Good day, everyone. Welcome to the Abercrombie & Fitch Third Quarter Fiscal Year 2018 Earnings Call. Today's conference is being recorded. [Operator Instructions] At this time, I'd like to turn the conference over to Scott Lipesky. Mr. Lipesky, please go ahead.

Thank you. Good morning, and welcome to our fiscal third quarter 2018 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Joanne Crevoiserat, Chief Operating 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, which we will be referring to in our comments. Before we begin, I would like to remind you that any forward-looking statements we may make today are subject to the safe harbor statement found in our SEC filings. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and a reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning. Also due to the calendar shift resulting from the 53rd week in fiscal 2017, third quarter comp sales are compared to the 13-week period ended November 4, 2017. With that, I will turn the call over to Fran.

Thanks, Scott. Good morning, everyone, and thank you for joining us today. We are pleased with our third quarter performance. We delivered another quarter of comparable sales growth across brands and improved net income, building on our strong U.S. business, while making progress with our ongoing transformation initiatives. Our focus on the consistent execution of our playbook, keeping the customer at the center of everything we do, continued to pay off. This marks our fifth consecutive quarter of comp sales growth for the company, the eighth quarter in a row of positive comps for Hollister and the fourth for Abercrombie. This also marks the first time in nearly 7 years the company has delivered positive comps on top of positive comps. I'm pleased to report this momentum has carried into the fourth quarter. We saw a solid start to the holiday season in November with strong double-digit growth on Singles Day on Tmall and a record performance of the peak holiday period from Thanksgiving Day through Cyber Monday. We remain on track to achieve top line growth, gross profit rate expansion and operating expense leverage for the full year. In addition to our Q3 results, this morning, we announced some important organizational changes. I am pleased to report we've appointed Hollister brand President, Kristin Scott, to the newly established role of President, Global Brands. Kristin will be responsible for driving the growth of all the company's brands globally, reporting to me. We also announced that we've eliminated the individual Brand President roles, and Stacia Andersen, Brand President of Abercrombie & Fitch and abercrombie kids, will be leaving the company. I am grateful to Stacia for the many valuable contributions she had made to stabilizing the Abercrombie brand. As part this organizational change, we've also combined the leadership of planning and…

Thanks, Fran. As Fran detailed, our third quarter results reflect another quarter of progress. Going through our third quarter results in more detail. Net sales were $861 million, slightly higher than last year, reflecting positive comparable sales of 3% and adverse impacts from the calendar shift resulting from the 53rd week in 2017, which impacted the top line by approximately $20 million or 2 percentage points, and adverse changes in foreign currency exchange rates of approximately $7 million or 1 percentage point. Q3's comp sales growth of 3% reflects positive comp sales of 4% for Hollister and 1% for Abercrombie. Our results were driven by a strong U.S. business, with positive U.S. comp sales for the quarter of 6% on top of the prior year comp of 6%. The International business saw a sequential comp trend improvement versus the prior quarter with comp sales down 3%. The trend improvement was driven by performance across the brands in Europe. Our direct-to-consumer business is performing strongly with solid growth across brands and geographies. For the quarter, total company DTC net sales were up 16% and represented approximately 28% of total sales compared to 24% last year. Gross profit rate was 61.3%, flat to last year. On a constant currency basis, gross profit rate was down 40 basis points, driven by slightly higher average unit cost. Our year-to-date gross profit improvement on a constant currency basis is a key indicator of a healthier business. I'll now recap the rest of our results for the quarter compared to last year on an adjusted non-GAAP basis. Excluded from our third quarter adjusted operating results were pretax benefits related to certain legal matters of approximately $3 million compared to pretax legal charges and store asset impairment of approximately $15 million last year. Starting with expense. Adjusted…

Thank you, Scott. We had another strong quarter of execution, and we're off to a solid start to the fourth quarter. We remain on track to deliver improved results this year, including top line growth, gross profit rate expansion and operating expense leverage for 2018. We continue to focus on transforming our operating model to deliver the best customer experience in a rapidly evolving retail environment. Lastly, I would like to thank all of our associates around the world for their passion and commitment as we pursue our strategic transformation. Thank you. And with that, I'll hand it over to the operator to start the Q&A.

[Operator Instructions] We'll take our first caller, Omar Saad with Evercore ISI.

Two quick questions. First of all, what gives you -- as you think about that low single-digit guidance for the fourth quarter, it sounds like you had a good start, so far. Are there other levers you have in hand that gives you confidence in that low single-digit guidance for the fourth quarter just given how much harder the compare, as you guys had such a great comp last year in the fourth quarter? And then I also wanted to ask about the reorganization around the brand presidencies. How do you think about why it makes sense to split -- to combine that function of Brand Presidents of Abercrombie and Hollister, especially given the positioning of those 2 brands has evolved and kind of really tried to have their own positioning separate from each other? Does it still make sense to consolidate the leadership at the top?

