Good day, and welcome to the Abercrombie & Fitch Second Quarter Fiscal Year 2017 Earnings Call. Today's conference is being recorded. [Operator Instructions] At this time, I'd like to turn the conference over to Brian Logan. Mr. Logan, please go ahead.

Thank you. Good morning, and welcome to our second quarter earnings call. Earlier this morning, we released our second quarter sales and earnings, income statement, balance sheet, store opening and closing summary and an updated financial history. Please feel free to reference these materials, which are available on our website. Also available on our website is an investor presentation, which we will be referring to in our comments during this call. Today's earnings call is being recorded, and the replay may be accessed through the Internet at abercrombie.com under the Investors section. Joining me today are Fran Horowitz, Chief Executive Officer; and Joanne Crevoiserat, Chief Operating Officer and Chief Financial Officer. After our prepared remarks, we will be available to take your questions. [Operator Instructions] Before we begin, I remind you that any forward-looking statements we may make today are subject to our safe harbor statement found in the SEC filings. In addition, we'll be referring to certain adjusted non-GAAP financial measures during the call. Additional details and a reconciliation of GAAP to non-GAAP financial measures are included in the release issued earlier this morning. With that, I turn the call over to Fran.

Thanks, Brian. Good morning, everyone, and thanks for joining us. We are encouraged by our results for the second quarter, with overall net sales close to flat and another sequential quarter improvement in comp sales. Hollister, our largest brand, is performing strongly, even in a tough environment, and we continue to show improvement at Abercrombie & Fitch, which is on track. We have a highly experienced and talented team, and we are benefiting from that depth of experience. We are making clear progress, with the continued aggressive execution of our business plan. While we are only partway through our revitalization journey as a company, the areas we are focusing our time and investments are yielding the improvements we expect to see. We maintain a steadfast focus on staying close to the customer and on providing a unique, engaging customer experience across all touch points. In addition to our ongoing advances in digital engagement in stores, we have made strategic investments to build depth behind our core items in a more focused and balanced assortment, ensuring we have sufficient depth of product in style, color and size to meet customers' needs. We've also strengthened product presentation and display. This has all made easier for customers to locate popular core items, enhancing their overall store experience. The key related metrics we track, such as brand health scores, our voice of the customer data and Net Promoter Scores, are trending upwards and reinforce our confidence in our strategy. Hollister capitalized on momentum it has been building over the last few quarters to deliver a 5% increase in comp sales and a 6% increase in total net sales. Hollister continues to leverage high levels of customer engagement to drive growth across all touch points. It demonstrates how our customer response when product, brand voice…

Thanks, Fran, and good morning, everyone. As Fran mentioned, our second quarter results reflected clear progress across all brands, with the continued aggressive execution of our strategic plan. We delivered our third consecutive quarter of sequential comp sales improvement, resulting in overall net sales down less than 1% versus last year. We are tightly managing the business in a difficult environment, driving expense leverage, while still supporting those initiatives that are driving top line improvement. We maintain a strong balance sheet, providing us with the stability and resources to execute against our strategic plan, invest in our business and make the necessary investments to accelerate our brands' performance in this rapidly evolving retail landscape. I'll briefly cover our second quarter results, then update our full year outlook. Starting with the second quarter results. Net sales were $779 million, down slightly from $783 million last year, but up slightly on a constant-currency basis, with FX adversely impacting sales by approximately $5 million. Comp sales for the quarter were down 1%, with improvement from last quarter delivered across both brands and both geographies. Global traffic trends continue to improve from last quarter, particularly in our physical stores, which included solid year-over-year growth in U.S. Hollister stores. As shown on Page 6 of our investor presentation, by geography, comp sales for the quarter were flat in the U.S. and down 1% in international markets. By brand, comp sales for the quarter were up 5% for Hollister and down 7% for Abercrombie. Hollister continues to build momentum, delivering positive comp sales in both geographies and channels and demonstrates how strong customer engagement drives growth across all touch points. Abercrombie also showed progress, with comp sales improving from last quarter across both geographies. Our direct-to-consumer business delivered another quarter of growth in both the U.S.…

