Good day, and welcome to the Abercrombie & Fitch Fourth Quarter Fiscal Year 2018 Earnings Call. This 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.

I'll turn it over to Pam.

Thanks, Scott. Good morning, everyone, and welcome to our 2018 Fourth Quarter Earnings Call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; Joanne Crevoiserat, Chief Operating Officer; and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our fourth 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. 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 uncertainty that could cause actual results to differ materially from the expectations and assumptions we mention today. A detailed discussion of these factors and uncertainties is contained in the company's 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 reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning. With that, I will turn the call over to Fran.

Thanks, Pam. Good morning, everyone, and thank you for joining us today. I am happy to be here to discuss our fourth quarter and full year 2018 results. It has been quite a year for us. At our Investor Day in April, we laid out an ambitious agenda. And our team has delivered, successfully completing the first full year of our transforming while growing phase. As a result, we grew top line. We comped the comps, posting our sixth consecutive quarter and second consecutive full year of positive comparable sales. We achieved over $1 billion in annual digital sales. We drove gross profit rate expansion in a highly competitive environment. We delivered operating expense leverage, and we had 100 basis points of adjusted EBIT margin expansion and a 77% improvement in adjusted net income. Most importantly, we remain on track to deliver our previously disclosed fiscal 2020 targets including doubling our 2017 adjusted EBIT margin. We delivered these results while making important progress on the transformation initiatives that we outlined on our Investor Day: optimizing our store network, enhancing our digital and omnichannel capabilities, increasing the speed and efficiency throughout our concept-to-customer product life cycle and improving our customer engagement through our loyalty programs and marketing optimization. Throughout the year, we were laser focused on our playbook and aligning product, voice and experience across all touch points. Our customer is our driving force and always at the center of everything we do. Our goal is to be there for them whenever, wherever and however they choose to engage with us. We provide them with product and branded experiences that are relevant to their everyday life, and the customer is responding. Turning to our fourth quarter accomplishments. At Hollister, we delivered a 6% comp on top of an 11% comp in…

Thanks, Fran, and good morning, everyone. I'm excited to walk you through our strong end to the year and our outlook for 2019. Starting with the fourth quarter. Total net sales of $1.2 billion declined 3% from last year. As a reminder, we had a combined, adverse impact of approximately $60 million from a calendar shift and the loss of fiscal 2017's 53rd week and an additional $15 million adverse impact of changes in foreign currency exchange rates. Comp sales came in at plus 3%, representing our sixth consecutive quarter of positive comps against our most difficult comparison of the year. Our marketing and loyalty investments continue to deliver positive cross-channel traffic, which was the key driver of our comp growth. Our largest brand, Hollister, achieved a 6% comp, while Abercrombie was negative 2%, reflecting previously disclosed women's tops and dresses challenges. Kristin and team are aggressively working through the underperforming classifications, and these ongoing efforts are reflected in our sales and margin outlook. By geography, we had positive comp sales of 5% in the U.S. International comps were negative 2%, representing a sequential improvement from Q3. In Europe, we saw a sequential improvement at Hollister, offset by continued weakness in our Abercrombie flagship locations. In China, demand was strong across brands, as we continue to focus on driving the digital business on Tmall and our owned sites. As Fran mentioned, we surpassed the $1 billion mark in annual sales for the digital channel. For the quarter, digital sales grew to approximately 36% of total sales compared to 34% of total sales in Q4 last year with gains across brands and regions. Gross profit rate rose to 59.1%, up 70 basis points from last year. On a constant currency basis, net of hedging, gross profit rate was up 20 basis…

Thank you, Scott. 2018 marked the first full year of our transforming while growing phase. We put a plan in place and successfully executed to it. With that as a foundation, we are building on recent momentum, and we'll continue to strategically invest on transformation initiatives, enabling us to drive growth for each of our global brands. We are so excited about the future, and I would personally like to express my gratitude to all our associates around the globe for their passion and commitment, as we continue along with our journey. Thank you.

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

[Operator Instructions] And our first question comes from Paul Lejuez with Citi Research.

Question about Gilly Hicks. Any way you can size that business up for us, maybe remind us how many stores had the Gilly product in F '18? What sort of comp lift did it provide? And curious, how big of an online business that is as well? And what your plans are for Gilly in F '19.

