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

Thank you. Good morning, and welcome to our 2017 fourth quarter earnings call. Earlier this morning, we released our fourth quarter and full year sales and earnings, income statement, balance sheet, store opening and closing summary and an updated financial history. Please feel free to reference these materials, which are available on our website. Also available on our website is an investor presentation, which we will be referring to in our comments during this call. Today's earnings call is being recorded and the replay may be accessed at abercrombie.com under the Investors section. Joining me today are Fran Horowitz, Chief Executive Officer; Joanne Crevoiserat, Chief Operating Officer; and Scott Lipesky, Chief Financial Officer. Before we begin, I remind you that any forward-looking statements we make today are subject to our safe harbor statement found in our SEC filings. In addition, we will be referring to certain adjusted non-GAAP financial measures during the call. Additional details and the reconciliation of GAAP to non-GAAP financial measures are included in the release issued earlier this morning. With that, I turn the call over to Fran.

Thanks, Brian. Good morning, everyone, and thank you for joining us today. I am delighted to report another quarter of meaningful progress across all our brands. The continued execution of our strategic plans throughout the year culminated in positive comparable sales in the fourth quarter across brands, channels and geographies and is fast exceeding our expectations for the business. Putting our customers at the center of everything we do remains our north star. That is reflected in our people, our processes and our product, and we have seen that continuing to translate into positive overall traffic and conversion trends. Coupled with a well-embedded and disciplined approach to expense management, we delivered on both the top and bottom line, while maintaining strategic investments in marketing, DTC, omnichannel and loyalty. Looking back over 2017, it has been a year of significant progress, several years in the making, with many important milestones achieved. Some of the year's highlights included, Hollister passed the $2 billion mark in sales, Abercrombie returned to positive comparable sales in the fourth quarter, we saw record digital sales across all brands, we've launched A&F on Tmall to a strong response, we've rolled out the first new A&F prototype stores in 15 years, we've launched the A&F Club loyalty program, we've rolled out loyalty programs in Europe across brands with more than 14 million worldwide members at year's end, we received feedback and insight from more than 1 million customers through focus groups, voice of customer engagement and surveys and our brand health and our customer satisfaction scores improved across brands. Overall, a busy and productive year. We achieved what we set out to do at the start of the year and more. 2018 will be a year of building one these foundations and investing in the drivers of future…

Thanks, Fran, and good morning, everyone. As Fran said at the outset, we continue to put the customer at the center of all we do, and over the past few years, we have focused on building and enhancing our capabilities that allow us to do that and keep us at the forefront of this rapidly evolving retail landscape. Overall, 2017 was an important year of hardening our foundations as the base for our future growth, and our investments and actions were focused on delivering that platform. We continue to invest in those things that get us closer to our customer and make the most difference to them. In 2017, that investment was weighted towards marketing, DTC, omnichannel and loyalty as well as the ongoing innovation and testing in the physical stores environment through remodels and new prototype stores. 2018 will be an equally important year in the company's ongoing transformation, as we scale our investment to match the opportunity we see ahead of us and build on the foundations laid to date. In 2018, our investments will still be heavily weighted towards marketing, DTC, omnichannel and loyalty with a significant proportion going to enhancing the store environment and stores productivity. I'll be covering the key areas of investment focus in 2018 with a few highlights from the progress made in 2017. Looking at marketing first. 2017 saw important gains in brand sentiment across brands, with marketing investments playing an integral role in that progress. The A&F launch of This is the Time, our first fully integrated campaign and platform for the brand, helped reach our target demographics and started to reset and reshape expectations and perceptions of the brand. At Hollister, we focused on driving engagement through immersive, innovative mobile content and leveraging influencer programs. This has driven strong engagement…