Thank you, Joanne. As I said earlier, we are encouraged by the meaningful progress this past quarter, but we are far from satisfied. We are still focused on continual improvements on the basics, on delivering excellence in all aspects of our execution and all with a view to inspiring customers, innovating throughout our business and developing our leaders to help drive our future success. Finally, I want to say a word about the team we have in place here. I can confidently say this is one of the most talented teams I've worked with. The depth of talent across the organization from our global supply chain operations, to DTC, to consumer insights, to stores, to real estate, every aspect helps keep us close to our customer and inspire, surprise and delight them. The passion and commitment the whole team has shown and continues to demonstrate in a tough environment, and its ability to maintain focus during this past quarter has been an inspiration. Over the past months, as I've been in our stores in Arizona, New York, Texas and China, to name but a few, I have been energized by the excitement and passion my colleagues consistently show for the company, the brands and the journey we are all on together. I remain confident in our strategic plan and our team's ability to execute on it. I would like to thank all our teams for their energy, passion and dedication to continuing to move our brands forward. Now I will turn the call back to Brian.

Thanks, Fran. That concludes our prepared comments. We will now be happy to take your questions. [Operator Instructions] Thank you.

[Operator Instructions] And our first question will come from Tiffany Kanaga with Deutsche Bank.

Could you give some color around the cadence of the quarter, especially how July fared, given positive commentary from your peers? And how your August trends compare to your second half guidance?

Tiffany, it's Fran. As we mentioned, we are encouraged by the progress that we made in both brands. We don't specifically comment on cadence within the quarter, but I will tell you that we had a strong performance throughout the quarter. Specifically in A&F, we did see sequential improvement throughout the quarter. We saw that in actually both our men's and women's business, especially across our tops business, and we are encouraged by the progress that we continue to see.

And Tiffany, we don't comment on current quarter performance, however, I would say that our outlook incorporates what we're seeing quarter-to-date.

I wanted to also ask how much of the sequential improvement in gross margin in the second half do you anticipate to be driven by FX tailwinds versus moderating AUR declines and lower AUC?

FX is definitely going to be an important part of the story. As we mentioned in our prepared remarks, FX was a headwind in the front half of the year, and we expect it for the full year to be a tailwind. So definitely an improvement to AUR and to gross margin as we move through the back half. But we also expect improvement on our AUR trends to be driven by the improvement in the assortment that we're making and the better balance in our inventories and customer response to our improved assortments. It's about -- Tiffany, the FX piece is about half, roughly. It's roughly about half the improvement we're expecting from the first half.

And we will now go to Brian Tunick with Royal Bank of Canada.

This is Kate on. Fran, I guess I just wanted to talk a bit more about the A&F brand repositioning. It sounds like you're definitely pleased with some of the progress. If you could just talk about where you see the greater challenges, as well as the opportunities for that brand in the next few quarters, that will be helpful. And then nearer term, as we're looking ahead to the back half, are there just any categories across both brands that you see greater opportunities with?

Sure, Kate. So yes, we are pleased with our progress that we've made with A&F. As you know, we've talked about it before, our revitalization journey for this brand started a little bit later than our Hollister journey did, but we've had another quarter of continuing progress. We continue to apply the Hollister learnings. And as I mentioned, we did see sequential improvement throughout the quarter. This improvement was in both genders and in many, many categories, especially the tops category for both genders we did see improvement. As we move into the back half of the year, we believe that the improvements that we've seen are in categories that play more important in the back half of the year, and that these improvements will continue to gain traction as we move through the back half.

