Abercrombie & Fitch Co. (ANF) Q1 2015 Earnings Report, Transcript and Summary

Good day, and welcome to the Abercrombie & Fitch First Quarter Fiscal Year 2015 Earnings Call. Today's conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Brian Logan. Mr. Logan, please go ahead.

Good morning, and welcome to our first quarter earnings call. Earlier this morning, we released our first quarter sales and earnings, income statement, balance sheet, store opening and closing summary and 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 a replay may be accessed through the Internet at abercrombie.com, under the Investors section. The call is scheduled for 1 hour. Joining me today are Arthur Martinez, Executive Chairman; Jonathan Ramsden, Chief Operating Officer; Joanne Crevoiserat, Chief Financial Officer; Fran Horowitz, President of Hollister; and Christos Angelides, President of A&F and abercrombie kids. After prepared remarks, we will be available to take your questions for as long as time permits. Before I begin, I 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, effective for the first quarter, we have made a change to our operating segments. Previously, we segmented and reported our business based on channel, reporting separate information for U.S. stores, international stores and DTC. In conjunction with our transition to a branded organizational structure, which was substantially completed in the first quarter, we have determined our operating segments to now be Abercrombie and Hollister, which have been aggregated into one reportable segment. With that, I hand the call over to Arthur for some opening remarks.

Thank you, Brian. Good morning, everyone, and thank you for being with us. The past quarter, our company continued to take major strides to revitalize our brands, enhance performance and position ourselves to resume a solid growth trajectory. We've made significant changes in every aspect of our business, including augmenting our leadership team, enhancing organizational strength and efficiency, developing merchandising and design processes and optimizing our store fleet by adding stores in high potential markets and continuing to close underperforming stores. We've also made important investments in high potential areas, including the online business. Importantly, we have focused the entire organization on putting the customer at the center of everything we do, particularly with regard to the store experience and our merchandise assortments. We knew it was going to be a tough quarter for a lot of reasons, some environmental, notably foreign exchange; and some specific to our company; and most significantly because many of the actions we are taking to improve our business are in the early stages of implementation. And so our numbers don't reflect the many initiatives underway to reinvigorate our iconic brands. But we do see traction in several areas, comp sales performance on a sequential basis has shown improvement in a number of areas of our business, particularly within Hollister. The new more inviting storefront for Hollister continues to do very well, with converted stores still experiencing a high single-digit increase in sales and gross margin. We saw a sequential improvement in Europe in key markets such as the U.K. and France and are also delivering great results in China. And all of this has been accomplished against the backdrop of significant headwinds for our industry, most notably foreign currency translation. Our comparable sales trend has continued to improve in May, increasing our confidence that we will see continued sequential improvement into the second quarter and the back half of the year. Our turnaround won't be accomplished overnight, but we are expecting that the changes will help us stabilize our business this year and lead to meaningful and lasting improvement moving forward. Now let me hand it over to Jonathan Ramsden, our COO, to provide a more in-depth update on our strategic initiatives.