Paul, it's Fran. I'll kick off that question. So we currently actually carry Gilly in all of our stores globally around the world. We did actually revamp the product for back-to-school this year and had really nice product acceptance and an accelerated growth in the back half. But we are still very much in the test and learn phase with Gilly. We're trying different concepts, so for example, we opened up 36 carveouts in '18, and we opened up 3 side-by-sides, which we're seeing nice success with. It's a very synergistic customer to our Hollister customer, and we're going to continue to test and learn as we head through '19.

Yes, just to add-on to the end there, Paul, we will open additional carveouts in 2019. They have about 10 scheduled, and then 10 to 15 additional side-by-sides, and those side-by-sides are those stores where we have, kind of, a separate entrance and a little more marketing around the Gilly brand. So it's a nice way to get to the customer.

Our next question comes from Kate Fitzsimons with RBC Capital Markets.

Congratulations on the improvement in the quarter. I guess my question would be on the Q1 outlook of flat to up low-single digits for Q1. Can you just compare that to what you're seeing here in February? We've heard some chappier comments out of some of your peers. Any color by brand or region would be helpful. And then if you could just speak to what leverage do you see taking place through 2019 to get you to that low-single-digit guidance for the year?

All right, Kate, I'll kick it off with Q1. As you know, we don't comment on the current quarter business. For the quarter, as we laid out, the outlook is for comp sale to be flat to up 2%, and we are focused on delivering that. That outlook, as we're sitting here on March 7, that reflects our quarter-to-date trends and our assessment of any potential impacts. We know the Easter shift is coming. The weather is cold. The macro situation is bouncing around in Europe, and tourism is tough in the U.S. So we've tried to reflect all of those things into our outlook for Q1. I'll kick it to Fran for the levers.

Well, we're definitely prepared to comp the comp. Our customer remains very solid in the United States. We are pleased with where our inventory is. We mentioned the near term dresses and tops challenges, but that's obviously also baked into our guidance. We've seen some nice selling from our spring categories so far. We're very excited about our marketing and our integrated campaigns. We recently, as you know, relaunched Fierce. We've had very strong acceptance to that. We're heading into '19 with strong loyalty across brands. We doubled those numbers in '18, and we have lots of customer that are engaged and excited about our business. And then lastly, we're continuing to invest in our stores and our omnibusiness, and we see all of that as very positive as we head into '19.

We'll next go to Omar Saad with Evercore ISI.

This is Shayne Arcilla for Omar Saad. I'd like to know -- I was wondering if you could provide more color on the performance of the A&F kids and how trends have evolved? And also, could you provide more color on your brand ambassador programs, especially how the trends have evolved for the Abercrombie brand ambassador program that you started last summer?

This is Fran. I'll start with kids. So we are pleased with our performance. We had a solid year in kids. We're excited that our customer, both our kid and our parents, are really responding to our product and our experience. The kids seems to love wearing it, and the parents seem to love putting them into it. We believe that our kids business has opportunity. There's market share out there to be had, obviously, based on some recent news that's out there. We've opened up some very productive prototypes, and we are continuing to test and learn as things move forward with this business, but overall, pleased with the performance. We have a successful Hollister program, the brand ambassador program, which is the first-ever High School Ambassador program. We recently have actually transitioned our brand ambassador program with A&F, and we've created what we're calling a sounding board -- or board of directors -- of our consumer to understanding, get closer to our customer. But with that said, we're still using lots of influencers. Our current relaunch of our Fierce fragrance has been successful through a very exciting influencer program that we launched.

We'll next go to Simeon Siegel with Nomura Instinet.

Yes, this is Dan Stroller on for Simeon. Could you give any color on what the comp cadence for the quarter and then any traffic trends? And then also, how is the tourism performing overseas?

I'll grab this one. This is Scott. We don't get the monthly breakdown for the comp cadence in Q4. We were pleased with the results in Q4, delivering the plus 3 on our hardest comp from last year, the plus 9. So comping the comp was a good show of momentum for us. As we think about the tourist business, I'd say it's been difficult in the U.S, we've talked about this the last couple of quarters, along the East Coast and down into Florida. We've seen challenging tourism from Europe, Asia as well as South America. Obviously, the geopolitical environment is pretty tough out there; currencies are weak compared to the US dollar. So I think that's all contributing to the tourist pattern.

