Abercrombie & Fitch Co. (ANF) Q2 2020 Earnings Call Transcript

Abercrombie & Fitch Co. (NYSE: ANF) Q2 2020 earnings call dated Aug. 27, 2020

Corporate Participants:

Pamela Quintiliano — Vice President of Investor Relations

Fran Horowitz — Chief Executive Officer

Scott Lipesky — Senior Vice President and Chief Financial Officer

Analysts:

Jay Sole — UBS — Analyst

Paul Lejuez — Citigroup — Analyst

Susan Anderson — B. Riley FBR — Analyst

Janine Stichter — Jefferies — Analyst

Carla Casella — J.P. Morgan — Analyst

Janet Kloppenburg — JJK Research Associates — Analyst

Kate Fitzsimons — RBC Capital Markets — Analyst

Sarah Goldberg — Robert W. Baird — Analyst

David Buckley — Bank of America — Analyst

Marni Shapiro — Retail Tracker — Analyst

Presentation:

Operator

Good day and welcome to the Abercrombie & Fitch Second Quarter Fiscal Year 2020 Earnings Call. [Operator Instructions] Thank you.

At this time, I’ll turn the conference over to Pam Quintiliano. Please go ahead.

Pamela Quintiliano — Vice President of Investor Relations

Thank you. Good morning and welcome to our second quarter 2020 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our second quarter earnings release which is available on our website at corporate.abercrombie.com under the Investors section. Also available on our website is an investor presentation. Please keep in mind that any forward-looking statements made on the call are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mention today.

A detailed discussion of these factors and uncertainties is contained in the Company’s filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning.

With that, I will turn the call over to Fran.

Fran Horowitz — Chief Executive Officer

Good morning, everyone. I hope you and your loved are healthy and safe. Before discussing second quarter results, I would like to start by thanking our global teams and partners. Despite unique challenges they’ve all faced, they continue to team up, build up and get it done. From our DC store and home office associates, to our vendor partners around the world, together, we continue to successfully navigate this unprecedented period of uncertainty. I am so proud and humble to be a part of this amazing organization.

Due to the hard work, patience, ingenuity and perseverance of our team, we have been able to quickly react to changing customer demand of fortifying our position for the future. Our total Q2 Company revenues were down 17% as compared to last year. Throughout this quarter, we remain nimble. We utilized our lean and agile inventory management strategy while authentically speaking to our customer and providing them with relevant products aligned with their lifestyle needs. Our customers respond favorably with our gross profit rate expanding 140 basis points fueled by lower promotions and clearance and improved AUR. We also tightly manage expenses, leading to operating expense leverage on our best Q2 operating income in six years.

Of this unwavering focus on maintaining strong liquidity, we generated a $187 million operating cash flow, ending the quarter with $767 million of cash and equivalents and approximately $1.1 billion of liquidity. This empowered to make quick and strategic near term decisions while continuing to fund critical long-term investments for future growth. Over the last several years we strengthened our foundation as we executed against our key transformation initiatives, including reducing square footage and updating our in-store experiences, investing in digital omnichannel capabilities, increasing the speed and efficiency of our supply chain and continue to evolve brand positioning while including customer engagement.

The significant progress we made leading into pandemic on our transformation initiatives liquid investments in systems, processes and talent have been key differentiators in our ability to strategically pivot our entire organization. Our solid foundation has enabled us to thoughtfully engage with our customers, as they continue to deal with COVID-19 and the physical, mental and social challenges associated with it. At the same time, we’ve also been responding to calls of social justice and struggling with the uncertainty of back-to-school or back-to-work, will look like this fall.

Throughout, we have stayed close to our customers, pivoting and adapting our products, marketing, messaging and inventory to align with their changing reality. When we last spoke in May, we were encouraged by our Q1 and quarter-to-date results, and have planned in Q2 in the back half conservatively. At that time, we had roughly 50% of our global store base open, stores operating 70% productivity and digital continuing to show impressive growth. As this quarter progressed, restrictions eased, we opened more stores. At the end of the quarter, roughly 90% of our global base is open, which is consistent, before we are today. Although open, we are operating at reduced hours in many of our global locations.

Similar to Q1, stores have continued to experience year-over-year decline in traffic, partially offset by improved conversion. As we continue to open and at times we close select stores, the spacing and well being of our customers’ associates and community has remained a top priority. We continue to school be shift inventory by channel. We’re starting to manned by demand, while utilizing ship and store. We’ve adding fulfillment options, by adding curbside pickup, it is available quite roughly 80% of our US store base by the end of the quarter.

Scott will provide more detail on our reopens performance trends. The stores, we are opening, our digital business has remained strong, for the quarter, digital sales grew 56% to $386 million with robust double-digit gains in each month and improved. Traffic, conversion and AUR. Combined total visits to our website and highly rated app growth of a 25%. With ad business alone rising approximately 50% in the quarter. We spoke directly, to our customer about COVID-19 as well as the social issues that we’re facing. Our honest awards [Phonetic] combined with relevant products result in a strong digital growth across brands in every month of the quarter.

