Abercrombie & Fitch's (ANF) CEO Michael Jeffries on Q2 2014 Results - Earnings Call Transcript

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 |  About: Abercrombie & Fitch (ANF)
by: SA Transcripts

Abercrombie & Fitch (NYSE:ANF)

Q2 2014 Earnings Conference Call

August 28, 2014 08:30 A.M. ET

Executives

Brian Logan - VP, IR and Controller

Michael S. Jeffries - CEO

Jonathan E. Ramsden – COO

Joanne C. Crevoiserat - CFO and EVP of Finance

Analysts

Randy Konik - Jefferies & Company

Unidentified Analyst - J.P. Morgan

Kimberly Greenberger - Morgan Stanley

Paul Lejuez - Wells Fargo Securities

Janet Kloppenburg - JJK Research

Stephanie Wissink - Piper Jaffray

Dana Telsey - Telsey Advisory Group

Matthew McClintock - Barclays Capital

Janine Stichter - BMO Capital Markets

Anna Andreeva - Oppenheimer

Jennifer Black - Jennifer Black & Associates

Thomas Filandro - SIG

Betty Chen - Mizuho Securities

Barbara Wyckoff - CLSA

Gene Vladimirov - Nomura Securities

Jennifer Davis - Buckingham Research Group

Susan Anderson - FBR Capital Markets

Richard Jaffe - Stifel Nicolaus & Company

Liz Dunn - Macquarie Research

John Kernan - Cowen & Company

Operator

Please standby we are about to begin. Good day everyone and welcome to the Abercrombie & Fitch Second Quarter 2014 Earnings Results Conference Call. As a reminder today's call is being recorded. (Operator Instructions). At this time, I would like to turn the conference over to Brian Logan. Mr. Logan, please go ahead sir.

Brian Logan

Good morning and welcome to our second quarter earnings call. Earlier this morning, we released our second quarter 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 through the internet at abercrombie.com under the Investors section. The call is scheduled for one hour. Joining me today are Mike Jeffries, Chief Executive Officer; Jonathan Ramsden, Chief Operating Officer; and Joanne Crevoiserat, Chief Financial Officer.

Before we 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. After our prepared comments this morning, we will be available to take your questions for as long as time permits.

With that, I hand the call over to Mike for some opening remarks.

Michael S. Jeffries

Thank you Brian and good morning everyone. I will comment on the numbers in a moment. But I want to start by saying the most significant development over the past quarter has been the great progress we believe we have made in evolving the fashion component of our assortment. Many of you have seen and commented on this with regard to our back-to-school floorset and we could not be more excited about it within the company.

Sales for the second quarter were somewhere below our plan but we have seen modest improvement since we set back-to-school in mid-July. Importantly we have been able to achieve this improvement despite adverse likes in our logo business as we work to strategically reduce that element of our assortment. We are confident that the evolution of our assortment will drive further improvements in sales as we go forward.

While we continue to operate in a challenging environment, we are please that we were able to exceed both our earnings expectations coming into the quarter, and prior year’s earnings, as we continued to manage expenses tightly and exceeded expectations on our profit improvement initiative.

We are also pleased that for the second quarter in a row our A&F brand comp close to flat, and we continue to see sequential comp sales improvements in our U.S. stores overall. From a merchandize standpoint we performed well during the quarter in Jeans, dresses and skirts.

Chase represented approximately 20% of the female assortment in the quarter and we expect to roughly double that figure for spring 2015. And while Chase currently represents a much smaller percentage of the male assortment we will be looking to significantly expand its use there as well.

Meanwhile we continue to make good progress on AUC with like to like AUCs expected to be down for the balance of the year and through 2015. To compliment our evolving assortment we continue to focus on increasing brand engagement through enhanced marketing initiatives and campaigns, and are making great progress that many of you have also noticed. For back-to-school our marketing initiatives have been focused on developing digital editorial content around our newest product and key trends.

Being on track with our core merchandizing and marketing initiatives is critical to our efforts to stabilize and improve productivity levels in both our U.S. and international stores and while some of these initiatives will take time to fully pay off, we remain confident we are on the right track.

Turning to our international performance we continue to be pleased by our expansion efforts in Asia. During the quarter we opened our 8th Hollister store in China and on Saturday we will open our first mall based A&F store in Chengdu. In Japan we opened our 3rd Hollister store during the quarter at LaLaport Tokyo Bay and we remained very pleased with the volumes and profitability of our Hollister stores in both China and Japan.

We look forward to accelerating our store openings in both markets in 2015. We also continue to be excited about the Middle East where we plan additional openings in Dubai and Abu Dhabi this year.

In Europe comps remain challenged. The general economic situation in Europe remains difficult, and at any time weakens during the quarter. But we believe that our company-wide merchandizing initiatives as well as pricing, marketing and other initiatives within key markets in Europe and they help us stabilize productivity.

In Canada we have now comped positively for the fourth time in the last five quarters. Among other factors we believe that the adjustments we made to pricing in 2012 have contributed to the sustained improvement we have seen since then.

As you know aggressively growing our DTC business is a key component of our long-term strategy. We’ve launched a redesigned Hollister website for back-to-school which included increased mobile optimization. In addition we are focused on expanding our international infrastructure to support future growth there on which Jonathan will go into more detail in a moment.

