Earnings Call Transcript - ANF Q2 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to the Abercrombie & Fitch Second Quarter Fiscal Year 2025 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Mo Gupta. You may begin.

Mohit Gupta, Speaker

Thank you. Good morning, and welcome to our Second Quarter 2025 Earnings Call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; Scott Lipesky, Chief Operating Officer; and Robert Ball, 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 we will make certain forward-looking statements on the call. These subjects are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mention today. These factors and uncertainties are discussed in our reports and 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 reconciliations of GAAP to adjusted non-GAAP financial measures are included in the release and the investor presentation issued earlier this morning. With that, I will turn the call over to Fran.

Fran Horowitz, CEO

Thanks, Mo, and thanks, everyone, for joining this morning. We entered 2025 aiming to build on our track record of delivering consistent total company success. I'm excited to share that our second quarter results continued this trend as we delivered our 11th consecutive quarter of growth while also exceeding our top and bottom line expectations. Our team continues to leverage our strong foundation to balance reading and reacting to the current environment while diligently investing to realize the long-term global potential for our business. Our strong first half and start to the third quarter gives us confidence to increase our full year net sales forecast, building on a record 2024. In short, our team and brands are strong, and we are entering the back half of the year with momentum to deliver sales growth, top-tier profitability and drive shareholder return. Second quarter net sales reached a record $1.2 billion, growing 7% over last year and above our expectations from May. We also exceeded our outlook on both operating margin and earnings per share, even after excluding the benefit of a legal settlement. In addition, we continue to put our balance sheet to work, repurchasing $50 million of stock this quarter for a total of $250 million in repurchases so far this year. Regionally, the Americas achieved its 12th consecutive quarter of growth with net sales up 8% on continued traffic strength across direct channels. In EMEA, continued cross-channel growth in the U.K. was outweighed by softness in Germany and the remainder of European markets, with regional net sales lower by 1% against 16% growth in the second quarter of 2024. APAC continued to perform well, growing 12%, a nice cross-channel demand, while comparable sales grew 1%. Moving to the brands. Let's begin with Hollister. Wow, it is amazing to see this team so dialed into the team customer. Hollister brands delivered record first half sales growing net sales 19% in the second quarter on strong cross-channel traffic. Comparable sales were also up 19% in the quarter, and we continue to see growth in both units and AUR. Both the men's and women's businesses contributed to the growth story in the quarter, with good balance across categories. And dialing into this customer, we saw a great response to our brand activations at Lollapalooza in Chicago. Leading into August, we released our updated Collegiate collection, which included several exciting social and in-store campaigns with more on the way. We continue to find fun, effective ways to engage with the team, fueling Hollister brands impressive growth. For Abercrombie, the quarter was slightly below our expectations and similar to the first quarter overall. Net sales were lower by 5% against the backdrop of strong 26% growth in the second quarter of 2024. For further context on how exceptional last year was, the first half of 2025 remains the second-best in brand history. In the second quarter, the team executed on their goals, leveraging promotions to manage inventory levels and by testing into new product concepts. As we expected, AUR was lower year-over-year, driving the majority of top line performance for the quarter. Importantly, with the team's hard work, we exited Q2 with inventory in good shape, and we're in a position to continue reading and reacting. Entering the fall season, we're excited about some of the trends and fits from Boho to Western and we'll be chasing winners to give our customers more of what they're looking for, building into holiday. Abercrombie & Fitch continues to gather momentum as a powerful global brand, and we remain on offense. Traffic was nicely positive across both stores and digital direct channels in Q2, and we continue to engage with customers globally through social and in-store campaigns. We're also investing with conviction, supported by our digitally led customer base. We opened 13 new stores in the second quarter, including strong centers in Chicago and Toronto as well as a great location in Hoboken. We have an additional 14 store openings planned this quarter just in time for peak season. Strong brand health also allows for meaningful collaboration to capitalize on Abercrombie's significant addressable market. Earlier this week, we were excited to announce Abercrombie & Fitch as an Official NFL Fashion Partner, a first for a league sponsor. We look forward to collaborating with the NFL to bring A&F fashion to fans and players alike. Beyond the powerful NFL partnership, we've seen a great response to our August denim campaign, which focused on consistent fit across a variety of styles from baggy to bootcut. As part of the campaign, we hosted in-store demo events in key markets, successfully highlighting our strength in this category while driving great engagement across channels. For YPB, we were excited to announce the collaboration with TJ and Dani Watt, the Pittsburgh Steelers linebacker and former professional soccer player as we continue to build our presence in the active category. Finally, through the licensing partnership we announced in 2024, Abercrombie Kids has now launched globally with department stores like Nordstrom and Macy's amongst others. Overall, Abercrombie brands made good progress in the quarter. The brand remains strong globally, and we continue to target getting back to net sales growth by the end of the year. Looking to the second half of the year, we are increasing our full year 2025 net sales growth expectations based on our year-to-date results, supported by strong brand positioning, clean inventory, cross-channel traffic growth and our balance sheet. On the bottom line, we've adjusted our operating margin and earnings per share outlook to reflect the second quarter performance and revised estimated impact from tariffs, net of planned mitigation. On tariffs, we intend to bring our proven playbook built on years of experience to mitigate as much of the increased cost as possible over time as rates become more certain. As our teams have demonstrated before, we have a variety of options in our playbook, including shifting global production, enhancing supplier contracts and relationships, managing operating expenses and determining ways to increase AUR through lower promotions and lower clearance selling. As we said last quarter, we don't expect broad-based ticket increases in the back half and will concentrate on the fit, style and emotional connection our customers come to us for every day. Importantly, we are operating in this new tariff landscape from a position of strength in terms of our brand health, our balance sheet and cash flow profile. For the year, our objectives remain clear. We expect to deliver record net sales, top-tier operating margins and significant free cash flow. As our recent results show, we intend to deploy this cash flow to strengthen the business through long-term investments while enhancing shareholder returns via share repurchase. With each quarter, we're adding to a growing record of consistency that will keep us moving towards a significant global market opportunity for our brands. And now I'll hand it over to Robert to expand more on our results and key outlook drivers.

