Aug 30, 2016
Executives
Brian Logan - VP, Finance and Controller Arthur C. Martinez - Executive Chairman Fran Horowitz-Bonadies - President and Chief Merchandising Officer Joanne C.
Crevoiserat - CFO and EVP
Analysts
Christina Brathwaite - J.P. Morgan Randy Konik - Jefferies & Company Susan Anderson - FBR Capital Markets Oliver Chen - Cowen and Company Tiffany Kanaga - Deutsche Bank Paul Lejuez - Citigroup Kayla Wesser - Piper Jaffray Cody Ross - Wolfe Research Janet Kloppenburg - JJK Research Betty Chen - Mizuho Securities Gene Vladimirov - Nomura Securities Michael Binetti - UBS Brian Tunick - Royal Bank of Canada Mark Altschwager - Robert W.
Baird Kimberly Greenberger - Morgan Stanley Richard Jaffe - Stifel Nicolaus & Company Omar Saad - Evercore ISI Marni Shapiro - The Retail Tracker Dana Telsey - Telsey Advisory Group
Operator
Please standby we are about to begin. Good day everyone and welcome to the Abercrombie & Fitch Second Quarter Fiscal Year 2016 Earnings Call.
Today's conference is being recorded. [Operator Instructions].
At this time, I would like to turn the conference over to Brian Logan. Mr.
Logan, please go ahead.
Brian Logan
Thank you. 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 call is being recorded and a replay may be accessed through the internet at abercrombie.com under the Investors section.
Joining me today are Arthur Martinez, Executive Chairman; Fran Horowitz, President and Chief Merchandising Officer; and Joanne Crevoiserat, Chief Financial Officer. After our prepared remarks, we will be available to take your questions for as long as time permits.
We ask you to please limit yourself to one question so that we can speak to as many callers as possible. 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.
In addition we will be referring to certain adjusted non-GAAP financial numbers during the call. Additional details and a reconciliation of GAAP to non-GAAP financial numbers, measures are included in the release issued earlier this morning.
With that I hand the call over to Arthur for some opening remarks.
Arthur C. Martinez
Thank you Brian and good morning everybody and thanks for being with us today. Our results for the quarter were largely in line with the expectations we set out on our last earnings call.
Flagship and tourist locations which are concentrated in the Abercrombie brand business continued to account for the vast majority of the negative comp sales performance as traffic continues to be a significant headwind. We were encouraged, however, by strong growth of the direct to consumer business both domestically and internationally and by our comp sales rebound in the Hollister European business including the UK.
In addition conversion trends were positive in the travel channel across brand and geography. The overall business continues to be well managed with gross margin rate substantially maintained on a constant currency basis and expense and inventory under tight control.
I want to highlight two very important developments in the quarter that give us great confidence in the future of the business. First we began to rollout new brand positions for both of our brands.
While we’re in the early stages of these initiatives, a clearly defined brand image and voice are beginning to be communicated to the consumer. Fran will discuss our brand positions in greater detail but our research shows that the new brand positions resonates strongly with our target customers and we’re confident about their long-term impact.
Second, we welcome two talented and experienced brand Presidents to work with Fran and the great teams at Abercrombie and Hollister to execute on our strategic priorities including assuring a successful implementation of our new brand positions. Looking ahead to the rest of the year we now expect flagship and tourist locations will continue to weigh on the business.
Recognizing we’re still in a challenging environment, we are confident, however, that we are focusing on the right priorities and we expect to see traction in our business as we continue to introduce new products and invest in marketing initiatives to drive heightened awareness and increased relevance for our brands. Despite these near-term challenges we remain confident in our long-term outlook and are increasingly well positioned to capitalize on opportunities.
Now Fran will provide more color around brand performance and our strategic initiatives. Fran?
Fran Horowitz-Bonadies
Thank you Arthur and good morning everyone. Though I feel strongly that we have made a lot of progress in the quarter from both a strategic and operational standpoint, we are not yet satisfied with our results.
We still have much work to do to realize the potential of our brand and aggressive steps to continue to be taken to accomplish those objectives. I remain confident about the long-term potential of our business.
Let me start off by highlighting our results around the quarter. So our flagship and tourist stores continue to weigh heavily on comp sales, our overall international business improved led by a recovery in a Hollister Europe business.
In the U.S. softness relative to last quarter was largely due to fashion misses in the Hollister girl's tops business which we are addressing in future delivery.
Turning to our brand performance starting with Hollister, in addition to under performance in girl's tops, shorts remains weak. However, we saw strength in jeans where the customer responded well to our assortments in both genders and in our more emerging accessories and intimate businesses.
I was particularly pleased with the launch of Hollister Epic Flex throughout the guys assortment. Epic Flex is fabric innovation that allows greater stretch, performs well across polos, jeans, and shirts.
In Abercrombie the female business continues to outperform male, with swim, dresses, and accessories all performing well. Shirts and sweaters were also strong but the overall tops business decelerated.
On the male side of business, tops remained challenged but showed improvement in trends from last quarter. In addition the customer continued to respond to the new fabrication and fit in our chino assortments.
Coming back to the progress we made on our strategic initiative during the quarter we continued to focus on our increasing customer centricity and engagement at all points of contact to allow customers to seamlessly interact and shop with us in the way they prefer. Our new fully remodeled Hollister stores continued to perform well.
During the quarter remodeled an additional 32 stores and expect to remodel about 20 more by the end of the year. In addition we are working on a new A&F prototype to be tested in early 2017.
