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

Thank you. Good morning, and welcome to our second quarter 2018 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer. Also joining us for the Q&A session will be Joanne Crevoiserat, Chief Operating 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, which we will be referring to in our comments during this call. Before we begin, I would like to remind you that any forward-looking statements we may make today are subject to our safe harbor statement found in our SEC filings. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and a reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning. Also, due to the calendar shift resulting from the 53rd week in fiscal 2017, second quarter comp sales are compared to the 13-week period ended August 5, 2017. With that, I will turn the call over to Fran.

Thanks, Brian. Good morning, everyone, and thank you for joining us today. We are pleased with our second quarter performance, which capped off a strong first half of the year and demonstrated further progress against our strategic transformation. During the second quarter, we delivered another quarter of comp sales growth across both brands, gross margin expansion and expense leverage as we continued to execute our brands playbooks, aligning product, voice and experience. As we've said before, when these are aligned, they drive traffic and conversion. Importantly, we delivered the second quarter performance while continuing to invest in our key transformation initiatives. As previously discussed, these initiatives are focused on following 4 pillars: optimizing our global store network; enhancing our digital commerce fulfillment and omnichannel capabilities; streamlining our end-to-end concept to customer processes; and optimizing our marketing investments, including leveraging our growing loyalty programs. Supported by strong progress against these initiatives, our second quarter performance reinforces the confidence we have in our ability to achieve the 2020 targets we set at our Investor Day earlier this year, including a low single-digit sales CAGR, with modest gross margin expansion and doubling of our 2017 adjusted EBIT margins by 2020. Moving on to the performance of our brands. The continuing improvement in external and internal brand health metrics is further evidence that the rollout of our playbook is delivering results. Both Hollister and Abercrombie were among the 5 U.S. retail clothing brands in the YouGov BrandIndex, with the highest increase in Index 4 for the 12 months ended June 30, 2018. Our own internal voice of the customer and customer satisfaction survey report also showed year-on-year improvement. We recognize we still have a ways to go, but are pleased to be making consistent progress on a key indicator of our transformation efforts. Our…

Thanks, Fran, and good morning, everyone. As Fran mentioned, we are pleased with our second quarter results. Importantly, we drove the top line, expanded gross margin and delivered another quarter of expense leverage, while investing in the transformation of the business. Going through our second quarter results in more detail, net sales were $842 million, up 8% from last year, with the calendar shift resulting from the 53rd week in 2017 accounting for approximately $30 million or 4 percentage points of the increase, and foreign currency accounting for approximately $8 million or 1 percentage points of the increase. Comp sales increased 3%, with Hollister up 4% and Abercrombie up 2%. The U.S. business remained strong across both brands, with comp sales for the quarter up 7% as we continue to execute to our playbooks aligning product, voice and experience, driving higher traffic and conversion and improving brands health metrics. Internationally, comp sales remained positive in Asia, driven by strength in Tmall and the digital business. This was more than offset by a decline in Europe, as Fran covered earlier, resulting in international comp sales down 4%. Our direct-to-consumer business continued to perform strongly with solid gross -- growth across both brands in the U.S. and international markets. For the quarter, DTC net sales were up 16% and comp sales were up 11% and were approximately 26% of total sales. Gross margin rate was 60.2%, a 110 basis points higher than last year. On a constant currency basis, gross margin rate was up 70 basis points. Both AUR to AUC were lower in the quarter due primarily to department mix. Our gross margin expansion was primarily driven by lower cost on like-for-like items in some of our higher-volume seasonal categories. On AUR, we were able to reduce our promotional intensity in…

Thank you, Scott. We had another strong quarter of execution and we are on track to deliver another year of progress, including top and bottom line growth and operating margin expansion in 2018 while investing in our ongoing transformation. We are pleased with our solid performance this quarter, our continued brand health improvement and the progress we are making across all our strategic initiatives. I would like to thank all of our associates around the world for their passion and commitment. It's only through our collective efforts that we've been able to make this progress. We continue to focus our efforts on transforming our operating model to deliver the best customer experience in a rapidly evolving retail environment. Thank you. 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] We'll first go to Mark Altschwager with Baird.