Omar, it's Fran. We'll start with you with the first question. So we feel like we are prepared to comp the comps as we head into the fourth quarter. We obviously spent a lot of time in the stores, spent a lot of time out there during the holiday weekend, and we're seeing a healthy environment out there. Walking around the malls, seeing energy, seeing consumers ready to shop, seeing lines, the promo environment to us feels fairly competitive as always for the fourth quarter, but does feel consistent to last year. Specifically, our inventories are clean. We have depth in the right categories. We have seen some good signs. Specifically, in our must-win categories for the quarter, starting in the third quarter, had a nice strong outerwear performance. That grows in importance as we head into the fourth quarter. We've had positive results. We had a launch of the new line for Abercrombie called the Ultra parkas and Ultra puffers. That's off to a strong solid start, and we've seen some of those in our -- as our best sellers. Additionally, as the weather got cooler, we've seen nice reaction to things like fleece and faux fur, sherpa. Our marketing, to date, we're seeing strong performance in that as well. And all of that is in our -- is considered in our outlook for the fourth quarter and for the total year. Specifically to your other question regarding the change in our reorganization, we are really building on stabilized foundations. Particularly excited that A&F just delivered its fourth positive comp in a row, and Kristin has really proved to be a brand builder. She gets extremely close to the customer. She will continue to oversee all product-facing teams with -- now with all brands. Her track record with Hollister and how that business has continued to grow, our eighth consecutive quarter there of positive comps. So we feel that -- very thankful to Stacia for the work that she did in helping us to stabilize Abercrombie and certainly build a strong assortment architecture. But today, moving forward, and being able to achieve our long-term ambitious goals for global business, we feel Kristin is the right person to do that.

And are there certain functions, Fran, that are going to remain at the brand level, distinct at the brand level? Or are there going to be a lot of consolidations in terms of the functionality?

The functions that we are consolidating will be, I guess, I would consider back -- operational. So for example, our planning and inventory management will now be under one lead. But all brands, all customer-facing functions will remain branded.

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

First, just a quick follow-up on the reorganization you were just discussing. Just curious how that impacts, perhaps, your longer-term SG&A growth outlook. And then separately, regarding the successful renegotiations of leases, I think you mentioned in the release, I think you changed your store closure plans for the year. Can you give us a sense of the profile of the stores that have seen the successful renegotiations? Are these lower-tier malls where you're entering some shorter-term leases? Or how many of these represent situations where the landlord is contributing to rightsizing initiatives for new A&F prototypes, for instance?

Mark, It's Scott, I'll grab the first one quickly. No impact to our long-term SG&A outlook here. This is just the continued evolution of our organization and how we're going to build the structure around the company, so no real change go forward.

Yes. Mark, it's Joanne. I'll pick up the store closures. We've been very active in aggressively managing our fleet, as we've watched the customer shopping preference change over time. We've invested in our digital capabilities and our omnichannel capabilities. And we've managed our square footage, closing several stores, over 400 stores since 2010. We continue to have a lot of lease flexibility with 60% of our U.S. leases expiring by the end of 2020. That flexibility has allowed us to do a number of things. It allows us to continually evaluate our fleet. It does allow us to negotiate with landlords on stores that are maybe not performing or underperforming economically. We have had some successful negotiations. The changes that we announced today reflect both successful negotiations with landlords as well as improved performance of our fleet. We are very focused on driving productivity. And the tools that we have at our disposal include not just store closures, but rightsizes, to your point, and investments that we're making in improving the experience. And we've seen those investments pay off in terms of productivity. So our focus is really on driving productivity in our store fleet and improving the customer experience, and we've been successful at doing that over time.

[Operator Instructions] We'll take our next caller, Paul Lejuez with Citi.

Can you maybe give us a sense of how each brand performed in the U.S. versus International? And I'm also curious about how gross margin came in relative to your expectations for each brand in the U.S. versus internationally.

Yes, I'll take it off here, Paul. On the brand performance and geography, we've mentioned that we were very pleased with our performance in the U.S. Total company, we had a 6% comp on top of the 6% comp last year. Hollister outperformed a little bit, which has been consistent with the trends, outperformed Abercrombie in the U.S. But both brands positive, so we continue to be pleased with that performance. Our gross margin, we haven't gotten into this by brand at this point. But in total, we were generally pleased with our performance at flat to last year. Obviously, FX has flipped against us here in the back half. But as we look forward into Q4, we still have an outlook and projection of flat to up slightly. And for the full year, we still expect to deliver that outlook of flat to up slightly.