Thanks, Joanne, and good morning, everyone. As Fran mentioned earlier, we are pleased with our fourth quarter results, with operating income more than doubling from last year. We continue to tightly manage the business, delivering strong expense leverage while still supporting initiatives that drove the top line. I'll cover our fourth quarter and full year results, then provide our outlook for 2018. Starting with the fourth quarter. Net sales were $1.2 billion, up 15% from last year, with the additional week in 2017 benefiting sales by approximately $41 million or 4% and foreign currency benefiting sales by approximately $27 million or 3%. Comp sales were up 9% with improvement from last quarter delivered across brands and geographies. We drove growth in overall traffic and conversion with positive traffic trends improving from last quarter. Pages 8 and 9 of the investor presentation illustrate the sequential progress made throughout the year with positive comp sales across brands and geography in the fourth quarter. By geography, comp sales for the quarter were up 11% in the U.S. and up 5% in international markets. By brands, comp sales were up 11% for Hollister and up 5% for Abercrombie. Hollister's momentum continues with another quarter of strong performance. Abercrombie also showed further signs of improvement in stabilization with a return to positive comp sales for the quarter across geographies and channels. Our direct-to-consumer business continues to perform strongly with double-digit growth in both the U.S. and international markets, driven by our investments in mobile, omnichannel and fulfillments. For the quarter, DTC grew to approximately 34% of total sales compared to 31% of total sales last year. Gross margin rate was 58.4%, 90 basis points lower than last year, in line with our expectations coming into the highly competitive and promotional fourth quarter. Average unit cost…

Thank you, Scott. I am pleased with our fourth quarter results and the year as a whole. 2017 was another year of important progress, building a solid base for future growth. However, we know there's still much work ahead of us. I want to take a moment to thank our associates for their focus and commitment to our brands during one of the most challenging and fulfilling years I've experienced in my many years in retail. That's something worthy of a moment of celebration. As I've said before, there are no silver bullets. These results simply speak to continued progress from the rigorous, methodical execution of our strategic plan, a plan which we have been unwavering in our belief that represents the best route to delivering value for our stakeholders. 2018 will be a year of building and further investing to allow us to deliver the best omnichannel retail experience in the industry and sets the foundations for sustainable long-term growth. The progress we have made and the talent and commitment of our team has me energized and excited about what we can accomplish in 2018. And with that, I'll hand it back to Brian.

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

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

Just curious, what you're seeing in terms of the similarities and the differences on the efforts to turnaround the A&F brand versus Hollister. And then just a quick one. The performance of the flagship stores, curious, if you saw a similar improvement in those stores versus the rest of the A&F brand.

Paul, it's Fran. We are very excited about the progress that we made actually in both brands this year. Hollister had a very, very strong year, and A&F showed progress throughout the year, culminating in positive comps in the fourth quarter for the first time in several, several years. What we are seeing is the closer that we get to the customer, the opportunity to have our product, our voice and experience come together is working. As far as Abercrombie goes specifically, we saw lots of nice category opportunities. We saw growth across both genders, and we saw broad-based improvement across channels as well. In the fourth quarter, we saw a positive traffic and conversion growth. Those were all early indicators of what we saw at Hollister, as that opportunity -- as that journey started to happen as well. And truly, it's just a real focus on our playbook and a rigorous execution of that. And tremendous thanks to the team, to the amount of time they're spending in the stores and spending time with our customer and really understanding what they're looking for.

Then, was -- was store traffic positive at A&F?

North America was -- as I pick up the flagship comment, we did see improvement in trends in our international business, particularly our flagship stores in the A&F brand. So the traffic trends improved but remained negative. We continue to see positive conversion in those locations. We've embarked on a number of efforts to improve the performance of those stores, including making more with the traffic that we do have. We've tailored the assortments better in those locations. We've invested in the experience to allow us to drive conversion, and our focus is to integrate the digital and physical business in those markets. We've rolled out omnichannel to our international markets in 2017 and also have rolled out our loyalty programs with a focus on driving a more local, loyal customer in those stores.

Our next question comes from Tiffany Kanaga with Deutsche Bank.

Would you please discuss the cadence of comp sales by month in the quarter, if you can? And whether you're seeing your good fourth quarter performance extend into the first quarter at the same pace? Can we expect positive comps throughout the year as you're currently planning it?