Turning to our organizational structure we continue to make good progress in our evolution to a branded organizational model, and look forward to welcoming Christos Angelides to the company in October. Our search for the Hollister brand President is still ongoing but we remain confident we will find the right person for that brand as well.

I will conclude these opening comments by stating clearly that we remained highly focused on returning to growth and we are absolutely taking the right steps to accomplish that especially in the evolution of our assortments. Now over to Jonathan.

Jonathan E. Ramsden

Thanks Michael and good morning everyone. We are very pleased to have Joanne Crevoiserat joining us for our first earnings call this morning. Joanne has been spending much of her first few months with the company in the merchandize planning and inventory management areas and is now transitioning to take over day to day CFO responsibilities. Joanne is going to walk through our financial results for the quarter and then I will provide an update on the low range planned initiatives and our outlook for the remainder of the year. I’m going to hand it over to Joanne.

Joanne C. Crevoiserat

Thanks Jonathan and good morning everyone. It's great to be here with you on my first earnings call as the company's CFO and I look forward to meeting many of you over the coming months.

As you have seen in this morning's press release net sales for the quarter were $891 million down 6% to last year. Including direct-to-consumer, total comparable sales were down 7%. U.S. comparable sales were down 5% while total international comparable sales were down 9%.

By brand, comp sales including direct-to-consumer were down 1% for Abercrombie & Fitch, down 6% for Abercrombie Kids, and down 10% for Hollister. Comps by gender were approximately in line. Within the quarter comparable sales were weakest in June. Changes in foreign currency exchange rates versus a year ago benefited sales by approximately $13 million.

The gross profit rate for the quarter was 62.1%, 180 basis points lower than last year reflecting an increase in promotional activity including shipping promotions in the direct-to-consumer business. However, promotional activity was somewhat lower than we anticipated coming into the quarter leading to modestly higher gross profit rates than planned.

Stores and distribution expense for the quarter was $426 million or 47.9% of sales, down from $472 million or 49.9% of sales last year. The decreased expense was driven primarily by savings in store payroll which was offset partially by higher direct-to-consumer expense.

Marketing, general, and administrative expenses for the quarter was $111 million, a 6% decrease compared to $118 million last year. The decline in MG&A expense was primarily due to a decrease in compensation expense, partially offset by an increase in marketing expense. Excluding pretax charges of $2 million which are detailed on page 4 of our investor presentation, adjusted non-GAAP operating expense for the quarter was $535 million down $61 million from last year representing 190 basis points of leverage.

Savings were greater than anticipated coming into the quarter due to continued tight expense management and realization of incremental benefits from profit improvement initiatives on which Jonathan will provide more detail in a moment.

Other operating income was $4 million for the quarter, flat to last year and included insurance recoveries of $3 million. On an adjusted non-GAAP basis operating income for the quarter was $22 million approximately flat to last year.

The effective tax rate for the quarter excluding the effect of charges was 29.2% reflecting the application of the estimated full year tax rate to the year-to-date results. For the quarter the company reported adjusted non-GAAP net income per diluted share of $0.19 which was ahead of our expectations coming into the quarter.

Turning to the balance sheet, we ended the quarter with $311 million in cash and cash equivalent and borrowings of $188 million. During the quarter we repurchased approximately 1.5 million shares at an aggregate cost of $60 million. This brings our total year-to-date repurchases to approximately 5.3 million shares.

Subsequent to quarter-end we completed the refinancing of our credit facilities. The new credit facilities consist of $400 million asset based revolving credit facility and a $300 million Term Loan B Facility. A portion of the proceeds from the Term Loan B Facility were used to repay outstanding borrowings of $188 million and pay fees and expenses associated with the transaction.

The balance of the proceeds will be used for working capital and general corporate purposes including potential share repurchases. As of the end of the quarter we had approximately 11 million shares remaining available for repurchase under our previously announced stock repurchase authorizations.

We ended the quarter with total inventory at cost down 13% versus last year. We expect inventory at cost on year-over-year basis to continue to be down double-digits at the end of the third quarter.

At the end of the quarter we operated 836 stores in the U.S. and 161 stores in Canada, Europe, Asia, Australia, and the Middle East. With that I will hand it back over to Jonathan.

Jonathan E. Ramsden

Thanks Joanne. As mentioned I am going to give an update on some of our long range planned strategic initiatives, and will then provide an update on our outlook for the remainder of the year. As a reminder our object through our long range plan is to achieve a significant increase in return on invested capital through a combination of disciplined and focused capital allocation, and operating margin improvement.

As Mike mentioned aggressively growing our DTC business is a key component with this strategy. We continue to expect another year of strong growth in 2014 particularly in our international business with the segment margin remaining in the mid 30s on a full year basis. We are on track for the conversion of one of our distribution centers here in New Albany to be a dedicated direct-to-consumer facility which will support processing speed, throughput, and service.

We are also on track to launch localized sites in country fulfillment in China next month as well as regional fulfillment from Hong Kong for other Asian countries, giving us local or regional fulfillment coverage of all of our major markets in North America, Europe, and Asia. In addition we expect to open a Hollister store on Temo (ph) in China later this quarter, launch a localized website in Japan later this year, and launch in country e-commerce fulfillment in Japan next year.

With regards Omni-channel old range store is on track to be completed for old US stores during the third quarter in addition we are proceeding with our ship and store pilots with a rollout plan for approximately half of the U.S. fleet early in the fourth quarter. We expect our reserving store and in store pickup activated during 2015.