We achieved record Q2 digital sales. Abercrombie, excuse me, reached record Q2 digital sales. Abercrombie Adults, Kids to all hit new highs. With record digital sales times over two-thirds of our categories, including many of our must win, must grow classification. As a reminder, we had meaningful digital business entering this year. The channel accounted for roughly a third of our revenues that over $1 billion in fiscal 2019. With solid global platforms and distribution center infrastructure and site, which has enabled us to keep up the strong digital demand.

[Indecipherable] branded engagement is strong growth rates in the quarter benefiting from less than awareness. At Hollister, a focus on certain architecture continue to pay off with our must have top 30 items outperforming. Our customers find a wealth of the pattern on bringing across genders and will that remains. And while Lingerie popular, including lace and sweats, fashion content also resonated. I’m especially proud of our performance in girls’ denim shorts, a highly competitive category. But predominantly full price. On the guy side, must-have multipack tees, graphics, swim and lounge shorts were strong.

Needless to say, I’m extremely encouraged by our Q2 performance at Hollister. It is our biggest brands representing roughly 50% of our average store revenue in 2019. We remain confident in the global growth opportunity that lies ahead. At Gilly Hicks, we experienced double-digit sales growth, with over 100% growth in the digital channels. Our customer continue to embrace our new asset selection, Gilly Go as well as company lounge intimate offering. While still early in its lifecycle, we are excited about the global white space of Gilly as we continue to offer product that focuses on our team, customer’s lifestyle needs.

For the improved assortment in Hollister and Gilly Hicks, we shifted messaging away from promotions and into storytelling. We had a clear and well-defined product and brand stories across channels that authentically spoke to our customers. We also focus on topics they care about the most, with an emphasis on pride and mental health, two causes we champion. Our proud of new Pride campaign in support of quality and diversity is well received. As the quarter is closing, we launched our back-to-school denim campaign featuring TikTok stars, Charli and Dixie D’Amelio.

We are thrilled to have Charli and Dixie as part of the Hollister team. They truly align with our customer and causes and support included anti-bullying and equality. I think those of you who are not on TikTok, Charli is the most followed person on the platform with over 82 million followers and Dixie has almost 36 million. They’re popular across social media with roughly 27 million to 70 million respectively on Instagram. For back-to-school, they partnered in our Hollister Denim Lab with social influencers in one of our first Hollister brand ambassadors, Noah Pugliano and one of our customers’ favorite celebrities, Bill Nye, testing business styles to a wide, unique product recommendation.

In addition, Charli created the hashtag [Indecipherable] challenge. As of Monday, the campaign has 5 billion views worldwide, and 1.2 million video submission, since its launch. We experienced improved traffic and to metrics, and our partnership with Charli and Dixie does not end with back-to-school, stay tuned for additional story and collaboration throughout the remainder of the year. I also encourage you to tune to the housing volume series. But we have members of the team [Indecipherable] take over Hollister’s Instagram, that honest dialog that are current events that are impacting their lives.

Well, there is a lot to be excited about Hollister, Abercrombie has not standing still. Our A&F women’s business had multiple categories with double-digit omnichannel sales growth including short, knit tops, skirts and swim. Men’s product acceptance are also strong with double digit growth in tees, shorts, jeans and our signature fragrance, Fierce. The both genders our Soft AF line. It is one of our key volume driving selection continued to resonate.

In addition, our annual price selected is well received. At Abercrombie kids, continues to be driven by our summer essentials including shorts and swim. Abercrombie adults’ and kids’ second quarter marketing campaign, particularly about summer and all this fun celebration. But the current environment requires quick and creative thinking and some heartfelt conversations in order to properly show up for our customers. An example of, this is our price campaign. Our messaging was celebratory, but with the rise of protest weeks before its launch, the key pivoted to highlight the role, the bypass community in the site for LGBTQIA plus equality.

We are authentic, supportive and part of the conversation, and are overwhelmingly positive with summer. It’s important for many of our customers across swim, it’s the third time together with our customers, we have donated over $4 million combined to [Indecipherable] and Trevor Project. Organizations that we work closely with that we’re closely with the LGBTQIA plus community.

I would also like to congratulate [Indecipherable] marketing team to begin shipping in the [Indecipherable] award with corporate social initiatives and product marketing. I can’t wait to see what our marketing team need to accomplish, especially with our recently introduced and video conversation on our adult channel as well as our kids prime subsidiary both of which focus on equality and facility. We continue to be extremely pleased with the ongoing evolution of our A&F adults product and brand positioning and so excited about what the future holds.

Throughout the quarter we also continued our environmental, social and governance work. At Hollister, we launched our online progress of the production sustainability campaign that both brands we continue to be encouraged by response towards better partnership which customers incentive to receive [Indecipherable] recycled program. Before I turn the call over to start, I’d like to take a minute to discuss the US back-to-school season, which clearly looks very different this year.

The COVID-19 striked in several of our key and early back-to-school markets including California, Florida and Texas. The late start to across the country and many students beginning their site virtually. We’ve experienced a slow start from the years passed as store traffic decelerating from July levels, and building our continued planning, this was a scenario we considered on prepared for. Over the past several months, we proactively bought inventory conservatively, shipped it even more focus to warehouse assortment and retain to our product and marketing growth.

Quarter-to-date our preference continued to respond favorably to new products. We’ve experienced improved year-over-year omni conversion in digital and maintained strong double-digit growth. Recently on the sales trends that we received as we’ve anniversaried last year’s peak exclusive and our customers received more priority each line back-to-school and the mix between physical and virtual.