Tiffany. Yes, we were very excited to show the progress in the fourth quarter with positive comps in both brands. We don't typically comment on the cadence of comps, but overall, across both brands, we saw a very consistent positive performance. And as we look to Q1, again, we don't comment on current quarter business other than to say that anything that's going on in the current performance is reflected in our outlook, and we are again very excited to be able to expect growth on top of growth. So we had a great year in 2017. We implemented a lot of changes and a lot of process changes really through the rigorous execution of our playbook, and we're seeing traction with our customers, and we expect that to continue in 2018.

If I could just ask one more. I'd like to dig into what are the drivers behind your expectation for gross margin expansion, especially in the back part of the year and especially as you are seeing evaporation of AUC benefits and one could argue that it remains a highly competitive environment in the mall.

Yes. Tiffany, that's true. We did see -- we did meet our expectations for gross margin performance in the fourth quarter, so it's probably worth a couple of data points there. We got there a little bit differently than we expected coming into the quarter. We were able to step away from a few promotions during the fourth quarter, and we saw the AUR declines moderating somewhat, as we move through the quarter. We did see a little bit of pressure in AUC, as we commented on as we chased into more products to support the top line growth. Top line definitely outperformed our expectations, and we were able to feed that growth with our chase capabilities, but that did pressure AUC. As we move into 2018, we do expect the AUR declines to continue to moderate, as we move through the year. As we get the product voice and experience aligned, and we see traction, we expect to step away from some promotional activity. But we're also expecting a more favorable FX environment in 2018, and that's reflected in our outlook and our AUR expectations as well.

We'll next hear from Brian Tunick with RBC.

Great. Curious, Fran, I guess there's been a lot of talk about the enthusiasm for the category that we haven't seen in several years. So just curious, from where you sit, do you think that there is a great bottoms trend out there? Do you think some of your competitors have closed stores, you've picked up market share? Just curious on what you think is happening out there, certainly coming out of the fourth quarter enthusiasm. And then maybe a question on the expense side. I guess are there any other buckets, as you make these investments in 2018 and beyond, but are there any other buckets that you're looking to downsize beyond the $100 million expense initiatives?

Brian, yes, we are very excited about the progress that we made in both brands, actually, for the 2017, and we did see a significant trend in our bottoms business. As I mentioned, we had a record year in denim in Hollister, actually in both genders, which was very, very exciting. And we also did see nice denim business for the women's business for Abercrombie adults. There is a trend happening out there. In our men's Abercrombie business, we also had a very strong pants business. That's a trend that we've been seeing for a while. It's actually a category which really does build loyalty, and we're very excited to see that business continue to grow. Other than that, we saw lots of other things happening in our business. Our graphics business was also very, very strong across both T-shirts and fleece that was driven in both brands, both genders. So we're excited about seeing our customer response to the fashion items that we're putting out there for them. And again, as I said, the team is spending a lot of time getting very, very close to the customer and executing our playbook, and it's working in both brands.

And I'll pick up the expense side. We were pleased in 2017 to exceed our reduction target, our gross reduction target of $100 million. As we come to 2018, we are looking at this as an investment year, and we're excited to invest this year. Our OpEx, as we mentioned in the outlook, is up around 1%. Included in that is a significant investment back in the business in those parts of our playbook, that're really working, so marketing, DTC, omnichannel, loyalty, analytics, but we will be funding a significant portion of those investments with other cost reductions that we found across the model. We'll continue to drive store occupancy expense out of the business, but it's not just that, it's really across the entire model.

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

Joanne, I was curious on your answer to the comp question, current trend, not at I know you're not going to give it, but just reflecting on the easier comparisons in the first half versus the second half. I was curious, why you may not see some variation in the comp trend, as we move throughout the year? And then secondly, I was just wondering about the gross margin opportunity as well. Do you think that your full-priced selling trends can improve this year? Or do you think you'll have to continue to use promotion to drive traffic back to the brand? And Scott, if you could just comment on wage pressure.