Just looking at the Q3 guide, I think net sales guidance of flat implies comps up around 3% for Q3, which would be about in line with Q2. But a pretty big acceleration on a 2-year basis. So assuming that math is right and correct me if I'm wrong, but maybe what gives you the confidence in the steady comp growth despite the tougher comparisons as we get into the back half? And along that vein, just any color on Back-to-School trends or quarter-to-date trends that you would call out?

Mark, it's Fran. Thanks for your question. So we were pleased with our first half. We had a really solid first half. And that was driven by traffic conversion and product acceptance, and we expect that to continue to drive improvement as we head into the back half of the year. We are seeing strong response to our product strategies. Our playbooks continue to work. There are some exciting emerging trends happening. Our denim business continues. We've seen a nice reaction to soft dressing. As I mentioned earlier, the track details are working. We saw a terrific response to windbreakers. That's something that continues into the third quarter. Our must-win and must-grow categories gain importance as we head into the back half. With that, I will hand over to Scott and he'll give you a little bit more detail on the quarter.

Yes, the math is correct, Mark. We do expect to drive positive comp sales in the back half. We do have the calendar shift that will hurt us in both the third and fourth quarter. But as Fran mentioned, we feel that we have the strategies in place to drive the comp on the comp. One additional point there is we will be driving additional marketing investment in the back half. And we have nice momentum on marketing in the first half and it's driving brand health as we mentioned. So we expect that to continue into the back half.

Next, we'll go to Simeon Siegel with Nomura.

This is Julie Kim on for Simeon. Can you just give more color on the monthly comp cadence throughout the quarter and the traffic trends you saw for each brand in-channel?

Yes. We don't comment on the monthly trends. I will say that as we have moved through the first half of the year, we have been pleased with our traffic, especially in North America. We've been above what we see from the mall. And as we move into the back half, as we just mentioned, we expect to continue to drive traffic for all the reasons we mentioned.

And Julie, I would add that we're also seeing positive conversion and Fran touched on some of the product and assortment changes that we've made and the businesses that are really working. And the teams are really getting after the business with our chase capabilities, and where we see the customer responding to trend, we're able to get back into it. And that's what drove our conversion in the first half. We expect that to continue in the back half.

And just a follow-up. Can you just talk about your current inventory position and composition by brand, channel or geography?

Yes. We're pleased with our current inventory position. As we mentioned, came into the quarter down 3, slightly below our expectations. But we proactively cleared through some of the inventory in Europe so that we would come into the Q3 clean. As Joanne just mentioned, we do have the idle supply chain and we continue to chase into that which is working, and we'll continue to do that throughout the quarter. But no issues on inventory and looking forward to the back half.

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

I was wondering if you could talk a little bit about the trends in Europe now that the weather has stabilized and is more seasonal. And also if you could talk about the inventory levels in Europe given the disappointing performance there in the second quarter?

I'll kick off with the inventory. Just to add on to the last point, we're in a good position in inventory across Europe and Asia. As I mentioned, we did clear through some of the inventory that wasn't working in Q2 proactively. So we're in a good position at this point.

Janet, it's Fran. So on a global basis, we had a solid Q2, which is driven really by continued strength in the U.S. Nice strong comps of plus 7 where we initially introduced our playbooks. Hollister was particularly strong at plus 9. At international markets, specifically, Asia continued to be strong, driven by our digital business, including our growing relationship with Tmall. In Europe, A&F was consistent with prior quarters. Hollister is where we saw the change. It was really impacted, as Scott mentioned, by the cadence of our seasonal floor sets. We believe we've addressed the issues and our inventories are clean heading into the third quarter. What it really does is it highlights for us the opportunity to get closer to our customer by executing our playbooks on a more localized basis internationally. We are also currently building on our local infrastructure and developing our teams for timely market-specific insights to better inform our planning, our merchandising and our marketing efforts.

Next, we'll go to Susan Anderson with B. Riley FBR.

I just wanted follow-up maybe on Europe. So it sounds like the inventory is clean there. I guess, what's your confidence level on the Hollister brand that it was really kind of a weather initiative -- or weather problem and not really being in stock for that type of weather? And your thoughts just around that kind of getting back on track in the back half? And, I guess, for each of the brands, maybe if you could just talk about the customer base you feel that you're bringing new customers into the brand, particularly in the U.S. and with Abercrombie. Is that target customer are you reaching that -- 20-something customer that you're targeting?