Looking ahead, we are cautiously optimistic that the back-to-school selling seasons will extend into September, and potentially, October as throughout the country and weather becomes more seasonal. For the quarter, we expect to recoup some, but not all the lot sales in August which is historically our largest month. As such, we are planning Q3 sales trends to be consistent with Q2, and that down 15% to 20% range. With roughly 80% of our California store base still closed, our current trend is slightly above that gap.

Despite the challenging environment, we continue to believe in significant opportunities for our current brands and our growth vehicles, both domestically and internationally. We’ve made difficult decisions this year to ensure that we are well positioned coming out of this period to be stronger on the other side. As we approach year end, we have a chance to address roughly 25% of our leases that are up for renewal.

As we continue to be realize, increasing already — in our already deep digital penetration. This gives us the ongoing opportunity to level set our square footage and occupancy to a successful global omnichannel business requires. We have a solid foundation including a strong balance sheet and continue to leverage our financial flexibility to invest in the long term and further strengthen our position as a diversified global omnichannel retailer.

And with that, I will turn the call over to Scott.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Thanks, Fran. I’d like to start by adding a huge thanks to our global teams and our vendor partners. I’m incredibly proud of how we navigated. We achieved our best second quarter operating income since 2014 and delivered $187 million of operating cash flow.

Now onto Q2 results. Net sales of $698 million were down 17% as compared to last year. By brand, net sales declined 15% for Hollister, which includes Gilly Hicks, and 20% for Abercrombie, which includes Kids. By region, net sales declined 16% in the US, 15% in EMEA, and 38% in APAC, our smallest region. Store traffic remained below last year, partially offset by improved conversion and 56% year-over-year digital growth.

Looking specifically at reopened store performance, second quarter global store productivity was at roughly 70% of the prior-year period. By month, May and June saw an acceleration in trend. We subsequently experienced the productivity decline in July, led by the US. Breaking down trends further by region, starting with our largest market, US, second quarter store productivity was at 75% of last year, with 85% of our base opened at quarter end. On average, our US stores were unable to open for business for approximately one-third of the days in the quarter due to government and landlord imposed restrictions on occupancy and hours of operation.

We realized productivity improvements in to June, and took a step back down in July with the resurgence of COVID and key early back-to-school markets including the re-closing of roughly 80% of our stores in California and has laid back-to-school start throughout most of the country. In EMEA, store productivity was approximately 50% of last year. We ended the quarter with all but a few stores open, although the majority of our locations in our historically largest European market, the UK, did not open until mid-June.

In APAC, our store productivity was roughly 70% with 96% stores open at the end of the quarter. By brands, on a global basis, Hollister stores outperformed A&F and Kids, which generally have a higher digital penetration, while in the US, Hollister and Kids were more adversely impacted by back-to-school performance. As Fran mentioned, we have been actively preparing for COVID spikes and back-to-school uncertainty in the US. We have not been caught off guard by the shift. We do not believe back-to-school performance is reflective of assortment issues and have seen strong digital response to new products across brands.

We’ve also experienced store productivity improvements over the past couple of weeks as students have had more visibility for the fall. We continue to believe that the back-to-school season will last longer than it has in the past as most schools have delayed their start dates, some well into December.

Moving on, our gross profit rate of 60.7% was up 140 basis points to last year. This improvement was a result of higher AUR with promotional and clearance levels below last year. We entered Q3 with inventories current and down 7% to last year and are comfortable with our positioning. Our teams have done an amazing job managing the on-hand and on-order inventory. Over the past several years, we have made significant progress on improving the speed and agility of our product development calendar and lead times. This progress has enabled us to adapt quickly to changes in demand.

As we look to the back half, we will continue to balance gross profit rates with sell-throughs. With uncertainty in the top line, we are conservatively managing inventories, fluidly shipping goods to our channel, optimizing our distribution center capacity for increased digital demand and positioning the business to chase.

I’ll now cover the rest of our results on an adjusted non-GAAP basis. Excluded from our non-GAAP results this year, our $8 million of asset impairment charges that we believe are principally attributable with COVID-19. These changes adversely impacted results by $0.15. There were no exclusions last year. Operating expenses excluding other operating income was $404 million as compared to $538 million last year, which included $45 million of flagship store exit charges primarily related to our Hollister SoHo locations close in Q2. Operating expense leveraged 610 basis points, with 530 basis points related to the adverse impact in flagship store exit charges last year.

Stores and distribution expense decreased on a dollar basis driven by a decline in store payroll and store occupancy, partially offset by increased shipping and handling expense on higher digital sales. Marketing, general, administrative expense was down on a dollar basis, primarily driven by reduced payroll, marketing and other controllable costs. We remain focused on tightly managing expenses and finding areas for additional savings, but we will not start the business. We anticipate that certain expenses reflects back up in the second half, including store payroll and variable store occupancy assuming stores remain open.

Overall, our goal remains consistent, continue to reduce fixed non-customer facing costs to enable reinvestment in customer-facing activities and our ongoing transformation initiatives. Operating income was $22 million compared to a loss of $39 million last year and included a $1 million benefit from FX. The effective tax rate was 1%, which was lower than last year as a result of changes in the level and mix of projected pre-tax results of full year. Net income per diluted share was $0.23 compared to a loss of $0.48 last year or $0.46 on a constant currency basis, with last year, reflecting an adverse impact of flagship exit charges of approximately $0.50.

