At this time, I'd like to turn the conference over to Brian Logan. Mr. Logan, please go ahead.
Thank you. Good morning. Welcome to our 2017 fourth quarter earnings call. Earlier this morning, we released our fourth quarter and full-year sales and earnings, income statement, balance sheet, store opening and closing summary, and an updated financial history. Please feel free to reference these materials, which are available on our website. Also available on our website is an investor presentation, which we will be referring to in our comments during this call. Today's earnings call is being recorded, and the replay may be accessed at abercrombie.com under the investors section. Joining me today are Fran Horowitz, Chief Executive Officer, Joanne Crevoiserat, Chief Operating Officer, and Scott Lipesky, Chief Financial Officer. Before we begin, I remind you that any forward-looking statements we may make today are subject to our safe harbor statement found in our SEC filings.
In addition, we will be referring to certain adjusted non-GAAP financial measures during the call. Additional details and a reconciliation of GAAP to non-GAAP financial measures are included in the release issued earlier this morning. With that, I turn the call over to Fran.
Thanks, Brian. Good morning, everyone. Thank you for joining us today. I am delighted to report another quarter of meaningful progress across all our brands. The continued execution of our strategic plan throughout the year culminated in positive comparable sales in the fourth quarter across brands, channels, and geographies, and in us exceeding our expectations for the business. Putting our customers at the center of everything we do remains our North Star. That is reflected in our people, our processes, and our product, and we have seen that continuing to translate into positive overall traffic and conversion trends. Coupled with a well-embedded and disciplined approach to expense management, we delivered on both the top and bottom line while maintaining strategic investments in marketing, DTC, omnichannel, and loyalty. Looking back over 2017, it has been a year of significant progress, several years in the making, with many important milestones achieved.
Some of the year's highlights included Hollister passed the $2 billion mark in sales. Abercrombie returned to positive comparable sales in the fourth quarter. We saw record digital sales across all brands. We launched A&F on Tmall to a strong response. We rolled out the first new A&F prototype stores in 15 years. We launched the A&F Club loyalty program. We rolled out loyalty programs in Europe across brands with more than 14 million worldwide members at year's end. We received feedback and insights from more than one million customers through focus groups, voice of the customer engagement, and surveys. Our brand health and our customer satisfaction scores improved across brands. Overall, a busy and productive year. We achieved what we set out to do at the start of the year and more.
2018 will be a year of building on these foundations and investing in the drivers of future long-term growth. Turning to the quarter, we drove another strong performance at Hollister, with sales growth across all channels and geographies. We have previously said that Hollister started to revitalization journey earlier. It continues to build momentum and take market share. At Abercrombie, we drove further improvement, building on the early signs of stabilization of the core U.S. business and conversion improvements we noted last quarter and achieving a return to positive comp sales. As I've said previously, we see DTC as our largest storefront. We saw another strong DTC quarter. With an 18% increase in comp sales, DTC grew to 34% of total sales, compared to 31% of total sales last year. Mobile engagement continues to grow, with more than 70% of our DTC traffic coming from mobile during the quarter.
The investments we've made in this area are paying off with a 14% improvement in conversion. We continue to build on our strength in omnichannel with ongoing international rollout of our capabilities. In concert with these investments, we have made further strides with our physical stores, driving improved productivity from our new prototype and remodeled stores. In fact, several of the new stores we opened across brands during 2017 are among the best performing in our fleet. The focus of our efforts is on continual testing, learning, and adapting to make sure we have the most effective integration of the physical and digital world. That's the foundation of making sure our customers' engagement with our brand is the best it can be, whenever, wherever, and however they choose to shop with us. Turning to some specific details on the brands. Hollister, our largest brand, continued to show strong growth.
Our 11% sales comp was supported by strength across genders, categories, and channels during the quarter and the best Black Friday in the brand's history. Overall, both guys and girls businesses accelerated, which resulted in record sales across genders in outerwear and jeans for the year. Fleece and graphic tees were also extremely strong across genders for the quarter. Our guys business continued to take market share with its best annual sales in the brand's history. On the girls side, we continue to see an enthusiastic response to Gilly Hicks. Our ongoing testing is helping us assess the scale of its full potential.
We can attribute much of our success to closeness to the customer, both from our time in stores as well as the insights from our Club Cali loyalty program, which totaled more than 10 million members at year's end after just over 18 months and continues to grow. As we've said before, our club members shop with us more frequently and spend more per transaction than non-members. Our loyalty program is proving to be a powerful platform for testing and learning and for engaging with some of our most valuable customers. We are able to focus special attention on them through early looks at collections or special offers, members-only items, and access to unique members-only experiences. We've talked previously about our innovative approach to engaging with customers. Hollister is emerging as an industry leader in this space.
Our marketing activities across music, video, gaming, and influencer programs ensure we are embedded in our customers' daily lives in an authentic way, and we are there during the discovery process. A few examples. Our holiday mobile gaming ad had four and a half million plays with average play time of 65 seconds, well ahead of normal single-digit engagement time for mobile ads. Our Black Friday Snapchat filter was recognized by Snapchat as one of the best filters of 2017. Our Spotify mobile headliner generated over one million views on the Wednesday before Thanksgiving. Last month, we launched our second YouTube series with AwesomenessTV, "The Carpe Life." This builds on the success of and incorporates learning from our first series, "This is Summer," as well as successful aspects of other digital programs we have run.
