you. At this time, I'd like to turn the conference over to Pam Quintiliano.
Please go ahead.
Thank you. Good morning, and welcome to our Q2 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 2nd 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. Good morning, everyone. I hope you and your loved ones are healthy and safe. Before discussing second quarter results, I would like to start by thanking our global teams and partners.
Despite the 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've continued to successfully navigate this unprecedented period of uncertainty. I am so proud and humbled 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 read and react to changing customer demands while fortifying our position for the future. Our total Q2 company revenues were down 17% as compared to last year.
Throughout the quarter, we remained nimble. We utilized our lean and agile inventory management strategy. While authentically speaking to our customer and providing them with relevant product that aligns with their lifestyle needs. Our customers found favorably with our gross profit rate expanding 140 basis points, fueled by lower promotions and clearance and improved AUR. We also tightly managed expenses, leading to operating expense leverage and our best Q2 operating income in 6 years.
With an unwavering focus on maintaining strong liquidity, we generated $187,000,000 of operating cash flow, ending the quarter with $767,000,000 of cash and equivalents empowered us 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've strengthened our foundation as we execute 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 continuing to evolve brand positioning while improving customer engagement. The significant progress we made leading into the pandemic on our transformation initiatives, including 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-nineteen and the physical, mental and social challenges associated with it. At the same time, it's often been defined to cause the social justice and struggling with the uncertainty of a 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 we're planning Q2 in the back half conservatively. At that time, we had roughly 50% of our global store base open with stores operating at 70% productivity and digital continuing to show impressive growth. As this quarter progressed and restrictions ease, we opened more stores. At the end of the quarter, roughly 90% of our global base is open, which is consistent with where 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 declines in traffic, partially offset by improved conversion. As we continue to open and at times we close select stores, the safety and well-being of our customers, associates and communities has remained a top priority. We continue to fully ship inventory by channel, reflecting demand while utilizing ship from store. We've also expanded fulfillment options by adding curbside pickup, which is available across roughly 80% of our U. S.
Store base by the end of the quarter. Scott will provide more detail on our reopened store performance trends. With stores reopening, our digital business has remained strong. For the quarter, digital sales grew 56% to $386,000,000 with robust double digit gains in each month on improved traffic, conversion and AUR. Combined total visits to our websites and highly rated apps rose over 25%, with app visits alone rising approximately 50% in the quarter.
We spoke directly to our customer about COVID-nineteen as well as the social issues they were facing. Our honest ILO's combined with relevant products resulted in strong digital growth across brands in every month of the quarter. We achieved record Q2 digital sales AbbaCon excuse me, we achieved record Q2 digital sales. Abercrombie Adults, Kids, Hollister and Gilly Hicks all hit new highs with record digital sales volumes over 2 thirds of our categories, including many of our must win, must grow classification. As a reminder, we had a meaningful digital business entering this year.
The channel accounted for roughly a third of our revenues at over $1,000,000,000 in fiscal 2019. We have solid global platforms and distribution center infrastructure in place, which has enabled us to keep up strong digital demand. Both brands had high digital engagement and strong growth rates in the quarter, benefiting from lift and awareness. At Hollister, our focus on assortment architecture continued to pay off with our must haves and top 30 items outperforming. Our customers find it well to pattern on brand 4th across genders.
And while loungewear remains popular, including sleeves and sweats, fashion content also resonated. I'm especially proud of our performance in Girls Staying Short, a highly competitive category where we were predominantly full price. On the guide side, must have multi pack tees, graphic, swim and non shorts were strong. Needless to say, I'm extremely encouraged by our Q2 performance in Hollister. It is our biggest brand, representing roughly 50% of our annual revenues in 2019, and 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 channel. Our customer continued to embrace our new active collection, Gilly Go, as well as our company lounge and intimate offering. While still early in its lifecycle, we are excited about the global white space of Gilly as we continue to offer products that focuses on our teen customers for lifestyle needs. With improved assortments 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 customer.