Robert J. Ball, CFO

Thanks, Fran, and good morning, everyone. Recapping Q2, we delivered record net sales of $1.21 billion, up 7% to last year on a reported basis, above the range provided in May. We saw a 100-basis point benefit from foreign currency. Comparable sales for the quarter were up 3%. By region, net sales increased 8% in the Americas, 12% in APAC, partially offset by a 1% decline in EMEA. On a comparable sales basis, Americas was up 5%, EMEA was down 5%, and APAC was up 1%. Outside of the Americas, the spread between net sales and comparable sales benefited from new store openings and foreign currency, with EMEA additionally impacted by third-party channel headwinds. On the brands, Abercrombie brands net sales declined 5% with comparable sales down 11%. Consistent with our second quarter outlook, the sales decline was primarily due to lower AUR as we cleared through carryover inventory. Hollister brands net sales and comparable sales grew 19%, with both AUR increases and unit growth on lower promotions. The comp to net sales spread for Abercrombie brands in the quarter was driven by net store openings and foreign currency, partially offset by third-party channel headwinds. I'll cover the rest of the results on an adjusted non-GAAP basis, which excludes a $39 million net benefit related to the favorable resolution of a payment card interchange fee litigation in which we were a plaintiff. On the second quarter income statement, the net benefit is comprised of a $43 million settlement benefit in selling expense, partially offset by $4 million in settlement-related expense within general and administrative expense. Operating margin of 13.9% of sales was above the outlook range we provided in May, delivering operating income of $168 million compared to $176 million last year. Adjusted EBITDA margin for the quarter was 17% of sales on adjusted EBITDA of $206 million compared to $215 million last year. As expected, we did see around $5 million of adverse impact in Q2 from tariffs, mainly recognized in cost of sales. Lower gross margin was partially offset by around 60 basis points of operating expense leverage where general and administrative expenses levered 150 basis points on lower payroll and incentive compensation. Selling expense as a percentage of sales increased by 90 basis points, primarily driven by incremental store occupancy from new stores. Marketing was consistent to the prior year at around 5% of sales. We ended the second quarter with inventory in a clean current position with inventory at cost up 10% and units up 7%. In anticipation of tariffs, we did selectively clear third quarter receipts early within our bonded warehouses, driving around 1 point of the cost increase. As we alluded to last quarter, we saw a normalization of freight costs and unit mix that drove sequential improvement in year-over-year inventory comparisons. The tax rate for the quarter was above our outlook at 33%, driven by a valuation allowance of a deferred tax asset. Adjusted net income per diluted share was above our outlook at $2.32 compared to $2.50 last year. Moving to the balance sheet. We exited the quarter with cash and cash equivalents of $573 million and liquidity of approximately $1.02 billion. We also ended the quarter with marketable securities of $31 million. For the quarter, we repurchased $50 million worth of shares, consistent with our commentary from May, ending the quarter with $1.05 billion remaining on our current share repurchase authorization. Shifting to the outlook. As Fran mentioned, we entered the second half with good momentum from second quarter, and we are raising full year sales expectations. On the cost side, our 2025 outlook issued today reflects the tariffs announced through August 25. Our approach and underlying principles for tariff mitigation remain unchanged, supported by a deep playbook and experience. We continue to expect China sourcing share in the U.S. will be in the low single digits for the year, and we have minimal exposure to the de minimis