We also continued to invest in mobile and omni-channel capabilities. We saw strong growth in direct to consumer both domestically and internationally including a nearly 60% increase for the last year in sales generated from order spike in mobile devices.
And after successful roll outs of buy online, pickup in stores in UK and U.S. nearly run the capability out of Canada in the third quarter.
Buy online pickup in store continues to exceed our expectations accounting for 7% of online orders. The customers shopping digital are now being served in store, we have seen high attachment rates to their purchases.
In addition we continue to expand our already robust presence on social media. Across brands we have over 20 million Facebook fans, and close to 7 million Instagram followers, up 30% over last year and an average of over 120 million impressions and over 2 million post engagements every month.
We continue to be active on Snapchat where our follower base has increased over 20% from last year. All of these efforts are informed by the programs in which we have invested to better understand and respond to our customers.
In addition to our post purchase customer survey, we are learning more about our customers through our loyalty program. The Hollister Club Cali loyalty program in the U.S.
which we rolled out in June is strengthening our customer's relationship with the brand and driving higher customer identification, retention, and sales. We see future opportunities to use this program to better personalize the customer experience.
We are now in the process of developing a loyalty program for the A&F brand. We also continued to identify new opportunities to expand our brand reach through franchising, wholesale, and licensing partnership.
Just last week we announced our newest wholesale partnership with Zalando. They are the largest online platform for fashion.
Zalando will offer A&F, Hollister, and Abercrombie Kids products through its online stores in the 15 European markets it serves, providing its access to their more than 18 million active customers. In addition our fragrance licensing partner Inter Parfums recently developed and launched two new fragrances during the quarter.
First, Instinct by A&F and Wave by Hollister which are now being sold globally through international duty-free, specialty, and department stores. Now turning to our new brand position, we are very excited about the roll out and the powerful potential we are creating as we fully embed these new brand positions into the products, experience, and voice of our brands.
As you know these are the results of an intense effort over many months. Included at the end of our investor presentation are material highlighting our new brand position.
Our goal for Hollister is to be the iconic brand of the global teenage consumer. We know that today's teens are under enormous pressure and have a desire for freedom, a freedom typically found in summer.
We believe summer is not just a season but a state of mind. That is why we are positioning Hollister to deliver an experience that liberates the spirit of summer inside everyone.
Using the carefree California attitude as our inspiration we are creating products that draws on natural styles, playful expressions, and idealistic spirit. Now for A&F with its rich 125 year heritage, our goal is to be the iconic American casual luxury brand for today's 20 something consumer.
Research into today's young adult consumer demonstrates a shift in what confidence means. It is no longer outer directed but center directed.
Image is less important than character and it is more important to feel confident than to appear confident, which is why we are positioning A&F to deliver a casual luxury experience, that brings out our customers best self and inner confidence in casual, timeless looks, and special care, quality and attention to detail. For A&F casual luxury is about quality and style at an appropriate price.
Our research shows that new brand position resonate strongly with our target markets across the board and we are excited to bring them to life with strategic investments in marketing. Through our A&F denim campaign, The Blues and hosted events in New York City as well as our Hollister jeans movement campaign which featured a group of our customers who have received positive media coverage and generated tremendous excitement and buyers around the brand.
While we are just beginning to align all of what we do with these new brand positions, I am confident we have the right teams in place including our two new brand Presidents Stacia Andersen and Kristin Scott to realize the great promise of our brand. Going out the second half of the year remains challenging and traffic headwinds persist, we do expect to see improvement overtime as our intensified marketing efforts around our new brand positions and new product introductions interaction.
I would like to thank the teams around the world and on our campus for their continued passion and commitment in moving our brands forward. And with that I will hand it over to Joanne.
Joanne C. Crevoiserat
Thanks Fran and good morning everyone. While the top line was challenging driven by flagship and tourist stores performance it was in line with our expectations for the quarter.
As Arthur mentioned, our business continues to be well managed and we’re making important progress on our strategic initiatives as we position the company for long-term growth. I’ll be recapping our results for the quarter and providing an update on our full year outlook.
Beginning with Q2, net sales for the quarter were $783 million down 4% from last year. Foreign currency adversely impacted sales by approximately $5 million.
Comp sales were down 4% for the quarter primarily driven by flagship and tourist stores. Conversion with positive by channel across both brands and geographies continued to be more than offset by weak traffic.
As shown on page 5 of the Investor presentation, by geography comp sales for the quarter were down 4% in the U.S. and down 4% in international markets.
Comp sales improvement from last quarter in international markets driven by a recovery in the Hollister European business including in the UK was offset by a decline in the U.S. trends.
By brand, comp sales for the quarter were down 7% for Abercrombie and down 2% for Hollister. Flagship and tourist stores which are concentrated in the A&F brand continued to be the main contributor of negative comp across both brands and geographies.
Across brands we saw a strong growth in the DTC business in both the U.S. and international markets as investments in mobile and omni-channel capabilities continued to pay off.
The direct to consumer business grew to 23% of total sales compared to 21% of total sales last year. I’ll be recapping the rest of our results for the quarter compared to last year on an adjusted non-GAAP basis.
Excluded from our results for the quarter were net pretax benefits of $6 million compared to net pretax charges of $15 million last year which are detailed on page 4 of the investor presentation. For the quarter this included benefits of $12 million related to the settlement of certain economic loss claims associated with events that occurred in 2010 and charges of $6 million related to the impairment of the Abercrombie Kids flagship store in London.