We also focused on topics they care about the most with an emphasis on pride and mental health, 2 causes we champion. Our Proud View Pride campaign, in support of the quality and diversity, is well received. As the quarter is closing, we launched our Back to School Down campaign featuring TikTok stars, Charlie and Dixie's Emilio. We are thrilled to have Charlie and Dixie as part of the Hollister team. They truly align with our customer and the causes they support, including anti bullying and equality.
And for those of you who are not on TikTok, Charli is the most followed person on the platform with over 82,000,000 followers and Mr. Dixie has almost 36,000,000. Their popular cross social media is roughly 27,000,000 and 17,000,000 followers respectfully on Instagram. For back to school, they partnered in our Hollister Denim Lab with fellow influencer and one of our first Hollister brand ambassadors, Noah Cugliano, and one of our customers' favorite celebrities, Bill Mize. Testing fits these styles to arrive unique product recommendation.
In addition, Charlie created the morehappyzenadvancedchallenge. As of Monday, the campaign had 5,000,000,000 views worldwide and 1,200,000 video submissions. Since its launch, we've experienced improved traffic and new to file metrics, and our partnership with Charlie and Dixie does not end with access to school. So stay tuned for additional stories and collaborations throughout the remainder of the year. I also encourage you to tune into Hollister's volume on series, where we have members of the team BIPOC community take over Hollister's Instagram that's honest dialogue about current events that are impacting their lives.
Although there's a lot to be excited about Hollister, Abercrombie has not been standing still. Our AMF Women's business had multiple categories with double digit omnichannel sales growth, including short, knit top, skirts and swim. Men's new product acceptance of Officetron with double digit digital growth in teas, shorts, jeans and our signature fragrance, Spheres. For both genders, our soft AF line, which is one of our key buying driving collections, continue to resonate. In addition, our annual price collection was well received.
At Abercrombie Kids, performance continues to be driven by our summer essentials, including shorts and swim. Abercrombie Adults and Kids 2nd quarter marketing campaigns are typically about summer and all of its fun celebrations. 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 Pride campaign. Our messaging was celebratory.
But with the rise of protests weeks before its launch, the team pivoted to highlight the role of the BIPOC community in the fight for LGBTQIA plus equality. We were authentic, supportive and part of the conversation and had an overwhelmingly positive response. Pride is important for many of our customers across brands. In support of Pride, together with our customers, we have donated over $4,000,000 combined to GLSEN and the Trevor Project, 2 important organizations that we work closely with that work closely with the LGBTQIA plus community. I'd also like to congratulate the Abakami marketing team for being a recipient of Silver Halo Awards of Corporate Social Initiatives and Cause Marketing.
I can't wait to see what our marketing team continues to accomplish, especially with our recently introduced social posts and video conversations on our adult channel, as well as our Kids' Crime series, both of which focus on racial equality and inclusivity. We continue to be extremely pleased with the ongoing evolution of our A and F Adults and Kids product and brand positioning, and I'm 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 over protection sustainability campaign, while both brands continue to be encouraged by response to our threat up partnership, which gives customers an incentive to receive gift cards for recycled clothing. And before I turn the call over to Scott, I'd like to take a minute to discuss the U.
S. Back to school season, which clearly looks very different this year. With COVID-nineteen spike in several of our key and early back to school markets, including California, Florida and Texas, delayed start to school across the country and many students beginning their studies virtually. We've experienced a slower start from years past with store traffic decelerating from July levels. And building our contingency planning, this was a scenario we considered and prepared for.
Over the past several months, we proactively bought inventories conservatively, shifted even more focus to wear now assortments and re cadenced our fall product and marketing flows. Quarter to date, our customers continue to respond favorably to new products. We've experienced improved year over year omni conversion and digital has maintained strong double digit growth. Recently, omni sales trends have improved as we've anniversaried last year's key back school weeks and our customers received more clarity surrounding the timing of back to school and the mix between physical and virtual. Looking ahead, we are cautiously optimistic that the back to school selling season will extend into September and potentially October as school remains throughout the country and the weather becomes more seasonal.