Thanks, Arthur, and good morning, everyone. As Arthur mentioned, the first quarter marked some significant steps in our ongoing efforts to turn around our business. As summarized on Page 11 of our investor presentation, these changes include a number of elements: First and foremost, putting the customer at the center of everything we do; second, defining a clear positioning for our brands in a rapidly changing and highly competitive marketplace; third, ensuring we are delivering a compelling and differentiated assortment; fourth, from a channel standpoint, ensuring we are appropriately scaled and positioned to optimize our brand reach domestically and internationally; fifth, ensuring we continue to improve our efficiency, pare underperforming assets and reduce expense; and last, ensuring we are organized to succeed. I'm going to make some comments on specific actions against these initiatives and then Fran and Christos will add more color to their respective brands. Starting with customer centricity, we have made significant changes in our stores during the quarter to create a faster, easier and more enjoyable shopping experience. We have given our store managers greater autonomy, but also increased their accountability by implementing a new incentive program. Regarding omni-channel, we have enabled order-in-store in all U.S. stores and will have ship-from-store in place in approximately 70% of U.S. stores by the end of Q2. We will extend the ship-from-store to U.K. and Canada by the end of the year. In addition, we will have click-and-collect in place by the end of the year in the U.K., a market where this is very important, and will begin to enable online returns to stores in Europe, again, starting with the U.K. All of these changes are directed towards creating an easy, seamless and satisfying experience for our customers. With regard to brand positioning and our assortment, while there is more to do, particularly on long-term positioning, a lot of great work has been done over the past few months on assortment planning. Optimizing the scale and reach of our brands entails the following components: First, continuing to make selective international openings in key growth markets of Asia and the Middle East. During the quarter, we opened our second A&F store in Kuwait, our third Hollister store in the UAE and our fifth Hollister store in Japan. We are pleased with the initial volumes of these stores, particularly the Hollister store in Dubai, which is currently tracking to be one of our highest-volume Hollister stores globally. China also continues to do well for us with double-digit comp sales for the quarter, including positive comps in all 7 Hollister stores and over 300% growth in the Hollister DTC business, reflecting an outstanding return on our DTC localization investments. Second, continuing to optimize our footprint in the U.S. We continue to grow our outlet business with the opening of 3 new A&F outlet stores during the quarter. U.S. outlet stores have now generated positive comp sales for the third consecutive quarter and we continue to be pleased with the performance of our new stores, particularly MFO stores. On the other side of this equation, we expect to continue our domestic store closure program in 2015 and beyond. Excluding the RUEHL and Gilly Hicks brand closures, we have closed over 275 domestic stores in the past 2 years and have significant flexibility over the next couple of years. This tied to another important dimension of our U.S. real estate strategy, which is the testing of new store prototypes and sizes. Our ability to prove out a fresh and compelling new store format at a reasonable capital cost, while significantly increasing both productive square footage and unit density, has the potential to be a significant value driver. Third, we are moving forward on other opportunities to increase our brand reach, including through licensing, franchising and wholesaling arrangements. Earlier this month, we opened our first franchise store, the Hollister store in Guadalajara, Mexico. While still early, we look forward to using franchising selectively to extend the reach of our brands to new locations and markets with minimal capital investment. After a successful launch of our A&F wholesaling partnership with ASOS, we plan to extend that partnership to the Hollister brand in the second quarter. In addition, we plan to expand our A&F wholesaling business with a new partnership in the third quarter. We also are looking forward to Inter Parfums' planned launch to test selling Fierce in Sephora in France and global duty free locations beginning in the second quarter, and to their launch of new fragrance products in 2016. With regard to efficiency, during the quarter, we launched a continuous profit improvement program, which is the evolution of our highly-successful profit improvement initiative, which generated $250 million in annual savings. Continuous profit improvement will be at the foundation of how we operate moving forward, and these efforts resulted in meaningful savings during the quarter. We believe there are additional expense reduction and efficiency opportunities moving forward as we leverage strong engagement from associates across the company. Finally, ensuring we are properly organized to succeed is a key part of our strategy. During the quarter, we supplemented the branded teams by hiring several senior-level associates with extensive experience in design, merchandising and planning, that will help us -- lead us into our next phase of growth. As Arthur said, while the first quarter was difficult and the results are not acceptable, we do not believe they reflect the potential of our brands going forward, as we continue to make significant changes across all areas of our business. And I'm grateful to all of our associates across the company for their work to affect that change. With that, I'll hand it over to Joanne.