Yes, this is Joanne, Susan. I'll kick it off and let Fran add some color. But we have a solid business model in Hollister, in Europe, specifically. Over the past 2 years, we've driven very consistently, driven positive comps in that. In the first half of this year, we had an opportunity to better understand customer transition -- or assortment transitions for our customer. We have seen that customer behave differently in terms of when they're expecting seasonal transitions, and over time we've made adjustments in that timing. This year sort of amplified the opportunity for us to get even closer to our customer. We overreacted to slower selling coming out of the first quarter. We sold through our warm wear seasonal categories too quickly and frankly ran out of ammunition as we moved through the quarter and the weather turned much warmer for much longer. So as Fran mentioned, we're very focused on continuing to build on the infrastructure that we do have the there. We have a very profitable business model in Hollister, in those mall-based stores. And our focus is really getting closer to the customer and bringing more localized merchandising and marketing efforts in the region.

And regarding to the second part of the question -- it's Fran. I think you're specifically looking at the A&F brand, and we are pleased with our progress in A&F. We continue to build momentum in that brand and it was our third consecutive quarter of positive comps. Nice indication on our brand health index, it has been increasing each quarter which is a very strong sign for us. As the teams continue to get closer to the customer, there is evidence that our playbook is working. We've announced recently some exciting partnerships that we have coming up between sbe and Made in America coming up this weekend. We also recently launched our Team Abercrombie, which is our brand ambassador program, which is really helping us get closer to the customer.

And this is Joanne. I'll jump in on that one more time and just talk about some of the innovation that we're introducing that is very relevant to our customer base. The Venmo innovation that we added to our apps this past quarter has been incredibly well received. And very interestingly even we're getting much stronger engagement in A&F. So the A&F target customer is very engaged with the brand and loves the seamless experience they get in our app with the addition of that Venmo payment option.

And next, we'll go to Brian Tunick with RBC.

This is Kate on for Brian. I guess, first on the slightly up gross margin expectation for the year, can you just speak to what you are thinking about in terms of domestic and internationally, at least on a constant currency basis? Sounds like you used pricing as a lever this quarter to move through inventory in Europe, which I appreciate. But just overall views on flexibility, on pricing in Europe in particular as that market maybe remains a bit weaker.

Sure, Kate, I'll grab this one. We were pleased with the margin expansion we saw in the first half into Q2. As we think about the back half, we do expect a slight AUR growth and that's more on a global basis, forgetting about the FX. On the cost side, we have baked in some potential transportation pressure on the back half. But as we move forward and think about the full year in total, we're still expecting a slight up on gross margin and that will be driven by a slight up in AUR and a slight down in AUC.

And the opportunity, Kate, that we see in terms of AUR is really to step away from some of that promotional activity, where we have quite a bit higher promotional activity in the North American market, in the U.S. specifically. So our efforts have been focused on improving brand health and stepping away from some of that activity. We did have success in the first half in doing that, and we continue to look for ways to do that moving forward. And we're seeing the nice payoff and improvement in brand health, too, as we do that.

[Operator Instructions] We'll next go to Marni Shapiro with Retail Tracker.

Can I just dig in a little bit? I want to review the SG&A. It sounds like you do expect leverage in the back half of the year. Is that true in both quarters? And then could you talk a little bit about the marketing spend? Is the expected marketing spend in the back half raised versus the previous guidance? And is it across globally? Is it across both brands? Just curious where that money -- where the spend is going?

Marni, it's Scott. I will grab this one. Yes, OpEx, we were pleased with the leverage we saw in the first half. As we think about the back half, we will continue to invest in marketing. We are very pleased with the returns we're seeing on the higher marketing year-over-year that we invested in, in the first half of the year. As we move into the second half, we will invest in that marketing again year-over-year. The majority of that comes into the U.S., but there is a piece, obviously, internationally. As we think about leverage, obviously, the calendar shift was a bit of a help in the front half. So we'll get a bit of a headwind in terms of leverage in the back half from the calendar shift flipping against us. As we move to the full year, we continue to expect operating expense leverage on a full year basis, including all the investments we've talked about, marketing, investing in digital, as well as our transformation initiatives. And that is all baked into the outlook.