Thanks, Janet. I'll take the first 2 parts of that question, because they are related. They are definitely related. We are expecting growth on top of growth. We did deliver a 3% comp this year, and we're pleased with the progress that we've made, and we delivered nice improvement in operating income. As we move into 2018, we continue to expect our brands to deliver growth on the top line, but also growth on the bottom line, and we're very focused on making sure that we deliver a balanced result, including starting to see improvement in the gross margin line. And we have proven to be able to step away from promotional activities as we see the customer responding to our assortments and it's really the combination of getting the voice, the marketing, the product and the experience all aligned. And if those things fall into place, we have been able to in the past and we expect to continue to be able to step away from promotional activity and drive that regular-price business back into the business in 2018. And then in terms of driving traffic, there are number of levers that we're using to drive traffic. And we're moving away from having promotions be the only lever. And a key to that change has been the rollout of our loyalty programs. We've seen terrific engagement across both brands on our loyalty programs globally. And now we have that platform globally, and we'll continue to leverage that, but we see nice response from our customers, both online and in-stores to our loyalty programs.

Yes. On the expense side for wage pressure, we have seen pressure in wages across our fleet and in our distribution centers. So we have these wage pressures baked into our 2018 outlook. This is kind of a multiyear trend, so we will continue to offset these -- this pressure with efficiencies in the model and productivity improvements throughout.

Our next question comes from Mark Altschwager with Baird.

I apologize if I missed this, but what are you planning in terms of A&F prototype rollout for fiscal '18? And what's the sales lifts you're seeing in these stores and then just tweaks you're making to the concept, as you move forward, especially, as it relates to omnichannel capabilities.

Yes. On the prototype rollout, we had about 8 new formats rolled out from a remodel perspective and 1 new store -- I'm sorry, 4 new stores under the new prototype in -- during the year.

What we've learned, Mark, is very, very exciting. We've had an opportunity to really focus on the voice of the customer what the customer experiences in our stores? And we're hearing very, very positive things about that. We are really focused on increasing our productivity in these stores. A super exciting example, we talked last year about closing our Hong Kong store on Pedder Street and opening up a new prototype in Harbour City, and we've seen in about 1/3 of the space doing almost the same amount of business, so we continue to look at these opportunities as we move into 2018.

Yes. I'll just add one more piece. Related to our omnichannel capabilities, those omnichannel capabilities are embedded in our prototype stores. We continue to improve on our execution and melding that digital and physical experience. And in 2018, we'll also be investing in more technology to put in the hands of our associates to allow them to more effectively interface with our customers in the stores.

And just a quick follow-up. Just any update on the trends you're seeing in the digital business in markets where you're closing stores? Are you able to recapture much of that demand or any marketing strategies you have to do so?

Yes. Thank you. We have some transfer when we close stores, but it's very low to the digital business. We see the opposite actually happen. We see much more transfer or much more digital growth when we open stores in market or when we close stores where there's a physical store nearby is where we see more of the transfer. Certainly, one of the opportunities we have, now that we have more data on our customers, part of the loyalty program rollout has been the ability to engage our customers and have more data at our disposal to reach out to our customers and continuing to leverage that data, particularly in markets where we closed stores will be a focus as we move forward.

Our next question comes from Stephen Albert with Bank of America.

I was wondering if you could give some more color on the foreign currency impact both on gross margins and fourth quarter. What is contemplated as an FX tailwind to gross margin in your outlook for 2018? And then what gives you confidence in the gross margin inflection from continued pressure in 1Q to a benefit in 2Q through 4Q?

Yes. I'll start with the FX. So FX impacted sales in Q4 by about $41 million, ended about $18 million in margin. So as we look forward to 2018, we'll continue to see that tailwinds, as we sit here today with consensus rates, it's about $50 million on the top line and dropping about $15 million down to the op income line.