For the quarter, we expect to recruit some, but not all of the lost sales in August, which is historically our largest month. As such, we are planning Q3 sales trends to be consistent with Q2 and that's down 15% to 20% range. With roughly 80% of our California store base still closed, our current trend is slightly behind that. Despite the challenging environment, I continue to believe in significant opportunity for our current brands and our growth vehicles both nationally and internationally. We've made difficult decisions this year to ensure that we are well positioned to come out of this period even stronger on the other side.
As we approach year end, we have a chance to address roughly 25% of our leases set up for renewal. As we continue to realize meaningful increases 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 for prior. Have a solid foundation, including a strong balance sheet and we 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.
Thanks, Brandt. 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 Q2 operating income since 2014 and delivered $187,000,000 of operating cash flow. Now on to Q2 results.
Net sales of $698,000,000 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 U. S, 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, 2nd quarter global store productivity was at roughly 70% of the prior year period. By month, May June saw an acceleration in trend. We subsequently experienced a productivity decline in July led by the U. S. Breaking down trends further by region.
Starting with our largest market, the U. S, 2nd quarter store productivity was at 75% of last year, with 85% of our base open at quarter end. On average, our U. S. Stores were unable to open for business for approximately 1 third of the days in the quarter due to government and landlord imposed restrictions on occupancy and hours of operation.
We realized productivity improvements into June that took a step back down in July with the resurgence of COVID in key early back to school markets, including the reclosing 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 at approximately 60% 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 U. K, did not open until mid June. In APAC, our store productivity was roughly 70% with 96% of stores open at the end of the quarter.
By brands on a global basis, Hollister stores outperformed A and F and Kids, which generally had a higher digital penetration, while in the U. S, 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 U. S. 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 product 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 of school season will last longer than it has in the past as most schools have delayed their start dates, some well into September. Moving on, our gross profit rate of 60.7 percent 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% 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 the 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 are $8,000,000 of asset impairment charges that we believe are principally attributable to COVID-nineteen. These charges adversely impacted results by $0.15 There were no exclusions last year. Operating expense excluding other operating income was $404,000,000 as compared to $538,000,000 last year, which included $45,000,000 of flagship store exit charges, primarily related to our Hollister SoHo location disclosed in Q2.
Operating expense leveraged 610 basis points with 5.30 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 and 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 will flex 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 in our ongoing transformation initiatives. Operating income was $22,000,000 compared to a loss of $39,000,000 last year and included a $1,000,000 benefit from FX. The effective tax rate was 1%, which was lower than last year as a result of changes in level and mix of projected pretax results for the 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 from flagship exit charges of approximately $0.50 Our balance sheet remains strong.
We ended the quarter with cash and cash equivalents of $767,000,000 and total liquidity of approximately 1,100,000,000 We plan on holding higher than average cash balances to preserve flexibility in this uncertain environment. In July, we completed the issuance of $350,000,000 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 towards 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 $100,000,000 for the year, with about half of that attributable to stores and the other half attributable to digital technology investments and maintenance needs.
We still believe that stores matter and that they are the important part of the omnichannel brand experience, that they must be the right size and the right location with the right economics. To date, we have opened 9 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 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 or rightsizing 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 in 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 a 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 in 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 properly pivot and strengthen the company no matter what obstacles may be thrown our way. And with that, I'll turn it over to the operator, ready for questions.
Thank And
We'll
take our first question from Jay Sole with UBS. Please go ahead.
Great. Thank you so much. Frank, I just wanted to ask you two questions. First, were you surprised by the strength of denim in the quarter? A lot of talk about everything shifting toward athleisure.
So were you sort of surprised that you were able to generate the sales you did? And then secondly, how are you thinking about merchandising and you're planning your buys for the early part of next year, given if there's a vaccine, it could be a much more a different environment, people thinking differently, people going back to work and events and things like that. Are you thinking of it differently? Are you still going to plan conservative kind of not knowing what the one is going to
look like? Thanks so much.