Importantly the combination of our technology and international fulfillment investments which is in a strong position to rollout omni-channel capabilities as they increase in relevance in our international markets. Near term we see the UK being our highest priority market.

Turning to our corporate improvement initiative while some of the lower than expected expenses to date have come from continued tight expense management, we are also exceeding our goals for savings from the profit improvement initiative. As a result we now expect gross savings from initiative exceed $200 million versus the prior projection of at least $175 million of which $30 million was recognized in 2013.

In addition we expect to realize some additional savings beyond 2014 that are not included in this statement. As we have previously stated, these savings will be partially offset by approximately $30 million increase in marketing expenditures in 2014. We continue to expect total capital expenditures for 2014 to be approximately $210 million to $220 million with the priority remaining on DTC and IT investments to support growth initiatives.

During 2014 we now anticipate opening a total of 14 full priced international stores including 8 Hollister stores and 5 A&F stores. We also plan to open 8 to 10 international and U.S. outlet stores during the year.

As we think about capital allocation for 2015 and beyond we expect to increase our allocation to new stores particularly in Asia so we will continue to invest in support of our growing ecommerce footprint.

In addition we remained pleased with the result of the Hollister store remodel and we are working on a store remodel for A&F which we expect to be in testing later in the third quarter. We expect to allocate capital to accelerate the rollout of these new store fronts in 2015. In both terms we continue to expect that CAPEX will remain at approximately $200 million annually.

U.S. store closures remain a key part of our strategy to position our brand appropriately in U.S., achieving optimal balance between our bricks and mortar and online presence, and improved average store productivity. We now expect to close approximately 60 stores in U.S. during 2014 and naturally 6 for Asians (ph). We expect to close a similar number of stores into the next couple of years and expect to attain significant flexibility thereafter.

Moving on to our earnings outlook for the rest of 2014, we continue to expect full year diluted earnings per share in the range $2.15 to $2.35. The guidance is based on the assumption that full year total comparable sales will be down by mid single-digit percent. The guidance continues to assume gross margin rate from full year that is down slightly compared to fiscal 2013.

We continue to expect average unit retail pressure and lower shipping handling revenues to offset average unit cost improvement and a benefit from the company’s profit improving initiative. We expect gross margin rate improvement in the back half of the year as we begin to penetrate from lower AUCs and go up against more favorable AUR comparisons.

On a sequential basis we expect a lower year-over-year decline in operating expense in the back half of the year as we begin the anniversary savings realized last year. The guidance includes an increase in interest expense associated with the refinancing of our credit facilities and includes the full year effective tax rate of the mid 30s which remains sensitive to the mix between international and domestic income.

The guidance also assumes a weighted average share count of approximately 73.6 million shares which does not include the impact of any additional share repurchases over the remainder of the year. The guidance does not include charges related to the Gilly Hicks restructuring, the company's profit improvement initiatives, certain corporate governance matters and other potential impairment and store closing charges. This concludes our prepared comments and we will now be happy to take your questions. Thank you.

Question-and-Answer Session

Operator

Thank you sir. (Operator Instructions). We will first go to Randy Konik with Jefferies.

Randy Konik - Jefferies & Company

Good morning everybody, how are you?

Jonathan E. Ramsden

Hi Randy.

Jonathan E. Ramsden

Hi guys, I guess a question for Mike, can you give us some -- I guess stand and put on some color around the stuff you see, I guess the improvement you are seeing in the non-logo business, give us a little perspective on when the like for like I guess, ease in that logo business and any color what -- how far down you want to take the logo business? And then I guess that's domestically then internationally just give us a little bit more I guess color if you could on different country-by-country performance within the quarter? Thanks.

Michael S. Jeffries

We are really…

Randy Konik - Jefferies & Company

Hello. Hey, it is Randy. Did the call cut out?

Operator

We are resolving the issue. Ladies and gentlemen thank you for standing by, one moment while we connect our call. Okay, gentlemen you have rejoined the call.

Michael S. Jeffries

Do they hear me?

Jonathan E. Ramsden

Randy mate, did you hear Mike's answer to that question. We are not sure when the call got dropped.

Randy Konik - Jefferies & Company

No, I think it was just -- I think everybody got dropped right, when he first started speaking.

Michael S. Jeffries

Okay, here we go again.

Randy Konik - Jefferies & Company

Take two.

Michael S. Jeffries

Yeah, we are thrilled with the rate at which we are selling fashion. I think everyone has seen that in our assortments and it is working. We are up against big logo likes, we are looking to decrease that aggressively. For the fall season we are saying that we are going to be having the amount of business we did last year. In the spring season we are looking to take the North American logo business to practically nothing but protect logo in international stores.

More color around the country-by-country performance, I think this is a really interesting question in total and the first comment is that Europe remains really challenged and this contributes to a big percentage of Hollister's total comp lag to A&F because of the size of the Hollister business in Europe relative to A&F. This is a really important statement guys. And responding to country-by-country performance, the worst country is Italy and the best country is Poland which doesn’t do us much good.

Randy Konik - Jefferies & Company

Is there any color on the UK?

Michael S. Jeffries

UK remains tough, slight improvement in UK.

Randy Konik - Jefferies & Company

Got it, thanks guys, appreciate it.

Operator

And next we will go to Brian Tunick with J.P. Morgan.