Our balance sheet remains strong. We ended the quarter with cash and cash equivalents of $767 million and total liquidity of approximately $1.1 billion. We plan on building higher than average cash balances to preserve flexibility in this uncertain environment. In July, we completed the issuance of $350 million of senior secured notes which will mature in 2025. These proceeds were used to repay outstanding obligations under the existing term loan and ABL facilities as well as stores related fees. The transaction extinguished our term loan facility which was set to mature in 2021, improving our near-term liquidity position.

We continue to see capital expenditures of approximately $100 million for the year, with about half of that attributable to stores and the other half attributable to digital technology investments and maintenance fees. We still believe that stores matter and they are the important part of the omnichannel brand experience, but they must be the right size, in the right location, with the right economics. To date, we have opened nine stores that meet that criteria, while closing 14 that have not.

As we look at year end, we have over 200 leases coming due, which represents about a quarter of our store base. We will continue to hold conversations with our landlords to find a mutually beneficial and agreeable path forward. We will evaluate all options, whether it be remodeling the right pattern or walking away completely and closing stores. We are excited about the progress we have made on global store optimization and we’ll have more to share on real estate as we move through the year.

Lastly, our dividend and share repurchase programs remain suspended. Due to the heightened uncertainty in the marketplace, we are only providing a sales outlook at this time. For Q3, we are planning the business around the sales trend consistent with Q2. We are cautiously optimistic that the trend will improve, but we will manage expense and cash flow, assuming it will not. We are confident on our marketing plans and assortment and have the ability to chase inventory if demand improves. Looking ahead, we remain confident in our ability to win as a global specialty retailer that caters to a broad customer demographic from kids to post-collegiate adults. With continued progress on our transformation initiatives and our solid balance sheet, we are confident in our ability to thoughtfully pivot and strengthen the Company no matter what obstacles may be thrown our way.

And with that, let’s turn it over to the operator, ready for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] And we’ll take our first question from Jay Sole with UBS. Please go ahead.

Jay Sole — UBS — Analyst

Great. Thank you so much. Fran, just wanted to ask you two questions. First, we supplied by the strength of denim in the quarter, a lot of talk about everything shifting toward athleisure, where you sort of surprised that you were able to generate the sales, you did. And then secondly, thinking about merchandising and you’re planning your buys for the early part of next of next year, given that there is a vaccine, it could be a much more a different environment, people thinking differently, if we were going back to work in advance, and things like that. Are you thinking differently, are you still going to plan conservative kind of about more that the ones going to look like. Thanks so much.

Fran Horowitz — Chief Executive Officer

Hey, Jay, good morning. We were very excited about our denim business for Q2. I think everybody in the Company knows that one of my favorite words is balance and making sure we keep a balance in our assortments is very important. Although we did see a shift with the customer moving into more stocking cozy merchandise, we also have a very strong denim business, we understood the customer, we stay very close to them and hearing what their mindset is based. They were really responding to our products. So, not really surprised at all staying close to the customer.

And then regarding next year at this point, what we are seeing throughout this whole year that our entire cadence of our customer has been different. We knew once COVID started that for example summer would last longer. So we cadenced our merchandise to make sure that we had swim and shorts and tees out on our floors longer than we normally do in past years. We’re now stating that same thing happened with back-to-school, starting a little bit later, but recently as we started to flow in more of our back-to-school merchandising, really strong product acceptance. So we’re going to continue to stay close with the customer and cadence our products accordingly, as we learn more throughout the year.

Jay Sole — UBS — Analyst

Got it. And then maybe if you could you just sort of clarify your expectation for the third quarter, it sounds like, within the down 15% to 20% guidance, you’re saying that, like August has start up a little bit weaker, but you expect just further season be sort of later arriving, obviously with — especially if weather breaks a little bit later and sort of to make up whatever is happening in August and September and October. And that’s how you plan to get to 15% to 20%, or am I misunderstanding what you’re saying about that?

Fran Horowitz — Chief Executive Officer

Yes. You are understanding it correctly. I mean, we already see quite a spike at the end of July, in the beginning of August and then it declined through September and October, what we’re seeing is much more of a — an extended back-to-school. And I guess, I would call more of a plateau and a longer selling seasons of back-to-school, just like we saw for our summer products.

Jay Sole — UBS — Analyst

Got it. Okay, thank you so much.

Fran Horowitz — Chief Executive Officer

You’re welcome.

Operator

Thank you. We’ll next go to Paul Lejuez with Citi. Please go ahead.