This is Summer" generated double-digit lift across all key brand metrics, including affinity, purchase, and recommendation intent, all well above branded content performance averages, according to a survey by Nielsen. "The Carpe Life," which launched on February 14th on YouTube and is hosted by a leading Gen Z influencer, racked up close to one million views in its first three weeks. Turning to Abercrombie. I am pleased with the performance for the quarter as we continue to develop a base within our target demographics, both of newcomers to the brand and customers rediscovering the brand. Overall, A&F made progress, and we grew our business year-over-year. We drove sequential improvements throughout the year, resulting in a 5% comp in the fourth quarter, our first positive comp in five years. We saw improvement from last quarter with positive comps across geographies, channels, and genders, driven by strength in core categories.
In men's, graphic tees, fleece, and outerwear were the standouts, and in women's, knits were strong. Our bottoms business also performed well across genders. Women was driven by strength in jeans, and men's pants. A category that we know is particularly important to building loyalty showed another quarter of good growth. Our assortment architecture changes have been a big driver to our performance. Our focus on SKU count, depth of inventory and top items, and inventory investments in top stores drove improved conversion and sales comps. Our A&F Club loyalty program had a strong inaugural year, ending the year with more than four million club members. We successfully harnessed this in the fourth quarter, generating interest and engagement, particularly around Black Friday and Cyber Monday. As we saw with Club Cali, our loyalty members at A&F also shop with us more often and spend more than non-members.
The club is providing us with valuable data and insights on our new customer base and helping us to stay close to them. Listening to our customer remains a critical step in driving improved performance at Abercrombie. From store design, such as our prototype, to investing in specific categories in depth to the creation of our Kids Everybody Collection, everything we do is grounded in listening to our customers' needs, then applying analytics to our data, formulating an approach based on what we learn, and then measuring how we are doing. We know brand revitalization takes time, and we are encouraged by what we're seeing from a wide variety of touch points. In stores, through our engagement in the A&F Club, and what we're seeing in online reviews, our voice of the customer and Net Promoter Score data, and media coverage of our collection.
Similar to our experience with Hollister, the brand has successfully leveraged influencers as an authentic way to connect with customers. "This Is The Time" reintroduced adventure as part of the brand's DNA, rooted in its heritage, and we used this to start an initial program of influencer-driven activities. In 2018, we'll be building on this, incorporating more local grassroots activities to drive engagement and authentic user-generated content across key social channels. Our business results for the year, driving sales growth and profitability, reflect our team's continued focus on the fundamentals, our strong financial discipline, and execution of our brand playbook along each of our strategic pillars, which you'll recall are to inspire our customers, to innovate relentlessly, and to develop leaders. In 2017, the focus of our inspire pillar was threefold. Firstly, an obsessive attention on product integrity, consistently delivering high quality, highly differentiated, brand right assortments.
Secondly, integrated marketing to reach and engage with our customers where they live and play, not just where we have traditionally operated. Third, building and harnessing the insights from our customer analytics infrastructure and expertise, including our growing loyalty program as a basis for anticipating and meeting our customers' needs as they evolve. Turning to our innovation pillar. We focus on further improving our digital engagement experience, from marketing to shopping to checkout and fulfillment. With that said, the physical element and the interplay between physical and digital also remains an important piece of our brand engagement mix, and innovations in our use of space are a core element. We also continue to explore how best to reach our customers in different markets. It may be through expert local partners or through platforms such as Alibaba's Tmall, which has given us further reach into the important China market.
These different types of partnerships allow us to learn and refine our long-term growth strategies within each market. Finally, our develop leaders pillar. The success of any brand is built on its engagement with people. A key element to our success this past year has been getting the right people in the right roles, both from internal moves and attracting new talent. Throughout the course of 2017, we've made great progress. We've hired top talent and tightened and clarified key roles and responsibilities and organizational structures, and we've implemented new processes to ensure our team is equipped and empowered for the swift, informed decision-making required of today's fast-moving and highly competitive retail environment. The past few years, and 2017 in particular, we've been focused on building a solid base for future growth.
In 2018, that focus shifts to building on that base and making investments in the areas we believe to be the critical drivers for our future growth. With that, I'll hand it over to Joanne, who'll speak more on the details of the why and where we will be investing to support our long-term growth.
Thanks, Fran. Good morning, everyone. As Fran said at the outset, we continue to put the customer at the center of all we do. Over the past few years, we have focused on building and enhancing our capabilities that allow us to do that and keep us at the forefront of this rapidly evolving retail landscape. Overall, 2017 was an important year of hardening our foundations as the base for our future growth. Our investments and actions were focused on delivering that platform. We continued to invest in those things that get us closer to our customer and make the most difference to them. In 2017, that investment was weighted towards marketing, DTC, omnichannel, and loyalty, as well as the ongoing innovation and testing in the physical stores environment through remodels and new prototype stores.
2018 will be an equally important year in the company's ongoing transformation as we scale our investment to match the opportunity we see ahead of us and build on the foundations laid to date. In 2018, our investments will still be heavily weighted toward marketing, DTC, omnichannel, and loyalty, with a significant proportion going to enhancing the store environment and stores' productivity. I'll be covering the key areas of investment focus in 2018 with a few highlights from the progress made in 2017. Looking at marketing first. 2017 saw important gains in brand sentiment across brands, with marketing investments playing an integral role in that progress. The A&F launch of This Is The Time, our first fully integrated campaign and platform for the brand, helped reach our target demographic and started to reset and reshape expectations and perceptions of the brand.