exemption that is no longer in place. So it's not a factor of impact. Globally, we remain nicely diversified across 16 countries, and the team is continuing to evaluate supply chain footprint changes, vendor negotiations and operating expense efficiencies that will largely take shape in fiscal 2026. As discussed in May, we do not anticipate broad-based ticket price increases this year and have not assumed meaningful AUR mitigation in our outlook. Net of planned actions, the assumed tariffs carry a cost impact of around $90 million for 2025, impacting our full year operating margin outlook by 170 basis points at the midpoint of our sales outlook. For the full year, we now expect net sales growth in the range of 5% to 7% from $4.95 billion in 2024 with full year growth expected across regions. We've increased the full year outlook to reflect second quarter outperformance and for expected third quarter sales, and we're in a position to chase for the fourth quarter. We currently anticipate around 50 basis points of favorable foreign currency in the outlook. We now expect full year GAAP operating margin in the range of 13% to 13.5%. The increase from our prior outlook range is primarily due to the inclusion of the $39 million net benefit from the litigation settlement in the second quarter results, offset by the revised second half impact from tariffs, net of mitigation efforts. We are forecasting a tax rate around 30%. For earnings per share, we expect diluted weighted average shares of around 49 million, which incorporates the anticipated impact of 2025 share repurchases. Combined with the tax rate, we expect net income per diluted share in the range of $10 to $10.50. For capital allocation, we now expect capital expenditures of approximately $225 million, increased primarily due to the timing of projects. On stores, we expect to deliver around 100 new experiences, including 60 new stores and 40 right sizes or remodels. We also expect to be net store openers with our 60 new stores outpacing around 20 anticipated closures. At the current sales and operating margin outlook, we continue to target around $400 million in share repurchases for the year, subject to business performance, share price and market conditions. For the third quarter of 2025, we expect net sales to be up 5% to 7% to the Q3 2024 level of $1.2 billion. We expect operating margin to be in the range of 11% to 12%. We continue to expect slightly lower costs from freight as well as around $25 million of tariff impact, net of mitigation efforts. We are also increasing marketing investments year-over-year by over 100 basis points to support key partnerships and fall campaigns. We expect the Q3 tax rate around 31%. We expect net income per diluted share in the range of $2.05 to $2.25, with diluted weighted average shares expected to be around 48 million, including the anticipated impact of at least $50 million in share repurchases for the quarter. To wrap up, we're proud of our first half results, and we're excited to keep the momentum going through the rest of the year. We're in a great position with a strong balance sheet, and we'll continue investing across regions and brands to tap into global growth opportunities. At the same time, we're staying focused on what we can control, using our proven playbooks to navigate the environment and drive long-term value. And with that, operator, we're ready for questions.

Operator, Operator

And our first question will be from Dana Telsey of Telsey Advisory Group.

Dana Telsey, Analyst

As you think about the Abercrombie brand, Fran, and the markers going forward given last year's success with the Wedding Shop and other things, what are you seeing now? What are the markers that are giving you confidence for acceleration as we go through the year and into next year? And then Rob and Scott, on the credit card settlement inclusion, exclusion. Can you clarify exactly how you're thinking about it as we go through the balance of the year and why one versus the other, given others we've seen?