And I'll add to that, Kate. We are applying the learnings from Hollister and we've got process embedded and the teams are executing well against it. We continue to expect to see reduced SKU count and more depth behind our big top 30 items. We're driving better presentations throughout the store. We have a lot of things working for us in the back half, including the prototypes and the learnings from the prototypes, but also the A&F Club rollout, again, a little later than Hollister, but with over 2 million members in the A&F Club and growing strongly every week, it's an opportunity for us to continue to engage more customers and leverage that platform, both to learn and respond and react in the back half, but also to leverage that as a platform to engage customers and drive them to our stores.

And our next question comes from Mark Altschwager with Robert W. Baird.

I wanted to ask on the comp outlook. Would you expect to see sequential improvement at both brands in the back half of the year? I know there was quite a divergence between Hollister and A&F in the back half of last year, so just getting -- trying to get a better sense of your expectations there. And then separately, I wanted to follow up on the A&F Club program. Just given the brand repositioning, I'm curious if there have been any insights regarding your customer demographics, spending habits or anything that you've really found surprising relative to your expectations?

Okay, Mark, it's Fran, we'll start with the first part of your question, as far as the comp outlook goes. As we mentioned, 2017 we see approximately flat with the back half flat to up slightly, and we are anticipating to see still a promotional and challenging environment. Continued strength in both brands, in Hollister as well as the continued improvement in Abercrombie. We have invested behind core items in both brands. We've made significant efforts in building big, bigger. We talked a lot last year at the end of the year how we disappointed our consumer on size and color because we were not in position in many of our key items. We feel that we've really made sure that we have optimized this opportunity. We feel well-positioned as we head into the back half. Specifically on A&F Club, the insights are early. It's in the beginning stages of its club life, I guess, I would like to say. It's a bit behind the Hollister club life, but we are seeing strong interaction from those consumers and learning, really reacting and listening to those customer insights.

And we will now go to Stephen Albert with Bank of America Merrill Lynch.

I was just curious if you could comment a little bit on the gap between comp and non-comp growth or total sales growth being pretty much the same. There are no gap there. Online was up 4%, so that's only contributing maybe a point, it's 1/4 of your business. Can you talk to, yes, you're closing 5% of your fleet, what types of sales recapture are you seeing from those closed stores? What sort of contribution is wholesale to your top line?

Yes, so you hit on all the pieces, I think, Stephen. The gap between comp and non-comp would reflect a difference in closed stores and likely a bit of our remodel cadence from last year as well. So the net new stores and offsetting closed stores, as well as some growth in our wholesale business as well, would be contributing to a smaller gap there. In terms of sales recapture with closed stores, that's an opportunity for us. We have historically seen fairly low recapture. It's fairly dependent on how close, the proximity of another store in the market. We do see the DTC business to be a bit sticky after we close a store, but we don't see a lot of the brick-and-mortar sales migrating. That recapture has been relatively low, again, higher in places, in markets where we have other stores. But the efforts underway with our loyalty programs are intended to help us engage and keep those customers more engaged in our brand, even after a store close. So more to come on that.

[Operator Instructions] We will now go to Adrienne Yih with Wolfe Research.

This is Doug Drummond on for Adrienne today. As you accelerate store closures and see natural leases expire, are you starting to realize impacts will benefit from better rent occupancy terms? In that vein, has there been any meaningful lowering of your required comp to lever buying and occupancy expenses?

Yes, thanks for the question, Doug. Our store -- we've been on a path, store closure path, for quite an extended period of time. I think we mentioned in our prepared comments we've closed over 400 stores since 2010, and it's in an effort to rightsize our store fleet in what is an evolving retail environment, where consumer shopping preferences are changing. We do see the store as a very important part of the story as we move forward, and we're investing back into our stores to ensure that we're delivering the right experience at store level, both with our omnichannel investments, but also with our new prototypes and remodels, where we're providing a much better shopping experience, in many cases, on lower square footage. So the flexibility that we have in our lease portfolio is providing us with an opportunity to address those issues. And it's not just about store closures, it also includes negotiating with our landlords on lower rents or also downsize opportunities in certain malls or relocations within malls. So we have a number of tools in our toolkit available to us to help drive productivity. And at the end of the day, it's that productivity that's really driving the leverage in rent. And we were pleased to see in the second quarter that we did deliver leverage on store occupancy for the quarter, and we continue to value the flexibility that we have in our lease portfolio to make those decisions as we move forward.