At Hollister, we focused on driving engagement through immersive, innovative mobile content and leveraging influencer programs. This has driven strong engagement from our digitally native customer on platforms and media that are relevant to them. 2018 will see us continuing on this journey with Hollister looking to build its leadership position as an innovator and A&F continuing to build its base and starting to scale its influencer programs. Our digital engagement with our customers continues to be a core strength. The DTC investments we've made early and continue to build on are paying off, validated by our customers' high level of mobile engagement. This was reinforced by recognition for our overall mobile experience across brands in several leading industry analyst reports.
2018 will see us continuing to invest in our DTC capabilities and applying our rich customer insights and data analytics to drive innovation in this channel, including increased personalization, both in terms of product offers and experiences tailored just for them. Our loyalty programs are a growing and powerful means of customer engagement across our brands. They have grown in scale and strength in 2017, ending the year with more than 14 million members. Loyalty acts as a versatile platform to drive innovation and inspire customers, driving engagement in both digital and physical stores environments. The 2018 investments in loyalty will drive further membership growth as we continue the geographic rollout of our programs. Our investment will also be directed to further enhancing and applying our analytics capabilities to our program's rich data.
The wealth of insights from our customer interactions will deepen our understanding of their behavior and how best to engage and inspire them on a personal basis. Our focus on the customer drives our omnichannel approach, with a priority on delivering a great experience for our customers at every touchpoint. In 2017, we expanded our omnichannel capabilities in more markets and saw an increasing number of customers take advantage of this functionality through purchase online, pickup in store, order in store, and reserve in store. We're continuing to learn and improve the customer experience with these capabilities, both online and in our physical stores, allowing seamless migration between the two environments. Gen Y and Gen Z customers have an increasing expectation of being able to engage with a brand on any platform or medium they have at the moment, wherever they are in the world.
Our investments in omni-channel in 2018 will continue on this road, ensuring we are attuned to our customers' needs as their behavior and use of technology continues to evolve. Our goal is to become an industry leader in omni-channel experience. As is the case with omni-channel, the physical and digital experience is increasingly connected. Digital is often a starting point for product discovery and purchase journeys, but not always the endpoint. Our physical stores still serve an important role for the customer journey, from a brand experience, product trial, and familiarization, and fulfillment perspective. We continue to make progress driving productivity across our fleet and reached an important inflection point in 2017, with improved store productivity across both brands, both in the fourth quarter and for the year as a whole.
The investments I previously covered in marketing and the digital customer experience, as well as our investments in our physical stores, has helped drive improved traffic and productivity to our store fleet. During 2017, we completed 35 Hollister store interior remodels and seven new A&F prototype stores, which included 16 downsizes of existing stores across the brand. In 2017, we also closed 39 stores, fewer than the 60 we expected coming into the year. This reflects improving store trends and productivity and favorable lease renewal terms. Full details of our store openings and closings for the fourth quarter are included on pages 13 and 14 of the investor presentation. We have closed more than 400 stores since 2010.
With about 60% of our U.S. leases expiring over the next two years, we continue to have significant lease flexibility to strike the right channel balance and drive efficiency by remodeling or resizing our stores, renegotiating leases, or closing stores. Our experience has shown we can drive greater store productivity through an enhanced store experience on a smaller footprint. We continue to take a holistic approach to driving improved productivity. An investment in our associates, in inventory, and in omni-channel capabilities are all part of the mix. Longer term, it's worth remembering there's no real finish line here, as customer needs and individual market dynamics will continually evolve. The focus of the investments made to date in stores has been on improving the customer experience through integrating omni-channel capabilities and smart use of smaller footprints, which has resulted in improved productivity.
We continue to evolve the store's role for the future of retail. In 2018, we'll be accelerating our efforts in this area with further investments in omni, as I mentioned earlier, and rollout of new prototype stores. For 2018, we plan to open 21 full-price stores across geographies, including 13 Hollister, four A&F, and four kids stores. In addition, we plan to downsize seven A&F stores and three kids stores to the new prototype format and remodel approximately 40 Hollister stores, six of which will be downsizes. We also expect to close up to 60 stores in 2018, primarily in the U.S., pending lease negotiation and business outcomes. As mentioned earlier, 2018 is a particularly important year in the company's ongoing transformation as we look to invest in and build on the foundations laid to date.
Overall, we're pleased with our performance in 2017, having delivered on the goals we set for ourselves and positioned the business for continued progress through 2018. As ever, we tightly manage the business, directing our capital towards strategic priorities that underpin our long-term strategic growth plans. Now I'll turn the call over to Scott.
Thanks, Joanne, and good morning, everyone. As Fran mentioned earlier, we are pleased with our fourth quarter results with operating income more than doubling from last year. We continue to tightly manage the business, delivering strong expense leverage while still supporting initiatives that drove the top line. I'll cover our fourth quarter and full-year results, then provide our outlook for 2018. Starting with the fourth quarter, net sales were $1.2 billion, up 15% from last year, with the additional week in 2017 benefiting sales by approximately $41 million, or 4%, and foreign currency benefiting sales by approximately $27 million, or 3%. Comp sales were up 9%, with improvement from last quarter delivered across brands and geographies. We drove growth in overall traffic and conversion, with positive traffic trends improving from last quarter.