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 that we keep a balance in our assortment is very important. Although we did see a shift with the customer moving into more soft and 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. 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 is that our entire cadence with 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 tea out on our selling floors longer than we normally do in past years. We're now seeing the same thing happen with back to school. Starting a little bit later, but recently as we started to flow in more of our back to school merchandise, seeing really strong product acceptance. So we're going to continue to stay close to the customer and cadence our products accordingly, as we learn more throughout the year.
Got it. And then maybe can you just sort of clarify your expectation for the Q3? It sounds like within the down 15% to 20% guidance, you're saying that like August is starting up a little bit weaker, but you expect just for the season to be sort of later arriving, obviously, especially if weather breaks a little bit later and sort of to make up the whatever is happening in August, September October, and that's how you plan to get to 15% to 20%, or am I misunderstanding what you're saying about that?
Yes, you are understanding it correctly. We normally see quite a spike at the end of July and the beginning of August and then a decline through September October. What we're seeing is much more of an extended back to school and I guess what we call more of a plateau and a longer selling season for back to school, just like we saw for our summer product.
Got it.
Okay. Thank you so much.
You're welcome.
Thank you. We'll next go to Paul Lejuez with Citi. Please go ahead.
Hey, thanks guys. Can you then talk about the profitability of the ecom channel as it grows in size 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 just Wood said about 25% of the stores coming up for renewal.
But in the stores that remain, do you have opportunities to work rents down and 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.
All right. Thanks, Paul. I think I'll grab all of these. So let's start with the e com channel and the size and the relative to last year. So our e comm channel is profitable on a 4 wall basis and actually a little bit more profitable this year than last year.
The one thing we love about the e comm channel is 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.
Yes, 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 close to the 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 then 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 and L. A dollar is a dollar is 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 $200,000,000 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. Yes, 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 day and working with our landlords and seeing some of the saves 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 5 years and there's 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 location. So tons of 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 3 opportunities to lead flagships this year that's in our current lease stack and we'll continue to try to find opportunities in the future.
Thanks. Appreciate it, guys. Good luck.
Thank you. We'll next go to Susan Anderson with B. Riley. Please go ahead.
Good morning. Nice job on the quarter. I was wondering if you could maybe give a little bit more color just around back to school in the Q3. 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, won't materialize this year?
Thanks.
Susan, I'll start and I'll take it over to Scott. So we discussed that August is our largest month, but we do believe that what we're seeing from the customers' shopping habits, but the back school is getting extended longer. So we don't anticipate making all that up, but we do expect to see a much longer run into September and looking potentially even into October. Once the weather changes as well and the mindset shifts, and we're already starting to see that shift now that the kids are realizing that 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 was evident in the margin that we're able to drive through that. And we're going to continue to cadence and listen very closely to our customer on a weekly basis. The teams are responding and keeping our inventory lean so that we can make sure that we can chase where need be.
Great. That's helpful. And I guess, so just a follow-up on the gross margin then. Nice job in the quarter and pulling back on the promotions. I guess, how are you thinking about that for Q3 in the back half given, I guess, the prolonged back to school, but then also the holiday period?
Are you expecting it to be promotional?
This is Scott. I'll 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 how we delivered the gross margin expansion in Q2 and what that does to the P and 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.
Great. Well, nice job again and good luck in the back half.
Thank you.
Thank you. We'll next go to Jeanine Stitcher with Jefferies. Please go ahead.
Hi, good morning. Thanks for all the color. Just want 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 light and don't have the inventory to meet demand?
Well, the team is very focused on keeping a very balanced inventory, Jeanine. So at this point in time, they have been so diligent with their inventory and responding to the business that we feel our inventories are very balanced at this point in time. We have a great sourcing team, very agile, that can chase into what we need. So we're meeting with the teams weekly at this point to make sure that we're staying on top of all the demand.
Great. And then just a
follow-up on gross margin. I want to ask about input costs. Are you still seeing potential for unfavorable costing in the back half of the year?
We are. Yes, the environment remains positive for costing with cotton where it is and transportation is a little tricky. That's 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 opportunity good costing in the back half and hopefully into 2020 when we get there.
