Good day, everyone. Welcome to the Abercrombie & Fitch Second Quarter Fiscal 2019. Today's conference is being recorded. [Operator Instructions] And now at this time, I'd like to turn the conference over to Ms. Pam Quintiliano. Please go ahead, ma'am.

Thank you. Good morning and welcome to our Second Quarter 2019 Earnings Call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our second quarter earnings release, which is available on our website at corporate.abercrombie.com under the Investors section. Also available on our website is an investor presentation. Please keep in mind that any forward-looking statements made on the call are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we 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 the reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning. With that, I will the call over to Fran.

Thanks, Pam. Good morning, and thank you for joining us to discuss our second quarter results. To let you know in advance, our prepared remarks are going to run a little longer than usual today as we are providing detailed new information on our flagship. With that, let's get started with our second quarter results. As you heard from many of our retail peers this earnings season, the second quarter got off to a slow start. I am pleased to report that we experienced monthly improvements as the quarter progressed, enabling us to deliver on our previously issued second quarter outlook. Momentum has continued quarter-to-date with a solid start to the back-to-school season in the U.S., where comps are positive across brands. Equally important, we are making progress on our key transformation initiatives and continue on the path to achieving our fiscal 2020 target. I'll go into more detail on our transformation initiatives in a moment. But first, let's start with a discussion on the second quarter and how we navigated an escalating promotional environment to deliver on our outlook. Our second quarter comps were flat to last year, benefiting from record results in jeans, pants, swim and intimates, offset by softness in female tops. We made positive momentum in the U.S. with a plus 2% comp, but that strength could not counter our international comp of down 3%, which although improved from Q1 levels, was impacted by several well-publicized external factors including extreme weather, Brexit and protests. In Europe, comp results were consistent with last quarter, with weakness in the U.K. and Ireland offset by net improvements across other European markets. In Asia, improvements in China helped offset weakness in the Hong Kong region. Turning to the U.S., which represents approximately 2/3 of our revenue base, we achieved our…

Thanks, Fran. Before starting, I want to highlight that we are now providing sales, operating margin and EPS on a constant-currency basis to add clarity to our fundamentals. Now on to our second quarter results. Net sales of $841 million decreased 0.2% from last year and were up 1% on a constant-currency basis, reflecting a $10 million adverse impact from changes in foreign currency. Comps came in flat versus plus 3% last year, driven by positive cross-channel traffic, offset by lower conversion. Positive cross-channel traffic reflected strong digital interest with traffic to the channel up double digits and accelerating from last quarter. This helped offset challenging mall traffic trends. By brands, both Hollister and Abercrombie posted flat comps. This compared to plus 4% and plus 2%, respectively, in Q2 2018. By geography, we achieved a plus 2% comp in the U.S. on top of a plus 7% last year, with each brand in positive territory. Our international comps were minus 3% and compared to minus 4% last year. Our gross profit rate of 59.3% was down 90 basis points from last year, reflecting higher AUC driven by product mix and slightly lower AUR. On a constant-currency basis, gross profit rate was down 60 basis points. As Fran previously discussed, the promotional environment was heightened during the quarter. In order to effectively compete and not lose share with our respective target customers, we offered calculated promotions and markdowns. Looking at the rest of our results on an adjusted non-GAAP basis. Adjusted operating expense, excluding other operating income, was $538 million. This included the previously disclosed $45 million of flagship store exit charges incurred in the quarter, which reflected our decision to close both the Hollister SoHo and A&F Fukuoka locations. These charges were primarily -- these charges primarily represent the present…

Thank you, Scott, and thank you to our global associates for all your hard work. We are planning our business for the future as we successfully execute to our key initiatives, including making meaningful progress against our flagship opportunities. I'm excited about the significant global runway that we have across brands.

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

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

Thanks for all the information, especially on the flagships. So I just want to make sure I understand, are you guys saying that the flagships -- most of the flagships, you're going to let expire -- the leases expire naturally? Is it also fair to assume that those locations are less of a drag because you're not paying to get out of there early? And then maybe if you could also talk about, obviously, strong -- another strong performance in the U.S. The international business still seems to be a little bit of a drag, but it would be great to get your thoughts on what you can do to kind of have more of a coordinated kind of consistent positive performance. Are those things in your control, or is it all macro issues?

I'll let Scott kick off with flagships, then I'll pick up in the second part, Omar.