Fran Horowitz, CEO

Dana, we are very proud of the strong results for the total company that we put up in the first half. As you look back, to your point, on the stellar season that Abercrombie had last year, we did take a little bit of a step back. But we are very confident in where we're headed. The brand is in great shape. Our traffic is strong. We are signing exciting partners. I mean who would have dreamed a few years ago to partner with an iconic global brand like the NFL. We're investing. We opened up 17 new stores this first half. We've got 20 more in the second half. The team has worked through very diligently the carryover inventory that we've talked about for the last two quarters that we're starting clean. We've got some good reads on Boho and Western that the team is chasing. We had a really strong denim event to kick off the third quarter. So we are confident we're on a path to improvement, and we expect to see us return to growth by the end of the year.

Robert J. Ball, CFO

Yes. And Dana, on the credit card exclusion for the year, so as we guide, we guide from a GAAP standpoint. So we did include that $39 million net benefit here in that 13% to 13.5% guide. When you think about where the guide moved from last quarter to this quarter, we were at 12.5% to 13.5% last quarter. Two big moving pieces here. We obviously had the interchange benefit of $39 million, around $40 million, and that's offset by the incremental tariffs as the rates have become a little bit more clear here in the back half. That was about $40 million. It's net about $40 million. We talked $50 million last quarter for the year. We're talking $90 million now. So those two pieces offset, and you've got a little bit of benefit from, obviously, the Q2 outperformance rolling through. So those are the big pieces. Our guidance is just on a GAAP basis, and you've got the pieces and parts to back it as needed.

Dana Telsey, Analyst

Great. Just one quick follow-up on the entry into department stores with Abercrombie Kids. How is it going? Do any of the other brands ever go in department stores? And what are you seeing?

Fran Horowitz, CEO

Sure. Last year, we discussed our efforts to diversify our operating model. One of the first steps we took was signing a global licensing deal for kids, which has been an exciting development. I recently visited our shop at Macy's with Tony, and it was great to see the positive feedback from our new partner and the department stores. While we've announced this initiative today, we are looking forward to expanding our operating model and introducing new offerings in the future.

Scott Lipesky, COO

Dana, it's Scott. I'll just jump in here, too. When you think about the kids brands, we don't have a lot of stores out there. So this is a great opportunity to get more eyes on that brand and have people find us in different places. And then hopefully come to our brands either through digital or the handful of stores that we have out there. For Hollister and Abercrombie, we have great scale, specifically here in the U.S. So we'll see what happens in the future. But this right now is a great opportunity for the kids brand.

Operator, Operator

And our next question will be coming from Corey Tarlowe of Jefferies.

Corey Tarlowe, Analyst

Fran, I wanted to ask about the momentum in Hollister up 19%. Hollister is probably one of the busiest stores in the mall, and it sounds like you've made some inroads early into back-to-school here. I'm curious if there's anything in particular that stood out to you in the second quarter with regards to some of the momentum that you're seeing? Anything so far in the third quarter that you've seen some nice momentum in? And then what maybe in terms of developments ahead for the brand that might help to continue the momentum into the back half?

Fran Horowitz, CEO

Corey, yes, simply, I mean, an outstanding performance for Hollister. I am incredibly proud of the team and how dialed in they are, honestly, to the team consumer. I must have to ask that question reverse, what's not working? Everything is working. It's actually kind of an exciting time. That's true across categories. That's true for both genders. I mean the team is just so dialed into what is happening. We launched, I'll give you a good example. We did a little bit of a heritage launch, our Y2K, a couple of weeks ago. It just absolutely flew out the stores. The customers were asking for it. We stayed very close to our customer. They were telling us, could you do some reissue. We did it. They loved it. We did a homecoming shop recently that also got tremendous sell-through. So stay dialed into this customer staying close to them. The Collegiate collection is off to a good start. So again, we've got momentum heading into the back half, and we're excited about what's happening at Hollister.