Thanks, Jonathan, and good morning, everyone. Before I begin, I wanted to take a moment to reiterate that effective for the first quarter, we have made a change in how we think about our operating segments. Previously, we segmented and reported our business based on channel, reporting separate information for U.S. stores, international stores and DTC. This quarter, as we substantially completed our transition to a branded structure with strong accountability to branded results, and recognizing the increasing overlap of our channels as a result of omni-channel activity, we have determined that our operating segments are now Abercrombie and Hollister. Given similar economic characteristics across these operating segments, we have aggregated them into one reportable segment for actuarial reporting purposes. Notwithstanding this change, we will continue to provide appropriate comments in our calls to help investors understand the evolving dynamics in our business. And with that, I'll start with a brief recap of our first quarter results and then provide an update on our outlook for the rest of 2015. For the quarter, net sales were $709 million, down 14% to last year. Changes in foreign currency exchange rates versus 1 year ago accounted for approximately 560 basis points or $46 million of the sales decline. Total comp sales were down 8% for the quarter. By brand, comp sales were down 9% for Abercrombie and down 6% for Hollister. By region, comp sales were down 7% in the U.S. and down 9% in international markets. Across brands, the direct-to-consumer and omni-channel business grew to approximately 23% of total sales compared to approximately 21% last year. Year-over-year, our international DTC business returned to healthy growth, while the U.S. business was slightly negative as we were less promotional during the quarter versus last year. On a sequential basis, Abercrombie comp sales declined slightly in both the U.S. and international markets. However, Hollister comp sales improved sequentially in both the U.S. and international markets, which included positive comp sales in Asia and broad-based sequential improvement in Europe, including in the U.K. By category, continued weakness in the tops business, driven by reduced logo levels, offset continued strength in jeans and dresses during the quarter. As I mentioned, the reduced logo business continued to weigh heavily on our results, contributing approximately 7 percentage points to our down 8 comp for the quarter, in line with our expectations coming into the quarter. Excluding a net pretax charge of $27 million, the gross profit rate was 61.8%, 70 basis points higher than last year on a constant currency basis, primarily due to lower average unit cost. Average unit retail in our U.S. business continued to stabilize, with a slight increase in the quarter, while our international AUR declined. During the quarter, we incurred a net pretax charge of $27 million related to a write-down of the carrying value of certain inventory. As we continue to improve our assortment and store experience, we made an elective decision during the quarter to accelerate the disposition of some aged inventory that does not reflect our perspective brand positioning. We believe this will de-clutter the stores, reduce clearance inventory penetration in our stores and result in an overall increase in productivity. Excluding net pretax charges of $11 million this year and $16 million last year, adjusted non-GAAP operating expense for the quarter was $493 million, down $38 million as a result of benefits from the effects of foreign exchange rates as well as further expense reduction efforts identified during the quarter and the realization of expense savings on lower sales. I'd like to take a moment to run down the pretax charges excluded from operating expense for the quarter, which are detailed on Page 4 of our investor presentation. These include asset impairment and accelerated depreciation charges of $6 million related to a decision to discontinue the use of certain fixtures from Abercrombie and Hollister stores to improve the customer in-store experience, and a further fair value adjustment of $2 million related to the company-owned aircraft currently held for sale. These also include lease termination and store closure costs of $3 million related to the accelerated exit of our 2 Hollister stores in Australia and severance charges of $2 million related to our profit improvement initiatives. In addition, we recognized the benefit of $2 million from the restructuring of the Gilly Hicks brand related to a favorable settlement of previously [indiscernible] lease termination costs. On an adjusted non-GAAP basis, stores and distribution expense for the quarter was $387 million, down $30 million from last year and benefited from the effects of FX as well as further expense reduction efforts identified during the quarter and the realization of expense savings on lower sales. On an adjusted non-GAAP basis, marketing, general and administrative expenses for the quarter were $106 million, down $9 million from last year, primarily due to savings associated with the expense reduction efforts during the quarter. On an adjusted non-GAAP basis, the operating loss for the quarter was $52 million compared to $16 million last year and included adverse effects from FX of approximately $13 million. The tax rate for the quarter, excluding the effects of charges, was 34.8%. For the quarter, the company reported adjusted non-GAAP net loss per diluted share of $0.53 compared to an adjusted non-GAAP net loss per diluted share of $0.17 last year, and included the adverse effect from FX of approximately $0.13. Turning to the balance sheet, we ended the quarter with $383 million in cash and cash equivalents and gross borrowings outstanding of $299 million. We also ended the quarter with total inventory at cost down 9% versus last year, which included the impact of the inventory write-down. We continue to expect an improvement in inventory management and productivity as we move forward. Details of our store openings for the quarter are included on Page 10 of the investor presentation. At the end of the quarter, we operated 789 stores in the U.S. and 173 stores in Canada, Europe, Asia, Australia and the Middle East. Moving to the rest of 2015, we are updating our outlook on elements of our performance for the year. We continue to expect foreign currency exchange rates to be a significant headwind to our results in 2015. With regard to comp sales, we expect to see continued sequential improvement into the second quarter and the back half of the year. This includes a meaningful impact from logo products as we lap the significant declines of last year. In addition, we are encouraged by improvement in our comp sales trend in May although it's important to note that the majority of the volume for the quarter is still ahead of us. We continue to expect the gross margin rate to be flat to slightly up for 2015, driven by AUC reductions, partially offset by adverse currency effects. With regard to operating expense. Excluding the effects from changes in comp sales, we now expect a year-over-year reduction of approximately $40 million, primarily as a result of additional expense savings identified. In addition, we would expect to appropriately manage expense with fluctuations in comp sales. Excluded from our full year outlook are charges incurred during the quarter as well as other potential future charges related to impairment and store closing charges and other potential charges related to our restructuring efforts. Over time, we expect a sustainable tax rate to return to the mid- to upper-30s as profitability recovers within the jurisdictions in which we operate. However, for 2015, the tax rate is expected to be elevated and remains highly sensitive to the earnings mix by jurisdiction, particularly at lower levels of profitability. In addition, we are continuing to project weighted average share count of approximately 70 million shares, excluding the effect of potential share buybacks. 2015 capital expenditures are still targeted at around $150 million. This includes new stores, store remodels and refreshes, including the continued rollout of the new Hollister storefronts. In addition, this includes testing new store prototypes and improvement inside the store to deliver an improved customer experience and stronger productivity. This also includes the recently completed DC conversion to a dedicated direct-to-consumer facility as well as other DTC and IT investments to support growth initiatives. With regard to real estate plans for the year, we plan to open 17 full-price stores in key international growth markets of China, Japan and the Middle East and 5 full-price stores in North America. We also plan to open 9 new outlet stores in the U.S. In addition, we expect to close approximately 60 stores in the U.S. during 2015 through natural lease expirations. Now I'll now hand it over to Fran, who will provide more color around the strategic initiatives occurring within the Hollister brand. Fran?