And Marni, this is Joanne. I'll just comment on our marketing spend. We are focused on increasing our investments, but also making that spend work a little harder for us. Part of our transmission initiatives is focused on leveraging data and analytics to better measure our marketing spend and make sure it's positioned in the places where it drives the highest return. We've already seen some early wins from that work in the first half and we've repurposed some of our marketing. We're also investing in the opportunities to better segment using all of our loyalty data and that growing asset that we have. And we're beginning to improve our communications and outreach to our best customers through those programs. But that will all also impact the back half of the year.

Are you guys spending against what you are doing in Tmall with Tmall? Like how's the spending in China versus what you're doing here?

Yes, we are continuing to invest globally and Tmall is definitely a piece of that. We've seen really nice acceleration in our business and our relationship with Tmall. We had a fantastic event this quarter with the A&F brand, and a key influencer in the market and saw a really nice business response on Tmall with that effort. So we are looking at our marketing spend globally.

We'll next go to Janine Stichter with Jefferies.

I just had a couple of questions. I wanted to ask quickly about tourism. Did you see any change in the first quarter either in tourism to the U.S. or tourism trends internationally relative to -- in the second quarter relative to the first quarter? And then on the promotions. You mentioned you've been pulling back on the -- in the U.S. and seeing some success with that. Could you talk a little bit about how you see the opportunity to pull back on the broader store-wide promotions by marketing more directly to the loyalty consumer?

I'll kick off with the first one on tourism. We have seen a bit of softness in tourism, but really for us, it's been centralized in Florida. Obviously, if you track the Brazilian customer, the currency has been hit pretty hard over the past couple of quarters. So we did see that impact on our tourist business in Florida. We talked earlier a bit about A&F, the tourism market in Europe. We haven't seen a trend go either way there. That business has remained relatively consistent quarter-over-quarter.

And in terms of -- this is Joanne. But the opportunity to reduce promotions through our loyalty programs, we're excited about the engagement we are seeing from our loyalty programs from members -- loyalty members. We are finding that to be a terrific driver of traffic to our stores. We're seeing loyalty members engaged with us both for special events and special offers, but also, as they come back and redeem their rewards, we're seeing loyalty members spend more. And we talk about spend more often, in fact, we see the loyalty members spend 1.5 to 2x more than a non-loyalty member. So we're seeing very nice returns in our loyalty program, but we're really just scratching the surface and just beginning to leverage the data that we have. As we improve our abilities to segment that data and communicate with our customer, more personalized messages, we think there's more opportunity to come.

[Operator Instructions] We'll take the next question Dylan Carden with William Blair.

Yes, just curious if you have any more detail on the gross margin upside in the second quarter? And then on, sort of, the pricing initiatives that you have going on in the back half, any timing or expected benefit from that?

I'll kick it off with the first half. Yes. As we mentioned in the prepared remarks, the up in gross margin in Q2 was really driven by cost on some of those higher-volume seasonal items, think about shorts, high core categories in the summer. Behind the scenes in AUR, it was really kind of a mix. We had the ability to walk -- we saw the ability to walk away from some promotions in the U.S. So we were able to get some AUR there. But we invested that AUR back into the international business to make sure those inventories came in clean.

And related to the pricing initiatives, we are working on implementing price optimization tools in the business. We're working through the implementation this year. We expect to see the benefit more in 2019 forward.

We'll take our next question from Omar Saad with Evercore ISI.

This is Shayne Arcilla for Omar Saad. Following your special collaboration with Khalid within the Hollister brand, how are you thinking about expanding that sort of initiative, especially for A&F?

Shayne, it's Fran. That initiative actually with Khalid continues through the back half of the year for us. He will be a strong part of our anti-bullying campaign as we move forward. It's been really well received by our customers. We have had really nice engagement on that program and then we'll continue into the back half. Exciting things happening with A&F. For example, this weekend, we are headline sponsor for Made in America concert, Jay-Z's music festival in Philadelphia. We just formed a partnership with sbe Hospitality Group. So lots of exciting things coming up for that brand as well in the back half.

And it looks like there are no further questions at this time. So I'd like to turn over to Ms. Fran Horowitz for any additional or closing remarks.

Thank you. We are excited about the second half of the year. Our global team is prepared and well equipped to compete and deliver top and bottom line growth in 2018, and I look forward to updating you all on our progress in November. Thank you for your continued interest and support.

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