Pages eight and nine of the investor presentation illustrate the sequential progress made throughout the year, with positive comp sales across brands and geography in the fourth quarter. By geography, comp sales for the quarter were up 11% in the U.S. and up 5% in international markets. By brand, comp sales were up 11% for Hollister and up 5% for Abercrombie. Hollister's momentum continued with another quarter of strong performance. Abercrombie also showed further signs of improvement and stabilization with a return to positive comp sales for the quarter across geographies and channels. Our direct-to-consumer business continues to perform strongly with double-digit growth in both the U.S. and international markets, driven by our investments in mobile, omni-channel, and fulfillments. For the quarter, DTC grew to approximately 34% of total sales, compared to 31% of total sales last year.
Gross margin rate was 58.4%, 90 basis points lower than last year, in line with our expectations coming into the highly competitive and promotional fourth quarter. Average unit cost was also pressured during the quarter as we reacted to higher sales trends and leaned into our chase capabilities. I will now recap the rest of our results for the quarter compared to last year on an adjusted non-GAAP basis. Excluded from our adjusted fourth quarter results were legal charges of $4 million and store asset impairment charges of $4 million, which are detailed on page seven of the investor presentation. Also excluded from our adjusted fourth quarter results were discrete net tax charges of $20 million related to the Tax Cuts and Jobs Act of 2017, primarily associated with the one-time deemed repatriation tax on accumulated foreign earnings.
The estimated impacts related to the act for the fourth quarter and full year are provisional and subject to further analysis, interpretation, and clarification of the act, which could result in changes to these estimates during 2018. Beginning with expense, adjusted operating expense, including other operating income, was down slightly to last year on higher sales. During the quarter, we delivered meaningful expense reduction, allowing us to exceed our targeted full-year gross expense reductions of $100 million from last year, driven primarily by our continuous profit improvement projects in non-customer-facing areas. As a result of our efforts, we drove 740 basis points of expense leverage during the quarter while still supporting strategic investments in marketing, DTC, omni-channel, and loyalty.
Adjusted operating income was $148 million compared to $61 million last year and included the benefits from foreign currency of approximately $14 million and the additional week in 2017 of approximately $3 million. The adjusted effective tax rate for the quarter was 32%. Adjusted net income per diluted share was $1.38 compared to $0.75 last year and included benefits from foreign currency of approximately $0.14 and the additional week in 2017 of approximately $0.03. Recapping our full-year results, we were pleased with our overall performance and growth over last year. Net sales were $3.5 billion, up 5% from last year, with comp sales up 3% and the additional week in 2017 and foreign currency, each benefiting sales by approximately 1%. Gross margin rate was 59.7%, down 130 basis points from last year, driven primarily by lower average unit retail in an environment that remained highly promotional throughout the year.
Adjusted operating expense was down 2% from last year on higher sales, resulting in 410 basis points of expense leverage while still supporting investments in our strategic initiatives. On an adjusted basis, operating income was $101 million compared to $3 million last year, and net income per diluted share was $0.65 compared to a loss of $0.06 last year, with foreign currency benefiting operating income by approximately $10 million or $0.09 per diluted share. Our strong fourth quarter performance was a key driver of our full-year operating cash flow of approximately $290 million compared to $185 million last year, which funded our CapEx investments, the dividends, and debt reduction. Turning to the balance sheet, we ended the year with $676 million in cash compared to $547 million last year.
During the quarter, we repaid $15 million of term loan debts, bringing gross borrowings outstanding at the end of the year to $253 million compared to $268 million last year, and maintaining a leverage ratio of below one. Total inventory at the end of the quarter was up 6% compared to last year, in line with our expectations coming into the quarter. We were well-positioned at the start of the fourth quarter and continued to react to selling in quarter to position us for the first quarter. Looking forward, we expect to end the first quarter with inventory up low to mid-single digits. Turning to the outlook for 2018, we expect comp sales to be up low single digits. We also expect net sales to be up low single digits with benefits from foreign currency largely offset by the adverse impact from the loss of 2017's additional week.
We anticipate foreign currency to benefit sales by approximately $50 million and operating income by approximately $15 million net of hedging. We expect the gross margin rate for the year to be up slightly to the 2017 rate of 59.7%, with some continuing pressure in the first quarter. On a full-year basis, we expect flat average unit cost to be coupled with slightly higher average unit retail, including net benefits from foreign currency. In addition, we expect operating expense, excluding other operating income, to be up approximately 1% from 2017 adjusted operating expense of $2 billion while still driving further expense leverage. More than half of the year-over-year increase is expected to be driven by adverse impacts from foreign currency and increases in volume-related expenses from higher sales, partially offset by the benefit from the loss of 2017 additional week.
As we build on the foundations of our transformation, we plan to make significant incremental investments in 2018 with the majority funded through our ongoing expense reduction efforts. We do not anticipate other operating income to be significant, including as a result of gift card breakage now being recognized within net sales due to the adoption of the new revenue recognition accounting standards. Other operating income will still continue to include foreign currency transactional gains and losses. We estimate the core tax rate to be in the mid to upper twenties based on tax reform. However, for 2018, we expect to incur discrete non-cash income tax charges of approximately $10 million related to the write-off of certain deferred tax assets associated with share-based compensation. As a result, we expect the full-year effective tax rate to be in the mid to upper thirties.