Thank you, Joanne, and good morning, everyone. First, I would like to thank the entire global Hollister team for their hard work over the past quarter. I'm grateful for your urgency, openness and willingness to drive significant change in our brand. As we look at the first quarter, business remains challenging as we delivered a 6% comp decline. While the comp remained negative, we were encouraged by the sequential improvement from the last 2 quarters, especially in light of a reduced promotional stance in the U.S. business. We significantly reduced our reliance on percent off entire store messaging and as the quarter progressed, we increasingly sold more merchandise at ticket versus a year ago. In the U.S., we were most encouraged by the stabilization of our girls business. As we moved past the clearance selling period early in the quarter, we saw improvement in the girls top categories with each update. Our guys performance -- our guys business performed consistent with the Q4 trend with the comp challenged by our reduced promotional stance. In Europe, we saw sequential improvement driven primarily by the U.K. and France. And in Asia, our China business was very strong. As Jonathan mentioned, we have made many changes over the past several months as part of our efforts to improve the performance of the Hollister business. First, we have made significant progress to ensure we have the people and organizational structure to set us up for success. We reorganized our product-facing teams into a structure that will enable us to build regional, tailored assortments that will be adjusted based on consumer preference. In addition, I have made several senior-level hires and internal appointments across our customer-facing functions to help lead those teams. Second, we have made significant progress during our last 2 product review cycles to ensure we have the right process in place to develop, review and buy our assortments. We have plenty of opportunity to improve our merchandise assortment and I'm confident that we will see incremental improvement with each floorset going forward. Third, we are shifting our focus to a more customer-centric experience and we see this evolution taking place in several key areas: in-store experience, [indiscernible] experience and pricing and promotion. With regard to pricing and promotion, we must simplify the customer shopping experience and appropriately position our brand to compete in each region. As you know, based on our U.K. price test result, we rolled out the adjusted pricing to remaining U.K. stores with our Spring Break floorset and have seen continued sequential comp improvements. We plan to roll out updated pricing to the rest of the world in conjunction be the Back-to-School floorset. In the U.S., we will continue to moderate our promotional activity to provide a simpler shopping experience and clarity to our customers around our quality and value proposition. With regard to in-store experience, we have made meaningful progress over the past couple of months. First, we removed some of the in-store props and fixtures that will not be part of the future Hollister experience. Second, we continue to roll out the updated Hollister storefront around the world. But in addition, we're in the process of developing and testing options for our future in-store prototype, and we are excited to have opened our first Hollister store with our future in-store prototype with a fully redesigned and re-fixtured interior at the Polaris Mall here in Columbus. The new prototype allows for more space and flexibility between genders. And with increased visibility, brighter color paints and better layout, customers will have an easier shopping experience. We are pleased by the initial customer reaction and will be converting 4 additional stores over the coming weeks. Finally, we are creating greater ownership and accountability within our store management teams through new incentives and training programs. With regard to brand experience, we continue to improve our understanding of our customer and we look to define the modern Hollister. With a better understanding of our customer, we will refine our marketing approach to represent our brand position, rooted in the Southern California lifestyle, and engage our customer on their terms using the channels they deem most relevant. Clearly, we have had significant amounts of change happening in our brands. That said, I am confident that we are focused on the initiatives that will turn around our performance and capitalize on the strengths and global reach of the Hollister brand. I will now hand it over to Christos.

Thank you, Fran. The first quarter was challenging for the Abercrombie & Fitch brands delivering a combined minus 9% comparable sales result, reflecting a slight sequential decline in comparable sales from the prior quarter. While we have some wins for the quarter, tops business still remained weak as a result of both continued logo headwinds and a real lack of differentiation between the new spring season and the fall season carryover product. I'm well aware of the challenges we face, but really do believe that we're focused on the right things as part of our efforts to improve the trend of the Abercrombie business. This focus includes: one, having the right organizational structure in place to create better product. To that end, I've supplemented the talented team here by hiring 3 general managers with strong industry experience for the men's, women's and kids businesses. The new GMs will have direct oversight, design, merchandising, inventory management and planning functions. Two, reestablishing the vision for the brand, with a focus on being the best at design, whether that being our heritage homeland of preppy or military styling, authentic denim or pretty lace, or in chasing the latest trends. We've also been improving quality levels in terms of fabrications, washes, embellishments, styling and the fit of our clothes and the sizes we offer. In addition, we've made progress in evolving buying and inventory management processes to ensure that we're offering a well-balanced assortment by channel across fashion, classics and also logo. Three, focusing on making the customer shopping experience clearer and more convenient, both in-store and on DTC, by enabling customers to more easily see, touch and select our clothing. We've adjusted the in-store experience by removing a number of forms and props to improve navigation around the store. We've adjusted presentation methods to increase the amount of hanging product versus folded and also to better showcase our newest product details, colors and silhouettes. We've also made adjustments to the music, scent and lighting levels in the store. We're in the process of identifying a new store layout and plan to hope -- and plan to have these first prototype opened this fall. On DTC, all product is now photographed on body and not flat, so the customers can imagine the real silhouette and the fit of the garment. Moreover, we've implemented programs to help store managers take on a more customer-centric, business-driven approach through our previously announced store incentive programs. We've also continued to enhance our store training to ensure that our managers and brand representatives will have the tools necessary to drive their business, manage expense and improve the overall productivity of their store. My focus is on creating a consistent, compelling brand experience across stores, DTC and marketing channels that resonate with the modern Abercrombie & Fitch customer and extends our reach to a broader target market. We do have a considerable amount of work ahead of us, but I'm really encouraged by the changes that are being made and I believe the strategies will be significant in building on the rich heritage of the Abercrombie & Fitch brands. Before I conclude, I would like to thank the Abercrombie & Fitch teams for their contribution, commitment and positive approach with all of the changes that are currently taking place. With that, I'll hand back to Arthur for some closing remarks.