Unidentified Analyst

Hi, good morning. This is Teeca Tamondon (ph) for Brian. I was wondering if you could speak to improvement that you are seeing thus far during the back-to-school season, is it across all brands as well as any color on the international and U.S. businesses? And then also just you know, you are in the early stages of implementing the lower AUR strategy at Hollister, just if you could share any early learning from that, that would be great? Thank you.

Michael S. Jeffries

We are seeing improvement in fashion selling in fall brands. The North American business is clearly better than international business on a likes basis because of the difficulties in Europe which I just mentioned. The logo business is larger in Hollister and that becomes a little more difficult to overcome than it has in A&F although we are overcoming that in both brands.

Jonathan E. Ramsden

I think that the second point of -- sorry, go ahead.

Unidentified Analyst

No, just in terms of the lower AUR strategy?

Jonathan E. Ramsden

I think we are still working into elements of that. What we have actually said is that we anticipate overall AURs to be up against slightly more favorable compared in the back half of the year but in general we are taking AURs down in Hollister selectively and continue to test into that.

Michael S. Jeffries

And it is primarily an international strategy.

Unidentified Analyst

Great, thank you.

Operator

And next we will go to Kimberly Greenberger with Morgan Stanley.

Kimberly Greenberger - Morgan Stanley

Great, thank you. Mike I wanted to just ask you about the Hollister business. It is down like negative 10 comp, it has been weighed on particularly by the international comps, do you happen to have the Hollister brands U.S. numbers if you might be willing to share with us?

Michael S. Jeffries

The Hollister, hold on, I don’t understand you want the Hollister…

Kimberly Greenberger - Morgan Stanley

The Hollister U.S. comp. I think you just ended the global comp including U.S. comp?

Jonathan E. Ramsden

Yes, you are right. I think what I can tell you simply is the gap in North America was closer than the overall gap between the brands, because the gap to Mike's point earlier was wider in Europe. So the North America Hollister and A&F comps were closer together than their total comp.

Michael S. Jeffries

Exactly and going back to what I said, the big percentage and that's the lion percentage of the difference is due to Europe. I would also say if we just look at the total Hollister lag behind A&F, the lions share is due to the European -- size of the European Hollister business.

Second, the logo headwind skews towards Hollister and third, I think there is still a little bit of a difference and I think that while Hollister has done a good job in evolving its assortment it is still slightly behind A&F. But that's a small difference.

Kimberly Greenberger - Morgan Stanley

Gentlemen, thank you.

Operator

Now we will take question from Paul Lejuez with Wells Fargo.

Paul Lejuez - Wells Fargo Securities

Hey thanks guys. Hey, just on your increase DTC revenues, it doesn’t seem to be driving incremental operating profit so just wondering if that’s more of a result of having to be a bit more promotional online or is it a function of shipping revenue pressure and if its shipping, can you talk about how big that piece is of the DTC revenue line? Thanks.

Michael S. Jeffries

Yes. Good morning Paul. A couple of pieces on that first of all we do expect on a full year basis that we will see incremental operating profit from DTC so the effect you’re seeing in the first half of the year where operating profit dollars are kind of flat on sales that we do see on a full year basis that converting into being incremental operating profit dollars with the segment margin remaining in the mid 30s. To your point, a big part of the pressure is around the shipping and handling revenue and expense probably as we’ve begun to offer shipping promotions in Asia and internationally. Generally when we do those, the shipping expense is greater particularly for Asia.

One of the bits of good news on that is, as we enable fulfillment within Asia our shipping expense when we run those free shipping promotions of the threshold will be much lower than it is today. So the positive factor is just the revenue –- shipping handling revenue coming down as we have continued to use shipping handling promotions and been competitive on that. But also because of the SKU of our business to international and the rapid growth in Asia when we run those promotions with greater shipping expense which as I just said will alleviate as we enable the regional fulfillment.

Paul Lejuez - Wells Fargo Securities

Any color on the size of that line, that shipping revenue line?

Michael S. Jeffries

I don’t think we have broken out these figures specifically but it is the biggest driver of the lack of flow through to the bottom line in terms of the sales improvement that you are seeing in the segment.

Paul Lejuez - Wells Fargo Securities

Okay, thanks guys. Good luck.

Michael S. Jeffries

Thank you.

Operator

And our next question will come from Janet Kloppenburg with JJK Research.

Janet Kloppenburg - JJK Research

Good morning everyone and congrats --

Michael S. Jeffries

Good morning Janet.

Janet Kloppenburg - JJK Research

Good morning. Congrats on the progress being made. Just a couple of quick questions, Mike if your could talk a little bit about the impact that the logo decline might be having on comp so we can understand what kind of traction you are getting in the fashion business that might help and also of some visibility on how long this impact may impact the costs, perhaps hiding the improvement that you’re seeing in the fashion business? And I also was wondering if you could talk about your perspective on pricing in Europe given the success that you’ve had in Canada with low end pricing? And Jonathan if price of that will come down if you have offsets to that to maintain a healthy margin in Europe? Thank you.

Michael S. Jeffries

The first part of the question Janet I think I can say this is that we are making up the logo decline in the business in terms of comps, which says that we are doing better in the rest of the business which we are and that’s fashion related. There is wonderful traction in fashion partially due to our Chase strategy. Chase is working wonderfully well for us.

How long the impact of logo will last, clearly through this year into first quarter of next year but as I just said we would say North America we’d want to be out of the logo business essentially by next spring. It will remain a factor in the rest of the world. I would say that by this time next year we will really be over the major dollars.