Corey Tarlowe, Analyst

Great. And then just a follow-up for Rob and Scott. I think you guys had mentioned that your inventory is now in good shape. Is there any update on the state of the carryover inventory that you have? And then maybe what the shape of that inventory is going to look like throughout the remainder of the year? And then what of that is inflation and tariff-related versus units? And how are you thinking about units in the back half as well?

Robert J. Ball, CFO

Yes. Corey, I'll grab this one. So yes, to your point, made a ton of progress here on inventory in the quarter. Ended up in a very clean and current position. Supply chain is stable. Both brands are now positioned to chase into the back half, which is awesome. We did end the quarter inventory up 10% at cost. Within that, units were up 7%. And so we're happy about where that sits kind of sitting here against our third quarter sales guide here. Tariffs did have a small impact on us ending inventory at cost for Q2, call it about 1 point. And that will have an impact on ending inventory values as we move through the back half. Not quantifying that sitting here today. But as you know, we like where our units sit, and we'll continue to manage units tightly to support those growth plans for the back half of the year.

Operator, Operator

And our next question will be coming from Matthew Boss of JPMorgan.

Matthew Boss, Analyst

So Fran, could you speak to the cadence of traffic that you saw during the second quarter, what you've seen for early back-to-school at both brands? And at the Abercrombie brand, I guess what specifically missed your plan in the second quarter? How do you see the progression of comparable sales in the third versus fourth quarter relative to the second quarter down 11%?

Robert J. Ball, CFO

Sure, let me address the traffic aspect, Matt. Traffic has been excellent. We have two strong, healthy brands performing well. We're experiencing growth in traffic globally, across both brands and channels. This has been a consistent and positive trend for us. While we won't discuss the month-by-month details for Q2, it's clear that we're witnessing traffic growth. Our customer base is expanding, and this momentum has carried us into the early back-to-school season. I'm very pleased with the results on the marketing side and the traffic this is generating for our brands.

Fran Horowitz, CEO

Thanks. So to answer the second part of the question, Matt, so the miss in Q2 for Abercrombie was really the AUR that we talked about. The carryover inventory drove the AUR down a bit, and that was really the significant miss. So we are excited about what we're seeing. Our model helps us chase the product. We've gotten some nice reads, particularly on Boho and Western, as I mentioned earlier, a nice kick off to the third quarter with denim, which is an important category for us. So the brand is in a great place. We've opened up stores. We're continuing to open up stores. We're continuing to invest. So a lot of exciting things coming up for the back half.

Matthew Boss, Analyst

Great. And then maybe, Robert, just as a follow-up. How best to think about gross margins in the third quarter relative to your operating margin forecast for the over 300 basis points of decline?

Robert J. Ball, CFO

Certainly. In Q3, we anticipate some margin pressure compared to last year, primarily due to an expected $25 million tariff impact, which translates to roughly a couple of hundred basis points. Freight rates remain steady, and we are managing our mode mix closely, which should provide a slight benefit in terms of freight. However, this will not be sufficient to offset the tariff challenges. Regarding our average unit retail, we're maintaining our forward-looking stance and plan to keep our AURs relatively stable. We'll adjust promotion days based on consumer response and see how that unfolds in the latter half of the year. When considering our operating margin forecast, last year's Q3 was around 14.8%. With the anticipated tariff impacts and our ongoing marketing investments, which include some promising partnerships and fall campaigns, we're focused on driving traffic and attracting customers. This will lead to a drop of over 100 basis points, guiding us towards an estimated operating margin of 11% to 12% for the quarter.

Operator, Operator

Next question will be coming from Paul Lejuez of Citi.

Paul Lejuez, Analyst

Can you talk a little bit more about the tariff impact? I know you said $90 million net. Can you talk about what the growth is? And just how you are able to offset the big pieces in your mitigation efforts? And then second, maybe a little bit more about the Europe business. Anything further you could share by country you saw during the second quarter and any changes throughout the quarter? Maybe how you started versus where you finished, the exit rate? And what's the outlook for the second half in Europe?