For the quarter gross margin was 60.9% with FX having a greater than expected impact from the movement and exchange rates post Brexit. On a constant currency basis the gross margin rate was 20 basis points lower than last year driven by higher average unit cost partially offset by higher average unit retail in both brands as we continue to focus on reducing the level of promotional intensity, an important part of our strategy to improve long-term brand health.
Moving to operating expense, we remain committed to complimenting our growth initiatives with a focus on efficiency and continuous improvement, which once again enabled us to exceed our expense expectations for the quarter. Stores and distribution expense decreased $5 million from last year due to lower variable expenses on lower sales and expense reduction efforts partially offset by incremental investments and direct to consumer.
Marketing, general, and administrative expense increased $8 million from last year primarily due to higher marketing expense related to the new brand position which will continue to an even greater degree in the third quarter. The adjusted operating loss for the quarter was $17 million compared to adjusted operating income of $16 million last year and included the adverse effects from FX of approximately $9 million.
The adjusted effective tax rate for the quarter was 27%, adversely impacted by jurisdictional mix of earnings and certain discreet tax items. We continue to expect the full year tax rate to be in the mid to upper 30s.
Adjusted net loss per diluted share was $0.25 compared to adjusted net income per diluted share of $0.12 last year and included the adverse effects from FX of approximately $0.08 net of hedging. Turning to the balance sheet we ended the quarter with $456 million in cash and gross borrowings outstanding of $293 million compared to $408 million in cash and $298 million in borrowings a year ago.
Total inventory was down 5% compared to last year second quarter. Inventory continues to be well managed and is well positioned as we enter the third quarter.
Details of our store openings and closings for the quarter are included on page 9 and 10 of the investor presentation. At the end of the quarter, we operated 744 stores in the U.S.
and 182 stores across Canada, Europe, Asia, and the Middle East. Updating our outlook for the full year fiscal 2016, we now expect comparable sales to remain challenging through the second half of the year with a disproportionate effects from flagship and tourist locations.
Adverse effects from foreign currency on sales of approximately $25 million and on operating income of approximately $20 million was the greatest impact in the third quarter. We expect the gross margin rate flat to last year's adjusted non-GAAP rate of 61.9%, but down in the third quarter due to adverse effects from foreign currency.
Partially offsetting the additional adverse effects from FX is an expectation now for operating expense dollars to be down slightly to last year's adjusted non-GAAP operating expense. With investments in marketing skewed towards the third quarter offset by savings from expense reduction efforts.
We expect an effective tax rate in the mid to upper 30s and a weighted average diluted share count of approximately 68 million shares, excluding the effect of potential share buybacks. Excluded from our outlook are the effects of certain potential items including, but not limited to, insurance recoveries, impairments, and other items.
We expect capital expenditures to be at the low end of the range of $150 million to $175 million for the full year, which includes approximately $70 million for new stores and store updates and investments of approximately $60 million in direct-to-consumer, omni-channel and IT to support growth and profit improvement initiatives. We expect to complete over 60 Hollister store interior remodels by year-end and have completed 44 stores year-to-date.
In addition we plan to open approximately 15 full-price stores in 2016 including approximately 10 in international markets, primarily China and five in the U.S. We also anticipate opening six new outlet stores, primarily in the U.S.
Year-to-date we have opened five full-price stores and two outlet stores. Finally optimizing the store fleet continues to be an important aspect of improving overall store productivity.
We reported approximately one third of our U.S. fleet over the past six years as we have proactively responded to the dramatic shifts on how our customers chooses to shop.
We will continue to close underperforming stores and expect to close up to 60 stores in the U.S. during 2016 through natural lease expirations.
And with about 50% of our U.S. leases expiring by the end of fiscal 2017, we continue to have significant flexibility to strength the right channel balance as we anticipate evolving customer shopping preferences.
We are making progress on our strategic initiatives and are confident in our long-term potential. As we did in the second quarter we will continue to tightly manage the business with strong oversight over the levers we control.
I will now turn the call back to Arthur.
Arthur C. Martinez
Thank you, Joanne. Before we take your questions, I would like to say that it is clear to me that aggressive steps are being taken to position our company for long-term success.
While we are certainly not satisfied with our current performance, we believe strongly that the work we are doing to rebuild this company and to develop differentiated and relevant brand positioning is laying the foundation for our future success. Let me now turn the call back to Brian.
Brian Logan
Thanks Arthur. That concludes our prepared comments.
At this time we will be happy to take your questions. As a reminder, please limit yourself to one question so we can speak to as many of you as possible.
Thank you.
Operator
[Operator Instructions]. We will first go to Matthew Boss with J.P.
Morgan.
Christina Brathwaite
Hi, it's Christina Brathwaite on for Matt. Thanks for taking our question.
Just to go into the tourism drag a little bit more, can you just quantify the drag on comps that you saw during 2Q and how large that business is as a percentage of total sales? And then looking beyond 2Q, can you walk through your expectations for the tourist store performance throughout the rest of the year, are you expecting it to accelerate -- that drag to accelerate and at what point can it moderate?
Joanne C. Crevoiserat
Thanks Christina, this is Joanne. As it relates to the tourist stores impact as we mentioned in our comments the majority of our comp decline was driven by the tourist stores.
We haven't historically disclosed the total impact or the total penetration of our business, but we have seen in the business is consistent traffic headwinds in our tourist locations driven in part by currency devaluation but also safety and security concerns in those regions. And as we said in our outlook we expect the environment to remain challenging.
We don’t see a near-term catalyst for that to change so we expect the environment to continue to be challenging with those traffic headwinds as we move forward. However, we are focused on our strategic initiatives and are confident that we’re focused on the right priorities including improving our product with our new brand leadership in place, improving the overall store experience, and also investing in marketing behind our new brand positioning.