I think the question on our perspective on pricing in Europe is really a good one given the success in Canada. We are testing pricing in Europe, a pretty extensive testing as we talk now. We think there is opportunity there. And we think we have the ability to work on pricing given where we are in AUC. But that’s a really good question Janet.

Janet Kloppenburg - JJK Research

Comment on the fashion top results Michael.

Michael S. Jeffries

Beg your pardon.

Janet Kloppenburg - JJK Research

Can you comment on the performance of the fashion tops for the back to school I thought they looked terrific but you didn’t highlight them when you called out the categories of strength?

Michael S. Jeffries

Fashion tops are performing very well. The top category in total is negative because of the logo impact but, we are delighted with fashion tops.

Operator

And once again in the interest of time please limit yourselves to one question for today’s session. We will take our next question coming from Steff Wissink with Piper Jaffray

Stephanie Wissink - Piper Jaffray

Thank you, good morning everyone. I’d also add my congratulations on the progress. If I can ask one clarification question Jonathan, I think you mentioned that you are raising the cost takeout guidance of $200 million versus $175 million previously, could you just talk about what area of the expense structure you are finding that incremental saving?

And then Mike I was wondering if you could just talk about some of the early feedback on the incremental marketing spend, some of the initiatives particularly the more social media based initiatives around the Hollister brand if you could talk a little bit about some of the success there that would be great? Thank you.

Jonathan E. Ramsden

Stephanie just on the first part, the primary driver of the increased savings is coming out of the stores, store pay roll and other variable expenses within the stores that are certainly the biggest component of it.

Michael S. Jeffries

In terms of marketing Steff, it's still early days but we are seeing benefits particularly in terms of improving brand sentiments and brand engagement. I think as everyone knows these efforts take time to realize the full benefits in traffic and sales but we are pretty delighted with where we are right now.

Stephanie Wissink - Piper Jaffray

Thank you.

Operator

And now we’ll take a question from Dana Telsey with Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Good morning everyone.

Michael S. Jeffries

Good morning Dana.

Dana Telsey - Telsey Advisory Group

Hi, can you give any comments on denim, how denim is doing, what’s happening with price points of denim? And then on the performance on men’s and women’s anything you are seeing that’s any significant improvement from last quarter, certainly seems like fashion is coming on? And just lastly given the beat you had this quarter and the cost savings running ahead is there something offsetting it that prevented you from raising full year guidance, is it the margin picture and the pricing environment? Thank you.

Michael S. Jeffries

We are happy with how denim has performed. As we said comp sales were up but gross profit was up too. We are able to drive the business through expanded assortment, I think compelling price points, and engaging store and DTC presentations that were supported by lifestyle marketing.

Your second question, we are seeing performance on men’s women’s an improvement I am trying to think of what the statistics would say. We are seeing North American improvement in both.

Joanne C. Crevoiserat

Yeah and I can jump in here, men’s and women’s comps were relatively in line. As Mike mentioned earlier we are seeing a lot of traction in our Chase, which represents a 20% of our women’s assortment. It is lower in men’s overall but we expect that to be increasing as well. So men’s and women’s are in line in terms of performance and we expect if those Chase components continues to improve in both.

In terms of offsetting improvement in margin as it relates to guidance, we do expect the back half guidance or the back half margin to be improvement driven by the AUC in roads we are making as well as profit improvement initiative efforts that will have some impact on margin in the back half and we do also see AUR pressure abating somewhat as we move into the back half as we see inventory in the segment normalizing.

Operator

And now we’ll go to Matt McClintock with Barclays.

Matthew McClintock - Barclays Capital

Hi yes, good morning. You know Jonathan you actually talked a lot about some exciting omni-channel initiatives that you are rolling out back half of this year going into next year and I was wondering if you think about some of these initiatives shipped from store, urban store, etc. it seems like the focus is United States, how do you think about using those initiatives in international markets? Thank you.

Jonathan E. Ramsden

Matt, I think that’s a great question. I think the state of omni-channel varies as you go around the world but it is generally not as far along as it is here in the U.S. So, UK is probably relatively far along within Europe. In Asia omni-channels still, you know, relatively undeveloped. But I think the key point is we -- the combination of us building the technology to rollout omni-channel in the U.S. that same technology would be applicable internationally and then by virtue of moving to regional fulfillment now in Asia in addition to Europe the combination of those two things puts us in a very strong position to roll out omni-channel as it becomes relevant in key markets going forward. So we foresee the UK as a priority. We are looking at the rest of Europe, we will continue to monitor Asia. But I think the important point is that we will be ready to roll out omni-channel as it becomes significant in each of those markets.

Operator

Next we will go to Christian Buss with Credit Suisse.

Christian Buss - Credit Suisse

Yes, hello. I was wondering if you could talk a little bit about how you are thinking about the European business developing over the next six months, what are you doing to try and stabilize that business, and how much control do you really have, I mean what the end point is for productivity for the flagship location there?

Jonathan E. Ramsden

Yeah, I think as we talked about a little bit in the prepared comments Christian, there are market-by -- first the broader initiatives we are undertaking with regard to the assortment in particular we believe will benefit the European business as well as the international business. But also within specific markets in Europe there are local pricing, marketing, other initiatives and then going back to prior question, omni-channel could become part of the equation going forward in certain markets. So there are combinations of the global initiatives we are undertaking particularly around the assortment and then market specific initiatives which we will be increasing over the next 6 to 12 months.