Robert J. Ball, CFO

I will address the tariff issue. It's continually changing, and while we are gaining some clarity on rates, the situation remains fluid. Many agreements are still being finalized. We are not reacting impulsively to these rates as they evolve. Instead, we are maintaining a proactive approach. Our teams are skilled, and we have effective strategies for managing disruptions, similar to what we've done in the past. However, changes in this area are complex and time-consuming. Therefore, we need to ensure our actions are well-informed, strategic, and executed correctly. Currently, our tactics remain consistent with what we discussed in May. We are well diversified, sourcing from 16 countries, and continually seeking to optimize our sourcing strategy. We have strong partnerships with our vendors and engage in ongoing discussions regarding costs. Additionally, we are looking to improve efficiency within our operating model. Pricing is a tool we can use, but we do not expect widespread ticket price increases for the year. Our focus is on delivering value to customers beyond just price, a strategy that has proven effective during previous disruptions. We will not specify a dollar impact of our mitigation efforts, as the effects of most initiatives will begin to materialize in 2026 due to the time required for implementation. Rest assured, we are taking a cautious approach and are confident in our ability to adapt to this environment while protecting both the customer experience and our profit margins.

Fran Horowitz, CEO

We have made significant investments in the U.K. and are seeing success in that market through new store openings and marketing initiatives, with a strong focus on our product. This successful approach is being applied across Europe, with Germany being the next target. Although we faced a minor setback in Germany this quarter, we remain confident in our overall global and EMEA opportunities. We believe in the potential of the region and are excited about our progress in the U.K., and I'm optimistic that we can replicate that success elsewhere.

Operator, Operator

And our next question will be coming from Marni Shapiro of the Retail Tracker.

Marni Shapiro, Analyst

Congratulations, and thank you for making back-to-school enjoyable, as the stores have been a pleasure to explore. Can you provide a quick update on the marketing? I believe you mentioned a 100 basis points increase in marketing for the third quarter. Is this mainly related to the NFL launch with the start of football season and the NCAA? What should we anticipate for the holiday season? Will you continue that approach as we move into the playoff season?

Robert J. Ball, CFO

Yes. So Marni, so yes, we are sitting here today. We're thrilled with what our marketing team has been able to do and the investments that we've been able to make, obviously, driving healthy traffic and growing those customer files, which is what we're trying to do here to grow the top line. We are funding full funnel marketing strategies across all three regions to build these brands for the long term. That's been our approach. That will be our approach going forward. As we think about the back half, obviously, we've got some great opportunities in the back half, to your point. We'll continue to engage with those consumers, but we do need to support these new partnerships like the NFL and lock into some other great fall campaigns that we've got on the docket. So keep your eyes out for those things. We are anticipating some increases there, obviously. So you will see, to your point, and our call out here a little over 100 basis points of deleverage here year-over-year in Q3, and we'll likely be a little bit north of 5% here for the back half of the year as well to continue to support holiday.

Marni Shapiro, Analyst

And then is it equally balanced between like social media content and that, as well as you guys have been very effective on events? Or is it still more heavily leaning into social media content versus events?

Robert J. Ball, CFO

It's a pretty balanced approach for us, right? And it really comes down to the strategies that the marketing teams are putting in place. So I don't want to get into too many details. Obviously, I don't want to give anything away here. But happy with that balance that we're seeing. The Lollapalooza event is a great example of some of these events that we're leaning into for our brands. And you'll see us kind of sprinkle those in as we go along, and we'll continue to push on the social selling to your point.

Fran Horowitz, CEO

Thanks, Marni.

Operator, Operator

And our next question will be coming from Alex Straton of Morgan Stanley.

Alexandra Straton, Analyst

Congrats on a nice quarter. Maybe for Fran, can you talk about why store growth is the right path for the A&F banner? And maybe bigger picture, how many stores do you envision moving to by the end of the year and over time? Maybe any color on Hollister, too, from that store growth perspective would be helpful as well.

Robert J. Ball, CFO

Yes. So let me jump in here real quick. So Alex, stores, we've said this a lot in the past year. Stores are an absolutely essential part of our brand experience. The new stores that we're opening up as well as the remodel programs that we've been putting out there, they're both performing really well. We're seeing higher productivity. We're seeing nice paybacks in those spaces. And when we marry that stores and the digital component, which continues obviously to be a critical growth channel, it's a nice experience for that consumer. We don't see it as an either/or, yes, A&F is a little bit more distorted to digital today, but really what it is, it's about omnichannel. So the stores help us to acquire consumers, and create that physical brand experience for us. And while the digital allows us to scale, reach more customers, provide personalization and engage more frequently with our consumers. So we need both to make this thing work. And we see opportunities in the A&F brand to continue to build out that fleet.