We'll next go to Susan Anderson with B. Riley FBR.

Sorry, if I missed this. I hopped on a bit late. But I was wondering, can you just talk about just kind of the breakout between the international comps and the U.S. by brand? And I guess specifically for Abercrombie, if you saw better performance in the U.S. and the product issues that you had in the U.S., and when you guys kind of expect that to be fixed?

I'll kick off actually, Susan, with the second question. With our A&F business, yes, we did perform better in the U.S. than we did international for A&F specifically. Although, A&F for the year did positive comp, and we are excited to see the brand really stabilized. We have -- believe that we have isolated those issues specifically to tops and dresses in the women's business. We are super excited. I'm sure you've heard that we have Kristin Scott at the helm now. She's our Global Brand President. She's been at the job for about 90 days and has really dug in with the team and applying a lot of her learnings in the Hollister playbook and helping us to evolve the product in Abercrombie. We expect that each delivery, we will see improvement, and we'll really see her handwriting in the back half of the year.

Yes, I'll grab the comps on the U.S. On the U.S. piece, the comps, continue to be very happy with the performance we've seen in the U.S. across brands. In total -- we haven't given the level down to the brand at this point. But in total, we delivered a plus 5 in Q4 of 2018 and that was on a plus 11 from Q4 of '17. So in light of some of that U.S. tourism difficulty that I talked about a minute ago, we're still delivering strong comps in the U.S. and as Fran mentioned, continue to see that customer remain solid in the U.S.

And I...

Go ahead.

I was going to jump on the international. As Scott mentioned earlier -- this is Joanne. As Scott mentioned earlier, the flag business was a bit softer, was softer internationally, but our Hollister business did improve internationally. And our goal is to cultivate a more local omnichannel customer in these markets for the A&F brand. The Hollister business in our international markets is mostly a mall-based business and the improvement there gives us encouragement that moving into a mall-based strategy in a more local, cultivated more local customer for Abercrombie is the right move. We were -- we did open 2 mall-based locations in Europe in the MyZeil Shopping Center and in Trafford, and that is the start of -- we'll continue to pursue opportunities for accelerated exits of those flagship locations and pursuing moving into the more mall-based locations in Europe for Abercrombie.

And if I could just add 1 follow-up on the, I guess, the Hollister business improvement. What do you think that drove that? Is it product or just allocations that you think you did better this quarter? Because obviously, the macro issue continued to be pretty pressured over there.

You are talking about Europe or international business?

In Hollister, yes, correct. Yes.

Yes, we talked throughout the year of some of our transitional and product issues throughout the first 3 quarters of the year into Q3 into Q4 as that weather became more seasonal and the adjustments we've made, they started to stick a little bit. So we've seen that business in light of all the macro uncertainty across many European countries. We've seen that business improve a little bit. So we're on a good track here, and we have much more opportunity in the future to better localize our voice and our products across Europe, and that'll be a good place for us to focus in 2019.

We'll next go to Kimberly Greenberger with Morgan Stanley.

Great. I wanted to ask a real estate question. What percentage of your fleet now is profitable? And if you could wave a magic wand and sort of downsize your fleet to the ideal size, how many of your current stores would you close?

Kimberly, this is Joanne. I'll pick that up. Now the vast majority of our store fleet is profitable. As you know, we've been on this path for many, many years, optimizing and improving the health of our fleet. It is important to note the majority of our fleet is in A and B malls. And over the past 8 years, we've closed roughly 475 stores. But we believe that stores still matter and closure is one of the many tools we use to improve our fleet and that customer experience, including remodels, rightsizes and relocations. And I would say in 2018, we improved -- the evidence of improved store performance, we improved store performance, we reduced square footage, and we drove higher productivity and better economics in the box, and that's evidenced by the leverage of 140 basis points in our store occupancy. We continue to have a lot of flexibility with 50% of our leases expiring over the next couple of years to continue to review our fleet in a rigorous and methodical way. But we're very committed to improving that physical touch point for our customers, embedding omnichannel capabilities, reducing our square footage and driving higher productivity across the board.