Thanks, Christos. Hopefully, all of you now have a much stronger sense of the profound changes that are taking place within our company. It's important to note that our company ran as a singular business model for 2 decades. That model became less relevant in a changed marketplace with new customer expectations. There is great potential in front of us and there is a great amount of work being done throughout the organization to realize that potential. And I and the board continue to be confident that the changes taking place will allow us to realize the full value of our brands. We're fortunate to have a team of very, very talented executives, who you heard from today, leading the charge on these initiatives. A new CEO will be appointed at an appropriate time to continue this work and the board is deeply engaged in that process. This now concludes our prepared comments and we'll be happy to take your questions. Thank you.

[Operator Instructions] Our first question today will come from Randy Konik with Jefferies.

A lot going on. Glad to see it. So a couple of things. Just I guess, on the -- if you look at the international business versus the U.S. business, some different things going on. It looks like you're saying that the international -- almost feels like the international traffic is inflecting because the AUR is still down, recognizing that I think you're saying the price point's probably a little too high there, so you're bringing them down and you're seeing that corresponding traffic improvement. Then in the United States, you're seeing AUR stability -- or AUR stability but the traffic's still down. Maybe can kind of give us some perspective on where you're seeing the progress points in the 2 different regions of the business? And then, I guess I just wanted to ask lastly, when you look at the CapEx breakdown, it's kind of almost reversed on its head now where the new stores CapEx is only about 20% of total CapEx and you have these store enhancements in IT and DTC accounting for about 80%. If we look out a couple of years from now, if you assume that the new store CapEx will be -- remain very low, when do we end the store enhancement kind of CapEx? Kind of where are we in the Hollister reformats? And then when do we kind of come down on the IT, DTC CapEx? Meaning, I'm trying to get a sense of what is the maintenance or normalized level of CapEx in the business on a long-term basis?

Randy -- so Joanne's going to come in on the first piece, and I'll take the second part of your question.

Yes, on the -- Randy, on the international business versus the U.S., we have seen for the second quarter and are encouraged by the stabilization in AUR in the U.S. business. The AUR in the international business was down in the quarter, pressured by FX primarily, but also with the price investments that we've made internationally. Again, those price investments, we expect to drive conversion, which we have seen and that was the driver of the sequential improvement in the international business for the quarter.

On the CapEx part, Randy, I think there's a lot of moving parts as you alluded to in the earlier part of your question. We do expect to continue to open new stores in the key growth markets we called out. I think one of the big questions we're working through is new store prototypes for both A&F and Hollister. And as we prove those out, it's to be determined how much reinvestment there would be in the existing fleet to convert stores to a new, more productive, easier, shoppable store format. So that's still, I think, open at this point. And then the IT, DTC, we continue to expect to invest in DTC. That's been a very productive, high-return investment for us over the past few years.

So do you think the CapEx levels will get -- could get down to more a normalized rate around $100 million or so? And then just following up, when do we lap the logo stuff? And then on -- lastly, you mentioned on real estate closures, you have a lot of flexibility. Where are we in the flexibility cycle? Or how many more stores are up for renewal or lease renewal over the next, let's say, 24 months?

Randy, I'll take parts 1 and 3 and then go to Joanne for part 2. So the CapEx level, no, I don't think we're ready to say that it's going to come down to a lower run rate of $100 million. I think we've said in the past that we think $150 million is reasonable run rate, but that is obviously a function of the returns we're seeing on different investments over time. And then real estate closures, we've said in the past that we have very significant flexibility domestically over the next couple of years with a very high proportion of our U.S. leases up for renewal between now and the end of fiscal 2017. So essentially, over the next 2.5 years. So as we test these different prototypes and as we see how productivity changes in the existing stores over the next year or so, we have a lot of flexibility to make changes on that front. I'll go to Joanne on logo.

Yes, on the logo pieces, Randy, we expected that the logo headwinds would start to abate in the first quarter. They represented 7 points of headwind to comp on our down 8 comp for the first quarter. We expect that to continue to abate in the second quarter and then neutralize in the back half of the year when we will have lapped the significant declines from 1 year ago.

[Operator Instructions] Next, we hear from Matthew Boss, JPMorgan.

Christina Brathwaite on for Matt. Can you just dive a little bit into the profitability by segment? You kind of excluded that a little bit from the presentation. In particular, just given the price decreases in -- on Hollister international, can you talk about international profitability and what you can see there longer term?

Yes, I'll take that one up. Christina, this is Joanne. The selling margin rate internationally declined related to the price decreases as well as the impact of the foreign currency fluctuations we saw in the quarter. With the stability in the AUR in the U.S. business, the selling margin rate -- and with the average unit cost coming down across all markets, we're seeing those selling margin rates come closer together, so improvement in the U.S. market and declines in the international markets. But again, we believe the investments -- and we have been seeing the investments, both in test as well as in the first quarter, in price internationally drive improvement in the top line and through the test, improve men in gross margin dollars in international markets.

Next we'll hear from Ed Yruma, KeyBanc Capital Markets.

Could you talk a little bit of AUC? I know you called that out as a bright spot in the quarter. Kind of what are you doing to improve that and kind of how should we think about AUC longer term?

Yes, from an AUC perspective, we continue to see AUC improvement, as we expected, in the mid-single digits for the first quarter. We do expect AUC to continue to be down in 2015. And it's really the driver of our ability to deliver flat to slightly improved margin rate this year. Longer term, AUC management will really be directed by the product development and the assortment changes that we're making.