Christian Buss - Credit Suisse

That's very helpful, thank you and best of luck.

Jonathan E. Ramsden

Thanks Christian.

Operator

Now we will go to John Morris with BMO Capital Markets.

Janine Stichter - BMO Capital Markets

Hi, it is Janine Stichter on for John Morris. I was just wondering just given what you are saying about the European business, if you could comment a little bit on some of the tourist locations within the U.S. and whether or not they are in overall drive to the total company comp, thank you?

Michael S. Jeffries

Yeah, we generally haven’t broken that out. I think we can take that and see if there is some color we can give around that. So, why don’t we go onto the next question and we will see if we can dig out something on that.

Operator

Okay, we will go Anna Andreeva with Oppenheimer.

Anna Andreeva - Oppenheimer

Great, thanks so much and let me add my congratulations to a continued improvement in the business. A follow-up on the gross margin, you guided down slightly for the year, should we expect gross margin to be up in the third quarter and fourth quarter or that improvement to be more of fourth quarter weighted? And just a follow-up on the buy-back, it looks like you guys brought back a little bit less than in the first quarter, maybe talk about the appetite from the Board towards completing the remainder of the buy back in 2014? Thanks so much.

Joanne C. Crevoiserat

Yes, we do expect gross margin to be down in the -- to be improved in the back half. Again the AUC efforts, those two become bigger in the fourth quarter than the third but it is relative. We do see improvement in both as well as our property improvement initiatives that have margin implications kicking into the back half. So slightly skew to fourth but I think the bigger issue in that equation is really the relief we expect on the AUR pressures we have been seeing as the inventories in the segment normalized through the fall season.

In terms of buy backs we have said that we -- and have authorization to continue to buy back shares of stock, we make those decisions, our practices to make those decisions on a quarter-by-quarter basis really is contingent on the stock price and managing to our liquidity target of $350 million.

Jonathan E. Ramsden

I will just come back on Anna's last question, so we typically don’t give a lot of color on the U.S. stores but what we can say is that they performed somewhat below the U.S. chain stores but better than the international stores for the quarter. We know it is relatively consistent with the first quarter.

Anna Andreeva with Oppenheimer

Thanks so much guys.

Operator

Now we will go to Jennifer Black with Jennifer Black & Associates.

Jennifer Black - Jennifer Black & Associates

Good morning and let me add my congratulations and Mike you probably can guess what I am going to ask. You know with your streamline run with less logo it seems like accessories you could really do a lot of -- you know I have been working on this?

Michael S. Jeffries

Of course, and Jennifer I have to congratulate you because you have been on the push for less logo for a while. So you are a forecaster there. Thank you. We are engaged in developing the accessory business. I think going to a branded organization is really helping us as we develop these accessories because being more brand focused by category I am feeling that we are going to make progress. So, I hope to report something to you in the future about accessories.

Jennifer Black - Jennifer Black & Associates

Do you think we will see something in the next quarter, are we looking six months…?

Michael S. Jeffries

I really think it is going to be spring that you are going to start to see more exciting brand right accessories.

Jennifer Black - Jennifer Black & Associates

Okay, I am looking forward to it. Thank you very much and everything does look much improved, thank you.

Michael S. Jeffries

Thanks Jennifer.

Operator

Next we will go to Thomas Filandro with SIG.

Thomas Filandro - SIG

Hi, thanks and welcome to Joanne, nice job to all in executing on these strategic initiatives. I was hoping you guys could offer some insight into these online exclusives, the collaboration, the licensed product, and in relation to that can you give us some sense that you are seeing any change in the profile of the shopper either at Hollister or Abercrombie? And my final one is what's the style differentiation now between the brands and how much longer do you have before you get to where you want to be on that target of style differentiation? Thank you.

Michael S. Jeffries

Okay, first question Tom, we currently have partnerships in footwear, accessories, and apparel and they have all been successful. We have a long list of additional collaborations in the work which we are going to be introducing in the coming months. We know that the customer does value these relationships and we believe they can improve our brand positioning while driving incremental sales and margin. We are early days here but we are happy with where we are going.

Style differentiation -- we have changed the profile of customer of both brands. I think that we see that we are ageing the A&F customer which is exactly what we are trying to do. I think if you look at the Abercrombie and Hollister websites, you look at them today, I think you can see a real difference in terms of the customer that we are targeting. More sophisticated, little older in A&F, clearly young in Hollister but the difference I think is pretty apparel when you turn on the DTC and our websites.

I think the differentiation is an ongoing thing. I believe we are going to get there pretty quickly. I can't say that it is February 2, 2016 but we are on a track that we are comfortable with.

Thomas Filandro - SIG

Thanks, best of luck Mike.

Michael S. Jeffries

Thanks.

Operator

Now we will go to Betty Chen with Mizuho Securities.

Betty Chen - Mizuho Securities

Good morning everyone and congratulations on a great quarter. I was wondering Mike if you can talk a little bit more about plan to expand the Chase program, sounds like that's been a key factor -- and in terms of doubling that for next year is that mainly coming from women's or men's and which category, any additional color would be really helpful? Thank you.