These charges will primarily be recognized in the first quarter, which is expected to reduce our first quarter effective tax rate to the low double digits to low teens on an anticipated pre-tax loss. For the balance of the year, we expect the effective tax rate to be in the mid to upper twenties. Beyond 2018, we currently do not anticipate share-based compensation significantly impacting the effective tax rate. It is worth noting that while tax reform may provide additional flexibility, it does not fundamentally change our capital allocation philosophy. Our approach to capital allocation remains consistent. We will focus on investing in the key drivers of sustainable long-term growth. For 2018, we expect capital expenditures of approximately $130 million compared to $107 million in 2017, as we scale investments that are driving the business and are critical to our future growth.
We plan to increase investments in new store expansion and continue the rollout of new store prototypes and our ongoing programs of driving improved fleet productivity and customer engagement through the digital channel. These investments will include approximately $85 million for new store and store updates and approximately $45 million for the continued rollout of omni-channel and CRM capabilities, including our loyalty programs. After investing in our business, our remaining capital allocation priority is to return cash to shareholders through dividends and share repurchases. These priorities are evaluated with the board quarterly, considering both liquidity and valuation factors. Last month, we announced that our board of directors approved the $0.20 quarterly dividends. With that, I will turn the call back over to Fran.
Thank you, Scott. I am pleased with our fourth quarter results and the year as a whole. 2017 was another year of important progress, building a solid base for future growth. However, we know there is still much work ahead of us. I want to take a moment to thank our associates for their focus and commitment to our brand during one of the most challenging and fulfilling years I've experienced in my many years in retail. That's something worthy of a moment's celebration. As I've said before, there are no silver bullets. These results simply speak to continued progress from the rigorous, methodical execution of our strategic plan, a plan which we have been unwavering in our belief that represents the best route to delivering value for our stakeholders.
2018 will be a year of building and further investing to allow us to deliver the best omni-channel retail experience in the industry and set the foundation for sustainable long-term growth. The progress we have made and the talent and commitment of our team have me energized and excited about what we can accomplish in 2018. With that, I'll hand it back to Brian.
Thanks, Fran. That concludes our prepared comments. We will now be happy to take your questions. As a reminder, please limit yourself to one question so we can speak to as many of you as possible. Thank you.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please signal by pressing *1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, we do ask that you please limit yourself to one question. Again, press *1 to ask a question. Our first question comes from Paul Lejuez with Citi. Please go ahead.
Hey, thanks, guys. I'm just curious what you're seeing in terms of the similarities and the differences on the efforts to turn around the A&F brand versus Hollister. Then just a quick one, performance of the flagship stores. Curious if you saw a similar improvement in those stores versus the rest of the A&F brand. Thanks.
Good morning, Paul. It's Fran. We are very excited about the progress that we made actually in both brands this year. Hollister had a very strong year. A&F showed progress throughout the year, culminating in positive comps in the fourth quarter for the first time in several years. What we are seeing is the closer that we get to the customer the opportunity to have our product, our voice, and experience come together is working. As far as Abercrombie goes specifically, we saw lots of nice category opportunities. We saw growth across both genders, we saw broad-based improvement across channels as well. In the fourth quarter, we saw positive traffic and conversion growth. Those were all early indicators of what we saw at Hollister as that opportunity as that journey started to happen as well.
Truly, it's just a real focus on our playbook and a rigorous execution of that. Tremendous thanks to the team for the amount of time they're spending in the stores and spending time with our customer and really understanding what they're looking for.
Fran, was store traffic positive at A&F?
North America was, as I pick up the flagship comment, we did see improvement in trends in our international business, particularly our flagship stores in the A&F brand. The traffic trends improved but remain negative. We continue to see positive conversion in those locations. We've embarked on a number of efforts to improve the performance of those stores, including making more with the traffic that we do have. We've tailored the assortments better in those locations. We've invested in the experience to allow us to drive conversion, and our focus is to integrate the digital and physical business in those markets. We rolled out omni-channel to our international markets in 2017 and also have rolled out our loyalty programs with a focus on driving a more local, loyal customer in those stores.
Great. Thank you. Good luck.
Thank you.
Thanks.
Thank you. Our next question comes from Tiffany Kanaga with Deutsche Bank.
Hi. Thanks for taking our questions. Would you please discuss the cadence of comp sales by month in the quarter, if you can, and whether you're seeing your good fourth quarter performance extend into the first quarter at the same pace? Can we expect positive comps throughout the year as you're currently planning it? Thank you.
Thanks, Tiffany. Yeah, we were very excited to show the progress in the fourth quarter with positive comps in both brands. We don't typically comment on the cadence of comps. Overall, across both brands, we saw very consistent positive performance. As we look to Q1, again, we don't comment on current quarter business other than to say that anything that's going on in the current performance is reflected in our outlook. We are, again, very excited to be able to expect growth on top of growth. We had a great year in 2017. We implemented a lot of changes and a lot of process changes, really through the rigorous execution of our playbook, and we're seeing traction with our customers, and we expect that to continue in 2018.