Next we'll take our question from Susan Anderson, FBR Capital Markets.

I was wondering if you could maybe elaborate on merchandise or pricing architecture strategy for Back-to-School. How should we expect maybe the merchandise or assortment to evolve? And then maybe also if you could kind of talk about just the plan to kind of change the brand perception with the consumer of both brands, particularly in the U.S., and start to drive more traffic back into the stores.

So we're going over to Fran for the -- at least the first part of that question, yes.

Susan, as we move into Back-to-School from an assortment architecture perspective, we have worked on a much more balanced assortment. So you will see an assortment that has fashion, logo and core well positioned relative to what the customers' interests are. We've also worked through pricing. We will have -- we will continue with our must-have and entry-level price points and we will increase the prices up from there, measuring off the good, better and best architecture. The evolution of the assortment, I think, is the second part of your question. We are seeing continued customer acceptance for our product, which is giving the team confidence in moving forward and how they're assorting the line.

In terms of customer perception, we were very clear that, that will only change once we improve the product line and the product assortment. And so that's where our total effort is focused.

Susan, this is Arthur. Regarding the second part of your question on brand positioning, a couple of things. Number one, we've actually, in the last few days, seen some syndicated research that shows both brands have stabilized very nicely in the preference scale of our target customer. So certainly, any decline has been arrested. And the question is now how to restore them to a higher level of esteem in the minds of our customers. We have some work underway to help us think that through. It's not ready for prime time yet to be shown or discussed openly. But over the next couple of 3 months, I think you'll begin to see some elements of that come to light.

And next is Anna Andreeva with Oppenheimer.

I was hoping to follow up on May improvement. Is that being seen across Hollister and A&F and domestically and internationally? And also, we noticed you haven't bought back stock in the past couple of quarters, I believe. Just maybe talk about what are the board's views on the share buyback? And just how much cash cushion do you need to see on the balance sheet?

Yes, I'll just start with the May piece here. Yes, we said we saw a sequential improvement into May. We didn't -- we haven't parsed that over. We didn't get into more detail. There's obviously the caveat there too that, that's -- we're still very early in the quarter. In terms of stock repurchase, you're right. Obviously, we didn't make any repurchases during the quarter. We continue to evaluate that through our usual filters of looking at liquidity and long-term value at any given point in time, and that's a decision we make quarter-by-quarter as we go through the year. I missed the third part of the question.

From a capital allocation standpoint, we still look to invest back into the business through CapEx on projects that have the required risk-adjusted returns. And also look to return cash to shareholders through dividend and share repurchase programs.

At this time, we will move to our next question, Kimberly Greenberger, Morgan Stanley.

My question's on cost of goods sold, but I did just want to clarify the comments around May. Can we assume that the improvement in May is against the most difficult comparisons of Q2? Just let us know if that's not a good assumption. And then Joanne, my question's on cost of goods sold. I'm not sure I totally understand the rationale for excluding the $27 million inventory write-down? It just -- it sounds like you're deciding not to move forward with selling those goods. But that sounds sort of like a normal course of business and ought to flow through normal cost of goods sold. So maybe if you could just add some color around that.

Yes, the -- I don't believe May was the lowest comp of the quarter, but we don't -- we just have quarterly results that we reported externally. So can't really comment on that piece. In terms of cost of goods sold, we excluded that because this is a unique decision that we made to remove these goods, this aged inventory from our business, from our stores. It is important to note that we are not buying back into these goods, so it is a reduction in the overall level of ownership of clearance and penetration of clearance in our stores. So we expect that this is a onetime move down in the level of penetration of clearance, taking that -- really accelerating the sell-through and the disposition of those goods. Again, we don't plan to buy back into it. We plan to maintain lower inventory levels moving forward.

I think it's important to add to that also that it was an elective decision. It wasn't something that we had to do. We were selling the inventory but we wanted to clean up the stores and not have old low-AUR clearance competing with our new assortment as we grow in confidence that our new assortment is going to be stronger than where we've been.

Our next question will come from Paul Alexander, BB&T Capital Markets.

Jonathan, you mentioned earlier in the call that in the last few months, you've done a lot of work on assortment planning. Is that related to this disposition of aged inventory? Or -- the company has historically had difficulty buying the right levels of inventory in fashion. Is it -- is this progress in planning more about that and the correct distortion of fashion to core?

Yes, they're definitely related. I think Fran or Christos could elaborate a little bit on what we're doing in the assortment and planning area, and did a little bit in their prepared comments. But it -- yes, it's tied to both. The better assortment we think we have coming in tied to discipline generally around buying going forward and generally moving to a place where we think we have a stronger assortment and not wanting to have that diluted by having aged inventory that's still clearing through but at a relatively low AURs.

In terms of assortment planning, our focus really is on offering more variety to customers through several avenues: through pricing architecture, through trends in color analysis and also through fabrication and the fit of the product. Rather than just offering a one-dimensional collection, we're looking at offering several dimensions within that collection.

Barbara Wyckoff, CLSA, is next.

This question's for Christos and Fran. In the past, we've heard about speed-to-market testing initiatives. You talked about the impact of implementation of these processes, holding fabric testing and then chasing goods. Where are you on this process?