Alexandra Straton, Analyst

Perfect. And then just on the number of stores that you guys envision by the end of the year and then maybe over time for both banners.

Robert J. Ball, CFO

Yes. So we've talked about 60 stores opening in total this year, about 20 closures, so call it a net 40. Fran mentioned it, but we've opened 17 A&F stores so far this year. We've got about 20 on the docket. So you can do the math there. It's around 37 of the 60 are tilted to the A&F side. The balance will be in the Hollister side.

Operator, Operator

And our next question will be coming from Mauricio Serna Vega of UBS.

Mauricio Serna Vega, Analyst

I wanted to ask about Abercrombie's results. You talked about some third-party channel headwinds. Could you just elaborate on what that meant when you meant with that? And then on the quarter-to-date, like anything that you can tell us about the Abercrombie brand's performance that maybe gives you confidence that you would return to sales growth by the end of the year? And then just on the gross margin for Q2, it was down 230 basis points. It seems like 40 basis points was related to tariffs. The rest of it, the 190 basis points, could you elaborate how much of that is like the carryover situation versus freight?

Fran Horowitz, CEO

Mauricio, let's break that down. Starting with the middle question about our confidence in Abercrombie. To reiterate, the first half of this year was still the second-best spring in the brand's history. We experienced a slight step back, but there's still incredible business out there. The brand is in great shape, and as we mentioned, traffic remains strong. We're partnering with some very exciting collaborators and have great fall campaigns coming up. We're continuing to invest in the brand. Earlier, we stated that we are off to a strong start for the total company in the third quarter, and we are very satisfied with Abercrombie's start to the third quarter. Our recent denim event was successful, and it was exciting to see customer responses to the various fits currently trending in denim. Boho and Western styles are also gaining popularity. Therefore, we are confident there's a path to improvement, and we expect to see growth by the end of the year.

Robert J. Ball, CFO

Yes, I'll address a couple of these points. Regarding the third-party challenges for A&F, there isn't much to say. It contributed to the gap between comp sales and net sales, mainly due to the timing of orders with our partners. We anticipate this to normalize in the second half of the year. As for Q2, there were no significant surprises compared to our discussions in May. We expected margin compression due to selling through higher levels of carryover from the previous year, which did occur and affected AUR, resulting in a decline for the quarter. In that context, Hollister performed well while A&F experienced a downturn. Additionally, the cost of sales increased as we sold through higher-cost inventory from our balance sheet at the beginning of the quarter. We also faced about $5 million in tariff impact for this quarter, which are the major factors influencing gross margin. We discussed the outlook for gross margin earlier in the call.

Operator, Operator

And our next question is coming from Adrienne Yih of Barclays.

Adrienne Yih, Analyst

Great. Congratulations on the progress for back-to-school. My question is regarding tariff timing. I wonder how the tariff developments from August 7 and the new information from India will affect us. I expect they won’t significantly impact the third quarter and likely the fourth quarter as well. How should we consider potential price increases or any further mitigation strategies you might implement in the spring to counteract the ongoing effects of these decisions?

Robert J. Ball, CFO

Yes, you're generally right. Our outlook and guidance were based on information we had a couple of days ago on August 25. While there's some new information regarding India, we want to see it confirmed before reacting. Currently, we have $90 million in our outlook, with $5 million in Q2, $25 million in Q3, and $60 million in Q4. We are not providing any projections for 2026 at this time. Our priority is to finish 2025 strong. In terms of mitigation tactics, we are exploring four levers: country-of-origin footprint, vendor negotiations, operational efficiencies, and pricing. From a pricing perspective, our customers don’t come to us based on price, and we won’t chase traffic through lower prices; instead, we aim to maintain our value proposition. Our team has extensive experience managing uncertainties like tariffs, the pandemic, inflation, and various supply chain challenges. We have a skilled team and a proven strategy to navigate these issues while growing our business and enhancing our financial strength. We are focused on making informed, strategic decisions for the long-term health of the business. More updates on 2026 will come as we progress through the year.