If I could just ask one more, I'd like to dig into what are the drivers behind your expectation for gross margin expansion, especially in the back part of the year, and especially as you're seeing the evaporation of AUC benefits, and one could argue that it remains a highly competitive environment in the mall.
Tiffany, that's true. We did meet our expectations for gross margin performance in the fourth quarter, it's probably worth a couple of data points there. We got there a little bit differently than we expected coming into the quarter. We were able to step away from a few promotions during the fourth quarter, and we saw the AUR declines moderating somewhat as we moved through the quarter. We did see a little bit of pressure in AUC, as we commented on, as we chased into more products to support that top-line growth. Top line definitely outperformed our expectations, and we were able to feed that growth with our chase capabilities, but that did pressure AUC. As we move into 2018, we do expect the AUR declines to continue to moderate as we move through the year.
As we get the product voice and experience aligned and we see traction, we expect to step away from some promotional activity. We're also expecting a more favorable FX environment in 2018, and that's reflected in our outlook and our AUR expectations as well.
Thank you so much.
You're welcome.
We'll next hear from Brian Tunick with RBC.
Great. Thanks. I'll add my congrats on the strong end of the year. Curious, Fran, I guess there's been a lot of talk about the enthusiasm for the category that we haven't seen in several years. Just curious from where you sit, do you think that there is a great bottoms trend out there? Do you think some of your competitors have closed stores, you've picked up market share? Just curious on what you think is happening out there, certainly coming out of the fourth quarter enthusiasm. Then maybe a question on the expense side. Are there any other buckets as you make these investments in 2018 and beyond, but are there any other buckets that you're looking to downsize beyond the $100 million expense initiatives? Thank you very much.
Hey, Brian. Yes, we were very excited about the progress that we made in both brands actually for 2017. We did see a significant trend in our bottoms business. As I mentioned, we had a record year in denim and Hollister, actually in both genders, which was very exciting. We also did see nice denim business for the women's business for Abercrombie adult. There is a trend happening out there. In our men's Abercrombie business, we also had a very strong pants business. That's a trend that we've been seeing for a while. It's actually a category which really does build loyalty, and we're very excited to see that business continue to grow. Other than that, we saw lots of other things happening in our business. Our graphics business was also very strong across both T-shirts and fleece. That was driven in both brands, both genders.
We're excited about seeing our customer respond to the fashion items that we are putting out there for them. Again, as I've said, the team is spending a lot of time getting very close to the customer and executing our playbook, and it's working in both brands.
Yeah, I'll pick up the expense side. We were pleased in 2017 to exceed our reduction target, our gross reduction target of $100 million. As we come into 2018, we are looking at this as an investment year, and we're excited to invest this year. Our OpEx, as we mentioned in the outlook, is up around 1%. Included in that is significant investment back in the business in those parts of our playbook that are really working: marketing, DTC, omni-channel, loyalty, analytics.
We will be funding a significant portion of those investments with other cost reductions that we found across the model. We'll continue to drive store occupancy expense out of the business, but it's not just that, it's really across the entire model.
Super. Thanks, and good luck.
Thank you.
Thanks.
Our next question comes from Janet Kloppenburg with JJK Research.
Good morning, everyone, and congratulations on the progress.
Thank you.
Joanne, I was curious on your answer to the comp question, current trend. I know you're not going to give it, but just reflecting on the easier comparisons in the first half versus the second half, I was curious why you may not see some variation in the comp trend as we move throughout the year. Secondly, I was just wondering about the gross margin opportunity as well. Do you think that your full price selling trends can improve this year, or do you think you'll have to continue to use promotion to drive traffic back to the brands? Scott, if you could just comment on wage pressure. Thank you.
Thanks, Janet. I'll take the first two parts of that question because they are related. They are definitely related. We are expecting growth on top of growth. We did deliver a three comp this year, and we're pleased with the progress that we've made. We delivered nice improvement in operating income. As we move into 2018, we continue to expect our brands to deliver growth on the top line, but also growth on the bottom line, and we're very focused on making sure that we deliver a balanced result, including starting to see improvement in the gross margin line. We have proven to be able to step away from promotional activities as we see the customer responding to our assortments. It's really the combination of getting the voice, the marketing, the product, and the experience all aligned.
As those things fall into place, we have been able to in the past, and we expect to continue to be able to step away from promotional activity and drive that regular price business back into the business in 2018. In terms of driving traffic, there are a number of levers that we're using to drive traffic, and we're moving away from having promotions be the only lever. A key to that change has been the rollout of our loyalty programs. We've seen terrific engagement across both brands on our loyalty programs globally. Now we have that platform globally, and we'll continue to leverage that. We see nice response from our customers, both online and in stores, to our loyalty programs.
Yeah. On the expense side, for wage pressure, we have seen pressure in wages across our fleet and in our distribution centers. We have these wage pressures baked into our 2018 outlook. This is kind of a multi-year trend, so we will continue to offset this pressure with efficiencies in the model and productivity improvements throughout.
Thanks so much.
Our next question comes from Mark Altschwager with Baird.
Great. Good morning. Let me offer my congratulations as well. Apologize if I missed this, but what are you planning in terms of the A&F prototype rollout in fiscal 2018, and what's the sales lift you're seeing in these stores? Just tweaks you're making to the concept as you move forward, especially as it relates to the omni-channel capabilities.