Well, we do have a process in place here at both Abercrombie and Hollister to hold fabric, to hold open to buy in terms of dollars and to speed up the process at the last minute to chasing products as quickly as possible. We have set a criteria in terms of which product areas are impacted on. So some product areas are obviously quicker than others, so we have a process. Our key focus, though, is getting the product right first time, and that's where we're really concentrating our efforts.

Just to underscore, I think we discussed last time, we have the ability to be fast. What we have worked on considerably over the past quarter is making the decisions quicker. That has helped our process considerably.

Oliver Chen, Cowen and Company, is next.

In our checks we've noticed your assortment with the Essentials program. And I'm just curious about how you're feeling about that balance? And then, on the denim side, what we've observed is a real interest -- consumer interest in fabric treatments. How long will that take? My inclination is that the fabric innovation itself is a longer process. And our last question, which is about how you're feeling about the differentiation between your banners and where you are with regards to the marketplace feeling about consumer reception on differentiation.

Okay, so on Essentials, we're very pleased with the performance of Essentials, but we think there's more work to be done, both in improving the quality levels and the variety of Essentials we offer. And I think there's opportunity to increase the AUR in that particular section as well. In terms of denim, there is a lot of development work and innovation going on in denim. And it does take a little bit longer, I have to confess. But that's -- the length of time is far outweighed by the benefits that we're getting by these new fabrications, and there really are some interesting techniques coming through. In terms of the differences between the brand, well, Fran and I both really focus on our own brands and the segment in which we're operating. Obviously, now that we're a branded organization, we feel that's really going to drive the difference in the 2. We've got very clear view on our brand positioning, which we can't really elaborate on at the moment, but that will evolve over the course of the year.

And then, just to underscore. In the Hollister as well, we are also very pleased with our essentials. As far as our pricing architecture goes, it was very, very well received by our customer as nice entry into the brand. The differentiation between the brands, we just celebrated our first year as being separated, and you will see the handwriting continue to develop amongst both brands as we continue to move forward.

Okay, and we've noticed this nice agility and the changes you've been making from fixturing to color to the composition of the assortment. But how do you talk to us when you zoom out about the customer and kind of moving the customer to your vision and kind of retaining customer and taking on the new customer, as you embrace different brand details as well as assortment planning and actually store experience kind of changes. I'm just curious about your thoughts on striking the balance.

My view, firstly, is we don't -- we're not trying to move -- I'm not trying to move the customer. I'm trying to follow the customer. I work for them, they don't work for me. And in terms of -- there's 3 buckets, I guess: We're trying to continue to cater to the existing customers. We want to appeal to previous customers that have lapsed, and we want to attract new customers. They're all 3 different approaches and we have a plan for each of those.

[Operator Instructions] Lindsay Drucker Mann with Goldman Sachs has our next question.

I was hoping maybe we could dig into the pricing strategy in Europe and in the U.K. Can you just give some details on what region, how many stores you took pricing down for Hollister, the magnitude of reductions and whether you've rolled that out to other stores in Europe and kind of what the plan of attack is there?

Yes, I can kick it off, Lindsay. If Fran wants to add any color, I'd welcome it at the end. But our pricing test occurred in the U.K., specifically, and a couple of other smaller tests around Europe in the fourth quarter. Leading into the first quarter, we had taken price down. In the U.K., we saw -- and we're pleased with the results, both on sales as well as the absolute gross margin dollar lift. And with the back of -- with the Spring Break floorset, we took price down throughout the U.K. So for the first quarter, it was mainly U.K.-directed strategy. We did see some sequential improvement in the business, in the trend of the business in the U.K. so we are -- continue to be encouraged. And our plan for rolling out is to more broadly roll it out globally with the Back-to-School floorset.

Great. And then maybe just a housekeeping ones. Number one, based on your hedges and spot rates, can you tell us the per-share impact you expect for currency on fiscal '15? And then secondly, can you give us the specific buckets where the new cost savings, the $40 million, I guess, or the other new cost savings that you identified are coming from?

Yes, we articulated in our last call the impact of foreign currency. And interestingly, as we sit at the end of the first quarter that those numbers haven't changed a lot. The currency's moved around a bit, but we sort of landed at the end of the first quarter basically where we were at the end of the fourth quarter. And that we still expect foreign currency to be a headwind, restating 2014 based on current spot rates at the end of the quarter, would have resulted in a $60 million reduction in operating margin for the year. So that number is still approximately right. So that is how it tumbles through our P&L. In terms of the cost savings initiatives for the year that were identified in the first quarter, they're really broad based. Some of them in the stores buckets but also in the home office. So -- and as we continue to focus on driving efficiency and productivity everyday as a way of life in the company, we expect there's more efficiency to find. But again, no big buckets in one specific area. I think it will be broad based.

Our next question will come from Janet Kloppenburg, JJK Research.