Great. Thank you very much.
Thank you. We'll next go to Carla Casella with JPMorgan. Please go ahead. 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?
I would say this is Scott. I would say the promotions look similar. They feel similar to me to 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 or out of the ordinary, I would say.
And the inventory reduction you had this quarter, is that a similar rate you expect for the next Q, the 7% reduction?
We're going to be planning inventories down. Year over year, our receipts 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, to 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, couple of 100 basis points up and down, and we're continuing to make progress towards that.
Okay, great. And then just one last one. On the priorities for free cash flow, you mentioned them 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?
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, dollars 1,100,000,000 of liquidity. I just did a financing last quarter to clear up some near term maturities. So we're in a nice position.
We have nice flexibility. As you mentioned, dollars 100,000,000 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, then 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.
Great. Thanks. All the answers.
Thank you. And we'll next go to Janet Kloppenburg with JJK Research Associates. Please go ahead.
Good morning. Can you hear me?
Yes, we can hear you.
Great. Congrats on a nice quarter. Fran, a couple for you and a couple for Scott. I was wondering what you were seeing in Europe. I think the back to school demand trends are not similar to the U.
S, maybe they're lighter, 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 the $26,000,000 occupancy expense decline, is that rent that is permanently eliminated from the P and 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 and L outlook as we go through the rest of the year while you're negotiating?
Thanks so much. Okay, Dan, I'll kick off. So starting with EMEA, yes, you are correct. The back to school in Europe starts much later. In fact, it has not even started yet.
They are really in a much more summer mindset, so that really happens much later in Q3. Additionally, North America has a much more significant back to school business. A lot of kids in Europe also wear uniforms, so it's just not as significant. Regarding company and cozy, yes, the inventory management team, the planners, the merchants, sourcing team have really been focusing on the customers' response to our products. So company and cozy is part of our DNA.
As you know, I mean, we have a franchise in A and 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 and F women's dress business is very strong, whether she's wearing those dresses on her Zoom calls or she's getting ready to go out.
Right. Yes.
So we have shifted, but balance is extremely important.
Okay, Janet, on the
I just want to ask, Jan,
as a follow-up plan on Europe, does that mean that maybe their current trends are better? And just I'm just trying to get an idea of how product is resonating in Europe because I know you've put a big effort behind that.
We've had a good response to our product in Europe. The countries have opened up at different times, so we're seeing different things across the country. Our largest market in the U. K. Just opened in mid June.
But overall, we've seen good response.
Yes. We talked last year about opening our office in London and putting teams in there that are getting closer 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.
Yes, that's encouraging and that was what I was trying to understand better. So thank you.
And just Scott on my questions there. Great.
Yes, for sure. Moving on to the rent question. So the $26,000,000 occupancy save in Q2, yes, that is permanent and will not come back. A couple of pieces in there. There's 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 have come to terms with our landlords. Rent concessions for the balance of the year, yes, we expect to see some additional rent concessions for the balance of the year. We continue to be engaged with a 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 and our expectation is to make further progress on occupancy in store square footage then.
Okay, great. Good luck you guys. Thank you.
Thank you.
Thank you. We'll next go to Kate Fitzsimons with RBC Capital Markets. Please go ahead.
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, inventories, product flows, 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 Q4, at least to The Street. I am curious just your views on the outerwear category as we approach the back half. Thank you.
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. What we are seeing in our business, is an extension of the season. So I know I've mentioned a couple of times this morning that summer lasted longer and we expect back to school to last longer.
We don't necessarily believe that our customer is going to shift that quickly then in to 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 as an industry about the trough that we always hit at the beginning of December. That could be a great opportunity for us to really understand what's working in our assortments and be able to drive that through marketing.
So we're seeing a very different flow, but we're taking it honestly week by week at this point and continuing to stay close to our customer.
Yes. And on the management of expense and inventory, I agree. Conservatively is the right word. It's 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 and 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 could help drive the top line and for longer term investments. So that's what we're trying to do. We're to manage it tight. We're to generate that cash and liquidity and have flexibility in the business.