Yeah. On the prototype rollout, we'll have about eight new formats rolled out from a remodel perspective and four new stores under the new prototype during the year.
What we've learned, though, Mark Altschwager, is very, very exciting. We've had an opportunity to really focus on the voice of customer and what the customer experience is within our stores, and we're hearing very, very positive things about that. We are really focused on increasing our productivity in these stores. A super exciting example, we talked last year about closing our Hong Kong store on Pedder Street and opening up a new prototype in Harbour City. We've seen in about a third of the space doing almost the same amount of business. We continue to look at these opportunities as we move into 2018.
I'll just add one more piece. Related to our omni-channel capabilities, those omni-channel capabilities are embedded in our prototype stores. We continue to improve on our execution and melding that digital and physical experience. In 2018, we'll also be investing in more technology to put in the hands of our associates to allow them to more effectively interface with our customers in the stores.
Thanks. Just a quick follow-up. Any update on the trends you're seeing in the digital business in markets where you're closing stores? Are you able to recapture much of that demand or any marketing strategies you have to do so? Thanks.
Thank you. We have some transfer when we close stores, but it's very low to the digital business. We see the opposite actually happen. We see much more transfer or much more digital growth when we open stores in market or when we close stores where there's a physical store nearby is where we see more of the transfer. Certainly, one of the opportunities we have now that we have more data on our customers, part of the loyalty program rollout has been the ability to engage our customers and have more data at our disposal to reach out to our customers and continuing to leverage that data, particularly in markets where we close stores, will be a focus as we move forward.
Great. Thank you.
Our next question comes from Stephen Albert with Bank of America.
Good morning. I was wondering if you could give some more color on the foreign currency impact, both on gross margins in fourth quarter. What is contemplated as an FX tailwind to gross margins in your outlook for 2018? What gives you confidence in the gross margin inflection from continued pressure in Q1 to a benefit in Q2 through Q4?
Yeah, I'll start with the FX. FX impacted sales in Q4 by about $41 million and maybe about $18 million in margin. As we look forward to 2018, we'll continue to see that tailwind. As we sit here today with consensus rates, it's about $50 million on the top line and dropping about $15 million down to the Op Income line.
Yeah. As it relates to the inflection in Q1, we expect to continue to see moderating AUR declines as we move through the year. As I mentioned, we did see that occur in the fourth quarter as we were able to move away from some promotional activity. We are also expecting, as we mentioned, the FX environment to benefit AUR as we move through the year. We are up against steeper hedging headwinds in the first half of the year than the back half of the year. That plays a factor into the cadence of our AUR expectations.
As a quick follow-up, maybe if you could parse out how much incremental savings you found this year, then of that, how much you are going to reinvest or how much you are going to invest into some of your strategic initiatives, and whether you view the investment cycle in front of you as kind of a multi-year cycle, given how much cost you have stripped out of the business over the past five years.
Yeah. As we think about the outlook for 2018, the total OpEx is up around 1%, with half of that coming from foreign exchange being offset by the loss of the extra week in 2017. The other half of that will be the net incremental investments that we're making outside of the savings. We're not going to give a number around a savings target at this point, but I will say that we're making significant investments this year, and a large majority of that will be funded by our ongoing cost reduction initiatives.
Our focus, Steven, is to continue to drive leverage, operating expense leverage in our model. We'll continue to identify savings. We have a very rigorous, and as we mentioned, well-embedded profit improvement process. We continue to review all of our processes, particularly as they evolve with omni-channel dynamics. We're looking at those processes for more efficiencies, and we expect to find more efficiencies in the model moving forward.
Our next question comes from Simeon Siegel with Nomura Instinet. Please go ahead.
Hey, this is Dan Stroller on for Simeon. Thanks for taking our question. We were wondering if you could talk a bit about inventory. Could you parse out composition by brand and any expectation going forward? Quickly on marketing, how are you planning $ and impressions this year? Thanks.
Hi, Dan. It's Fran. I'll start with that question. We talked about the fourth quarter, that we were using inventory as an asset, and it was quite a strategic plan to come into the quarter invested in our key items. The goal was to not disappoint our customer. In fact, we accomplished that goal, obviously, by the results that you saw today. Our inventories as we head into the spring are clean, and they're very current. We don't normally parse out by brand, but we are confident with where our inventories are, and they are very current.
As it relates to the marketing investments, we do expect to increase our marketing investments this year. We don't parse out the number of impressions, but we have had and seen really terrific engagement with our customer and traction as we've been innovators in our marketing efforts. We plan to continue in that space, both engaging our customers in the digital experiences in an authentic way and building off the foundations that we've laid over the last year to two years in marketing.
Awesome. Thanks, guys.
Mm-hmm. We'll next move to Marni Shapiro with The Retail Tracker.
Hey, everybody. Congrats. Great quarter. I love your social media.
Thank you.
Thank you.
As you guys continue to grow your DTC business, which has a nice penetration at this level, can you talk a little bit about what % of that is getting returned, of those returns are coming to the store? Have you been successful in converting those returns to purchases? It sounds like your conversions are up at the store level. Then just one quick on Tmall. I know it's very early, but are you feeling good about it, and would you consider a similar venue in the U.S.?