Joanne, I had one question on the operating expense savings of $40 million. I assume that is a full year number. And as I calculate it, between store operating and G&A, your costs were down about -- you saved about $39 million in the quarter. So does that mean that the rest of the outlook for the rest of the year depends on comp store trends, i.e., are most of the cost savings behind us? Or could you help me with that. And then on the knit product for both Christos and Fran. It sounds like some of your underlying trends in knits are improving, the essentials performing, et cetera. So once we anniversary the logo business, could we start to see an improvement? Should it just be a natural mathematical uptick that we should enjoy in the knit category?

So I'll start with the OpEx part of the question, Janet. We, as you recall in the last call, we expected the benefits from foreign currency exchange rates on operating expense to be roughly offset by investments we're making in other parts of the business. Again, foreign currency exchange rates haven't changed. That picture hasn't changed so the benefit expected for the year in foreign currency exchange rates remains the same. However, we have identified more savings during the quarter that will tumble through the year. So the $40 million is incremental to what we expected at the end of last quarter. The timing of when that flows varies during the year and the majority -- I would say the majority of the savings for the first quarter was related to the benefit from foreign currency exchange rates. However, some of the offsetting expenses happened later in the year. So the $40 million is an incremental save from where we were last quarter.

In terms of the anniversary of the logo and the math, I really wish it was just a mathematical equation that would solve it. But unfortunately, it isn't. We are going to have to rely on the extra design content that we've put into the new logo product. And we've got confidence that we've done the right thing there and hopefully, bought the right quantity. So it's the mix of those 2 equations that will give us the right mathematical result.

Clearly, Janet, our turnaround will be led by product. We are very encouraged by what we're seeing in that category and some other categories. Our full-price selling continues to increase. Our sell-through rate continues to increase at regular price, particularly, we mentioned earlier, in the girls tops business. We've made significant improvements in our comp. So we are encouraged at what we're seeing.

Brian Tunick with Royal Bank of Canada has a question.

Curious maybe, Joanne can talk on the gross margin guidance of flat to up slightly for the year. Can you maybe elaborate on your assumptions on inventory planning into the back half, I guess, as you say, comps are going to accelerate? And also merchandise margins in Europe versus the U.S., how should we think about that as you change your pricing architecture in Europe? And then maybe for the brand presidents to talk about supply chain and lead times, just the benchmark. Maybe you guys could talk about where are we now on your lead times and how often you're flowing product into the stores? And where you think we'll be 1 year from now?

Okay, Brian, on the first part of your question, gross margin guidance reflects the lower average unit cost that we've seen this quarter and expect to continue during the year. We do expect the average unit retail in Europe, specifically, and international markets to be pressured by exchange rates as well as the price investments that we've made. But we do see stabilization and have seen stabilization in the U.S. AURs, which I think implies that the U.S. margin rate -- selling margin rates would expand and the international margin rates would contract a bit this year.

On supply chain, I can't give too much detail at this point actually, other than it is something we're focused on. It's something that needs further evaluation. There are some real strengths but there are also some opportunities that we want to evaluate over the coming months.

Next we will turn to Dana Telsey, Telsey Advisory Group.

This is Melissa Calandruccio on for Dana. Our question is just in terms of the opportunity you see to adding A&F product to other multi-brand channels, such as ASOS and Sephora. Just any color there on sort of the sales and margin opportunity that there might be?

Melissa, this is Jonathan. I'll take that one. I think it's early days on these initiatives. We just started testing wholesaling in the fourth quarter of last year with ASOS. We're pleased with what we've seen so far. We're going to expand that over the course of 2015, including into Hollister. But I think it's too early to say what the long-term potential is. But obviously that's accretive to EBIT as we roll it out. Or at least, that's our expectation. On the licensing side, which is really where the fragrance comes in through Sephora, that's pursuant to the deal we announced late last year with Inter Parfums, where they're going to be distributing Fierce through third-party channels, such as duty free and through Sephora and so on. Again, we haven't started that yet, so it's too early to say what we think the potential of that is. But the -- again, we would expect that to be incremental. There's very limited investment on our side. And then, as part of that arrangement, Inter Parfums are also developing entirely new products to sell through those channels as well as potentially through our stores over time. So again, too early to say, but we think both of those are very interesting opportunities going forward.

And we'll take our final question today from Marni Shapiro, The Retail Tracker.

I'm just curious if we can talk a little bit about China. Because you have quite a number of stores there and it sounds like the business is still fairly healthy there. Can you -- does that customer differentiate between the 2 brands, Hollister and Abercrombie, the way we do here, that whole East Coast, West Coast situation? And if they do, is there an opportunity eventually to bring Hollister there? Or really Abercrombie will be the brand to bring there?

So Marni, we have -- we only have 2 A&F stores in China. Most of our stores are Hollister and the A&F flagship store in Shanghai only opened just over 1 year ago, and then the second store in Chengdu opened last summer. So A&F's relatively newer and it's much less prevalent than Hollister currently. We obviously have a very healthy e-com business in both brands. So I think it's early days for us still in China, frankly. We think it's a significant opportunity, both from a store standpoint still, but also from a e-com standpoint, where, as we alluded to earlier in the prepared remarks, we've seen very strong growth, particularly in Hollister but also in A&F since we went live with our localization late 2014.

And that will conclude our question-and-answer session today. Also, that will conclude today's conference call. We thank you for your participation today.