We'll next go to Janet Kloppenburg with JJK Research.

Joanne or Fran, you had talked about localization efforts in Europe in terms of where more wear now products and recognizing the seasonality differences between the U.S. and Europe. I was wondering when we might expect to see that transition in the assortments? And with respect to the A&F flagship closings, Joanne, how many can we expect this year? And what do you think the cadence of that, Europe -- and I'm talking about Europe, the European flagship closing will look like for the A&F brand?

Janet, this is Fran. I'll kick off with the first part of the question. So as we mentioned, we saw some nice improvement in Hollister across our mall-based business in Europe from the third quarter to the fourth quarter. As Scott mentioned, the product was a little bit more sticky, and we were more seasonally appropriate. What we are working on here is we have a playbook domestically, aligning product voice and experience, which drives traffic and conversion for us, and we are currently exporting that playbook overseas. We're also working on creating a global operating model to have more merchants in Europe and closer to the consumer. All of those efforts are rolling out through 2019.

And Janet, as it relates to the flagship closures, as we mentioned, our goal is to cultivate a more local omnichannel customer in these markets. So store openings and mall locations and locations that attract more local customers is a complement to our flagship strategy. I definitely want to mention that, and that will also help build our digital business across Europe. But each flagship has its own set of facts and circumstances with lease terms, locations and tourist exposure. We're continuing to pursue opportunities for accelerated exits in those flagships, but we have closed the Copenhagen store this year. That closed in March. So we continue to pursue closures, but we have nothing more than that to report at this time.

But there should be a gradual slowdown every year, I mean a gradual closing, Joanne, as we go through the next 5 years or so?

Well, as I mentioned, each of these flagship locations has its own set of facts and circumstances and has different landlords. So we're working with our landlords to manage the process and -- as evidenced by the moves that we've made in Hong Kong and Copenhagen. And we're complementing that, as I mentioned, with openings in more localized markets to help bolster our business and attract a more local customer in Europe.

We'll next go to David Buckley with Bank of America.

Just interested in hearing your outlook for freight and wage expenses for 2019. And then can you discuss the drivers of operating expense growth beyond first quarter?

I'll start with freight and wage for 2019. So a consistent theme, we've been talking about this throughout 2018. From a wage perspective, we've seen inflation mainly from a minimum wage perspective in our stores and then also in our distribution centers, as we're in a very competitive market here in Columbus. So we'll continue to see that as we go into 2019. From a freight perspective, a couple different angles here from inflation perspective, we have. Ocean and the freights into the U.S., It's been an interesting market in Q4 as a lot of people have tried to beat that deadline, that January 1 deadline for the, I guess I'd call it the previous tariff deadline, so it was pretty congested out there. As we move into 2019, it's an unknown. We expect to see continued inflation there, and that's baked into our outlook. Also, from the freight side, we've seen some shipping and handling expense inflation. We've been able to manage through that as best we can. We actually leveraged our shipping and handling expense as part of our DTC business in 2018, so we're pleased with that. Moving on to the full year. So the outlook for the full year would be up to from an OpEx basis, and that's -- so beyond 2019 or Q1 of 2019, is a similar theme. We'll absorb some inflation. We'll also invest in our business. We're investing in marketing, we're investing in our transformation initiatives because we like what both of those things are delivering. Our marketing, as Fran mentioned, we're getting better and better at delivering our marketing, and we are getting smarter and smarter about how we allocate the resources. So we'll continue to increase our investments in 2019. It'll be a little bit more of a moderated pace than 2018. But again, we like both -- we like the result we're seeing from both marketing and transformation. And one big thing to finish is, we still expect to see leverage from OpEx in 2019 with all these investments also.

We'll next go to Mark Altschwager with Baird.

This is Drew North on for Mark Altschwager. Can you discuss some of the actions you've taken to improve the Abercrombie women's tops and dresses assortment? How are you feeling about the spring assortment and inventory position in these categories relative to the fourth quarter? And then more directly, does your outlook embed positive comps at Abercrombie as you course correct there?

