited to discuss this for the company. We have worked extensively on every line of the profit and loss statement and it’s great to see that reflected in our numbers. Looking ahead, there isn't much to report today, but we see potential across the profit and loss statement. Firstly, regarding revenue, we believe there is significant growth potential for our brands and regions. The Americas, our largest region, is growing at strong double digits, and we still have numerous real estate opportunities and customer growth potential in the US. When we look at our international business, we recognize that we are underrepresented in both Europe and APAC. We are focused on expanding our customer base in those regions while building brand awareness to grow revenue. Concerning gross margin, we've made progress in terms of average unit retail. We are maintaining strong product acceptance and effective inventory management. We can improve our gross profit rate by reducing clearance sales. Each quarter, we aim to keep average unit retail stable, and if we can increase it further, we will. Regarding operational expenses, we are investing in the business for long-term growth. If we do this effectively and achieve good returns, we should see operating leverage in the future. This describes how we've reached our current position and informs our outlook moving forward.

Great color. Best of luck.

One moment for our next question. Our next question comes from Paul Lejuez with Citi. Your line is open.

Hi, thanks guys. Curious if you can maybe talk about the progression of sales throughout the quarter? And also what you saw from a promotional perspective relative to what you thought you were going to see, what you're seeing for back-to-school on promotions and what you have built in for the fourth quarter as well? And then just Scott, any sense of the year-end cash balance and just what you want to keep on the balance sheet in terms of minimum cash? Thanks.

Yes, let me kick off, Paul and Fran, you can add any color obviously. Progression of sales throughout the quarter, nice Q2, double-digit growth in each month of the quarter, which is exciting. And again, talking about double-digit growth as we get here into Q3. I mentioned it, Fran, we are excited about the start of Q3. Our business actually improved pretty dramatically nicely in the past. We really ramped up last year. In 2023, as back-to-school, as Hollister started to get back into a groove. So we are excited to be talking about growth on growth again here in the third quarter. Promotional, nothing is jumping off the page to us. I think you are seeing the brands that are performing well, being promotional but promotional in their own way. That's the same way we're executing against our plans and happy with that. We always talk about being a promotional business, and we continue to do that, and we like the promos we are delivering. The customer is responding well.

Yes. I would say, Scott, as we've mentioned many times before, our promotions are based on our business. We collaborate with the team every Monday to assess what is effective and what is not in our operations, and we tailor our promotions accordingly. They have decreased significantly over the years, as you know. So yes, we will always have some promotions in our business. Currently, we are not observing anything unusual.

And then the last piece, year-end cash balance, No target sitting here today. We are really excited to get the senior secured notes, those 8.75% notes behind us, paid those in full in Q2 and came out of the quarter with a nice cash balance, $700 million and nice liquidity at $1.2 billion. Looking out in the back half, I talked about, we'll focus more on share repurchases, with excess cash and just really like the fact that we have a strong balance sheet. It's continuing to enable us to invest in any environment. We are opening 120 new store experiences this year. I talked a minute ago about investing in digital. We are investing in our teams outside of the US and inside the US and really setting up the company for long-term sustainable growth. So we are going to use that strong balance sheet in that way.

Thanks guys. Good luck.

One moment for our next question. Our next question comes from Marni Shapiro with The Retail Tracker. Your line is open.

Hi everyone. Congratulations on a fantastic quarter and first half of the year. Best of luck with back-to-school if I forget to mention it. Could you share your thoughts on a couple of topics? First, I’m interested in your loyalty initiatives for each brand. Is your customer base engaged? Are you implementing loyalty programs, and are they proving to be significant and growing? Secondly, Fran, could you discuss your choice to collaborate with an external company to enhance Abercrombie Kids and what that may imply for your other brands or sub-brands?

Good morning. Are you still there?

Good morning. I'm here. I'm here.

Okay. Yes, so exciting, the partnership that we just signed with Haddad. So we've talked for a while about the majority of our business being owned and operated and that we are continuing to look for opportunities to grow our business around the world. Our brands are stronger than ever, as you know, and an opportunity to partner to grow kids particularly outside of North America, where the majority of our business is today just speaks to long-term opportunities ahead for us.

On the loyalty effort, Marni, happy with the programs. They continue to grow. It is a great way for us to engage with consumers. But just like every other piece of the consumer engagement, we are always looking at them, how do we evolve? What is the next level for loyalty? So that's something that we continue to think about, just like every other piece of that customer engagement. So we are thinking about that today and we'll continue to think about it into the future. But to date, loyalty programs have been a great asset for us.

Is there a percentage of your customer base that comes through the loyalty programs? Is it 50% signed up or higher? I'm just curious.

Yes, it's higher than that. We haven't given an exact number, but it is a good piece of our sales come through that loyalty base.

Excellent. Thanks. I'll let somebody else take the next. Thanks guys.

One moment for our next question. Our next question comes from Alex Straton with Morgan Stanley. Your line is open.