Yes. On flagships, Omar, we are expecting that the majority of these will expire naturally as we move forward. We did provide in the investor presentation, I think it's Page 24, a summary lease stack of our expirations as we go forward, through 2020. We talked about the 3 that we expect to close this year: 2 that we've already closed and then Milan, Italy, that will close at the end of this year. We have an additional 3 stores coming up for expiration next year, which will give us the opportunity to reposition within those markets. The remaining drag of the stores that are out there, we'll continue to go through that checklist that I talked about and evaluate if it makes sense for us financially and qualitatively and from a brand perspective to exit those stores early. So we'll remain in contact with our landlords and will continue to try to improve the operations and the profitability of those stores.

Thanks, Scott. And as far as our international performance, I'm going to kick off actually first, Omar, with the U.S. To your point, we were very pleased with our U.S. performance, and it does remain strong. Internationally, we actually saw slight but sequential improvement from first quarter to second quarter. It clearly is a complicated landscape that is out there today. But we did announce this morning some very exciting news, the addition of 2 new associates, Dan Le Vesconte in London and Olga Wu in Shanghai. We will be opening up regional offices for the first time. You know from the past, we've been a very centrally controlled business here. We are building teams underneath them. Those teams will be focused on very important issues, such as assortment, pricing and promotion, marketing. They're going to help us get really close to our customer. We've had great success domestically with our playbooks, bringing [ product, voice and ] experience together. Those teams will be helping us export those playbooks across the world. And we're looking forward to them really impacting our business in 2020.

Next question comes from Paul Lejuez with Citi Research.

This is Kelly on for Paul. Just wanted to talk a little more about your comments on back-to-school. It seems like it's off to a strong start, but your guidance implies that there's no sequential improvement in comp growth [ in the ] second quarter. Could you just talk about that a little bit? Is that coming from the international markets? Or is there just some conservatism baked in? And then just secondly, could you talk about the expectation for markdowns in the third quarter? It seems like your gross margin guidance for the back half of the year is down above and beyond the tariffs impact. So could you just talk about any changes you're making there?

So we are pleased with what we delivered for the quarter. And we do have a nice start, a solid start to back-to-school in the U.S. Back-to-school does start later outside the U.S. So we are currently talking about U.S. back-to-school, positive comps across the brands. In the second quarter, we continued to see very strong reaction to our brands. We continued to have positive cross-channel traffic. Our mall traffic is above the average U.S. mall traffic. And as you know, over the past couple of years, we've seen nice increase in our brand health. Regarding this kick-off to Q3, exciting things happening. Our denim business is very strong. Q2, we had a strong denim business. We launched 2 new jeans, Curvy from both Hollister and Abercrombie, both of which has been well received by the consumer. We're chasing into those to continue to drive that trend through the back half of the year. So there's lots of exciting things. With that, I'll turn it over to Scott. He can talk about the Q3 markdowns.

Yes. On the gross profit rates outlook for third quarter and the full year, I'll cover both. On the third quarter, if you look at the outlook, it's down 100 basis points. 90 basis points of that down is coming from foreign currency and then the addition of the List 4 tariffs. So call it the majority of that down 100 coming from those 2 items. As we look at the full year, our range that we put out there is down 50 to 90 basis points. Looking at those same 2 factors of currency as well as the tariffs, that's going to get us about 60 basis points, so it puts us right within that outlook. The high end of that outlook, it gives us the opportunity and allows us to be more promotional if it gets more competitive in the back half. As we look around the industry, and we read the same calls and listen to the same calls you do, it appears that inventory is a little heavy across the industry. So we're giving ourselves the ability to compete if others get more competitive throughout the quarters.

Great. One more question. Could you just give the markdown rates by brand in the second quarter? Is there any big difference there?

Not a big difference. No.

Let's go to Kate Fitzsimons with RBC Capital Markets.

I guess my question would be, looking out to that 2020 5.8% EBIT margin target. Obviously speaking to some headway on the occupancy front this year with the flagship closures. But just how are you thinking about that target engine next year? What are levers you see at your disposal that you think can help you make progress towards that in the next -- in the coming quarters?

Sure. Kate, it's Fran. We are laser-focused on those targets. There have been some curveballs, the currency, the tariffs, the geopolitical environment that we talked about. We are controlling what we can control. The real estate optimization benefits, Scott will get into a little bit more detail, that's a significant lever for us. But we've also been investing. We are investing in some key tools to drive our business. Size optimization, market optimization, personalization, those will start to benefit us in 2020 as well. But these are all laying the foundation to achieve our 2020 goals, and we remain on track across all our key transformation initiatives.

On the flagship charges specifically, that $45 million charge that we took this year will not repeat next year. That's more of -- bracketed here in 2019. And so just to echo Fran's sentiment there, we do have a lot of opportunity remaining on store occupancy. This is and has been a key priority for us and is really the key lever for us to get there to our 5.8% in 2020. So a lot of work left to do over the next, what is it, 6 quarters on occupancy. And we're happy with the progress we've made so far.