Got you. And then anything -- and you mentioned the strong start to holiday. Any color you can give on how promotions look over that quarter-to-date period?

We had a solid start to the fourth quarter. As we did mention [ both ] brands, that we had record sales between Thanksgiving Thursday through Monday. We are seeing that the environment is about consistent -- competitive -- about consistent to last year from a promotional activity perspective at this point in time. We go into each quarter with an opportunity to reduce promotions, but we also go in ready to compete. So as we see it today, the environment looks healthy. Our inventories are clean, and we're ready to compete for the fourth quarter.

Next question comes from the line of Tiffany Kanaga with Deutsche Bank.

Given the 40 basis point decline in constant currency gross margin, would you dig into AUR and markdown rates in the quarter and how you're thinking about constant currency gross margin for the fourth quarter and into 2019, especially as freight is still a headwind?

Yes. Looking at Q3, specifically, as you mentioned, down 40 and FX neutral, flat on a reported basis. The primary driver here was a slightly up AUC. That was driven mainly by mix and then also some of the transportation headwinds that you mentioned. So AUR was up slightly on mix also, but just not enough to cover that increase in cost. So there's no real call-out to talk about from an increased markdown perspective. As we think about Q4, again, the outlook is for flat to slightly up. And as we -- we haven't talked about 2019 yet, but we'll be sure to cover that at year-end call.

We'll next go to Brian Tunick with RBC.

This is Kate on for Brian. I guess, first, if you could just dig in, in terms of what you're seeing in terms of tourist sales in the U.S. and also internationally. And then also on the sequential improvement in the International business, could you just speak to any headway you're making in terms of appealing to that local customer, particularly in Europe?

Okay. This is Scott. I'll kick it off with the U.S. tourism and then send it over to Fran for the International piece. In the U.S., as I mentioned a bit ago, we had a very strong U.S. business, a plus 6% comp on top of the 6% comp last year. The base U.S. business continues to more than offset some weakness that we see in tourism. We mentioned last quarter that we saw some softness in Florida on more of the South America customer. We have seen a little softness on the coast out of Europe. But again, we've been able to overcome that with the strong U.S. business. Given the geopolitical and currency environment, we expect this softness to continue in the U.S., and that's baked into our outlook for Q4. I'll hand it over to Fran.

Sure. Kate, so we did see sequential improvement actually in both brands. We saw that both from second quarter to third quarter as well as seeing it throughout the quarter, certainly as the weather even turns more seasonal towards the end of the third quarter. For Hollister, we are leveraging our local insight to adjust our assortment, making them more wear now. But we did see A&F also improve sequentially. There, we're focused on, as you know, really transitioning from our flags to local mall-based stores. We just opened our first European mall prototype, and we're off to a solid start in Trafford. But overall sort of big picture, our international penetration is still low. We see opportunity to grow, as stated in our Investor Day and our future plans.

Our next question comes from the line of Simeon Siegel with Nomura Instinet.

This is Julie Kim on for Simeon. Could you give more color on your thoughts around marketing spend as we wrap up the year as well as looking into next year, and the return you're seeing, kind of where that spend is being allocated?

Julie, it's Fran. We have increased our marketing spend. As we head into the fourth quarter, we're actually seeing nice results from our investments. We've done a lot of work on integrating all of our campaigns, as we refer to them as a real 360 in our business. Our integrated campaigns are paying off. We mentioned earlier today we had a strong back-to-school campaign for Hollister. We won a Billboard Music Awards for that. But what you see in our marketing is every channel that you go to, whether it's through our AwesomenessTV show, whether it's Instagram, in-stores or e-mails, it's very connected. In Abercrombie, as well, we just came off a strong integrated campaign, launching our new coat line for Abercrombie, the Ultra puffers and Ultra parkas. But I'll hand over the specifics then to Scott.

Yes. Thanks. For all those reasons, we're going to continue to increase our investment as we move into Q4. That is baked into our OpEx outlook. And one quick add there is part of our transformation initiatives that we've been going through is really trying to understand the return and the effectiveness on our marketing. We've made great progress this year. So while we're increasing spend, we're also making sure the underlying spend that we have is more effective and giving us a great return. So again, that is baked into our Q4 outlook, and we will increase the spend.

Next question from the line of Janet Kloppenburg with JJK Research.

Fran, I was wondering if you could talk a little bit more about the International store performance progress that you saw in the third quarter and what the outlook is. And I was also wondering if you could talk a little bit about other operating expense pressures for next year. People are talking about further wage pressure, freight pressure, et cetera, and how that may impact your outlook for operating margin improvement next year. And just lastly, on the A&F brand, slower to turn than Hollister, and if you could talk about your outlook there and the opportunity for accelerated traction at A&F.