Perfect. Thanks for taking the question. Congrats on a great quarter. I just have two for you here. One is just on the gross margin freight being higher. I feel like a lot of peers are actually speaking to it still being a tailwind. So I'm just curious, what is happening there and then your outlook for the rest of the year? And then for inventories, I saw 9%. I think it is the first time we've seen an inventory build like that in a bit. So I'm just curious how you feel about levels, composition? And how should we think about where that goes for the rest of the year? Thanks a lot.

Yes, on the gross margin side, freight has become a bit of a challenge for us in the latter half of the year. We've noticed that ocean rates have increased significantly, and that has been well reported in the market. Additionally, air rates are also on the rise. Freight coming into the US has been busier than usual for this time of year. This creates some friction in our outlook. We’re managing the ongoing situation in the Red Sea and other routes from Asia. Regarding inventory, it's up 9%, and we're quite pleased with it at this point. While units are up less than that, we have some additional freight costs due to the higher expenses and the shift towards Abercrombie, which has higher-cost products compared to Hollister. Hence, year-over-year, there’s a slight mix impact with that 9% increase. However, we have maintained tight control over units. Each brand is actively responding to market conditions, and we're looking forward to how this positions us for the holiday season.

Great. Good luck.

One moment for our next question. Our next question comes from Mauricio Serna with UBS. Your line is open.

Good morning. Thank you for taking my question. I apologize for dropping off a few minutes ago. Congratulations on the results. I have a couple of questions about sales. Could you share the growth you experienced in the UK and Germany? I understand you've worked hard to enhance the brand's positioning in those markets, so I'd like to hear more about that. Regarding the updated guidance for the year, it seems the sales outlook for Q4 indicates growth when excluding the impact of the calendar mix. What factors lead you to be somewhat more conservative about Q4 compared to Q3? Thank you.

Hi, Mauricio. Let's begin with the UK and Germany. It's great to see that these are our two largest markets in Europe and they're also among our fastest-growing. Our localization efforts over the past year have been concentrated on the UK and Germany. We've increased our marketing expenditures and enhanced our product offerings in these countries to drive focus and engagement. It's important to start with our largest markets, and we'll build from there. The positive performance in these two countries is significantly contributing to our success in the EMEA region. I am very pleased with what our teams are achieving there. Regarding our guidance for Q4, it's still a bit far off as we're focusing on Q3 right now. We're excited to report low double-digit growth in Q3 following over 20% growth last year. It's thrilling to highlight the strength of our brands and their ongoing growth. We will provide more details on Q4 as we approach it. Just to note, even after accounting for the 5.5 percentage points from the 53rd week, we still anticipate growth on top of last year's strong Q4 performance. I'm very satisfied with the positioning of our brands, the company, and our inventory as we look toward the latter half of the year.

Got it. And then just a quick follow-up on gross margin. I think if I understand the message from when you are talking about Q3 guidance, it kind of says that you expect gross margin to be relatively flat. Is that the same expectation for Q4? And like I remember like you used to provide a little bit more details on the contribution from cotton and average unit retail to Q2 gross margin gain. Could you provide any more details behind that? Thank you.

Yes, we have shared some details in the past. There were significant changes, but those factors have now stabilized, leading to less information being available. During our discussion about Q2, we observed good growth in average unit retail. We noticed a slight increase in cotton costs, which was countered by higher freight expenses. This is the scenario we are currently experiencing across the company. As we approach Q3, conditions are more stable as we navigate through these changes and return to the strategies we mentioned earlier. We aim to achieve some growth in average unit retail, although we expect some challenges from freight, and we will monitor the cotton costs for the quarter. This is our perspective on gross margin for Q3. We don’t have anything to share regarding Q4 for now, but we will address that in our next call.

Got it. Thank you. And congrats on the results.

One moment for our next question. Our next question comes from Dylan Carden with William Blair. Your line is open.

Thank you very much. I'm interested in understanding the opportunity for scaling the Abercrombie brand as it matures. Can you share any insights, even anecdotal, about the changes in the customer mix you’re observing, especially in comparison to pre-pandemic times? Additionally, information on repeat purchases would be helpful.

Yes, we've observed a noticeable shift in our customer demographics, especially compared to the pre-pandemic times. We aimed to differentiate the Hollister and Abercrombie brands because they were competing in the teen market. Our focus has been on attracting the Abercrombie customer who is slightly older, specifically targeting the post-collegiate and early mid-20s demographic, and we've experienced great success in this area. The average age of our customers is moving into the mid-20s, which is fantastic. Regarding customer retention and new customer acquisition, we are successfully attracting new customers through effective marketing strategies. We're also concentrating on retaining existing customers. In terms of Abercrombie, we've introduced various categories, such as Best Dress Guests, and collaborations like NFL and YPB, which allow us to offer fresh experiences to our customers each time they return. Our focus as a company and brand is on growing our new customer base and maintaining loyalty among our Abercrombie customers. We have a significant opportunity to keep these customers engaged for an extended period, and we are thrilled to see this reflected in our performance metrics.

Okay, thank you.

And I'm not showing further questions at this time. I'd like to turn the call back over to Fran for any closing remarks.

Thanks, everyone for joining the call today, and we look forward to providing more updates to you all soon.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.