Go to Mark Altschwager with Baird.

This is Connor on for Mark. Can you just give a bit more color on the updated SG&A outlook, where you're seeing incremental savings? And maybe talk about the balance between your incremental marketing to drive comp and protecting EBIT margins as you plan the back half of the year?

On the OpEx points. This is part of our DNA. Tight expense control is part of our culture, it has been. I was pleased with how we finished Q2, beating our outlook, coming into the quarter on OpEx. The team across this campus has done a lot of great work on continuing to find efficiency across our business. That's enabled us to take down our outlook or improve our outlook for OpEx for the full year. We were plus 4% to 5% on our last call. We've taken that to plus 2% to 3%. Breaking that 2% to 3% apart a little bit. We have that 220 basis points from the flagship charge in Q2. That leaves us more or less flat to up a little bit. We're investing in the business. Fran mentioned we're laying the foundation for the long term. We're not going to stop investing in the business. We're making key investments in our transformation and to drive the digital growth. She mentioned personalization, markdown optimization, couple tools there. Marketing, on your direct question, we are investing in marketing this year. We made a nice leap last year in our marketing spend and will continue to leap this year. It will be a little more measured than it did -- than it was in 2018. But at the same time, we've been doing some great work through our transformation efforts to really measure our marketing spend. So while our increase won't be as dramatic last year from a dollar perspective, we are spending smarter than we ever have. Our teams in all of our brands are using these tools and they're just driving great, effective spend. So pleased with our outlook for OpEx, and we'll continue to try to find more opportunities throughout the year.

Your next question comes from the line of Susan Anderson with B. Riley FBR.

I was wondering if you can maybe give a little bit more color around just the lower comp outlook for the rest of the year, especially given the fact that you're comping positive quarter to date. Maybe are you seeing a little bit more pressure globally, maybe the rest of the year? Or any thoughts just around that outlook. And then really quick on the gross margin guidance for third quarter. So it sounds like most of that is China and FX. So just curious if you're factoring in also the potential for increased promotional environment.

I'll start with the Q3 gross margin outlook. I'd say it's a stable promotional environment. You nailed it there. We are -- our comp of -- our guide of down 100 basis points is essentially all factored in through FX and the China tariffs kicking in. As we think about the comp guide for the year, coming out of the spring, we are moderately positive for the 6 months year-to-date period. Thinking about our outlook for the full year, we've bracketed that. We have a flat to a plus 2% for the full year on comps. And assuming the trends continue as they are coming out of the spring season, that would put us closer to the flat side of that. And if we can reaccelerate growth here in the back half, based on some of the product changes we've made in the Hollister business and continued acceleration in Abercrombie, that will take us towards the top half. So we are laser-focused on returning to growth in the back half, but what our outlook does is brackets that. Specifically on your back-to-school points. We've seen a nice response on early back-to-school here in the U.S. But we are certainly cognizant of the geopolitical environment and the macro environment we're seeing around the world. So that's what's baked into our outlook.

Now we'll go to Janine Stichter with Jefferies.

Just wanted to ask a little bit more about the Hollister girls business. Can you just give us a little bit more color on where you think you maybe went off-course there? And then you mentioned you saw a change in trend in tops during the quarter. How do you just feel about the assortment broadly? And when do you expect this to kind of be back where you want it to be?

Sure, Janine. So we are pleased with our Hollister business. Particularly, our U.S. business remained strong. Our cross-channel traffic remained strong. We had an exciting quarter. We had another record quarter in guys. We've had a nice record quarter in girls swim. So lots of really positive things happening. The one place where we did see an opportunity is in girl's tops. I'll tell you that started probably late Q1. We had a tough May, I think, as most did in the industry. The good news is, is that with the agility of our supply chain, we can course-correct very quickly. We've seen sequential improvement in those tops ever since we identified what those issues were. Great proof point for us. Talked on the Q4 call about the difficulty, for example, in Abercrombie in dresses. And then we proceeded, we ended up having a record quarter in dresses in Q1 and Q2. So it just really supports the team's ability to identify issues, move on them, work with our sourcing team and adjust them. So we're excited to compete in the back half and we feel excited about our product.

Our next question comes from the line of Janet Kloppenburg with JJK Research.