Great. I think it's on that question, Caitlin. Sorry, yes, I'm just getting to that one. At this period of time, we are planning all of our businesses, as Scott just quoted you conservatively, and 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.
Thank you. Best of luck.
Thank you.
Thank you. And we'll next go to Mark Altschwager with Baird. Please go ahead.
Hi, good morning. This is Sarah Goldberg on for Mark. Thanks for taking our question. I wanted to dig into SG and A savings this quarter. How much of this is a temporary reduction that will come back as sales recover versus a more permanent change to the cost structure?
And then your sales range expectation for FQ3 is in line with what you reported this quarter. Should we expect a similar decline in SG and A if sales come back in your expected range? Thanks.
Thanks, Sarah. On the savings for this quarter, yes, we were 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 have some reinvestments back in the business as we think about the long term and not just today. So there could be some SG and 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 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 and 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.
Great. Thank you.
Thank you. And we'll next go to David Buckley with Bank of America.
Hi, good morning. Thanks for taking my questions. Scott, was there any reversal in your 1Q inventory write down that contributed to the 2nd quarter gross margin expansion? And then just building on the SG and A question, any details you can provide on the amount of ongoing COVID operating expenses that you expect in the second half of the year? Thank you.
Okay, David. On the first question, there was no impact in Q2 due to a reversal or anything with that Q1 inventory write down that stayed in the past in Q1. And then on SG and A, so COVID OpEx, it is definitely a little more expensive to operate our stores these days and operate our distribution centers, things like the plexiglass that you see in there and much heavier cleaning and additional cleaning. So there are bits and pieces here as they add up to a few $1,000,000 here and there, but what we're trying to do is offset these increased costs with savings elsewhere in the P and L. So we feel good about the work that we've done as a company around OpEx and are confident that we can continue to find some savings to offset the additional operating costs.
Thank you.
Thank you. We'll next go to Marni Shapiro with Retail Tracker. Please go ahead.
Hey, guys. Congratulations on a really stunning quarter, especially given everything. I love the Charlie, although I know her little vaping situation these days might as a re thinker. So can you just talk about the digital business, very strong growth. And I'm curious, did you see the customer file grow as well?
And is that customer are you seeing a new customer? Is it a lapsed customer? It is the store only customer that finally moved online? If you could just put a little color behind that.
So I'll start. 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 Charlie and Dixie just for a minute, that drove a tremendous amount of brand awareness, UNICEFIL, loyalty, that we're pleased with those results.
Great. And then I'm just curious if you're seeing are
you seeing lapsed shoppers come back into the brands and where shoppers
that were store only coming online digitally?
The more latter. So 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 closed for a very, very long time. Some of those store customers waited to come back for whenever the stores were open. So we like that. That's one of the silver linings of what has happened here to get some of those store only customers shopping online.
We want to turn them into dual channel customers because those are our best customers. So that's a nice silver lining coming out of COVID and hopefully we can keep those as dual channel in the future.
Definitely. It's a great time to be an omnichannel retailer, Marty, because we're obviously benefiting from the blend of the digital as well as the store. You mentioned earlier today, we're able to get curbside up and running in 80% of our stores and we're seeing a nice week over week build on that. So that's also helping the customer shop.
That's fantastic. And can I just sneak in one more, you see any advantages with AUC as you were booking holiday and into spring?
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 costs, the commodity costs with cotton have been down. And the supply demand dynamic is probably tilted a little bit in the retailer's favor. So we achieved good costs. We are pleased with our costs for the back half.
Like I said, hopefully, we're going to see that continue into 2021. We're planning conservatively on inventory, so our receipts are definitely down to last year, but we're seeing the benefits on those costs.
Fantastic. Best of luck with the rest of Back to School.
Thank you.
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.
Just want to thank everybody for participating in our call today. I look forward talking with all of you again at the end of the Q3 about our ongoing progress. And until then, please continue to take care of yourselves.
Thank you. And again, that does conclude today's call. We do thank you for your participation. You may now disconnect.