Adrienne Yih, Analyst

Great. And then, Fran, for you, let's move to the demand side on the denim category specifically. I have not seen sort of breadth of pricing from entry-level $40 to well north triple-digit numbers with so much variety and so much quality and content. Clearly, I'm seeing it in the Abercrombie assortment. I'm just wondering, could you give us some perspective on the assortment this year, the spread of initial price points and variety. And are we in kind of a denim cycle that is a little bit more premium than I'd say, like classics of last year?

Fran Horowitz, CEO

Thanks, Adrienne. So yes, obviously, we're very excited about our Abercrombie denim business, as you have mentioned. So when I think about the architecture of our business, what's kind of exciting that's happening in denim today is it's really not just one fit. A lot of times, we talk about like what the key fit is that the consumer needs to buy. And we're in an interesting cycle because now it's really about their wearing occasion. So if they want this new boot-cut that's really starting to rise in importance, they're also still wearing a low-rise baggy or wide-leg jean, all depending upon where they're going and what they're doing. The pricing of all of that is driven by the customer demand. So we have been seeing tremendous demand when we get the product, the right product, voice and experience aligned and the consumer continues to respond. So it's exciting to see what's happening. Our Hollister denim business is also very strong. That one harkens back a little bit to our heritage. It was exciting to reissue like our rainbow pockets in the back that the customer is really responding to. So there's a lot of exciting things happening. And when there is a denim cycle, it also drives different tops to go with it. This whole Boho and Western thing that's starting to happen for us. It's exciting and more to come on that for the fall.

Operator, Operator

And our last question will be coming from Janet Kloppenburg of JJK Research.

Janet Kloppenburg, Analyst

Congrats on a good quarter. Fran, when I look at the achievements of Hollister and A&F, Fran, last fall, Hollister's comps get a lot tougher and A&F somewhat easier. So I'm just wondering, should we think that your comp performance in A&F should start to gain some momentum? And I know Hollister is going to continue to do well, but should we expect a cooldown there? And then I have another question.

Fran Horowitz, CEO

Yes, I'll kick off. So as I started my script this morning, Janet, I own the total and driving the guide right is really what matters. And so if you look at the outlook of what we're putting out there, our expectation takes the momentum that we've had from the first half into the back half. We had a nice record year 2024, and our expectation is to have another one right on top of that. So I'm excited about what we're seeing. We are seeing continued incredible excitement about the Hollister brand and some nice improvement in the Abercrombie brand. So with that, I don't know if you want to add anything else, Robert?

Robert J. Ball, CFO

Yes, we believe our current outlook is reasonable and appropriate. We're excited to project 5% to 7% growth on top of last year's over 14% in Q3. While we're not giving specific brand-level guidance, we are pleased with the record first half we just achieved. As we enter Q3, we anticipate Hollister will continue to outperform Abercrombie & Fitch. We're eager to keep driving Hollister's growth and are encouraged by the positive developments at Abercrombie. We're satisfied with our guidance and will work diligently, as we have in the past, to achieve record sales in the second half of the year.

Janet Kloppenburg, Analyst

Great. And on AUR that was down for A&F and up for Hollister. Do we think that there'll be improvement for A&F as some of the markdown or, I guess, you call it excess inventory levels have moderated?

Robert J. Ball, CFO

Yes, while we aren’t providing specific brand-level guidance, our aim each quarter is to maintain the gains we’ve achieved with these brands. The average unit retail prices have increased significantly over the years for both brands, and we want to sustain that. Our focus is on delivering a high-quality product and effectively managing our inventory. Additionally, minimizing promotional events is beneficial for our operating model and contributes positively to our results. We have strong teams dedicated to this effort, and we are working diligently on it every day.

Operator, Operator

And I would now like to hand the call back to Fran for closing remarks.

Fran Horowitz, CEO

Thank you. And thank you, everyone, for joining us this morning, and we look forward to updating you after the third quarter.

Operator, Operator

And this concludes today's conference call. Thank you for participating. You may now disconnect.