Drew, it's Fran. So as we mentioned earlier, we put Kristin at the helm of Abercrombie as our Global Brand President. She came into a brand that has been stabilized. We actually had a plus 1 comp for the year of 2018. So we're excited about her applying the playbook of Hollister more aggressively to the A&F brand. As far as what they've been doing relative to the spring position is that we have a very agile supply chain. We produce in 18 countries around the world, and we can affect our own order as we move forward. The expectation is to see an improvement in those categories with each delivery as we move through the year. And relative to your question on positive comps in A&F, everything is reflected in our Q1 outlook.

We'll next go to Marni Shapiro with The Retail Tracker.

Stores and particularly, Hollister's look really fantastic. Can you just give us an update on the loyalty programs across the 2 brands and will you do a separate loyalty or something for Gilly? And then just anything behind some of the initiatives behind payment that you've talked about on and off?

Marni, it's is Joanne. I'll jump on that. Our loyalty programs have been very successful at engaging our customers with growth to over 28 million member accounts this year, and we view the loyalty programs as a key asset and a big opportunity going forward to better understand and engage with our customers. We're really just scratching the surface in engaging our customers on a personalized level, and we intend to invest more in technology to better leverage that data and better personalize our communications and engage our customers. At this point, we don't have a plan for a separate Gilly Hicks loyalty program. Those customers are engaging with us through the Hollister program. And as you mentioned our payment capabilities, Fran mentioned in her prepared remarks, we can never sit still. We're continually looking out there for what's new and next, and importantly what's important to our customers. So we spent a lot of time getting close to our customers and understanding those payment capabilities that they value, and we have a tremendous array of capabilities across the globe, and what's important to customers in the U.S. may not be important to customers in Germany and it's different than what's important to customers in China. And we vary those capabilities around the world, and we continue to look for and stay close to our customers for those capabilities that we need to continue to offer.

And to your -- wait, my last thing, on the loyalty. We have also recently rolled out a loyalty program across Europe and we'll be rolling out China this year as well. So we're in early stages of our international loyalty programs as well.

That's exciting. And could I just ask one more pay question there. Some of the other retailers who target younger shoppers the -- your neighbors up The Street or someone in California have said that they do have still a decent amount of their business done in cash, which might shock people, but I'm just curious if you see that same trend?

We do have a decent base -- I would say, a base of cash business. It's -- we have a younger customer base. So we do have a fairly decent cash business but also in terms of noncredit businesses, that's where the Venmo option comes into play, as we've added that to our apps, is becoming more appealing to our customers, particularly, our younger customers and our Abercrombie customer.

And our last question comes from Tiffany Kanaga with Deutsche Bank.

Your gross margin guidance for a slightly higher rate in the first quarter stands in contrast to significant declines expected at some of your peers, despite your inventory being up 3%, and what still looks like a promotional environment out there, so can you help walk us through some of the puts and takes behind how you're anticipating driving a relatively better margin trend at the mall, especially if Abercrombie is still seeing lower AUR?

Sure, Tiffany. I can't comment on our competitors but I can comment on us, which I will. So as we look to Q1, yes, we are still clearing through some of that A&F women's tops and dresses that'll leak into Q1, and that's reflected in our outlook. We continue to see opportunities from a cost perspective in Q1, and we'll make sure that we balance the AUR. I mean, we're going to remain competitive. We feel like our promotional calendar is competitive in Q1, and we'll lever some of that outperformance we've seen in Hollister to reinvest in Abercrombie. So again, we feel confident with our outlook as we sit here today for that flat to up slightly in Q1.

And Tiffany, I think, we -- you can use Q4 as a fact -- data point to support our ability to manage through a highly competitive environment and still grow gross margins. We did leverage gross margin in the fourth quarter, which is arguably the most competitive quarter of the year, and we saw higher AUR in Hollister, and we offset that with some investments in Abercrombie to make sure we were positioned well coming into the first quarter and our inventories are at up 3%, are in line with our outlook at the beginning of the quarter. So we feel good about how our inventories are positioned and about our ability to manage margins -- the margin line through the first quarter.

That'll end our questions for today.

Thank you. We are pleased with our 2018 performance and have a playbook in place to deliver top line growth, gross profit rate expansion and operating expense leverage in 2019. I look forward to updating you on our progress as the year progresses, and thank you for your continued interest and support.

Thank you. And this does conclude today's call, and we thank you for your participation. You may now disconnect.