Paul Lejuez — Citigroup — Analyst

Hey, thanks, guys. Can you maybe talk about the profitability of the e-com channel as it grows in size and relative to last year and how do you expect to handle shipping surcharges during the holiday season. And then Scott, also curious if you could talk about the real estate opportunities, maybe I heard you say, about 25% of the stores coming up for renewal, but in the — in the stores that remain, do you have opportunities to work rents down, maybe get out of certain locations faster than you would have been able to previously and specifically on the flagship side, if you could address those. Thanks.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Thanks, Paul. I think I’ll grab all of these. So let’s start with the e-com channel, the size, the relative to last year. So our e-com channel is profitable on a four-wall basis. And actually, little bit more profitable this year than last year. The one thing we love about the e-com channel, it is highly leverageable. As we grow the sales there, you do bring along some of that variable shipping, but you’re leveraging a fairly fixed pool of assets through our distribution centers around the world. So I’m really excited about what we saw in the channel through Q2. Let’s see, moving on to holiday shipping surcharges, yeah, we have seen that in the news. We’ve been working very closely with each of our carriers. We’ve been adding new regional carriers. It’s going to be busy up there in the fall season, for sure, as we get closer to holiday. So we expect to see surcharges, like I said, we’ll work with our carriers and mitigate those as much as we can, but some of those will flow through. And that’s baked into how we’re planning for the back half.

The goal there is to offset those surcharges with expense savings across the rest of the P&L, a $1 is a $1, the way we like to think about it. So we’re doing great work around expense. Going back to last quarter, we mentioned that we took out about $200 million plus of expense from where we were in the beginning of the year. We remain on track for that, and every day, we’re looking for more to help offset things like surcharges.

Moving on to the real estate opportunities. Yeah, we have a great opportunity this year. I mean, we’ve learned a lot this year so far with what we’ve seen in COVID, we’ve seen some nice occupancy saves to this date working with our landlords, and seeing some of the sales on variable occupancy, but we really need to do a lot more work. We’ve been talking about this for years, we have a great opportunity at this Company to reduce occupancy, reduce square footage. We’ve reduced square footage on average of about 4% per year over the past five years and there is definitely more to come.

So we’re excited about what we’re going to see in the back half. We love stores, but we have to have the right economics, the right size, and the right locations. So a ton of a work to do. We have a great opportunity at year end. And then on the last question, on flagships, we remain committed to exiting our flagships in the future. Nothing new to report at this point. We have three opportunities to leave flagships this year, that’s in our current lease stack and we’ll continue just to try to find opportunities in the future.

Paul Lejuez — Citigroup — Analyst

Thanks, Scott. Congrats [Phonetic], about it. Good luck.

Operator

Thank you. We’ll next go to Susan Anderson with B Riley. Please go ahead.

Susan Anderson — B. Riley FBR — Analyst

Good morning. Nice job on the quarter. I was wondering if you can maybe give a little bit more color just around back to school in the third quarter, and I guess what percent of your business typically makes up back to school or how levered are you to that category? And then I was wondering, it sounds like you expect it to be prolonged, but are there pieces of the back-to-school business that you think, just, I guess more materialized this year. Thanks.

Fran Horowitz — Chief Executive Officer

Susan, I’ll start and I’ll kick it over to Scott. So just have the — August is our largest month, but we do believe that what we’re seeing from the customers’ shopping habit, but it’s the back-to-school that’s getting extended longer. We don’t anticipate making all of that, but we do expect to see a much longer run in September, and looks like potentially even into October. Once the weather changes as well, and the minds that shifts, and we’re already starting to see that shift, now that the kids are realizing that back-to-school is actually happening. And when they’re going back, be it delayed or virtual, the reality is always setting in for them. So what we’ve been able to do is cadence our inventory accordingly, kept those shorts and tees and swim at regular price on the floor longer throughout the quarter that’s evident in the margin that we were able to drive through that.

And we’re going to continue to cadence and working very closely to our customer. On a weekly basis, the teams are responding, I mean, keeping our inventory leads that we can make sure, that we can chase where they need to be.

Susan Anderson — B. Riley FBR — Analyst

Great. That’s helpful. And I guess, yeah, so just a follow-up on the gross margin then. Nice job in the quarter and pulling back in the promotions. I guess, how are you thinking about that, for third quarter in the back half, given, I guess the prolong back-to-school, but then also the holiday period, are you expecting it to be promotional?

Scott Lipesky — Senior Vice President and Chief Financial Officer

This is Scott. I will grab this one. Gross margin for the back half, we haven’t given an outlook obviously, but it’s really about inventory management. Fran mentioned, we are planning our inventories conservatively. And if we see demand outstrip supply, then we have a great opportunity to raise AURs and see gross margin expansion. So that’s how we’re approaching the back half. We’re going to be conservative on inventory. We want to expand gross margins. We like the — how we delivered the gross margin expansion in Q2 and what that does to the P&L, but it’s going to be about supply and demand.

Around holiday, absolutely, it’s going to be promotional, it’s promotional every year. And I think what you’re seeing across the industry is, those companies that have been able to really manage their inventory tightly have been able to expand margins and raise AUR. And so we’re in that camp, in Q2, and hopefully, we’ll be in that camp in Q3 and Q4, but there’s plenty of uncertainty out there on the top line. So we’re just going to manage it day by day as we go through the fall.

Susan Anderson — B. Riley FBR — Analyst

Great. Nice traffic, and good luck in the back half.

Fran Horowitz — Chief Executive Officer

Thank you.

Operator

Thank you. We’ll next go to Janine Stichter with Jefferies. Please go ahead.

Janine Stichter — Jefferies — Analyst

Hi, good morning, thanks for all the color. Just wanted to get a little more detail on the inventory, extremely clean, it sounds like you feel like you have enough, just wondering if there’s any categories where you feel like, you could be a little bit late and don’t have the inventory to meet demand?