Yes. As it relates to the inflection in Q1, we expect to continue to see moderating AUR declines as we move through the year. As I mentioned, we did see that occur in the fourth quarter, as we were able to move away from some promotional activity. We're also expecting, as we mentioned, the FX to benefit -- the FX environment to benefit AUR, as we move through the year. We're up against steeper hedging headwinds in the first half of the year than the back half of the year. So that plays a factor into our -- the cadence of our AUR expectations.

And as a quick follow-up. Do you -- maybe if you could parse out, how much incremental savings you found this year and then of that, how much you're going to reinvest? Or how much you're going to invest into some of your strategic initiatives? And whether you view the investment cycle in front of you as kind of a multiyear cycle, given how much cost you stripped out the business over the past 5 years?

Yes. As we think about the outlook for 2018, the total OpEx is up around 1%, with half of that coming from foreign exchange, being offset by the loss of the extra week in 2017. The other half of that will be the net incremental investments that we're making outside of the savings. We're not going to give a number around the savings target at this point, but I will say that we're making significant investments this year and a large majority of that will be funded by our ongoing cost reduction initiatives.

And our focus, Stephen, is to continue to drive leverage operating expense leverage in our model, and we'll continue to identify savings. We have a very rigorous and, as we mentioned, well-embedded profit improvement process. We continue to review all of our processes, particularly as they evolve with omnichannel dynamics. We're looking at those processes for more efficiency and we expect to find more efficiencies in the model moving forward.

Our next question comes from Simeon Siegel with Nomura Instinet.

This is Dan Stroller on for Simeon. we were wondering if you could talk a bit about inventory. Could you parse out composition by brand and any expectation going forward? And then quickly on marketing, how are you planning dollars and impressions this year?

It's Fran. I'll start with that question. So we talked about the fourth quarter that we were using inventory as an asset, and it was quite a strategic plan to come into the quarter invested in our key items. The goal was to not disappoint our customers and, in fact, we accomplished that goal, obviously by the results that you saw today. Our inventories that we had into the spring are clean, and they're very current. We don't normally parse out by brand, but we are confident with where inventories are and they are very current.

As it relates to the marketing investments, we do expect to increase our marketing investments this year. We don't parse out the number of impressions, but we have had and seen really terrific engagement with our customer and traction, as we've been innovators in our marketing efforts, and we plan to continue in that space, both engaging our customers in the digital experiences in an authentic way and building off the foundations that we've laid over the last year to 2 years in marketing.

And we'll next move to Marni Shapiro with Retail Tracker.

I just want to -- as you guys continue to grow your DTC business, which has a nice penetration at this level, can you talk a little bit about what percentage of that is getting returned, of those returned are coming to the store? And have you been successful in converting those returns to purchases, because it sounds like your conversions are up at the store level? And then just one quick on Tmall. Is it -- I know it's very early, but are you feeling good about it? And would you consider a similar venue in the United States?

Marni, it's Joanne. As it relates to DTC returns, it's great question. We do see a large proportion of our DTC returns going back to stores. We look at that as an opportunity to engage our customers. And it's been very important -- it's a very important aspect of the way we engage customers. We see them respond between both the digital environment and the physical environment. So having the capability return to a store is very important to our customers and it also allows us the chance to engage our customers and get more into their basket, introduce new aspects of our brand, particularly as we go through the brand turnaround. And as you pointed out, our conversion comps have been positive and continue to grow, so we're encouraged by what we're seeing. We're encouraged by the engagement that our associates are having with our customers when they go into the store. So that is a focus of ours and we'll continue to build on that as we move forward.

As far as Tmall goes, to your point Marni, we've had, I think, nice success on Tmall for both of our brands. It was very exciting to launch Abercrombie on Tmall this year to great success. That relationship will continue and we expect that to grow as we head into 2018. We're always looking at opportunities for us in any of our channels. So we certainly would look and consider U.S. opportunities, but nothing at this time.