Joanne C. Crevoiserat

The Chase strategy is really working for us and we are embedding it in our business practice. And simply stated, it is an integral part of our business and we are doing all the things we need to do to make sure that we can support Chase moving forward and grow it. In the female business we talked about doubling the amount of Chase, we will be leveraging specific strategies like severed platforming to help us get there as well as collaborating with our vendors. And reserving the open and buy to make sure it happens. The numbers we quoted were specific to female. As I mentioned it is not a big a piece of the male assortment today but we expect that to continue to grow as well, so on both sides of the aisle.

Betty Chen - Mizuho Securities

And Joanne you leveraged across all types of products or more so in certain buckets and others?

Michael S. Jeffries

I will answer that. It really is across the assortment but more intense in what we call a real fashion categories. Fashion tops is a huge percentage.

Betty Chen - Mizuho Securities

Great, thank you so much. Best of luck, the stores look a lot better.

Michael S. Jeffries

Thank you.

Operator

And now we will go to Barbara Wyckoff with CLSA.

Barbara Wyckoff - CLSA

Hi everyone, good progress.

Michael S. Jeffries

Thank you, Barbara.

Barbara Wyckoff - CLSA

Hi, what's happening with the kids business, can you talk about the sales and margins there, thoughts on consolidating some locations into the adult store? And then just a second question, what percentage of the back-to-school assortment was pre-tested in A&F and Hollister?

Michael S. Jeffries

Okay, kids business -- the girls business has been tougher than the boys business. I think we are just getting on our feet in terms of an assortment there that is clearly differentiated from the adult assortment. And I am happy with where we are going. We are opening a kids store by the way in London on Saturday which I have to say is about the cutest store in the world. If you are in London you got to stop to see this thing. But I think looking at that store you can see where we are taking the kids business. Practically it will clearly have a personality, has more personality of its own. We are testing carve outs in the kids business.

Joanne C. Crevoiserat

Yeah, and I can jump in on that carve out catch where in an effort to drive productivity in our boxes we are testing about 10 stores where we put kids into the adult stores and I would say during the test we are watching to make sure we get the expected increase in productivity within the store.

Michael S. Jeffries

Okay, percentage of back-to-school assortment, I can't give you an exact percentage. We look at testing in two ways, one electronically; two, in store test that increase is increasing. I have said we are going to be a 100%, it is not possible that we will be 100% but it is a very high percent.

Barbara Wyckoff - CLSA

Right, thank you.

Michael S. Jeffries

Thanks Barbara.

Operator

Now we will go to Simeon Siegel with Nomura Securities.

Gene Vladimirov - Nomura Securities

Good morning everyone, this Gene Vladimirov for Simeon. Thanks for taking that question. I was wondering if you could talk a little bit about your thoughts about the promotional environment out there. I believe you mentioned promo activity is bit lower than you expected, so I was wondering if you expect that to continue and how your strategy may have changed going into the back half of the year? Thank you.

Jonathan E. Ramsden

I think Gene, we are assuming that the environment will remain promotional. I think there is some indications that it may become less so and certainly as we look to the back half of the year inventory levels are probably going to be more rational and normalized than they were a year ago which should help see some year-over-year relief. But generally speaking we would expect the environment will remain fairly promotional.

Gene Vladimirov - Nomura Securities

It is helpful. Thank you.

Operator

And next we will go to Jennifer Davis with Buckingham Research Group.

Jennifer Davis - Buckingham Research Group

Sorry about that. Good morning.

Michael S. Jeffries

Good morning.

Joanne C. Crevoiserat

Good morning.

Jennifer Davis - Buckingham Research Group

Most of my questions have been answered but I was wondering if you could just talk a little bit about I guess what percent of the assortment is logo right now so we can just kind of get an idea around that and then just some color on the impact of the cost savings on the second quarter and if you could remind us how much they were in the first quarter? Thanks. Hello, is anyone there.

Operator

One moment, we will reestablish the line again. Please go ahead.

Jonathan E. Ramsden

Jennifer I think you were just starting your question, so if you could go back to the top on that we would appreciate it.

Operator

Ms Davis, please go ahead with your question.

Jonathan E. Ramsden

Why don’t we go to the next question operator?

Operator

Okay. Moving on Ms Davis I am sorry was that you, go ahead?

Operator

John can you speak? Can you hear me?

Jonathan E. Ramsden

Yes

Operator

Okay, sorry I’ll put her on the line.

Jennifer Davis - Buckingham Research Group

Hey sorry about that I somehow got disconnected. I was just wondering if you could give us a little bit of color on the amount of savings you realized in the second quarter and also remind us that the first quarter and then what percent of the assortment right now is logo, just to give us an idea around that please? Thank you.

Jonathan E. Ramsden

Yes, I guess on the first part I think you can see on the face of the statement that magnitude of the savings in Q2 which is a little over $50 million total expense reduction for the year versus last year. Obviously you have the comparable number from the Q1 reported figures. I think as we have said we have taken up the overall expectation from profit improvement initiative in terms of savings from $175 million to at least $200 million. That benefit on a full year basis is less in the back half of the year particularly in the fourth quarter as we start to lap the realization of benefits when we launched many of these initiatives in the latter part of 2013.

Michael S. Jeffries

Percentage of the assortment which is leveled off, I can’t give you but I believe that you go into the stores and look, you have to look pretty hard to find it.

Operator

Okay and next we’ll go to Susan Anderson with FBR Capital Markets.