And we believe that overtime and are confident that overtime those changes will lead to improved traffic and top line results.
Operator
Next we’ll go to Randy Konik with Jeffries.
Randy Konik
Hey, great, thanks. Just again to clarify the exposure, is there any -- the down 7% sales number in the U.S., is there any kind of guesstimate in terms of what that number would have been ex-tourism, that's my first little question.
Joanne C. Crevoiserat
I need to clarify your comment, the U.S. business was down 4% in the second quarter Randy.
So just to clarify that, the overall business in international was also down 4%. We were actually pleased to see recovery in the Hollister European business.
So that business did show signs of recovery from the first quarter into the second quarter and the international business in total improved from down 7 to down 4 in Q2.
Randy Konik
No, I'm talking about the total sales number. The total sales number is down 7% in the U.S.
So I'm just trying to get a sense of what would that number look like if you kind of back out the tourism?
Joanne C. Crevoiserat
That number was driven likely more by store closings than a comp basis. The tourism effect is more pronounced in our international markets as it’s a higher percentage particularly of the -- it’s more concentrated in the A&F brand and has a larger impact on the international markets than it does in the U.S.
Randy Konik
Okay, got it. And then, I guess, just to clarify, the last kind of clarification just around this tourism impact.
Did you see any kind of discrepancy in the tourism impact by region, let's say New York versus LA or anything like that and/or by brand, Hollister versus Abercrombie, just curious there?
Joanne C. Crevoiserat
The tourism headwinds have been very consistent so I’ll say that from quarter-to-quarter they been consistent. And by region there are some differences but it has affected our business broadly in those tourist markets and that does impact as I said our A&F business.
More of our tourist stores are concentrated and flagship stores are concentrated in the A&F brand. And as I mentioned earlier the Hollister brand did see a rebound in the European business and in the UK where we have more mall based stores in the Hollister brand and we were pleased to see that business rebound.
Randy Konik
Got it, and I guess last, sorry, just lastly, if I may. Could you just give us some perspective since this was kind of clarification item, just how do you think about the ultimate end game for store footprint in the U.S.
market by brand?
Joanne C. Crevoiserat
We haven't identified a specific store target. What we have done Randy is maintained flexibility.
We have been working diligently to improve our overall store productivity and closing unproductive stores has been a very important part of that story. And we have been at it for a number of years and have successfully closed a number of stores.
And we continue to maintain a flexibility as we see -- continue to see customer shopping preferences or customers change their shopping preferences. I think it is interesting to note that some of our investments in omni-channel have been exceeding our expectations like buy online, pickup in store.
And so we continue to see our customer shifting in their shopping preferences and we are investing behind those opportunities and we will maintain flexibility and monitor those changes over time.
Operator
And next we will go to Susan Anderson with FBR Capital Markets.
Susan Anderson
Hi, good morning. Thanks for taking my question.
I was wondering if you could maybe talk about any change in sales you are seeing now that you are starting to cycle the lower prices in the international markets which I think really help to drive the sales last year, are you seeing any tougher compares there? And then also if you could talk about maybe when you expect the FX impact to kind of taper off and it is going to be impacting third quarter?
Thanks.
Fran Horowitz-Bonadies
This is Fran, I will take the first part of that question regarding pricing. We specifically last year talked about Hollister and how we had become much more competitive in our pricing internationally.
We start to wrap those as we get into the back half of the year. We are pleased with the conversion rates that we continue to see and the customer's acceptance of our product.
And as it relates to the FX impact we have seen FX headwinds increase post Brexit particularly as it relates to the pound and to a lesser degree the euro. We do expect the FX headwinds to be more pronounced in the third quarter.
We still expect headwinds in the fourth quarter but they will abate somewhat.
Susan Anderson
Great, and then if I could just throw one more in there on AUC. It sounds like you guys still expect it to be up in the back half, are you expecting any benefit from cotton or anything to kind of mitigate that?
Fran Horowitz-Bonadies
Yeah, actually from an AUC perspective we are expecting AUC to be a benefit in the back half, weighted a little bit more towards the fourth quarter but in terms of margin, gross margin puts and takes FX is a little bit higher headwind as we move through the back half of the year as I just discussed. We expect to continue to offset that with slight increases and improvement in AUR with customer acceptance of products and as I mentioned AUC benefit particularly as we move into the fourth quarter.
Susan Anderson
Great, very helpful, good luck next quarter you guys.
Operator
Next we will go to Oliver Chen with Cowen and Company.
Oliver Chen
Hi, great job on the inventory control and excited about the positioning. I had a question about the tops business.
Do the tops need to improve in order for you to comp positive and could you clarify the nature of what you were seeing in the tops at Hollister versus Abercrombie, just key to understanding that and also the percentage mix of the business that's tops, if it's a critical driver as we look to model growth in comp store sales?
Fran Horowitz-Bonadies
So hi Oliver, it is Fran. So starting with the question regarding our Hollister knits in the tops area for girls.
We probably stayed a little bit too long at the plaid and boho trends that are happening. We are having success with them.
We got a little bit short on getting into the off shoulder and cold shoulder tops trends. So, since we have an agile sourcing and pricing we are able to see effect on orders going forward and we feel confident about where we have placed those in our future on orders.
The tops business versus Abercrombie I think was your second question. Unless you can ask a relative to one another or you are asking about within the business if you could just clarify that.