Janet, it's Joanne. I'm going to jump in on the first one regarding the International store performance. As we mentioned, we did see sequential improvements in the International business, really driven by improvement in Europe across both brands. As Fran mentioned earlier, a couple of drivers there. One was certainly the weather change as we moved through the third quarter, really helped lift some of our seasonal categories as we moved through the third quarter, but we also made adjustments to our wear-now assortments, and we saw the customer respond to those as well. We are very focused on getting closer to our customers in this market and taking the playbook that has been so successful in the U.S. and moving it to our International markets. We're in the early stages of that right now. We've rolled out our loyalty programs internationally. We're getting our teams closer to the customer and beginning to execute more marketing initiatives in those markets, and we expect those to pay off. We see a lot of runway in the future. Our opening of our A&F store in Manchester shows some early promise. We see nice productivity there, but we also see a building digital business around that store. So we know that there's some white space for us, particularly with the Abercrombie brand as we open in international markets. As it relates to OpEx pressure...

Yes, I'll pick up the OpEx here, Janet. So consistent story here on wages and inflation. Throughout the year, we have seen wage inflation in our distribution centers, in our stores. Those increases have been reflected in our outlook and our actuals throughout the year. From a distribution center performance, we continue to be pleased that we're competitive in the markets that we're operating in and see no issues there. And then on the store side, mostly a part-time workforce here. We continue to see minimum wage inflation. We've seen this for years, and we expect to see this for years to come. So without getting into 2019 specifically and going back a little bit to our 2020 goals that we talked about in the Investor Day, this inflation has been baked in, and we don't see updates needed to that right now.

Janet, it's Fran. I'll take the third part of the question. We -- so we are pleased with the progress that we continue to make in the A&F brand, coming off our fourth positive comp in a row. We are still on a journey. We've talked about that before, but we are seeing really positive signs for the A&F brand. For example, our internal and external brand health metrics are up and trending positive on the year. We are making nice progress executing our playbook and very confident, with Kristin moving into her new position, really getting us even closer to the customer and in charge of all those product-facing teams, that we will continue to move the brand forward. That is baked into our outlook for Q4.

[Operator Instructions] We'll next go to Susan Anderson with B. Riley FBR.

I was wondering maybe if you could talk about the A&F brand. It's nice to continue -- to see that continued better performance there. Maybe if you could talk a little bit more now about what's working. It sounds like outerwear was strong, but maybe in the other categories. And then also, as you look out, the opportunity to maybe potentially even accelerate the comps. And looking at the customer, any thoughts or data around, are you starting to see new customers come into the brand?

It's Fran. So we are seeing good cross-channel traffic growth, which really is illustrated in our brand traction. We are also seeing positive movement in our brand health. That's measured both internally and as well as externally. We're seeing nice strength in our core U.S. business. We did talk a bit about the outerwear. Our must-win categories also continued to perform and have grown in importance as we move throughout the year. Another category would be fashion denim, where we've seen a nice response to that category as well. We've launched our ambassador program. We've had a solid response to that as well. That's really helping us create, what we call, user-generated content that the customer is responding to. Additionally, our loyalty programs are growing. We have considerably more members in our program than we did last year for fourth quarter. So we are -- we're pleased with where we are and prepared to compete for the fourth quarter.

And we'll take our last question from David Buckley with Bank of America Merrill Lynch.

Hoping you could just discuss the traffic trends you saw for the quarter for stores. And then looking to 2019, what's your AUC outlook?

This is Scott. I'll grab this one. Fran just mentioned, but we were pleased with our cross-channel traffic growth for both brands, remained positive for both brands. We view this as evidence that our growing loyalty base and improved marketing efforts are working. As we think about the store traffic, we continue in the U.S. to outpace the malls, which, again, makes us feel that our efforts are working. In the end though, we're trying to balance that traffic growth with conversion and AUR to deliver profitable growth. And as we mentioned earlier, also, our OpEx outlook includes continued investment in marketing. And we feel that, that can help us continue this traffic trend into Q4. Too early to talk about 2019 at this point as we'll cover that on the end-of-the-year call.

Thank you. We are pleased with our year-to-date performance and are excited about the holiday season. Coming off a solid start to the holiday weekend, our global team is excited and ready to compete in fourth quarter and ready to deliver top line growth, gross profit rate expansion and operating expense leverage in 2018. And I look forward to updating you on our progress at year-end. Thank you for your continued interest and support, and have a great day.

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