Just to add on to that, the opportunity in Tmall is to expand our brand reach in a market where we have very low penetration and we have an opportunity to build awareness. And Tmall hits on all of those aspects and we've been, as Fran mentioned, really excited to grow the business on Tmall and grow the awareness of our brands in China specifically. The U.S. in terms of market penetration isn't -- doesn't represent the same opportunity. But as Fran mentioned, we're always open to new ideas.

Did you participate in Singles' Day, could you remind me?

Yes, we did. We had a very strong Singles' Day for both brands.

Our next question comes from Omar Saad with Evercore ISI.

Very impressive work in the last few years and seeing it pay off. I'm sure it's extremely rewarding. I wanted to ask Fran. You've been there more than a few years now. Maybe you could help us kind of put some perspective around how the consumer perception of the brands has evolved from when you first arrived to where it is today. And from a perspective of the company, how the consumers perceive the brand and how that's changed over time, I think it would be interesting to hear.

Sure.

Omar, thank you for that. Yes, very exciting to see the progress that we're making here and it's really is a great year. It has been exciting to see how the customer's perception has evolved over time. Hollister has really gained market share. Their understanding the customer, being where the customer is -- has been really quite exciting, really new opportunities that we have engaged in with that brand. Clearly a leader in innovative marketing. The customer, our customers, in Hollister loves music, video gaming, being in that place for them as really shown that they're willing to actually engage with the brand, not only for transaction, but for what we call the journey and the discovery process. So their spending time with us is not only just a transact but to learn about the brand and to be part of the brand. I mean, our game, for example, during the fourth quarter -- our Hollister llama game had 4.5 million views, and the customers stay with us for 65 seconds. That's considerably longer than the industry average. So it's showing that the customers are very excited to engage with us. We're also starting to see in Abercrombie, really resetting the perceptions and expectations. We had talked in the fourth quarter about the YouGov study and how Abercrombie's customer sentiment have gone from negative to positive for the first time in several years. So we're seeing progress in both brands. We're really, really encouraged with what we're seeing.

And next, we'll move to Susan Anderson with B. Riley FBR.

I guess, I want to follow up on the new Abercrombie format. I think that you'd said, maybe, you rolled out 4 last year and another 4 this year for a total of 8. And then also, I was wondering if you had any metrics yet in terms of their performance versus the old format.

Yes, actually we rolled out 7 Abercrombie prototypes this past year in 2017, 6 domestically and 1 internationally. What we're seeing is that our productivity in these stores is higher than our average productivity for A&F mall-based stores. One exciting example I mentioned earlier, our Hong Kong store, for example, we closed our Pedder location in the beginning of '17 and opened up in Harbour City where it's one of the largest malls in the word actually with over 80 million people visiting that mall a year, and we're doing almost the same amount of business in about 1/3 of the space. So productivity as well as customer sentiment and customer-improved experience are the 2 things that are really working for our prototypes.

Great. And then, did you guys see how many you're going to roll out this year then?

I think we have new stores plus remodels, I think, gets us to about a total of 11 new experiences in 2018 on the plan.

Great. Great. We have 1 actually in our mall and it just looks -- it looks really great. Just one follow-up on the A&F customer, too. In terms of the customer demographics, I know you were trying to take it a little bit up the age spectrum. Have you seen that demographic change at all?

Actually, our customer historically has really started to shop with us at the age of 18 and that is true today. About 60% of our customers start to shop with us at the age of 18. Our target, as we mentioned before, are bull's-eye is -- our customer who is 21 to 24. But as far as demographic goes, we're just really focused on who our customer is and relating to them in the space that they visit us and providing the product that they're interested in. So the demographic has really remained where it is.

And that concludes our time for questions for the call today. I'd like to turn the conference back over to Fran Horowitz for any additional or closing remarks.

Thank you. We are pleased with our progress this past year. We have a talented team, a playbook that's working and important year ahead of us. Building on the foundations we have laid over the past few years, I am confident the team is prepared and well-equipped to compete and to deliver the best omnichannel retail experience in the industry. We all look forward to speaking with you at our Investor Day at the end of April.

And that does conclude today's call, we thank you for your participation.