Fran Horowitz — Chief Executive Officer

Well, he is very focused on keeping a very balanced inventory, Janine. So at this point in time, they have been so diligent with their inventory and responding to the business, that we feel our inventories and very balanced at this point in time. We have a great sourcing team, very agile that can shape into what we need. So we’re meeting with the teams at weekly at this point to make sure that we’re staying on top of all the demand.

Janine Stichter — Jefferies — Analyst

Great. And then just a follow-up, on gross margin, I wanted to ask about input costs, are you still seeing potential for unfavorable costing in the back half of the year?

Scott Lipesky — Senior Vice President and Chief Financial Officer

We are. Yeah. The environment remains positive for costing with cotton where it is and the transportation is a little tricky. The part of the FOB, I’m getting it here, but a little cloudy out there, but outside of that, input costs have been solid and we see opportunities for good costing in the back half. And then hopefully into 2021, when we get there.

Janine Stichter — Jefferies — Analyst

Great. Thank you very much.

Operator

Thank you. We’ll next go to Carla Casella with J.P. Morgan. Please go ahead.

Carla Casella — J.P. Morgan — Analyst

Hi. I just have a question. You talked about the inventory being down, and your gross margin was a lot better this quarter than we expected. Can you just talk about the clearance trends as we go into back-to-school and if you’re seeing any major changes there on clearance trends or promotional trends across your competitive set?

Scott Lipesky — Senior Vice President and Chief Financial Officer

I would say — this is Scott. I would say, the promotions look similar, they feel similar to me, the recent past and past back-to-schools. I don’t think they’ve been overly elevated, but again, it comes back to a case by case basis. Those companies that have been able to manage their inventory tightly have been able to raise AUR and pull back on some promotions and we were in that camp in Q2. So nothing extraordinary out of the ordinary, I would say.

Carla Casella — J.P. Morgan — Analyst

And then, on the reduction you had this quarter, is that a similar rate you expect for next year, the 7% reduction?

Scott Lipesky — Senior Vice President and Chief Financial Officer

We’re going to be planning inventories down. Year-over-year overseas will be down. So it’s going to come down to the top line. And so with our outlook of the 15% to down 20% which is a similar trend to last year, or I’m sorry, the last quarter in Q2. We expect to continue to make progress on inventory. Our general goal is to try to keep inventory and sales in line. A couple of 100 basis points up and down, and we’re continuing to make progress towards that.

Carla Casella — J.P. Morgan — Analyst

Okay, great. And then just one last one, on the priorities for free cash flow. You mentioned in the quarter, when, at what point or what are you looking for either in terms of getting beyond COVID, free cash flow, before you reconsider share buybacks.

Scott Lipesky — Senior Vice President and Chief Financial Officer

That’s a great question, and something we’ve talked a lot about internally. It’s really about certainty on the top line or less uncertainty, I would say. We have a great balance sheet right now, $1.1 billion of liquidity. I just did a financing last quarter to clear up some near-term maturities, so we have — we’re in a nice position. We have nice flexibility. As you mentioned, $100 million in capital this year. We have great investments that we’re going to continue to make in the future. So as we get towards the back half of the year and we start to see some certainty in the top line, and that might be a time where we bring back share buybacks. But a lot of water to go under the bridge before then. But it’s really about certainty on the top line.

Carla Casella — J.P. Morgan — Analyst

Great. Thanks for all the answers.

Operator

Thank you. We’ll next go to Janet Kloppenburg with JJK Research Associates. Please go ahead.

Janet Kloppenburg — JJK Research Associates — Analyst

Good morning. Can you hear me?

Scott Lipesky — Senior Vice President and Chief Financial Officer

Yeah.

Fran Horowitz — Chief Executive Officer

We can hear you.

Janet Kloppenburg — JJK Research Associates — Analyst

Great. Congrats on a nice quarter.

Fran Horowitz — Chief Executive Officer

Thanks.

Janet Kloppenburg — JJK Research Associates — Analyst

Fran, a couple for you, and a couple of Scott. I was wondering what were you seeing in Europe, I think the back-to-school demand trends are not similar to the US, maybe the later. I’m not sure. And on the comfy cozy shift that you talked about, have you planned your inventory levels by content into that demand shift? How should we think about that? And Scott, I got on a little late, so on a $26 million occupancy expense decline, is that when that you — that is permanently eliminated from the P&L or might that come back? And what is the outlook for rent concessions for the rest of the year? Could that be a nice positive to the P&L outlook as we go through the rest of the year, was in negotiating. Thanks so much.

Fran Horowitz — Chief Executive Officer

Okay, Janet. I’ll kick off, just starting with EMEA, yes, you are correct, the back-to-school in Europe starts much later. In fact, that has not even started yet. They are really in a much more summer mind set, so that really happen much later in the third quarter. Additionally, North America have a much more significant back-to-school business, a lot of kids in Europe also wear uniforms, so just not as significant. Regarding comfy and cozy, yes, the inventory management team, the banners, the merchants, sourcing teams have really been focusing on, the customers’ response to our products, that comfy and cozy, it’s part of our DNA. As you know, I mean we have a franchise in A&F adult called Soft AF that has been incredibly strong. So we have shifted, but we also are keeping a balance. We’re seeing a response to fashion. Our A&F women’s dress business is very strong. But they should be wearing those dresses on her Zoom call or she’s getting ready to go out. So we have shifted, but balances is extremely important.