Just a couple of points of clarification from Fran. So it sounds like the U.S. market perhaps has accelerated as you've entered back-to-school. But the European markets, perhaps you're waiting for that to happen as they -- as schools open at a later date. Is that right? Better performance in the U.S., maybe not so in Europe, and that's why your comp guidance is what it looks like? And to Scott, I'm just a little confused on the fiscal '20 operating margin goal. I think this year, adjusted, you'll be somewhere in the low 3s. And it sounds like you'll get about 10 basis points from the fleet store closings next year. So if you could just walk me through the bridge to get me to that 5 -- mid-5% level, I'd appreciate that.

Janet, I'll kick off with the first part of that question. So we did see nice acceleration throughout the quarter. May, as I mentioned, was difficult industry-wide, but we did see sequential improvement. That momentum has continued into the third quarter. The back-to-school peak definitely, it's different timing here in the U.S. than it is around the world. So that's all we're really commenting on today, is that we're seeing some momentum continue into the third quarter and excited to see the reaction that we have to our products.

On the walk to the 2020 goal of 5.8%, depending on how we finish this year. There is a lot of business left in this year. We're going on towards the peak of the season. We obviously peak in the fourth quarter with holiday. So a lot of business ahead of us. And depending on where we end up versus our outlook, depends on where that operating margin ends up here for 2019. As we think forward to our bridge, I mentioned a little bit earlier, store occupancy continues to be another -- or a huge opportunity for us, go forward. We'll have our next wave of renewals at the end of this year and we'll look to make further progress on that line. We'll continue to evaluate expense. And then we look forward to some of the tools that we've been investing in throughout this year, through personalization, optimization, as well as the great product investments our teams have been making to drive growth next year. So that's our path, really hasn't changed, as Fran mentioned. Love the word -- a couple curveballs came at us here more recently, but it's our job to take some swings and get there.

So you don't think that you have to change that goal in light of the tariff pressure that's emerged.

No changes at this time.

[Operator Instructions] We'll now go to David Buckley with Bank of America.

Could you share performance by brand in both Europe and Asia in the quarter? And then can you share -- do your monthly compares ease as third quarter progresses?

We don't talk about the inter-quarter monthly progression from last year, David. Looking at the international performance by brands, I'll break -- I'll start at the total. So internationally, we were slightly better than last quarter, so a down 3% versus a down 4% last quarter. Europe was relatively consistent quarter-over-quarter and we saw some improvements in Asia. Something we called out in Q1 about the hit that we took in Q1 for Asia with some Hollister performance and things that we owned and we were able to rectify some of those things, which helped our China business specifically get a little bit better in Hollister. So generally pleased with where we are internationally. Very excited, as Fran mentioned earlier, about the hiring of our 2 folks to run our regions over in Europe and Asia. This is going to give us a great opportunity to improve our International business as we go forward.

Now go to Marni Shapiro with Retail Tracker.

So I guess if you can talk a little bit about 2 things. You talked a little bit about the international business, I think you touched on tourist business. If you could talk about the U.S. business, ex tourists, was that stronger than the core U.S. business? And then was the denim business strong on girls and guys? You touched on Curvy, but did you see that business accelerate through the second quarter with denim shorts and then into long denim?

I'll start with the U.S. tourist business. This has been a consistent theme, I'd say, quarter after quarter after quarter. We continue to see a drag on the coasts across our brands. With the currency levels where they are, travel's a little more difficult, a little more expensive to the U.S. So I think this is more of an industry-wide phenomenon here. Taking that out, we still delivered a plus 2% comp in the U.S. on a plus 7% last year, and there was definitely a drag from these tourist stores. The great thing is that the U.S. business in these tourist stores, as we track our credit card spend, continues to be stronger. So our goal is to continue to drive a more localized customer, even in the U.S. We talk a lot about that for flagships, but even in the U.S., we want to drive that more local customer in some of these key tourist cities on the coast. So continues to be a drag. Our expectations will be that it remains a drag for the foreseeable future until we potentially see some changes in currency.

Now regarding denim, Marni, we did have a record quarter in denim for Q2 across the company. Super excited about what's happening across genders and across brands. Shorts were strong in the second quarter as well, lots of newness happening in shorts, actually, the second quarter between waist detail and new fabrications. Exciting things to take us into next year. And we have seen momentum continue in our denim business. It's -- definitely the Curvy has been an exciting new addition to our assortment, but there's other things happening as well. Our mom jeans is also doing extremely well. The customer continues to respond to the higher-waisted jeans. That trend continues to build momentum. So there's a lot of exciting things happening in denim across genders and across brands.

And it looks like we have no further questions at this time. So I'd like to turn it back over to Fran for any additional or closing remarks.

Great. Thanks. I look forward to updating you further as the year progresses. Thank you, everyone, for your continued interest and support.

Thank you, everyone, again, for their participation.