Oliver Chen
Just the trend to get more color on the overall tops deceleration at Abercrombie and what we should understand about what was driving that and if it's a concern, and how does that interplay with customer acceptance and the opportunity to improve customer acceptance, or is that just a broader opportunity in the context of the brand repositioning, which you kind of expected?
Joanne C. Crevoiserat
Yeah Oliver, I will pick that up, I think we have made progress in the tops business. We still see it however as opportunity.
We lost a lot of share over the past few years in tops and we were seeing some traction as Fran mentioned. And we expect that will improve in addition to the rest of our businesses.
We are focused on product across the board. We have seen some nice acceptance on the bottom side with jeans and chinos in both brands and are also seeing nice business in emerging categories in dresses and accessories and intimates.
So we’re focused on improving the whole assortment, balance in our assortments and it has been one of the themes of our -- areas of focus of our strategy as we move forward to make sure that we’re appropriately moving forward all parts of our business. But we definitely still expect and see opportunity in the tops space.
Oliver Chen
Thanks a lot. The performance stretch in the chinos looks great, best regards.
Fran Horowitz-Bonadies
Thank you.
Operator
Next we’ll go to Tiffany Kanaga with Deutsche Bank.
Tiffany Kanaga
Hi, thanks for taking my questions. Can you talk more about what kind of traffic trends you are seeing in the mall, not in tourist and flagship locations or online and also what you are seeing in terms of promotional activity across the mall?
Joanne C. Crevoiserat
I think there is definitely has been widely reported mall traffic trends continue to be difficult across the U.S. and we’re seeing very similar results in our business.
I think in Q2 we did see a step up across the board in promotional activity. I think that was a bit of a result of more difficult Q1 cooler early business on the seasonal side.
But overall we feel good about our inventory position. We have had success over the past few quarters in stepping away from the intensity of our promotions and that’s driven AUR improvement.
And with our inventory position heading into the back half we expect to continue to be able to do that.
Tiffany Kanaga
Can you also talk about what specifically you think drove the Hollister rebound in Europe while Abercrombie continues to lag, is it simply a matter of flagships being concentrated in the Abercrombie brand or are there distinct improvements in the non-flagship stores and what drove that bounce back?
Fran Horowitz-Bonadies
Hey Tiffany, it is Fran. Yes specifically what drove the Hollister rebound was product acceptance by our customer.
We continue to see positive conversions across those channels actually not just internationally but across both channels if that was the driver internationally.
Operator
Next we go to Paul Lejuez with Citi.
Paul Lejuez
Thanks guys, can you talk about the performance in the UK both before and after the Brexit route, just curious if you find any difference -- any change in sales pattern, also curious about the performance of Greater China how that business progress during the quarter and still performance in the stores opening in that region? Thanks.
Joanne C. Crevoiserat
Yes Paul, this is Joanne, I’ll pick that up. We did monitor certainly very closely our business both before and during and after the Brexit vote and we did see actually only a minor disruption in traffic and sales trends around the Brexit vote.
It really impacted sort of the weekend of the vote and our business rebounded in the UK back to pre-Brexit levels pretty quickly thereafter. So we were very pleased with the way that business moved forward.
Certainly the biggest impact on our business however was the currency devaluation that we saw post Brexit and that is a bit of what you heard in terms of our expectation for continued FX headwinds moving forward. In terms of the performance of greater China, in first quarter we had very difficult performance in China.
We did see that business improve in the second quarter and we continue to be pleased with the results of our new stores that we’ve opened in the region. Those open and are exceeding -- meeting or exceeding our expectations but it is important to note that our exposure in Greater China today is still very modest.
We have I think about 20 stores in the region and we still continue to believe that we have opportunity for growth. The other piece of that business that continues to perform strongly is our digital business in China and our DTC business has consistently been positive and growing.
Paul Lejuez
Thank you, good luck.
Joanne C. Crevoiserat
Thanks.
Operator
Next we go to Neely Tamminga with Piper Jaffray.
Kayla Wesser
Great, good morning. This is Kayla Wesser on for Neely.
Just would like to go a little deeper on the advanced stretch product that you guys have in your jeans at Hollister. Our observation has been that they are actually selling out of that product in some of our store walks.
So just wondering how do you feel about that product and at this point, do you feel like you have the appropriate supply to meet demand, and if not, when do you think you will be able to calibrate that supply to meet demand? Thanks.
Fran Horowitz-Bonadies
Hi Kayla, it’s Fran. Yes, we had an exciting launch with our Epic Flex for Hollister guys and we were very, very pleased to see the results.
We actually have Epic Flex in more than just denim. We also have it in our shirts and our polos and we have exceeded our expectation on our selling.
Going forward, again as we have been able to react in business we will continue to place orders appropriately.
Operator
Okay, next we will go to Adrienne Yih with Wolfe Research.
Cody Ross
Hi, good morning, it is actually Cody Ross on for Adrienne this morning. Two quick questions, you had previously mentioned changing your strategy a little bit at Abercrombie going after an older customer.
Can you just update us on that strategy, and then also with Aeropostale kind of falling to layaway going into holiday, can you update us on some of your strategy going after that market share? Thank you.
Fran Horowitz-Bonadies
Sure hi Cody, it is Fran. Yes, we talked about and you have seen our Investor Presentation, the brand positioning that we have landed for Abercrombie which is to be the iconic American casual luxury brand for the 20 something consumer.
Today we actually have majority of our customers are over 20. So we are targeting that particular consumer.