Hey, Marni, it's Joanne. As it relates to DTC returns, it's a great question. We do see a large proportion of our DTC returns going back to stores. We look at that as an opportunity to engage our customers, and it's a very important aspect of the way we engage customers. We see them respond between both the digital environment and the physical environment. Having the capability to return to a store is very important to our customers. It also allows us a chance to engage our customers and get more into their basket, introduce new aspects of our brand, particularly as we go through the brand turnaround. As you pointed out, our conversion comps have been positive and continue to grow. We're encouraged by what we're seeing.
We're encouraged by the engagement that our associates are having with our customers when they go into the store. That is a focus of ours, and we'll continue to build on that as we move forward.
As far as Tmall goes, to your point, Marni, we've had, I would say, nice success on Tmall for both of our brands. It was very exciting to launch Abercrombie on Tmall this year to great success. That relationship will continue, and we expect that to grow as we head into 2018. We're always looking at opportunities for us in any of our channels, so we certainly would look and consider U.S. opportunities, but nothing at this time.
I would say, just to add onto that the opportunity in Tmall is to expand our brand reach in a market where we have very low penetration, and we have an opportunity to build awareness. Tmall hits on all of those aspects. We've been, as Fran mentioned, really excited to grow the business on Tmall and grow the awareness of our brands in China specifically. The U.S., in terms of market penetration, doesn't represent the same opportunity. As Fran mentioned, we're always open to new ideas.
All right. Did you participate in Singles' Day? Could you remind me?
Yes, we did. We had a very strong Singles' Day for both brands.
Fantastic. Best of luck for spring, guys.
Thank you.
Our next question comes from Omar Saad with Evercore ISI.
Hey, thanks for taking my question.
Thank you
over the last few years, and seeing it pay off, I'm sure, is extremely rewarding. I wanted to ask Fran, you've been there more than a few years now. Maybe you could help us put some perspective around how the consumer perception of the brands has evolved from when you first arrived to where it is today. From the perspective of the company, how the consumers perceive the brand and how that's changed over time, I think would be interesting to hear. Thank you.
Sure. Hi, Omar. Thank you for that. Yes, very exciting to see the progress that we're making here and really a great year. It has been exciting to see how the customer's perception has evolved over time. Hollister has really gained market share. Their understanding of the customer, being where the customer is, has been really quite exciting, some of the really new opportunities that we have engaged in with that brand. Clearly a leader in innovative marketing. Our customer in Hollister loves music, video, gaming. Being in that place with them has really shown that they're willing to actually engage with the brand, not only for transaction, but for what we call the journey and the discovery process. They're spending time with us not only just to transact, but to learn about the brand and to be part of the brand.
Our game, for example, during the fourth quarter, our Hollister llama game, had 4.5 million views, and the customer stayed with us for 65 seconds. That's considerably longer than the industry average. It's showing that the customer is very excited to engage with us. We're also starting to see, in Abercrombie, really resetting the perceptions and the expectations. We had talked in the fourth quarter about the YouGov study and how Abercrombie's customer sentiment had gone from negative to positive for the first time in several years. We're seeing progress in both brands. We're really, really encouraged with what we're seeing.
Thanks. Appreciate it. Good luck.
Thank you.
Next, we'll move to Susan Anderson with B. Riley FBR.
Hi. Good morning. Congrats on a nice quarter. I guess I wanted to follow up on the new Abercrombie format. I think that you had said maybe you rolled out four last year and another four this year for a total of eight. Then also, I was wondering if you had any metrics yet in terms of their performance versus the old formats.
Yes, actually, Susan Anderson, we rolled out seven Abercrombie prototypes this past year in 2017, six domestically and one internationally. What we're seeing is that our productivity in these stores is higher than our average productivity for our A&F mall-based stores. One exciting example I had mentioned earlier, our Hong Kong store, for example, we closed our Pedder location at the beginning of 2017 and opened up in Harbour City where it is one of the largest malls in the world, actually, with over 80 million people visiting that mall a year. We're doing almost the same amount of business in about a third of the space. Productivity as well as customer sentiment and customer improved experience are the two things that are really working for our prototypes.
Great. Did you guys say how many you were going to roll out this year then?
I think we have new stores plus remodels, I think gets us to about a total of 11 new experiences in 2018 on the plan.
Great. Thanks. We have one actually in our mall, and it looks really great. Just one follow-up on the A&F customer, too. In terms of the customer demographics, I know you were trying to take it a little bit up the age spectrum. Have you seen that demographic change at all?
Well, actually, our customer historically has really started to shop with us at the age of 18. That is true today. About 60% of our customers start to shop with us at the age of 18. Our target, as we've mentioned before, our bullseye is our customer who's 21 to 24. As far as demographic goes, we're just really focused on who our customer is and relating to them in the space that they visit us and providing the product that they're interested in. The demographic has really remained where it is.
Great. Thanks so much. Good luck next quarter.
Thank you.
Thank you.
That concludes our time for questions for the call today. I'd like to turn the conference back over to Fran Horowitz for any additional or closing remarks.
Thank you. We are pleased with our progress this past year. We have a talented team, a playbook that's working, and an important year ahead of us. Building on the foundations we have laid over the past few years, I am confident the team is prepared and well-equipped to compete and to deliver the best omnichannel retail experience in the industry. We all look forward to speaking with you at our Investor Day at the end of April.