Janet Kloppenburg — JJK Research Associates — Analyst

And the question is…

Scott Lipesky — Senior Vice President and Chief Financial Officer

Okay, Janet, on the — sorry, go ahead.

Janet Kloppenburg — JJK Research Associates — Analyst

As a follow-up, Fran, on Europe, does that mean that maybe their current trends are better. And just — I’m just trying to get an idea of how products is resonating in Europe, but I know you’ve put a big effort behind that.

Fran Horowitz — Chief Executive Officer

We had a — we had a good response to our product in Europe. The countries that have opened up different times. So we’re seeing different things across the country. Our market — our largest market in the UK just opened in mid-June overall, we’ve seen good response.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Yeah, Janet, we talked last year about opening our office in London and putting teams in there that are getting close to the customers, so we’re starting to see the benefits of our product teams over there. Really dialing up the assortments and making sure, we’re distorted in the right places to cater to that European customer across the different countries.

Janet Kloppenburg — JJK Research Associates — Analyst

Yeah. That’s encouraging. And that was what I was trying to understand better, so, thank you. And just Scott, on my question there. Yes.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Yes. For sure. Moving onto the rent question, so the $26 million occupancy save in Q2, yes, that is permanent and will not come back. A couple of pieces in there, there are some variable occupancy save as you can imagine, with store sales being down and or stores being closed and then we have some abatements in there that have been booked on fixed rent contracts as we come to terms with our landlords. Rent concessions for the balance of the year, yeah, we expect to see some additional rent concessions for the balance of the year. We continue to be engaged with the majority, large majority of our landlords to find a mutually agreeable path forward to get through these closure periods. And then that will really take us into year-end, where we have over 200 leases coming due in our expectation just to make further progress on occupancy and store square footage, then.

Janet Kloppenburg — JJK Research Associates — Analyst

Okay, great. Good luck, you guys. Thank you.

Fran Horowitz — Chief Executive Officer

Thank you.

Operator

Thank you. [Operator Instructions] We’ll next go to Kate Fitzsimons with RBC Capital Markets. Please go ahead.

Kate Fitzsimons — RBC Capital Markets — Analyst

Yes, good morning. Thank you for taking my questions and congratulations on an impressive second quarter. I guess my question, and I suspect, you’re going to tell me conservatively. But as we look ahead to holiday just how are you approaching managing the business between payroll, inventory, product flows and events as well, especially around Black Friday. We’ve heard some other retailers talking about promoting holiday starting in October. So just curious about how you’re seeing or how you’re internally planning on the holiday to shake out. And then real quick, Fran, outerwear, obviously was a pleasant surprise last year in the fourth quarter, at least to the street [Phonetic] I am curious, just your views on the outerwear category as we approach the back half. Thank you.

Fran Horowitz — Chief Executive Officer

Hey, Kate, good morning. So yes, we agree that holiday is going to be very different this year. Just as the balance of this year, I mean, since the beginning of this year certainly has been, but we are seeing in our business is the extension of the season, but I know I’ve mentioned a couple of times this morning, that summer last long, and we expect back-to-school to last longer. We don’t necessarily believe that our customer is going to shift back quickly then into a holiday mindset particularly pre-Thanksgiving. So we are going to manage our inventory and manage our cadence of our product accordingly. So once we get past peak. There’s a couple of opportunity weeks in December. We talk in the industry about the trough that we always said at the beginning of December that could be a great opportunity for us to really understand what’s working our assortments and be able to drive that through marketing. So we’re seeing a very different flow, but we’re taking it honestly, s week by week at this point and continuing to stay close to our customers.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Yeah. On the management, expense and inventor, I agree. Conservatively is the right word, is the key word. For us as we look towards the back half, it’s about managing expenses very tightly, managing inventory very tightly. And if you can do those two things, the top line is relatively stable. You can generate some cash flow and the liquidity could be strong. And what that does is it gives you flexibility, gives you flexibility to invest in the short term and marketing and things that can help drive the top line and for longer-term investment. So that’s what we’re trying to do, and manage it tight, to generate that cash and liquidity and have flexibility in the business.

Fran Horowitz — Chief Executive Officer

[Speech Overlap] Sorry, just getting to that one. At this period of time, we are planning all of our businesses. As Scott just quoted you, conservatively, we will approach the back half the same way. We have a great opportunity to chase our business. We test our product ahead of time, so we’re getting some views on that currently.

Kate Fitzsimons — RBC Capital Markets — Analyst

Thank you. Best of luck.

Fran Horowitz — Chief Executive Officer

Thank you.

Operator

Thank you. We’ll next go to Mark Altschwager with Baird. Please go ahead.