And our next question comes from Susan Anderson with FBR Capital Markets.

I was -- I guess I wanted to maybe drill down a little bit on the expense side. How should we think about kind of the ability to continue to adjust your cost structure? Is there kind of more room to reel in expenses going forward? And then just really quick on the promotional front. So it sounds like you guys are not really expecting anything to change in the back half in terms of the promotional environment. Is that what I should assume is contemplated in the guidance?

Yes, I'll kick it off, Susan, on the cost management. We have had a long track record of success in taking cost out of the business, and we have a strong culture of cost management now embedded in the company. We set a pretty high target this year at trying to drive about $100 million of gross expense out of the business, and we are on track to deliver against that target. We continue to expect to drive at least the 3% reduction in OpEx for the year. That has afforded us the opportunity to also invest back into the business. So as we think about our cost structure, we're thinking about it both from a where we can drive efficiency and continue to drive efficiency, but also where we need to invest to continue to position our brands for the long term. And we have made investments back in marketing, and we have made investments in DTC and in store and the store experience and in associate training, to help drive the top line, while at the same time, driving efficiency overall in our model. And I think the second quarter results speak nicely to the progress we've made, and I'm very proud of the team's ability to deliver against those objectives that we set. But we showed leverage in basically every line item in operating expense this quarter.

I'll take the second part of that question, Susan. It's Fran. We had a very solid execution in a very tough environment for the second quarter, evidenced by both improvement in A&F and a really strong performance in Hollister. So as mentioned, we do expect to see our gross margin down in 2017 overall and approximately flat in the back half. The promotional environment will continue, we said that we expect, but we also believe that we are positioned for better execution than last year. We are expecting lower AUC and a moderation in our AUR decline. The moderation will really be supported through better assortment balance, as Joanne mentioned, strengthening of the dollar and improved product acceptance. And we've worked through the tail, and we feel like the assortments -- we feel we're well-positioned in the back half.

And we will now hear from Marni Shapiro with The Retail Tracker.

I just have 2 quick questions. I wanted to clarify, I think you said that traffic at Hollister in the stores was up and I'm curious if this was true across regions and if it was driven by anything quantifiable, like a drop of a new product assortment or the weather. And then if you could just remind us, was Gilly Hicks out in the stores last Back-to-School and holiday? And what are the plans, I guess, for this year versus last year?

Sure, Marni, it's Fran. First question regarding traffic, we did see an improvement to our overall U.S. traffic to our Hollister stores throughout the quarter and conversion as well. We really believe that the reason driving that traffic is our strong engagement with the customer. When we get our products, and our voice and our engagement aligned, we get a nice reaction from the consumer. And with all the work that we're doing through our marketing efforts, we really believe it's what drove that traffic. On your second question regarding Gilly, we had small quantities of Gilly out there in the back half of the year, but the true launch, the global launch, was in the beginning of 2017.

And our next question comes from John Morris with BMO Capital Markets.

This is Trevor Lamb on for John Morris. Pertaining to the store remodels, I was wondering for the stores that have been open now for over a year, have they sustained traffic levels? Also, are they seeing an increase in new customer acquisition or customer retention? Any color on that would be helpful.

Trevor, yes, the remodels that we've done in the Hollister store have shown very sustainable improvement. Those -- the improvement, and we've been on this path for a couple of years now, and those stores that we've touched have maintained their improvement as we move forward. And we are excited to see that even as we reach further into the fleet, even our latest remodel stores in Hollister have been performing and driving nice returns. In terms of customer retention, we are seeing much stronger customer engagement overall. In fact, in all brands, we're seeing -- we're building higher new-to-file customers, so that we're growing new customers to our brand and the retention rates of our customers across all brands is improving.