As we did this research and we pressure tested around the world we actually had very positive feedback from both our existing and corporate future customers there was a brand position that really resonated with our customer base. Regarding the Areo market share going into the back half of the year, we are working diligently on our plans and our own strategies relative to the marketing for both of our brand positions as we move into the back half of the year.
Cody Ross
Great, thank you and best of luck.
Operator
Next we will go to Janet Kloppenburg with JJK Research.
Janet Kloppenburg
Hi everybody, just a couple of quick questions, Fran, in terms of the Hollister stores. The 60 that I think have been renovated, can you give us an update on the performance there and also if you are planning on more stores to be renovated going forward?
And just on the tops issue at Hollister in women's, and it sounds like maybe at A&F as well, I'm just wondering when you think those assortments may be better balanced. Thank you.
Fran Horowitz-Bonadies
Sure, first regarding the Hollister remodels, Q1 and Q2 -- I think recently we remodeled 32 and the balance of 20 left for the rest of the year and we will continue on this initiative as we move forward. We started doing the ones that we just reopened but that is however too early to read but prior to that they are continuing to meet our expectations.
I think your second question is regarding the tax business. [Multiple Speakers] Sure, the Hollister business specifically we have a very agile supply chain so we were able to expect our future on orders and have been able to really specifically figure out what the customer is looking for through our -- listening to our customer, voice of customer and have adjusted those.
At first A&F women got really decelerated a bit into the second quarter but we still have strong performance out there in our tops business.
Janet Kloppenburg
Okay, and Joanne is the FX impact that you have detailed in the outlook, is that exclusively because of the British pounds devaluation?
Joanne C. Crevoiserat
The majority of the change Janet will be related to the currency devaluation we saw during the quarter which was predominantly the pound but also to a lesser extent the euro. Most of it was related to the pound devaluation.
Operator
And next we will go to Betty Chen with Mizuho Securities.
Betty Chen
Thanks, good morning. Thanks for taking our question.
In regards to the brand positioning for A&F, Fran I was wondering if you can talk a little bit about from your studies, really to learn about where the customer went or where they are currently shopping and where do you think where they are coming back from, what are also the implications in terms of pricing or product design that you need to make and the timing of the changes if possible?
Fran Horowitz-Bonadies
Okay starting with what did we learn, we learned that our customer out there globally are very excited and very positive about our brand. In fact they have been according to us there is a latent affection for the brand.
We are excited to see what the brand is up to so they have been very, very positive feedback and we actually went around and pressure tested all of our positions and got very positive feedback. As far as pricing goes specifically for A&F we are comfortable with where our ticket pricing is.
I think one of the things that we really have to work on is our degree of promotion. As we mentioned a little bit earlier today we have been focused on reducing our promotional activity.
But as far as pricing goes we are positioned where we believe is appropriate for the product. And I am not sure the last piece of your question regarding product design.
Betty Chen
Just wondering from your study did you anticipate any adjustments to the designs whether it is in the tops or the bottoms at A&F?
Fran Horowitz-Bonadies
Part of our brand strategy is honestly to be very clear on our fit and our value for our customer. We will continue to reach out and make sure our customer gets through our reviews and our online information that we are able to get from our customer.
We seem to be able to tell whether or not we are set on where we are for our fit for Abercrombie as our quality goes as far as the adjustments for designs.
Betty Chen
My second question if I could is for Joanne, I think overall inventory was really clean but just curious given the comments you made about the tourists or flagship stores maybe a predominant impact on the A&F brands, is the inventory also adequately clean at A&F or are there any sort of carry over in the second half?
Joanne C. Crevoiserat
No, I think we feel very good about our inventory position across the globe in terms of not only the overall quantity but the content of that inventory as we move into the third quarter and inventory management has been the strength of ours as we’ve moved through this brand repositioning. And the teams have done a really nice job at managing and maintaining the inventory levels.
Operator
Next we go to Simeon Siegel with Nomura Securities.
Gene Vladimirov
Good morning. This is actually Gene Vladimirov on for Simeon.
Thanks for taking our question. I was wondering if you could give us some color around what drove the relatively robust performance in the DTC business, how that compared to your expectations, any divergences you saw either across the brands or the geographies, and how would you expect those trends to continue going forward?
Thanks.
Joanne C. Crevoiserat
You know we were pleased with the DTC growth. We did see growth across geographies and across brands so it was very widely distributed.
And one of the particular good things that we saw was the mobile we were able to capture very high increases in mobile traffic and conversion was up double-digits particularly in the mobile space. So that’s an area where we have been investing and those investments are paying off.
It is also a space where our customers prefer to shop. They’re increasingly going to their mobile device to browse and as an entry point for their shopping experience and we been pleased with the results to date and will continue to invest behind the DTC business.
Gene Vladimirov
And did you see any divergences across the brands?
Joanne C. Crevoiserat
You know there were some differences but it was broadly positive across brand and geographies.
Gene Vladimirov
Got it, very helpful, thank you much. Good luck for the rest of the year.
Operator
And now we’ll go to Michael Binetti with UBS.
Michael Binetti
Hey, good morning guys, thanks for taking the question. I wanted to talk to you about some of the promos we are seeing at Hollister on the denim side in particular because that category has been called out a little bit this earnings season.
Do you guys buy the denim at Hollister to be at that price point at $25 every day that we see on the website and do you feel like there is an opportunity maybe or there could be in the third quarter to take those prices higher given the denim environment we are hearing about from a lot of folks at the mall?
Fran Horowitz-Bonadies
Yeah, this is Fran. We certainly have a promotional plan that we are able to buy our product to provide for our customer the best prices that are out there.