Sarah Goldberg — Robert W. Baird — Analyst

Hi, good morning. This is Sarah Goldberg on for Mark. Thanks for taking my question. I wanted to get into SG&A savings this quarter, how much of this is a temporary reduction that will come back if sales recover versus a more permanent change in the cost structure. And then your sales range expectation for our Q3 is in line with what you reported this quarter, should we expect a similar decline in SG&A if sales come back in the expected range? Thanks.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Thanks, Sarah. On these savings for this quarter, yes, we are pleased with what we delivered in Q2. We mentioned on our last call that we went through a zero based budgeting exercise and looked at every spend that was going out of the Company for the rest of the year. So pleased with the results we saw in Q2. We do expect to see continued savings here in the back half. Some of that might be temporary. We might sell, have some reinvestments back in the business as we think about the long-term and not just today. So there could be some SG&A investments that trickle back in.

Marketing was the savings that we saw in Q2, our marketing teams have done an amazing job, saving things that are non-customer facing, content and things back of house. So I’m really pleased with the results there. And hopefully, we’ll see continued savings there, because we really want to protect the marketing that is in front of the customer and our digital marketing which has been amazing. Sales expectations, Q2, so with the similar sales trends in the back half, like we just said, we’re going to manage it conservatively. We’re not going to be plowing expense back into the P&L assuming sales are going to come back. So if we manage the inventory tightly, we manage the expense tightly, that’s going to be good cash flow and liquidity and that’s going to give us flexibility.

Sarah Goldberg — Robert W. Baird — Analyst

Great. Thank you.

Operator

Thank you. And we’ll next go to David Buckley with Bank of America.

David Buckley — Bank of America — Analyst

Hi, good morning, thanks for taking my questions. Scott, was there any reversal in your 1Q inventory write-down that contributed to the second quarter gross margin expansion? And then just building on the, as you may question, any details you can provide on them out of ongoing corporate operating expenses that you expect in the second half year. Thank you.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Okay. David, on the first question, there was no impact in Q2 due to reversal or anything, but that Q1 inventory write-down that state. In the past, in Q1 and then on SG&A so opex, it is definitely a little more expensive to operate our stores. These days and operate our distribution centers, things like the Flexiglass that you see in there and much, much heavier cleaning and additional cleaning, so there are bits and pieces here they add up to a few million dollars here and there, but what we’re trying to do was offset these increased costs with savings elsewhere in the P&L. So we feel good about the work that we’ve done in the company around opex and are confident that we can continue to find some savings to offset the additional operating costs, thank you.

Operator

Thank you. We’ll next go to Marni Shapiro with Retail Tracker. Please go ahead.

Marni Shapiro — Retail Tracker — Analyst

Hey, guys, congratulations on a really stunning quarter, especially given everything, and love the Charli although, and I know, a little deepened situation these days, made us to rethink. So can you just talk about the digital business, very strong growth and I’m curious did you see the customer file grow as now. And is that customer — are you seeing a new customer, is it a large customer, it is — is the store only customers that finding moved online, if you could just put a little color behind that.

Fran Horowitz — Chief Executive Officer

So I’ll start, I mean, yes, we did see our customer file grow, obviously based on the strength of that business. We have seen new customer to file as well. And back on, on Charli and Dixie, just for minute, that drove a tremendous amount of brand awareness due to file, loyalty those stays at those results.

Marni Shapiro — Retail Tracker — Analyst

And I’m just curious if you’re seeing, are you seeing lapsed shoppers come back into the brands and we’re shoppers that restore only coming online digitally so a bit more in center.

Scott Lipesky — Senior Vice President and Chief Financial Officer

Yeah. Depending on how long stores have been open, we have seen some of those store only customers come online. For those places where the stores weren’t close for very, very long time. Some of those stores customers waited to come back for whenever the stores were opened. So we like that, that’s one of the silver linings of what has happened here to get some of those store only customer shopping online. We want to turn them into dual channel customers because those are our best customers. So and that’s a nice silver lining coming out of and hopefully we can keep those as dual channel in the future.

Fran Horowitz — Chief Executive Officer

I mean, it’s a great time to be an omnichannel retailer, Marni, because we’re obviously benefiting from the blend of the digital as well as the store. You mentioned earlier today. Able to get current site up and running and 80% of our stores and we’re seeing a nice these build on that. So that’s part helping the customers’ shop.

Marni Shapiro — Retail Tracker — Analyst

That’s fantastic. In terms sticking one more, you see any advantages with AUC as you were booking holiday and into spring?

Scott Lipesky — Senior Vice President and Chief Financial Officer

We have seen good costing. I would say, as we’ve gone through the beginning of this year, towards the end, really, you’ve seen the input cost, the commodity cost with that have been down, and the supply demand dynamic is probably a little bit in the retailer favor. So we achieved good cost. We are pleased with our costs for the back half, like I said, hopefully, we’re going to see that continue into 2021. I mean we’re planning conservatively to be on inventories. So our receipts are definitely down to last year, but we’re seeing the benefits on those costs.

Marni Shapiro — Retail Tracker — Analyst

Fantastic. Best of luck with rest back-to-school.

Fran Horowitz — Chief Executive Officer

Thank you.

Operator

And ladies and gentlemen, this does conclude our time for question-and-answers. I’d like to turn the conference back over to Fran Horowitz for any additional or closing remarks.

Fran Horowitz — Chief Executive Officer

So I thank everybody for participating in our call today. I look forward to talking with all of you again at the end of the third quarter, about our ongoing progress. And until then, please continue to take care of yourself.

Operator

[Operator Closing Remarks]