Great. And then on the e-commerce business, I was wondering if you guys could give some color on the performance differences between A&F and Hollister and if it is similar to what you're seeing at stores?

Yes, we have -- we're pleased with our e-commerce performance. We continue to leverage that channel. Our penetration overall in the e-commerce business is strong. We have, at 24%, a very high penetration of digital business and increasingly strong customer engagement on our omnichannel functionality that we're rolling out. By brand, the performance has been strong in both brands, and we continue to expect to leverage this platform. Our customer base is increasingly using digital as a way to engage with our brands, both pre-purchase and for purchase activity. We continue to invest in our capabilities here, not only in our omnichannel capabilities, which we're rolling out to international markets for the balance of the year, but we're also investing in our mobile platforms. We mentioned in our comments that over 2/3 of our traffic is now coming through mobile devices, and we're engaging our customers, not only with our digital transactional information, but we're engaging our customers with our marketing efforts in the digital environment, with very innovative marketing techniques that engage the customer pre-purchase, as they're in the discovery process. And that has aided our ability to drive the digital business. And then the investments we're making in that experience are driving strong double-digit conversion across the brands.

And we will now hear from Dylan Carden with William Blair.

On the new A&F prototype, is there an opportunity here over the next 2 years, if you think about your lease negotiations, to accelerate that rollout, particularly as landlords increase their TI allowances? Is that something that you're finding sort of more receptiveness to?

Joe, it's Fran. We are excited about our new prototype, it's the first prototype that we've launched in 15 years. It's early stages, though. What we have learned from our prototypes, I've been -- I actually had the opportunity to visit many of them and engage with our consumer, is that they are really responding to the light, the changing room, the technology, our associate engagement. So we have lots of learnings. It's early in its life, and we're going to continue to learn from those. And we will get back to you later in the year as we have more learnings on our rollout plan.

I will say, Dylan, that we're excited by our new prototype. It is a fresh new look in the malls, and our landlords are excited by it as well and are excited to have us roll that out. And we partner very closely with our landlords, and will work with them as we develop our further rollout plans.

And our next question will come from Kimberly Greenberger with Morgan Stanley.

This is Lauren Cassel on for Kimberly. I just want to ask about inventory. I think this is the first quarter to increase in almost 3 years. Could you maybe talk about units versus AUC and then increases by brand as well, please?

Lauren, it's Fran. We believe, actually, our inventory has been a catalyst for the improvements that we've seen in both brands throughout the second quarter, and we believe that we are actually well-positioned as we head into the back half of the year. We really disappointed our customer last year, not being in position in size and color in many of our key items as we made it through the back half. So we've made some very strategic investments to build depth behind our core items. For example, in Abercrombie men's, we have built a very authoritative wall in our boxed underwear and T-shirt program that is beginning to show lots of strength. We've strengthened presentation, such as the one I just mentioned, has really enhanced our overall store experience. But we're current, our inventories are current, they're well-balanced and they are really positioned to drive business. We're ready to compete in the back half.

And Lauren, on your question on units versus costs, they're about -- they're aligned, they are very close.

And ladies and gentlemen, that concludes our question-and-answer session for today. I will now turn the call back over to Fran Horowitz for closing remarks.

Thank you. To reiterate, we are encouraged by our progress, with another great quarter at Hollister and continued improvement at Abercrombie & Fitch. We continue to make quantifiable progress by successfully applying learnings from Hollister to A&F. We will continue to tightly manage the business, positioning our resources behind our strategic priorities to drive both bottom line improvements, while funding top line growth initiatives and keeping us close to our customers. I remain confident we have the right plan and the right people to execute successfully against it. Thank you for joining us.

And that concludes our call for today. Thank you for your participation. You may now disconnect.