We don’t normally comment I guess on our promotional pricing but we feel that we are very strategically positioned in the mall with where we are. We are able to do the good, better, best pricing if that’s what you’re referencing which we certainly have out there today and we will continue to have through the balance of the year.
That varies between our core basics and the customer that we can offer them some fashion at the higher price points.
Joanne C. Crevoiserat
You know we’ve been particularly pleased with the performance being an innovation, I think that is the -- that we are hearing a lot about in the denim space. And when we get behind new innovation both from a product perspective but also with marketing we are seeing really nice response from our customers that we offer that as well in the denim space.
Michael Binetti
If I could switch gears for one second to the store fleet. As you look at the U.S.
store fleet, you guys have been pretty good about staying on the balls of your feet. In light of the recent closures though from some of the peers, I guess some of your peers have commented on adding some flexibility into lease renewals going forward to help stay nimble in case some of the B&T [ph] malls, the environment there changes.
Could you comment on how you guys are thinking about the store fleet going forward given some of the recent commentary around those malls?
Joanne C. Crevoiserat
Well our approach hasn’t really changed. We have been on this path for quite some time.
We have had a tremendous amount of flexibility and expect to continue. We have tremendous flexibility going through 2017 as I noted in my comments earlier.
We expect that we will be closing more stores and we evaluate those based on the economic merits of each store and the specific positioning of each mall. So, our plans haven’t changed, we have been on this path for a while and we continue to leverage the level of flexibility that we do have.
Operator
Next we will go to Brian Tunick with Royal Bank of Canada.
Brian Tunick
Hi, good morning. Just had two or three quick questions here, I guess we are already getting some emails from investors.
Joanne, when you say challenging comps to remain in the back half, do you expect any sequential improvement into the fourth quarter from the third quarter, do you look at the down 4% year-to-date, is that how you define challenging just curious on that perspective? And then same thing on the gross margin commentary, how much roughly would you expect either the third quarter to be pressured or fourth quarter, should we expect it to be up 50 basis points because of last year's either outerwear or sweater issues, or is it FX?
So just curious about those comments, if you could add any clarity because again we are assuming we are going to get a lot of questions around those two things?
Joanne C. Crevoiserat
Thanks Brian I appreciate the opportunity to clarify. What we did say regarding comps in the back half is that the environment we expect to remain challenging.
We have continued and we have seen very persistent traffic headwinds and we expect that to continue in the back half. As I mentioned with currency devaluation and safety and security concerns we see that more pronounced than our flagship and tourist business.
And we don’t see a catalyst for that to change in the near term. We are focused and confident that we are focused on the right priorities to improve those trends over time with the new brand leadership that we have on board are focused on improving the product, improving the store experience, as well as the investments we are making behind marketing.
We are confident that overtime we will show improvement in both traffic and top line. Related to the margin conversation, what we have provided in the outlook is an expectation that margins will be managed flat for the year.
We will -- we do expect to see some headwinds in the third quarter in margin related to FX and as I mentioned the FX headwinds are more pronounced in the third quarter and begin to abate in the fourth quarter. The other lever within the other two levers within margin AUR we expect to continue to show some slight improvement in AUR as we step away from promotional activity but we also expect benefit from AUC in the back half and that is weighted more towards the fourth quarter.
Operator
Next we will go to Mark Altschwager with Robert W. Baird.
Mark Altschwager
Good morning, thanks for taking the question. I also wanted to follow-up on margin, just regarding the updated SG&A guidance where are you seeing incremental savings versus your prior outlook and bigger picture, any updated thoughts on the longer-term operating expense and savings opportunities?
Thanks.
Joanne C. Crevoiserat
Yes Mark, this Joanne. We have talked about our continuous improvements, profit improvement efforts here.
We had a lot of success over the years taking cost out of the business and we have evolved those efforts into a continuous improvement mindset in the company and we are leveraging that for savings. It is not big buckets of money in one specific area.
We are finding savings from little, to use the baseball expression, we are hitting a lot of singles not a lot of home runs but they are adding up. And so we expect to continue to be able to drive operating expense improvement through those continuous profit improvement efforts and the efforts of the teams across the globe.
In terms of the long-term outlook for OPEX we have also been able to leverage those savings to allow us to invest in the things that we think are important to drive our growth going forward and that includes the investments that we made in the second quarter in marketing. We continue to invest in the DTC space.
As I mentioned a little while ago those investments have been paying off with strong performance on the DTC side and we expect to continue to invest in marketing as we move through the back half.
Operator
Now we’ll take a question from Kimberly Greenberger with Morgan Stanley.
Kimberly Greenberger
Great, thank you so much. Joanne I think you mentioned you’re expecting AC benefits here in the second half weighted towards the fourth quarter I just want to make sure I heard that correctly?
And then if you could give us any sort of feel for how you’re thinking about 2017 on the AUC side? And then for Fran, Fran I am not sure I understand the deceleration at Hollister from Q1 to Q2, is there something going on at Hollister after what I think was a general and more stable performance and what are the strategies in place to address that?
Thanks so much.
Joanne C. Crevoiserat
I’ll pick up the AUC, you were correct we do expect to see AUC benefit in the back half more weighted towards the fourth quarter and that is the result of the currency and commodity price decreases that we’ve been able to take advantage of in the back half of the year. As it relates to 2017 we haven't provided an outlook on our 2017 financials at this point and would look to do that as we move into the fourth quarter.
Fran Horowitz-Bonadies
This is Fran, regarding your second question, so we did have some misses in Hollister I think we have acknowledged particularly on the girls tops business. But considering that we have an agile sourcing supply chain here we were really able to react to what some of those challenges were and correct them on going forward.