Susan Anderson - FBR Capital Markets

Good morning and congratulations on the improvement too, really impressive. I was wondering if you could talk about the inventory, it looks very clean which is good but is it at all holding back the comp or you feel like you have an affability of Chase and then also on the social media campaign, it looks like you guys are doing a better job. You guys feel like you are getting a better return on that versus historically? Thanks.

Joanne C. Crevoiserat

I’ll pick up the inventory question. We are happy with where we are in terms of inventory levels. We don’t think the inventory is holding back our comps. As we’ve talked about on this call, the Chase strategy is working. It gives us much more agility in our assortments and allows us to get into the things that are working. So we feel good about the content as well as the level of our inventory.

Jonathan E. Ramsden

Sure on the second part of the question I think we’ve continued to dialup those investments. We think we have seen a benefit in terms of brand engagement and brand sentiment. I think as Mike alluded to in the prepared comments we would expect that we’ll need to have a sustained period of investment to drive the full benefit from these new marketing efforts that are underway.

Susan Anderson - FBR Capital Markets

Great, thank you.

Operator

Now we’ll go to Richard Jaffe with Stifel.

Richard Jaffe - Stifel Nicolaus & Company

Thanks very much guys and just a follow on question, the current penetration or percent that you described as a logo business in 2Q and what you think it will be in 3Q, let's say the rate of change you anticipate as a percent of total?

Michael S. Jeffries

The rate of change of Richard it's about we’re looking at having that business in 2Q and 3Q.

Richard Jaffe - Stifel Nicolaus & Company

Okay. And just a follow-up. I am sorry.

Michael S. Jeffries

Big numbers.

Richard Jaffe - Stifel Nicolaus & Company

No, it's exciting. The store count, do you see that the store editing and ongoing process obviously it has been very effective the last couple of years, can you anticipate it going into 2016 and 2017?

Jonathan E. Ramsden

Yes, absolutely Richard. I think we said in the prepared remarks as well as 60 closures this year we would anticipate a similar run rate for the next 2 years although we have significant flexibility around that since we have a very high number of lease expirations up between now and the end of 2016. And then either way we plan to keep significant flexibility beyond that. So as of today we will anticipate roughly another 60 or so closures in each of 2015 and 2016, beyond the 60 closures this year.

Richard Jaffe - Stifel Nicolaus & Company

Excellent. Thank you very much.

Jonathan E. Ramsden

Thank you

Operator

We’ll take our next question that will come from Liz Dunn with Macquarie.

Liz Dunn - Macquarie Research

Oh great, thanks for taking my question and congrats on all of the progress. I had a question on the expense savings. I guess could you just refresh this on how much is coming from COGS, how much is stores and distribution, and how much is marketing and G&A, you know, as I look at it, it looks like the bulk is towards the stores and distribution, and as I look at marketing and G&A over the last kind of 6 or 7 years its up 25% which is more than twice what sales are up, so is there more opportunity on marketing and G&A? Thanks.

Michael S. Jeffries

Yes, so on the piece that is going into COGS is relatively modest. I think we had indicated that it has been a year, probably in the order of $10 million on a full year basis, that number has moved around a little bit since then. So the great majority of the $200 million plus numbers in expense and the great majority of that is in the stores and distribution lying with a lesser component in MG&A. We have certainly anticipated some additional savings beyond $200 million in 2015 but I think it’s a little early to be too specific on that.

Liz Dunn - Macquarie Research

And you have invested in marketing, have you found offsets in sort of some of your more traditional marketing efforts?

Jonathan E. Ramsden

Yes, we have and there is some reduction of offsetting components of marketing.

Liz Dunn - Macquarie Research

Okay great. Thanks, good luck.

Jonathan E. Ramsden Thanks Liz

Operator

And we will take our final question from John Kernan with Cowen & Company

John Kernan - Cowen & Company

Hey guys, thanks for squeezing me in. Just a quick question relating to your DTC business, it looks like I don’t know, numbers that could be as big as 25% of your total business by the end of the year. As you close more stores 2015 and 2016, how big do you think DTC change that can offset but already seems it is higher than many of your competitors and then in terms of the fulfillment centers and all the major Asian markets, do you expect any incremental expenses associated with the roll out of this? Thank you.

Jonathan E. Ramsden

Yes, on the first question I think back in our Investor Day last November we referenced DTC getting to 25% of the business. Overtime I think we then said earlier in this year that we told that number was likely conservative when we see it continue to go higher. I don’t think we are in a position where we could say a specific percentage. I think there is a lot of factors that will flow into that but we certainly believe very strongly that DTC is going to be growing out of that business over the next few years and we are investing behind that as a very high priority.

In terms of the fulfillment centers, most of that is really behind us in terms of the investment we’ve made to set that up and in fact as I alluded to in an earlier question, the fact that we have the fulfillment capability within Asia low as our shipping handling expense which we think is a positive in terms of what I can help us do with the business going forward. But we don’t anticipate significant incremental expense as a result of setting up those fulfillment capabilities.

Michael S. Jeffries

What I would like to add is that they are really thrilling part of DTC is the international growth.

John Kernan - Cowen & Company

Okay, thanks guys. Good luck

Jonathan E. Ramsden

Thank you.

Operator

And that concludes today’s question and answer session. I would like to turn it back over to our speakers for any additional comments.

Michael S. Jeffries

I think that’s it, thank you.

Operator

Okay, that does conclude today’s conference. We thank everyone again for their participation.

Michael S. Jeffries

Thank you.

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