But it is really exciting as we get it right like we did it with our Epic Flex promotion for the guys back to school, our customer really responded and incredibly positive about that product. We have new leadership.
I mean Christine has brought in a tremendous energy for that team. She brings in a lot of leadership experience that will continue to help us drive this business forward.
Operator
Now we’ll go to Richard Jaffe with Stifel.
Richard Jaffe
Thanks very much and just a follow up on Hollister I guess. In the past you've said Hollister renovations would provide a double-digit lift in traffic and sales, I’m wondering if the comments you made tonight or today rather management expectations being realized at the Hollister renovations would that be consistent with the double-digit lift in traffic and sales you've previously stated?
Fran Horowitz-Bonadies
Hi Richard, it's Fran. Yes, we continue to be pleased and we continue to meet our expectations with the renovations.
The only thing I said was that the ones, the most recent ones during the previous period a little bit hard to read already but prior to that we continue to be pleased with our expectations, meeting our expectation, sorry.
Operator
Now we’ll go to Omar Saad with Evercore ISI.
Omar Saad
Thank you. Thanks for taking my question.
I wanted to ask about the A&F brand positioning, maybe you could talk a little bit about how it will impact stores, you mentioned about a new prototype for next year, the brand is obviously known for its stores versus the flagships, do you see a lot of change that is going to happen there as you adjust and reposition the brand?
Fran Horowitz-Bonadies
Hi Omar, it is Fran. We are just beginning to talk to our customer, right.
We are beginning to bring together the brand position as well as our DNA and our voice out there for our customers. We’ve spent a lot of time in the past year working on our customer experience which was really for both brands Abercrombie and Hollister.
Through our voice of customer we’re hearing that very positive things that our customers experience with in the stores. So we will continue to move along that path.
Specifically the prototype, yes, we announced a couple of weeks ago that we will be launching a prototype in the first half of 2017.
Operator
And next we’ll go to Marni Shapiro with Retail Tracker.
Marni Shapiro
Hey, everybody. I want to dive in a little deeper to some of your online it was nice list hearing DTC and its still growing.
Can you talk a little bit about the average transaction size that you see online in comparison to what you might see in a store and are you seeing the online shopper skewed more towards new products because they seem to highlight the new products earlier or is it more of a clearance shopper and then one last follow up after that on the same business?
Joanne C. Crevoiserat
Well Marni, this is Joanne. We definitely value the online shopper.
In fact we expect most customers are browsing if not shopping online. So we continue to invest in the omni-channel experience and we’ve seen nice response to the changes that we have made.
I think the online shopper is and has been more price elastic. So there is definitely a customer out there for the clearance business online.
However, we see nice traction with the online shopper. Also with new products and increasingly we’re seeing that customer -- our customer shop on their mobile device and we have been very pleased with the conversion we’re seeing, the changes that we’ve made to reduce friction in the shopping experience on a mobile device have yielded nice strong improvements in overall conversion.
So we have been pleased with the DTC business and we continue to invest in that space and we know that it is important for our customer specifically as one point of entry to the brands.
Marni Shapiro
One question, as she walks into your store whether it’s online or virtually is she buying about the same size basket, is it the same three units at x dollars whether it’s online or in store? And then just one follow up about the customer coming online, are you seeing new customers come into the brand and are they coming through your social media efforts?
Joanne C. Crevoiserat
Yes, in terms of the basket size the online basket size is higher and in terms of new customers we are capturing new customers through social media but those are details that we haven't disclosed previously.
Operator
And now we’ll take our final question from Dana Telsey with Telsey Advisory Group.
Dana Telsey
Good morning everyone. As you've ventured a little bit into the wholesale channel, whether it's with Zalando, with ASOS, what results are you seeing there and what are you learning from product acceptance there versus product acceptance in your own stores?
And then with the increased marketing spend that's going to be happening in Q3, what are you planning to do differently than Q2 and how are you thinking about the holiday season game plan this year versus last year? Thank you.
Joanne C. Crevoiserat
Hi Dana we’re excited about our wholesale business and what we’ve seen as we’ve rolled out the wholesale business in Europe specifically through ASOS and through Next is it has been a nice compliment to our other businesses there both our in store and our online business, our own online business. So we are expanding our brand reach and reaching new customers through these wholesale channels.
And with Zalando announcement last week we expect to have now access to 18 million new customers through that platform. So we have been very pleased with the results.
From a product acceptance standpoint I think we haven't learned anything specific from the selling there that we wouldn’t see or haven't seen in our own business. But we have seen a nice compliment to our businesses in those regions.
Fran Horowitz-Bonadies
Hey Dana, its Fran and on your question regarding marketing so competitively we can't really comment on where we’re headed for Q3 but what I can tell you is that the success of the thing that we have been doing in the business in Hollister and we’re going to start to ramp up doing in our Abercrombie business is a holistic marketing campaign which encompasses your social, digital out there. So we’re going to continue on the path that we have been on.
Operator
And there are no further questions at this time.
Arthur C. Martinez
Thank you all, this is Arthur. Thank you all for your thoughtful questions today.
I do want to say that I am confident that the teams here have a very firm grasp, the challenges we face are now in vigorous actions to address them. While there may be few obvious near-term catalyst of change to macro environment for the better we’re firmly in control of our business and are committed to getting the business moving and making progress in rebuilding this great company.
Once again thank you.
Operator
And that does conclude today's conference. We thank everyone again for their participation.